After months of speculation over how India will turn its economy around, the government finally unveiled its budget for the new fiscal year. While the $290 billion budget is business friendly, it doesn’t include major policy changes many had hoped for. This has disappointed analysts, as it comes at a time when the stakes are high: India is expected to surpass China as the world’s fastest growing major economy in 2015, with gross domestic product projected to grow between 8.1% and 8.5%.
Analysts are right to expect more economic reforms, but they have also failed to recognize the pragmatism of the budget and how it could actually help India realize its economic potential more effectively than radical change. Indian Finance Minister Arun Jaitley may have urged bolder moves, saying “we have to think in terms of a quantum leap,” but the budget signals that Prime Minister Narendra Modi’s administration prefers a more gradual and achievable approach.
Critics say the government isn’t doing enough to cut spending to meet its earlier target of 3.6% of GDP over the next 12 months. Officials have committed $11.3 billion for infrastructure, which includes spending on the construction and upgrade of roads and railways. Separately,officials have essentially left governments subsidies untouched; India will spendalmost $40 billion to subsidize oil, food, fertilizer, and other items this year.
While the infrastructure spend is large, it’s justified. India is notorious for its outdated and insufficient infrastructure, which can make commercial activities more expensive, unreliable, and ultimately unprofitable. Upgrading the country’s roads and railways is critical for promoting business activity and a pre-requisite for attracting foreign investment. It’s also important for meeting Modi’s goal of ramping up manufacturing, which he sees as a cornerstone for a strong economy and which depends heavily on the transport of raw materials to factories and goods to the market.
What’s more, infrastructure spending could boost economic growth, which could then reduce spending as a percentage of GDP in later years, especially as the need for further spending on infrastructure falls over time. The lack of that foundation, on the other hand, could slow India’s rapid economic growth and endanger its long-term progress.
As for the controversial subsidies, the government’s rationale is both similar and different.
Radical reform, such as eliminating subsidies en masse, would save the government money but could deliver a massive shock to average workers, many of whom rely on these subsidies for survival. In a nation where per capita income is 88,533 rupees (less than $1,500) and at least a fifth of all people live in poverty, subsidies are an essential part of life and can’t feasibly be eliminated until the economy is robust enough to provide citizens more jobs and higher wages. That, in turn, requires more economic activity and, not coincidentally, better infrastructure.
The point is that Modi rose on the promise of American-style capitalism but seems to be realizing that India’s path to prosperity might have to be different, and needs to take into account the welfare of its most valuable resource: human capital.
At the same time, subsidies next year are slated to fall to 14% of total spending versus 16% this year, according to Bloomberg, which is a sign that the government is just pacing itself and not abandoning plans to modernize the economy. Other initiatives in the budget, such as the reduction of the corporate tax rate from 30% to 25% over the next four years, and easing of restrictions on foreign investments, should further help to broaden the economy and help the government reduce spending to 3% of GDP by 2018.
Also, the Reserve Bank of India (RBI) has just adopted inflation targeting to decide monetary policy. A dangerous by-product of rapidly growing economies and deficit spending by governments is a rise in the prices of goods and services, which harms low wage earners and can force a tightening of interest rates, thereby choking the economy. By promising to watch this important metric and change interest rates accordingly, the government is signaling that it’s prepared to adjust its policies when needed. Whether this also translates into spending cuts and more reforms remains to be seen but there’s no overwhelming reason to believe that the Modi administration is not committed to fiscal discipline at a reasonable pace.
To conclude, India’s new budget may not be dramatic, but is based on a sober assessment of the reality of a vast and complex country. That is a good thing for investors, since a growth plan based on unrealistic expectations is bound to fail, whereas one that eschews fantasy in favor of slow, steady, progress can actually succeed.
Sanjay Sanghoee is a business commentator. He has worked at investment banks Lazard Freres, Dresdner Kleinwort Wasserstein, as well as at hedge fund Ramius Capital. He holds an MBA from Columbia Business School.
