Friday, July 11, 2014

Budget 2014 - Economy before Markets

Arun Jaitley presented his maiden budget on Thursday. The expectations from the budget were running high since the Modi govt got elected to power with clear majority. Narendra Modi's election campaign was rife with promises of reforms, employment and better days ahead. This budget, along with the railway budget presented on Tuesday were closely watched as they signaled the real intentions of new govt in power. It was not just investor's but the general public's way of finding out whether Modi govt can walk the talk.

Arun Jaitley, in a limited time and little maneuvering room available to him did a good job. He presented a budget which clearly indicated that India meant business. He, through his policy announcements tried to build a strong foundation for pro-growth path ahead. He did not fell in the trap of announcing reform measures to make stock market investors happy. Rather, he kept the focus on the audacious task of bringing economy house in order now, so that the benefits of growth can be reaped by all later.

But this budget was also not without few misses and disappointments. Many investors expected some announcement of doing away with controversial tax laws which FM has deliberately chose not to address. He explained his reasoning here in this interview. He also did not mention any policy to strengthen the recovery mechanism for banks.

Most investors were keen to find out how FM will create a balance between fiscal consolidation and kickstart the growth cycle. FM bravely accepted the challenge of capping the fiscal deficit target at ambitious 4.1% set by his predecessor. The fact that markets would not have blamed him or his govt on seeing a higher target number clearly sets out the intentions of the new govt. How much success will he meet only time will tell. For now, we can see and check the math behind the numbers and see for ourselves how much of these targets are achievable.

To meet the fiscal deficits target, FM seems to rely heavily on aggressive tax collections targets and divestment proceeds. The tax revenue is assumed to grow by 19.8% over actual FY14 figures with nominal GDP growth estimate of 13.4%. This tax revenue target is difficult to achieve, if not entirely impossible. The implicit assumption of tax elasticity of 1.5 in the tax revenue target is more reasonable during boom times, not when economy is trying to get out of pits.

Also, a third of tax revenues is corporate taxes which depend on their profitability, something which is beyond govt control. It will be unfortunate if govt resort to tax terrorism like its predecessor. In the event of not meeting their targets, they may have to hike their divestment targets.

Speaking of divestment targets, govt is hoping to net Rs. 63,425 crores in proceeds. Private companies have raised Rs. 12,000 crores via QIPs (which were heavily oversubscribed) in last few months. With India receiving $20bn annual FII inflows, the divestment target does not look unreasonable. Most analysts/economists expects govt to put its stake in Coal India and ONGC on block for retail investors soon. This will not only help achieve divestment targets, they will also help govt to adhere to SEBI prescribed promotor stake limit.

All in all, I think govt is on right track prioritizing fiscal consolidation over pro-growth measures. It would have been easy for govt to get carried away as country struggles with low growth rates, high inflation and threats of weak monsoons and drought situations. Instead, FM focused on getting the house in order, tightening the belts while trying not to hurt the wallet of general public and preparing the ground for better days ahead.

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