Indian shares joined China’s as the worst Asian performers on the MSCI index with a 15% loss through February, as foreign investor outflows continued in reaction to budget disappointment.
Finance Minister Arun Jaitley hailed its “transformative agenda” of heavy rural spending including $2.5 billion for irrigation projects, as he remains at odds with central bank head Raghuram Rajan, who has called for “deep surgery” on fiscal and banking reforms. The blueprint entails central government budget deficit reduction next year to 3.5% of GDP from the current 3.9%, but the figure including the states is over 7% as overall public debt-GDP approaches 70%, a sovereign rating danger zone. It outlined $30 billion for infrastructure and $3 billion for state bank recapitalization, and cut corporate income tax 1% to 29%.
However, the business and financial communities were upset not to see a pickup in public company asset sales now less than half the $10 billion annual target, and also will pay higher securities levies as retroactive tax demands on multinational firms stayed intact.
Government bond yields had already risen 25 basis points ahead of the announcement under pressure from civil servant wage increases, which could also aggravate 5% inflation. Food prices are due to jump after consecutive droughts, and possible increased imported energy costs may likewise erode the real income effects of reported 7.5% growth.
Prime Minister Narendra Modi’s pro-farmer tilt in the budget was a response to economic fragility also representing an electoral threat, with state contests in coming months looking unfavorable for the ruling BJP party. Almost two years into office he has increasingly diverted from the original structural reform agenda into efforts to solidify the political base, including a crackdown against student protestors for “treason” in New Delhi and a nod toward expanding the special preference caste system.
Private sector criticism has focused on the inability to follow through with ambitious industry liberalization and tax rationalization plans, and it now urges a cabinet reshuffle to recapture momentum. Finance Minister Jaitley previously lost credibility when he modified last year’s fiscal target, and has yet to win passage of an updated bankruptcy law as he tries to reassure investors over banking system health.
Shares of state lenders, which control 75% of assets, have been pummeled, and Bank of Baroda revealed the biggest loss in history in February. Their stressed loans were 15% of the total as of last September, and Fitch Ratings recommends an immediate injection of $15 billion for balance sheet cleanup, five times the amount the budget proposed. Rehabilitation is vital to investment and infrastructure recovery with the relatively small financial sector contributions of private competitors and capital markets, and independent experts believe liquidations and mergers are inevitable. The Modi administration will not relinquish majority ownership but has promoted governance changes with new executives and less interference from the capitol, as a tug of war rages with the central bank attempting tougher prudential standards.
Lowering the current account deficit, which placed India squarely on the “fragile five” emerging market list prior to Modi’s election, has been a signature achievement but both exports and imports continue to decline as the related manufacturing PMI index is flat around 50. To spur overseas sales, another “Make in India” conference was held in February and garnered $220 billion in pledges, around half the level of 2015’s gathering, although the conversion rate into actual investment has been less than 20%, according to outside research. Oracle committed to $400 million for a business incubator, but foreign sponsors were mostly absent as they continue to decry skills shortages and strict labor rules.
India’s strength has been in outsourcing and other services as opposed to manufacturing, and China’s export-led model there it seeks to duplicate is now under siege, according to regional commentators. Financial intermediation is one area that could be strengthened for cross-border franchises, but in the last quarter private equity startups dropped and Goldman Sachs exited mutual fund provision citing administrative and regulatory obstacles that require excision rather than mere scalpel touches.
Gary N. Kleiman is an emerging markets specialist who runs Kleiman International in Washington, D.C.