Investors Seek Proof That Modinomics Is Real Thing


FEBRUARY 23, 2015

If Morgan Stanley is right, Prime Minister Narendra Modi’s first full-year budget on Saturday may be the most important since India opened its economy in 1991.

Expectations for Modi have been high since his party won India’s biggest mandate in 30 years last May. A disappointing interim budget in July, coupled with the failure to pass key legislation in parliament, have only raised the stakes.

“This government has been given the benefit of the doubt for a long time and investors have begun questioning whether anything has been happening on the ground,” said Rakesh Arora, head of research at Macquarie Capital Securities India. “The government will have to go the extra mile in the budget.”

Using a tradition passed down from the British, Finance Minister Arun Jaitley will stand this coming Saturday and read the budget for the fiscal year starting on April 1.

It’s only the second time in India’s history that it’s been unveiled on a Saturday, when local stock, bond and currency markets are normally shut. Stock markets will be open during the budget speech.

Besides investors, central bank Governor Raghuram Rajan will be paying close attention. He’s linked further reductions in India’s benchmark interest rate to “high-quality fiscal consolidation” in addition to softer inflation.

Last month’s unscheduled cut showed he’s not afraid to act before the next scheduled policy review on April 7.

Undoubtedly, India has a lot going for it at the moment.

The country’s stocks and currency are among the world’s best performers in the past year; its economy is poised to become the fastest growing among major emerging markets as China slows; and oil’s slide has improved its public finances.

Still, the investment community wants more. While praising Modi’s pro-business approach since the election, it’s looking for concrete details on his plans to boost local manufacturing, improve infrastructure and cut back on food and fuel subsidies.

“The budget now matters more than ever,” Citigroup’s Rohini Malkani wrote in a note on Sunday. “The market will look for something to excite, differentiate.”

Here are eight numbers that will indicate whether Modi impresses or disappoints:

Budget deficit projection India’s biggest money managers have said they’ll forgive Jaitley if he projects a wider shortfall than the 3.6 percent of gross domestic product targeted by the previous administration for the next fiscal year — as long as the cash is used to fund roads and power plants rather than food and fuel subsidies.

The government is aiming to hit a target of 4.1 percent of gross domestic product in the year through March, which would be the lowest in seven years.

More funds for roads, bridges, highways and ports are crucial to spur an economy where private investment as a share of GDP is at the lowest in at least a decade.

Economists including Andrew Tilton at Goldman Sachs Group and Samiran Chakraborty at Standard Chartered predict Modi will boost capital expenditure to at least 2 percent of GDP, up from about 1.8 percent in the previous budget.

That would signal a rise to 2.8 trillion rupees ($45 billion) from 2.3 trillion in the previous budget.

While this is lower than the 2.4 percent of GDP budgeted after the 2008 global meltdown, the government may also offer state-run companies incentives to encourage them to spend their cash hoards.

Jaitley might also increase import taxes on crude oil to pay for more infrastructure spending, Chakraborty wrote in a report last Friday.


Food, fuel and fertilizer subsidies have risen to about 15 percent of total spending from 10 percent a decade ago, as the government looks to support living standards in a nation where 59 percent of the population lives on less than $2 a day.

Spending on subsidies will drop to about 2.49 trillion rupees, or 1.7 percent of GDP, from 2.61 trillion, or 2 percent budgeted the previous year, UBS Group’s Ed Teather predicts.

This is largely due to the 45 percent drop in Brent crude prices over the past year and the expansion of Modi’s program to reduce waste in the sale of subsidized goods through direct cash transfers to beneficiaries.

Although fuel and fertilizer spending is falling, those gains could be offset by increased food subsidy spending that is mandatory under a 2013 food security law, Teather said.

Revenue projection

Economists questioned Jaitley’s revenue projections in the interim budget in July, saying they looked unrealistic.

And indeed, tax revenues grew just 7 percent by the end of December compared with the budgeted 20 percent increase, leaving the government 44 percent short of its full-year goal of 9.8 trillion rupees.

With the economy now recovering and lower oil prices allowing the government to raise taxes on fuel without stoking inflation, net collection from levies will increase in the coming fiscal year to 10.6 trillion rupees, Goldman Sachs predicts.

Another number being looked at is the revenue deficit, which is the difference between collections and expenditure minus any debt.

The shortfall is estimated at 3.78 trillion rupees for the year through March, with revenue expenditure at 1.57 trillion rupees.

Modi will probably cut this spending to 1.52 trillion rupees for the next 12 months, according to HSBC’s Pranjul Bhandari.

Together with lower subsidies, this would result in a smaller revenue deficit, giving the government room to borrow more for capital expenditure.

Market borrowing

Yes Bank’s Vivek Kumar sees net borrowing rising slightly to 4.7 trillion rupees from last year’s 4.6 trillion rupees, while Goldman Sachs and Morgan Stanley predict it will drop to 4.4 trillion rupees.

Gross borrowing will rise to 6.23 trillion rupees from 6 trillion rupees, according to Morgan Stanley.

It predicts the government will also look to buy back debt or swap bonds maturing in the coming months with longer term maturities to rein in interest costs that now make up 24 percent of total spending.

Modi needs to inject at least 200 billion rupees of capital into Indian banks to prevent their credit profiles from deteriorating, according to the local unit of Fitch Ratings.

That compares with the 112 billion rupees Modi budgeted for the current year to prop up a sector battling the highest levels of stressed assets since at least 2001.

“We expect the government to bring about several changes in the banking space, with focus on asset recovery, roadmap for capital raising, among others,” said Soumya Kanti Ghosh, chief economic adviser at State Bank of India, the nation’s largest lender.


Unrealistic revenue projections have prompted governments into last-minute stake sales to meet deficit targets.

Divestment forecasts for the next fiscal year vary from Morgan Stanley’s 375 billion rupees, Standard Chartered’s 430 billion rupees and Yes Bank’s 500 billion.

For the year through March 31, Jaitley had budgeted 584 billion, of which so far he’s raised about 243 billion.

Anything more than this in the next year’s budget will raise questions about whether the target is achievable.

“An overambitious disinvestment plan at a time when energy companies and banks, the government’s main source of potential sales proceeds, are undergoing financial difficulties would score poorly,” Deutsche Bank’s Taimur Baig and Kaushik Das wrote in a report on Monday.