India Budget Disappoints Investors

India's Finance Minister Mukherjee presents a budget that increases spending on the rural poor but leaves the future of reforms uncertain

By Mehul Srivastava

Trapped between a stuttering economy and a spiraling deficit, India's newly reelected government of Prime Minister Manmohan Singh decided on July 6 to toe a middle path, with Finance Minister Pranab Mukherjee presenting a budget that disappointed an over-eager stock market and provided little clarity on the future of reforms that have driven the country's economic growth in the past. Instead, the government decided to tinker with tax rates, pledge increased spending in infrastructure, and borrow heavily from domestic markets to spend in rural areas, which make up more than 60% of India's population and 46% of its gross domestic product.

Investors immediately showed their disappointment. The benchmark 30-stock Sensex index dropped 5.83% following the budget speech by Mukherjee, after having rallied nearly 55% this year, including a 17% one-day leap after Indian voters gave a Communist-free coalition government a resounding victory in June. "Those of the view that the budget would encompass all sorts of exciting structural economic reforms have just had their hopes firmly dashed," says Robert Prior-Wandesforde, Hong Kong-based economist for HSBC (HBC). In addition, "there is a good chance that the government will, as has often been the case in the past, undershoot its infrastructure spending commitments," he said.

Now, members of Singh's government are responding that the public's expectations were simply unrealistic—and officials are blaming the media. Ahead of Mukherjee's budget presentation, Indian newspapers and business channels ran inaccurate stories about what sops the budget might contain, one of his deputies, Finance Secretary Navin Chawla, said in a televised speech. "Now that the budget is a public document, the blame has to be apportioned" between the newspapers and television channels, said Chawla.

tax break extended for outsourcers

Mukherjee, 73, last held the finance portfolio in 1984, when the closed-off Indian economy resembled that of the Soviet Union more than the U.S., and he admitted the limitations of the much-awaited budget in his Parliament speech. "We cannot solve all our problems through one budget speech," he warned, before announcing that he had decided to delay major disinvestment from government-run companies and not to raise foreign ownership limits in sectors such as insurance.

Still, some industries did well. Outsourcing companies, which have been the largest employers in the corporate world during the current slowdown, found some reason to celebrate in a proposed one-year extension of a tax holiday on exports. That totals more than $50 billion for companies such as TCS, Infosys (INFY), Wipro (WIT), and IBM (IBM); other smaller tax changes might bring some relief to India's most visible global industry, which is struggling with the worst slowdown in its young history. These decisions "will help the industry mitigate the impact of the current economic environment and help India retain its competitiveness," Som Mittal, president of the IT industry's lobbying group Nasscom, said in a statement.

The budget, though, seems largely meant for one constituency: the rural poor who returned the Congress-led coalition to power. The government is extending a rural debt waiver plan, first announced in late 2007. Moreover, a rural employment guarantee program that provides 100 days of work for impoverished farmers received a budget increase of 144%.

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