India FY16 Budget: A Déjà Vu for its incremental reform focus but progressively more impactful

Summary

Damping high expectations of big bang reforms from India’s FY16 (Year ending March 2016) Union Budget on February 28th, the Modi Government maintained its focus on incremental reforms to strengthen India's macro fundamentals. The 'several small steps' approach is a Déjà Vu by Mr. Modi, akin to his interim budget presented after taking office last May. Encouragingly however, the steps announced in the new Budget are progressively much more wide ranging, pertinent and impactful in correcting the structural deficiencies that are plaguing India’s economy, particularly on the supply side. Chief amongst these are 1) raising the ante on public investments in infrastructure, 2) greater devolution to states, 3) simplification of direct tax structure and a 5 percentage point cut in corporate tax rate, 4) enhanced investment options, deferment of retrospective tax law and rationalizing legislative norms for foreign investors, 5) regulatory reforms to deepen capital markets, 6) stringent penalties and compliance policy to discourage tax evasion to help boost India’s low tax-to-GDP ratio, 7) enhance scope for direct benefit transfer scheme to better target subsidies and 8) thrust on education, skill development and financial inclusion. In contrast to our expectations, the budget relaxed India’s fiscal deficit target to -3.9% of GDP for FY16 (earlier target of -3.6%), from -4.1% in FY15. However, we believe that the let-down from a modest fiscal lift-off is largely offset by India's current imperatives of enhancing productive investments and reigniting the capex cycle. Still, India can’t afford to lower its guard against policy implementation risks if it has to achieve its medium term fiscal consolidation targets. A close tab on revenue expenditure, effective implementation of tax reforms and divestment plans is critical to achieve the medium term fiscal deficit targets of -3.5% of GDP by FY17 and -3.0% by FY18.

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