Investors in Indian shares are set to bide their time over the next two weeks, awaiting the annual budget that will determine the outlook for Asia’s third-largest economy, which is headed for its slowest pace of growth in a decade during the financial year ending in March.
Finance Minister P. Chidambaram has kicked off a series of market-friendly reforms since taking over the crucial cabinet portfolio last August, including wooing foreign investors in a whistle-stop tour through two continents. Investor confidence in his ability to change things around has triggered a sharp jump in foreign capital inflows over the past few months.
However, the charismatic finance minister faces formidable challenges to achieve his top priority of containing India’s fiscal and current account deficits, which have pushed the country to the brink of a ratings downgrade to junk status – a worrying prospect that could jeopardise an economic rebound in the new fiscal year.
Complicating the situation many states go to the polls in the coming months, and national elections are due by early next year. So Chidambaram will have to tread cautiously with his objective of tightening the government’s purse strings, especially of large cuts in subsidies on food and fuel that would push up costs and alienate the poor.
The budget session of parliament begins on Thursday and is expected to be stormy, with the government on the back foot following reports of kickbacks related to the purchase of AgustaWestland helicopters. The corruption scandal is the latest in a series that have tarnished the image of New Delhi’s Congress party-led coalition government.
“The economic slowdown in India is lot grimmer than expected,” said a fund manager at one foreign institution who oversees Indian assets worth more than $700 million. “What is worrying is the fact that government agencies seem to be working at cross purposes, which could stall new investment in India.”
The official was referring to controversial demands and raids on foreign companies by the tax authorities, based on lopsided interpretation of rules that could be struck down by the courts. One such instance was the charge of avoiding capital gains tax by foreign recipients of new shares issued by a company.
“India is a difficult place to do business,” said the fund manager who did not want be named because of the sensitive issue. “Look at the irony: while the finance minister is hopping across world capitals to entice foreign investors, his tax department is busy scaring the wits out of responsible companies that have invested in this country.”
On Friday, the high court in Andhra Pradesh ruled that French drugmaker Sanofi was not liable to pay capital gains tax in India for its acquisition of Hyderabad-based vaccine maker Shantha Biotech in 2009.
Incidentally, one of the contributing factors for India’s sharp economic slowdown was last budget’s decision to amend tax rules retrospectively – mainly to override a Supreme Court decision favouring British mobile operator Vodafone in its case against the Indian tax authorities – and moves to impose tax on foreign portfolio inflows.
After Pranab Mukherjee, the architect of the retrograde tax proposals, moved out of the cabinet to become the president, Chidambaram had watered down the controversial plan and has been promising a clear and stable tax regime.
The main budget on February 28 is expected to spell out the change in stance and calm investors, encourage foreign direct and portfolio investment and curtail government spending to help rein in the fiscal deficit to 4.8 per cent of GDP from an expected 5.3 per cent in 2012-13.
Global ratings agencies are also awaiting the budget, wanting to see how the government proposes to bring the widening twin deficits – fiscal and current account – under control.
“Policies that trigger private investment and curb inflationary pressures in the near term are more likely to help narrow the account deficit, whereas deficit targets based on an assumption of accelerating growth rates are more likely to be missed,” Moody’s Investor Service said in a note
India’s current account deficit soared to a record 5.4 per cent of GDP in the September quarter, and the data for October-December that will be released in March should be further higher. The trade deficit in January was $20 billion, the second highest for any month, indicating more pressure on the current account deficit.
Moody’s said it would monitor whether the policy reforms already undertaken and new initiatives in the budget would help in foreign direct investment to fund a bigger share of funding the current account deficit.
“If funding for the current account deficit shifted away from external debt and towards foreign direct investment, the sovereign credit profile would benefit,” it said.
The top-30 Sensex has declined for three consecutive weeks and has lost 2.15 per cent this month. It slipped to 19,468.15 on Friday, its lowest close in 2013.
Shares in Jet Airways, which rose 3.7 per cent on Friday, will be on the radar next week on expectation that Etihad Airways would announce a deal to acquire a significant stake in the Indian carrier.
State-run refiners Indian Oil Corporation, Bharat Petroleum Corp and Hindustan Petroleum Corp and explorer Oil and Natural Gas Corp could rise next week after retail prices of petrol was raised by 2.7 per cent and diesel by 1 per cent on Saturday.
The writer is a journalist based in India