Populism, Political Headwinds Impact India’s Budget

Indian Finance Minister Arun Jaitley has released India’s 2018 budget and as expected, the minister took on healthcare and infrastructure, which are both in need of more investment, as well as the country’s agricultural economy. A number of economists and market analysts will agree on one thing–India’s 2018 budget has the polls in mind. It signals policy tilt towards populism amid political headwinds.

Jaitley’s budget focused on ensuring benefits to the poor while taxing the rich to raise funds for development spending in what was clearly a policy document intended to help increase the government’s popularity among the large rural voter base and low-income groups in a politically crucial year.

Jaitley pressed the brakes on fiscal consolidation as the government will play safe on reforms while trying to find short-term fixes to growth through consumption and government spending – even at the risk of deterioration in macroeconomic parameters such as inflation and the twin deficits. Jaitley overshot his fiscal deficit target for FY18 and set an easier goal for the next financial year in an effort to boost growth in an economy still recovering from the double-blow of demonetization and the rocky adjustment to the new Goods and Services Tax.

“The 30 basis point breach in the fiscal year target to 3.5% of GDP and a similar slippage in fiscal year 2019 to 3.3% of GDP was in line with our forecast that the government will go slow on its earlier proposed fiscal consolidation plan as it prepares for several key state polls in 2018 and the national elections in early 2019,” Jon Harrison, economist and managing director of emerging market strategy with London-based TS Lombard wrote in a note to clients on Feb. 7. “Together with the state deficits that are also expected to deteriorate owing to the populist farm loan waivers that some local governments announced, the combined deficit will rise this year to nearly 7% of GDP and remain at around those levels in 2019.”

Bond yields shot up in the aftermath of the budget announcement, mainly due to rising concerns over the fiscal deficit while equity markets fell as investors worried about the impact of the long-term capital gains tax that Jaitley announced in his budget. Gains on stocks held for a year had been exempt from any tax but now investors will have to pay a 10% tax on price gains of more than 100,000 rupees (US$1,468). The government will still allow shares bought before January 31 2018 and sold up to July 31st 2018 to be tax-free if they have been held for a year.

Higher compliance costs could deter foreign investors who have been pouring money into Indian equities on hopes of a growth revival.