One of the least enviable jobs in the world at the moment has to be that of Indian finance minister. Arun Jaitley will present his fourth annual budget to India’s Parliament on Wednesday amid terrible headwinds — mostly caused by his government’s bewildering and disruptive decision to invalidate 86 percent of India’s currency last November. If he’s to revive growth, the first thing he has to do is rethink his priorities.
The scale of the challenge should be clear. The government’s official estimate of 7.1 percent GDP growth this financial year (which began in April) is widely doubted and doesn’t take into account the chaos wrought by demonetization. The International Monetary Fund predicts growth will come in closer to 6.6 percent, or a full percentage point below earlier estimates. And these numbers conceal even more weaknesses. Most glaringly, Indian investment has shrunk for the last three quarters for which reliable data is available.
Under Prime Minister Narendra Modi, the government’s growth strategy has rested on two fundamental assumptions. First, there’s the unshakeable belief that India is so attractive a destination for capital, given the weakness in the rest of the world, all the government needs to do is tweak the investment climate and money will pour in.
Second is the idea that scaling up public spending, especially on infrastructure, will raise returns sufficiently to attract private investors — “crowding in,” as it’s known. The last three budgets — which, in India, are the year’s major statement of economic policy, not just simple accounting exercises — have operated on this principle.
Surely, however, Jaitley has noticed that this approach hasn’t worked. Even before the demand destruction caused by demonetization, India’s growth was hovering at or around the levels set in the last few years of the previous government’s tenure, when the investment crisis first hit. Clearly, companies aren’t “crowding in” as the government had hoped.
Meanwhile, Jaitley’s earlier budgets benefited hugely from low oil prices, which allowed the government to eliminate fuel subsidies while quietly raising taxes on gasoline to help pad its accounts and pay for a sharp increase in spending. Further declines in crude oil prices are hardly likely to come to the government’s rescue this year. At the same time, other calls on the purse have grown: Modi is likely to want a few giveaways in the budget to appease those hurt most badly by demonetization.
So, Jaitley may have to turn off the tap to the public infrastructure investment that’s been underpinning even the modest growth seen so far. He’s in a bind. He desperately needs to revive growth and investment. But he won’t have the money for his preferred strategy, which wasn’t working all that well anyway.
Unless the budget acknowledges this and sharply shifts focus, it’ll be a failure. India needs infrastructure and it needs investment, but only private capital can provide both. Jaitley’s priority thus has to be to create incentives for long-term capital to enter India.
How can he do that? Well, first he’ll have to recognize that, “bright spot in the world economy” or not, India is still seen as too much of a risk. This reputation is primarily related to policy and administration. Simply put, you’re still too likely to lose your money in India if some officer of the state decides you should.
Modi’s government has hardly altered this perception. Investors have noted that they might be told that they can’t take their money out once they put it in: The government acted to prevent the Japanese company NTT Docomo, for example, from getting the roughly $1 billion it was owed for exiting a contract with Tata Teleservices.
Nor do investors have much recourse in the face of arbitrary state action. The Indian court system is slow and overburdened. Companies have turned for relief to international arbitration. But Modi’s government has tried to close off even that avenue, declaring that 57 bilateral investment treaties that enshrine international arbitration would be renegotiated to ensure the primacy of Indian courts.
Jaitley’s budget will have to reverse this trend. He’ll have to announce wide-ranging reform of tax administration, as well as quicker and more transparent ways for investors to appeal judgments. He’ll have to show that the government now understands that money will only come into India if it’s allowed to leave and if investors believe disputes will be fairly settled. And he’ll have to show he’s serious about lowering the risks India poses as an investment destination, perhaps by announcing an infrastructure project pipeline that’s open for investment and in which the government will bear any risks arising from arbitrary state actions.
That’s Jaitley’s only chance to reverse the investment collapse that’s happened under his watch. A budget like the three previous ones simply won’t be good enough.
Mihir Sharma is a Bloomberg View columnist. He was a columnist for the Indian Express and the Business Standard, and he is the author of “Restart: The Last Chance for the Indian