Whats Next, Mr. Finance Minister?

Every February, India’s federal government releases its annual budget to outline revenues and spending plans. In the years following India’s independence in 1947, when government-owned enterprises dominated the economy, the budget was of utmost importance to market watchers. With the country’s economic liberalization in the early 1990s, the significance of this annual budget process diminished somewhat. However it is still meaningful, and this year’s budget exceeded US$300 billion in expenditures.

The traditional wisdom regarding pre-election budgets such as this one (federal elections are slated for next year) is that they provide incumbent politicians the opportunity to curry votes with plans for populist expenditures. However, this year, the government was remarkably conservative in outlining such expenditures.

Rather than rolling out any new flagship social welfare programs, India’s annual budget attempted a pragmatic response. Why? Asia’s third-largest economy has a continuing current account deficit and, hence, depends on foreign investments. Credit rating agency Standard & Poor’s had placed India on a watchlist last year for a possible credit downgrade to junk bond status. A ratings downgrade months before elections could result in extensive U.S. dollar withdrawals, rupee deflation, increased commodity costs and runaway inflation—not an appealing scenario for those seeking reelection.

The government therefore had little choice but to address the concerns of foreign investors by keeping spending under control, and aiming to meet its fiscal deficit target of 5.2% for the year ending March 31, 2013, and 4.8% for the next fiscal year.

However, besides needing to curb spending, India needs to boost growth. The country recorded a low growth rate of 4.5% for the quarter ending December 2012, and it still has much work to do to get back on track to its target of 8% GDP growth. Government approvals, particularly for infrastructure and capital expenditure plans, are still troublingly slow. Lack of labor reforms have ensured that many manufacturing companies look overseas rather than leveraging labor within India. Nevertheless, India’s inherent strengths remain—including its large and young population and a rapidly growing middle class that is driving consumption and creating opportunities for domestic entrepreneurs. India has demonstrated its growth potential over the past two decades, and Indian Finance Minister P. Chidambaram has played a key role in many successful reforms behind this development. We will continue to monitor whether he can build on this reasonably pragmatic budget with much-needed reforms.

Sudarshan Murthy, CFA

Research Analyst

Matthews International Capital Management, LLC

The subject matter contained herein has been derived from several sources believed to be reliable and accurate at the time of compilation. Matthews does not accept any liability for losses either direct or consequential caused by the use of this information. Investing in small- and mid-size companies is more risky than investing in large companies as they may be more volatile and less liquid than large companies.

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