Expectations from finance minister Arun Jaitleys first Budget were high given it offered the Narendra Modi government the first comprehensive opportunity to back its reform rhetoric with action. Financial markets might have given the Budget an initial thumbs up, but the overwhelming impression is that an opportunity has been missed. Though Jaitley hit many of the right notes, this is not the game-changing Budget to propel the governments reform drive. Indeed, the optimism of the Budgets tax and spending assumptions are strongly redolent of the fiscal legerdemain of the UPA administration. So, while fiscal consolidation is likely to continue, it would remain low-quality, with cuts to capex budgets.
Importantly, there are clear positives in the Budget. The government has confirmed that fiscal discipline is central to its macroeconomic strategy. Despite the Centres deficit likely to overshoot the 4.1%-of-GDP target set for FY15 by the previous government, Jaitley bravely committed to stick to the target and keep the deficit on track to reach 3% of the GDP by FY17. The commitment to undertake any further retrospective tax amendments with extreme caution is welcome as it signals the intent to have a more predictable and stable tax regime than the last governments. Another key positive is the lifting of FDI caps to 49% for the insurance and defence manufacturing sectors. The finance minister also reiterated the governments commitment to ushering in the goods and services tax regime as soon as possible, although, given the need for a Constitutional amendment and ratification by half of the state Assemblies, this sorely needed reform could remain elusive.
Turning to the negatives, while the commitment to fiscal consolidation is cheer-worthy, the Budgets tax and spending assumptions remain questionable. Recent budgets have been characterised by implausibly optimistic assumptions over both subsidy control and revenue growth. When these have failed to materialise, planned capital spending has been slashed to compensate. Deficit reduction has continued but it has been of poor quality, with cuts to capex muscle rather than subsidy flab.
Jaitleys Budget assumptions unfortunately risk continuing with this tradition. Spending on subsidies is budgeted to fall by around 0.3% of the GDP, to a 7-year low of 2.0% of the GDP. However, the Budget has precious little on how this will be achieved, despite a substantial roll-over of spending from FY14. A new policy on urea is supposedly in the pipeline but no details were given. Assumptions on