Editor's note: A previous version of this article referred to "30% to 40% unsustainable budget deficits" in European markets. The correct figures are "13% to 14%." The Fool regrets the error.
It was three cheers for India's stock market, the Sensex, after the Indian government released its long-awaited budget last week. Stocks like Dr. Reddy's Laboratories
A road map for success
More so than in any other country, the budget in India is the road map for the Indian economy. It is a fundamental statement of what the current year and the next five years are going to be, according to Ravilochan Pola, director and CEO of Kotak Mahindra. Pola oversees the U.S., Canadian, and South American businesses for the Indian bank, which had $11.2 billion under management as of last September.
All eyes were on whether the Indian government would take steps to bring down the country's fiscal deficit. And the budget laid out the steps for doing just that. The government is aiming to bring down the fiscal deficit to 5.5% of GDP for fiscal year 2011 and 4.8% the following year -- down from more than 6.5%.
Pola says India's commitment to fiscal deficit containment as laid out by the budget will help push economic growth forward. "I think it's a fairly positive budget on various fronts," he said in an interview. "It was better than expected on various parts of the budget: the fiscal deficit issue, the market borrowing of the government, the benefit for the consumption and growth story, and the push that the budget gave for that part of the growth."
Aside from plans for deficit containment, Pola says the budget provides funding for key programs that will fuel economic growth for India and help pave a path forward. "It's a fairly growth-oriented budget and focused on some of the key sectors in the economy, which seriously need a push," he said. "[That] will add to the growth of the economy to touch 9% for next year, and probably double digits the following year and onward."
The budget offers continued financing incentives for real estate, infrastructure and agriculture, three of the fastest-growing sectors in India. It also offers a reduction in the General Sales Tax from 2011 onward. "All are a policy push for the next four or five years," Pola says.
Benign for business
One of the biggest pluses for the budget is that it's favorable on many fronts for business. "It's a clearer vote for the private sector and the individual consumption situation there," Pola says.
According to Pola, the sectors that will benefit the most from the budget, thanks to greater funding allocations or financial incentives, include the agriculture and rural sectors, the infrastructure sector (especially in energy), and the financial sector. "I think there's been a clear, significantly higher focus on the financial sector by coming out and saying they're going to give more licenses for banking [and] non-banking financial services companies in India and expand the scope of banking as an industry," he said. "[It] clearly shows that the government is very keen to focus on the private-sector banks for the growth in the economy."
As such, investors might want to focus on investing in Indian companies that operate within the above-mentioned sectors -- for example, financials like HDFC Bank
On the flip side, sectors that lose out from the budget include oil and gas. The government cut back on subsidies for the sector, and there's a general tax hike on the petroleum sector, which Pola says could fuel inflation by an extra percentage point. In addition, the lack of direction for pricing deregulation regarding petroleum products acts as a negative against the sector. "That's been a big letdown for the sector, which includes companies like Reliance Industries," Pola says.
Challenges ahead
Though there are many positives in India's budget, it isn't perfect, and challenges to implementation remain. Getting the budget to 5.5% of GDP means making sure financial plans pan out. The government will still have to borrow 4.57 trillion rupees ($99.5 billion) to finance the budget gap. That's up slightly from 4.51 trillion borrowed in the current fiscal year, which is now ending. "It's going to be a major challenge for the Reserve Bank of India to ensure price stability and manage the economic monetary policy program," Pola says. "It should happen in such a way that it will not crowd the private-sector borrowings, which will be critical for the growth of the economy."
The government is planning to finance India's deficit by holding 3G and WiMax auctions (in which can companies can bid to provide wireless service in India) and by divesting government-sector companies into the market. These two actions have been key focuses for bridging the deficit apart from the reduction in expenditures. But Pola cautions against trying to predict what is going to happen in the near or medium term at this point, thanks to the uncertainty of the global situation.
"Depending on market forces to provide resources for the government is one of the key issues which could be a critical thing for the government,” Pola says. "If they're able to manage these two challenges and raise the money required, that will help in bridging the gap of the fiscal deficit. Otherwise, government expenditures won’t be able to be sustained. And you can't really control your fiscal deficit side to be 5.5% of GDP without the source of mobilization that they plan to do."
A world apart
One silver lining in all this is a potential upgrade of India's bonds by ratings agencies. Moody's
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