THE BLOG
07/15/2014 02:47 pm ET Updated Sep 14, 2014

India's New Budget: 8 Reasons Americans Should Care

Last week, India's new finance minister revealed his government's $300-billion annual budget for the fiscal year that began on April 1, 2014. Arun Jaitley, who has charge of both finance and defense in Prime Minister Narendra Modi's government, projected that the budget deficit would remain at the same level, 4.1 percent, as planned by his predecessor, Harvard M.B.A. P. Chidambaram.

Jaitley's 36-page speech took over two hours to deliver to India's lower house of parliament and was sprinkled with over two dozen small programs worth about $16 million each, or about 0.005 percent of the annual expense plan. However, many Western media reports have focused on the content of these miniscule projects while underemphasizing, even ignoring, key developments that affect American, European and Japanese companies.

Let's look at changes that are meaningful to companies outside India, basically in the area of encouraging investments by overseas entities, removing bottlenecks and deploying capital into the markets.

Encouraging Foreign Investment

Jaitley promised to lift economic growth to about 8 percent within three years, a conservative target for a minister who promised bold new initiatives. But contained in his long speech are a number of free-enterprise, fair-trade initiatives that, if they capture the attention of local and global corporate executives, could start to unlock the innate productivity of Indian workers. Here are four examples:

  • Income arising for foreign-portfolio investors (FPIs) in India from the sale of securities will be treated more favorably as capital gains; earlier there was some ambiguity about this. Currently such FPIs have invested over $130 billion in India's stock market, and their actions have significant effects on share prices.
  • The new government kept its election promise to permit foreign companies to own up to 49 percent of an Indian defense manufacturing venture. The United States is now India's largest defense supplier, and India is the largest buyer of defense equipment in the world. At the old limit of 26 percent, there was almost zero American foreign direct investment in defense in India. At the same time Indian defense spending is being raised to $37 billion per year, $1 billion more than Chidambaram projected.
  • A number of American insurance companies, such as New York Life, did enter India at the 26-percent investment limit. Again the FDI limit in insurance was raised to 49 percent.
  • If you wanted to invest in urban housing in India as a foreign company, you needed to build out at least 500,000 square feet. Jaitley lowered this limit to 200,000 square feet of built-up area and halved the financial investment threshold to just $5 million. Flipping your investment is still discouraged, so you must hold it for at least three years.

Deploying Capital

For the first time India is going to introduce real-estate-investment trusts (REITs) and encourage overseas Indians to participate. Over the decades REITs have played an important role in securitizing the real-estate market in the U.S.A. and should enable many passive Indian investors to participate in the benefits of an urbanizing society. India's real-estate market is notoriously opaque, and professionalizing might also start to shine stronger light and reduce the role of undocumented or "black" money in this asset. Bollywood has certainly benefited from corporate funding in marginalizing organized crime's role in funding movies.

A new kind of investment trust for infrastructure (InvIT) is also being introduced. It is still unclear if corporate entities with no ties to India can participate in these REITs and InvITs.

A $1.6-billion seed fund is being created to provide equity and soft loans to startup companies. The idea is to encourage private capital to join in as a co-investor. There is currently no specific guidance on whether foreign capital will be welcomed in these startup initiatives. Since about 1998, venture capital and private equity in India have largely been sparked from incoming investment from the U.S., Singapore and Europe.

Removing Bottlenecks

When I was researching my book, Doing Business in 21st-Century India, a retired, highly regarded chief of staff to India's prime minister admitted to me privately that much of India's economic progress had taken place despite the government, not because of it. While this is common wisdom in corporate America, it used to be near-heresy in India, with its legacy of a Soviet-style "planned" economy. Here are four key elements from the new Indian budget that essentially show government getting out of the way of business:

  • In an effort to increase tax revenue, India has been aggressive in review of transfer prices between foreign entities and their Indian associates; Jaitley proposes to make the transfer pricing rules more transparent and less ambiguous.
  • Nine international airports will be equipped with electronic incoming traveler authorizations to grant visas on arrival for foreign tourists from several designated countries, including the United States. Business travelers might still need a visa.
  • Currently, tax regimes in India vary by state and cause tremendous inefficiencies in the flow of goods across state boundaries. Finance Minister Arun Jaitley assured the government's intent to "end the talking" on the proposed standardized GST (goods and services tax) and move to implementation.
  • The government did not change most direct and indirect rates in any way that would deter foreign investors. Customs duties were reduced on several ingredient items (such as glycerin to make soap, steel-grade limestone and crude naphthalene) in order to encourage local manufacturing. These reductions will benefit any company, domestic or foreign, that uses the ingredients to manufacture specified products in India.

The Final Take

When Jaitley promised to stay away from "mindless populism" in the budget, many analysts mistook it to mean a retreat from populism altogether. In a democracy with high illiteracy rates and extreme rural poverty, populism is unavoidable. Perhaps the dozens of small giveaway programs are the new government's expression of "mindful" populism: Spend a little bit of money on a lot of tiny projects in order to please voters while reserving the gunpowder for a few key initiatives.

Was this budget a "bold departure" from the past for India? Not really, but it is a welcome incremental change in the right direction. If the Modi government is able to follow through with concrete actions on initiatives such as the standardized GST, India's growth rate will rebound readily. Two or three years of the right incremental changes could amount to an economic revolution in today's India.