On July 10th 2014 the highly anticipated Indian Union budget was presented to Parliament by the Finance Minister Arun Jaitley. The Modi government expects economic growth to bounce to 5.4%–5.9% in the current fiscal year and an annual growth rate of 7% to 8% for the next three years. Jaitley’s budget is designed to reduce government debt, bring inflation below 6%, provide for infrastructure investment and create more jobs.
The budget was highly anticipated because it is the first budget from the newly elected pro-market government of Narendra Modi; Modi was elected Prime Minister in a landslide in May of this year. It was also highly anticipated because foreign investors are eager to avail themselves of the opportunities they perceive will come from India’s new pro-market government. A caution for all: India cannot go from a semi-closed economic system to one that is wide open for foreign investment at any level overnight.
That said, for realistic investors—especially those who know India well—the new budget doesn’t disappoint because it’s a solid example that India is moving in the right direction. Clearly, Modi has to be very careful for a very simple reason: while India is an economic powerhouse—soon to become an economic superpower—unbridled capitalism would only grow the gap between rich and poor, and be detrimental to the country. Modi believes in a more bottoms-up, versus top-down, approach that will benefit the most people of India.
There is much to like and a lot to be excited about in this budget. First and foremost, India has boosted its defense spending by 12% for the years 2014-2015 and will permit as much as 49% of foreign investment in defense-related companies. That’s up from the current 26% level. The hope in doing this is that India will be able to further expand its defense industry, without having to purchase equipment from other countries and, in so doing, cut foreign exchange transactions. There is talk of allowing up to 74% foreign investment in those cases where there is a transfer of technology. As the defense budget was increased to $38.35 billion, 49% represents a very large amount of money. The companies that stand to benefit from this change include Bharat Electronics (NSE: BEL), Bharat Earth Movers Limited (NSE: BEML), and Pipavav Defence and Offshore Engineering Company Limited (NSE: PIPA).
Another sector that stands to gain from the new budget is India’s $60 billion insurance industry, which will now allow up to 49% foreign investment. According to Mr. Jaitley when he delivered the budget, “The insurance sector is investment starved. Several of the insurance sectors need an expansion.” There are many foreign insurance companies that currently operate in the Indian market as joint ventures with Indian companies. These include ICICI Bank (IBN) and HDFC Bank (HDB).
Another area of great interest for foreign investors are REITS, which have been introduced into the Indian market. Regulations originally drawn up (but shelved) in 2008 when the financial crisis hit the global markets, have now been resurrected. In his budget address, Mr. Jaitley said he intends to provide “the necessary incentives for REITS, which will have pass-through for the purpose of taxation.” This means the previously present issue of double taxation will no longer be an issue. The winners here will be two of India’s largest real estate developers, DLF Limited (NSE: DLF) and Phoenix Mills (NSE: PHNX), and the Blackstone Group, which is in the process of launching an India REIT.
For foreign institutional investors with lingering concerns about India’s General Anti Avoidance Rules (GAAR): It has now been affirmed by the Modi government that these rules will come into existence as of April 1, 2016. GAAR proposes to tax ‘impermissible avoidance arrangements’ entered into by a business. This is a reasonable timeframe for businesses to arrange ‘tax-compliant’ structures. Now that the Modi government has clarified that these rules will come into effect, businesses would be advised to accept and comply with them. In the words of a source at India’s Kotak Mahindra Bank (NSE: KOTAKBANK), “In our view, there can hardly be a business case (other than low or nil taxation) or ‘commercial substance’ for routing FDI or FII investments through Mauritius or any other low-tax jurisdictions since these countries are not and cannot be the source of investments.”
There are several India mutual funds and ETFs available in the U.S. However, these mostly provide country rather than individual industry exposure. The funds likely to see the most bounce from the changes wrought by the new budget are Emerging Global Advisors’ EGShares’ Indxx India Infrastructure ETF (INXX), the DMS NASDAQ India Bank Index Fund (DIIBX), the DMS NASDAQ India MidCap Index Fund (DIIMX) and Van Eck’s Market Vectors India Small-Cap Index ETF (SCIF). ICICI Bank and HDFC Bank are also available as ADRs.
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