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India’s Modi faces first test of reform pledges

Reuters, AFP-JIJI

India’s Prime Minister Narendra Modi faced the first major test of his reform credentials on Thursday, when his fresh-faced government presented its maiden budget amid early doubts about his willingness to make unpopular decisions.

The budget promised a new era of fiscal prudence and greater opportunities for foreign investors in key sectors of the economy.

Finance Minister Arun Jaitley told parliament that the new government had inherited a “challenging” situation of low growth and high inflation from the previous Congress administration. But he laid out what he said were broad indicators of the direction the government intended to travel in: toward lower government debt, more privatization and greater openness to foreign investors.

Government overspending would be brought down dramatically in the next three years, with the fiscal deficit reduced to 3.0 percent in 2016-17 from a target of 4.1 percent this financial year, Jaitley pledged.

Jaitley also announced an increase in the permitted level of foreign direct investment in the defense and insurance sectors to 49 percent from 26 percent.

He also said the government intends to sell shares in the debt-laden public banks, which need fresh equity.

But the leading index of the Bombay Stock Exchange fell as investors apparently reacted with disappointment to the absence of any sweeping structural reforms.

Modi, 63, won a landslide general election victory in May with a pledge to boost growth and create jobs for the 1 million people who enter India’s workforce every month.

He has since warned of the “bitter medicine” needed to nurse the economy back to health from high inflation and the worst slowdown since free market reforms in the early 1990s unleashed an era of rapid growth.

But, with an eye on state elections later this year, Modi has faltered in administering the medicine he has spoken of, delaying a decision to raise the price of natural gas and partially reversing a train fare hike after protests in Mumbai.

The government has tried to keep rural voters sweet by extending a temporary subsidy for sugar mills, benefiting farmers in Maharashtra, where Modi’s BJP hopes to consolidate its strength in elections later this year.

“This evidence that they are moving back and dithering on their decisions, and in a sense playing politics, is a sign of more to come,” said Nida Ali at Oxford Economics.

To be sure, the government has started a shake-up of politically sensitive labor laws and is expected to roll out plans for a new services tax that would unify India’s states into a common market for the first time.

Even the partial train fare hike was bolder than any measures by the last government to fix the tattered finances of the world’s fourth-largest rail network.

But some investors were disappointed by a railway budget delivered on Tuesday that was long on promises of opportunities for investors but short on details of how to make the sector attractive for such capital.

A finance ministry report on Wednesday laid out the government’s vision for a sustainable reduction in the fiscal deficit through a lower food and fertilizer subsidies and broadening the tiny tax base.

“It is but natural for the new government to move ahead gradually so as to avoid policy-induced distortions,” said Rupa Rege Nitsure, chief economist at Bank of Baroda in Mumbai.

Many of India’s economic ills are structural and will take time to fix. Food inflation, energy shortages and weak institutions will slow the pace of reform.