On the 26th November 1947, the first Union budget of Independent India was published. The latest, unveiled on 1st of February, echoes some of the same solemn notes as the Indo-Pakistan war of 1947-1948 bears an uncanny resemblance to the pandemic the world is fighting today. The focus on funding Defence Services in 1947, somewhat mirrors today’s decision to put $30.1 billion towards fighting the COVID-19 battle. As the pandemic is ravaging economies worldwide, India’s budget announcement captured the eyes of many.
India’s finance minister, Nirmala Sitharaman outlined plans to increase health spending by 137%, boost infrastructure investment and has presented an ambitious plan for divestment. Divestment refers to the selling of some or all of its assets or subsidiaries to streamline operations. In India's case, the budget sketches out plans for the selling of public sector firms, such as Air India, which are heavily debt laden. With such visionary policy proposals being put on the table, investors question whether Sitharaman can turn the tide on its battle against faltering GDP?
India’s impressive growth over the last century is recognised worldwide. However, with increasing protectionist reforms and a financial sector riddled with challenges, long predating the turmoil of 2020, many argue that two policy errors have significantly exacerbated a political divide and put a halt to the economy’s remarkable growth.
As mentioned above, India has increasingly been adopting protectionist policies, notably high tariffs and minimum import prices, intending to protect the economy from wide domestic price fluctuations. You may immediately be questioning why this is an error, as, on the surface, these policies seem rational. To a certain extent, you are not misled. Frequent price changes can cause uncertainty, deterring investment and adversely impacting the economy. This is largely due to what Keynes noted to be individuals’ ‘animal spirits’. The theory suggests that uncertainty triggers a herd mentality, increasing the snowball effect's risk where large amounts of money leave the economy. However, foreign investment only accounts for 1.76% of the nation’s GDP, suggesting an isolated impact. For this reason, the rationality of these protectionist policies can be brought into question.
Also, recent tariffs have been imposed in retaliation against the USA. These spiteful decisions pay little attention to the negative impacts consumers will be forced to face, and India’s history proves that protectionist policies materialise with only damaging consequences, marked by “higher prices, inferior goods, low productivity and self-fulfilling export pessimism”, as noted by the FT. India’s textiles industry exemplifies this risk as the implementation of protectionist policies prevented innovation, meaning India had no place in the global market.
However, the Bombay Stock Exchange’s 5% gain that accompanied the recent budget announcement has ignited hope in investors. India’s government aims to open up its financial sector by increasing foreign investment limits in insurance companies; thereby, allowing foreign ownership and control. Despite this positive reform, high tariffs persist and with rating agencies giving India the lowest investment grade rating, India’s attractiveness to foreign investment is as alluring as spending another year unable to go to the pub.
The second policy error is the relaxing of the 2016 Insolvency and Bankruptcy Code framework. The Insolvency framework serves to resolve problems that arise when firms and investors cannot repay their debts. Therefore, the code aims to protect small investors and increase the convenience of doing business. Overall, the framework helped India’s economy as its rebalanced class interests and improved capital allocation. Now, however, borrowers can skip payments and banks can pretend they are being paid. In addition, loans that would otherwise default are now permitted to be restructured.
The third problem with this reform is that government-owned banks can manipulate the system to maintain control of “zombie” businesses. In the world of business and finance, “zombies” are companies that earn just enough money to continue operating and service debt but are unable to pay off their debts. India’s faulty system allows these firms to stay liquid as government officials, with an overriding socialist mindset, believe that allowing insolvency will result in a loss of jobs, income and further provisioning for banks. Clearly, however, these firms impede productivity gains and adversely affect economic growth. India leads in the number “zombie” firms in Asia, bringing forth the question of whether these corporate underachievers be driving India’s faltering GDP?
Although growth has been decelerating since 2016, looking at the last 100 years, data from the world bank suggests that India’s growth has in fact been generally resilient to both domestic and external shocks. This phenomenon is largely explained by India’s diverse economy, which is seeking further divestment, as indicated by Monday’s budget.
However, with persisting crony capitalism, political anarchy and an economy in the midst of one of its most gruelling battles against COVID-19. Faced with faltering growth and a pandemic, it is unlikely that India’s finance minister, Nirmala Sitharaman, has the power to turn the tides with Monday’s announcement.