Economies: Indian Budget Fails To Help Sagging Economy

India has long been touted as the next coming emerging economy, and judging by the performance up to last year, it was a contender.

But since then corruption woes, a sinking currency, inept policy decisions, weak government decisions, slowing growth, rising inflation and higher interest rates have flattened growth, aided by some odd decisions on tax and investment by the national government.

But nothing can match the absurdities of 2012, from an increase in tax on iron ore shipments exports to 30% earlier this year, plus higher taxes on gold imports and on manufactured goods, as outlined in last week's $US298 billion national budget.

The document has added to the feeling that the national government is adrift and lost sight of the need for economic growth to continue.

While the International Monetary Fund this week supported the budget, local investment and industry groups have criticised it as being too cautious, while Moody's said it was "credit negative" for India's sovereign-debt rating.

India's gold markets have staged their own protest at the doubling of duty on gold and other higher charges.

They have stopped trading this week, meaning legal gold dealings have evaporated in the country for the time being.

There's growing talk of illegal gold imports and importers switching to Thailand which has a free trade agreement with India and low gold taxes (1%).

It seems to be more of the same: pandering to sectional interests, actively discriminating against foreign investors, and adding to the already high levels of inflation.

And it will do little to help the rapidly emerging bad debt problem plaguing state-owned and private banks (of which there are more than 50).

Non-performing debts are rising at the banks, as well as debts that are still viable, but are in danger of falling into arrears.

The budget has done nothing to help anyone but the government, although some sections of the steel and iron ore export industries might feel they have had a win.

Last week rail freights for iron ore exports were cut but lifted for domestic shipments, especially steel.

At the same time import duty was cut on some types of steel making equipment, a move that is supposed to boost consumption of low grade iron ore in the production of pellets and beneficiation plants.

But what stands out is the inconsistency in the country's national budget last Friday which saw a doubling in taxes on gold, to taxes on manufactured goods, not to mention lower import duties on imports of coal and LNG (which will help Australian suppliers, but hurt India's huge domestic coal industry).

The budget itself talked a lot about helping the economy and boosting growth, while bring down inflation, but it will do nothing of the sort. India's growth rate has fallen to an annual rate of 6.1% (December quarter of last year) from around 9% in the past two and a half years.

Inflation has risen sharply and remains persistently high at 7%.

As a result, the Reserve Bank of India is keeping its key interest rate at 8.5% to try and break the hold inflation has on the economy, but progress has been slow.

The growth rate suggested in the budget is 7.6% from 6.9% for the year to the end of this month.

That's optimistic given the weak outlook for manufacturing and the banks.

The government has forecast a fiscal deficit of 5.9% of GDP in the year to March, against the previous target of 4.6%.

If India was in Europe it would be vying with Spain and Italy as the next basket case.

The Indian government seems to be doing everything to discriminate against some industries, while giving preference to others, all without any rhyme or reason.

Let's take rail freights and iron ore taxes.

The latter were lifted in January to 30% after being increased to 20% midway through 2011.

The rate was 10%, 15 months ago.

India might be the word's third biggest iron ore exporter, but the tax rises and falling production caused by a crackdown on illegal mining, has seen exports fall, especially to China.

India also has ambitious plans to lift steel production from around 65-70 million tonnes a year to 160 million or more by 2020, a task many Indian analysts say will be impossible.

So it is restricting iron ore exports to keep higher quality ore for domestic producers.

Last week the state-run railways cut freight charges on iron ore meant for exports by up to 30% (to $US22.50 a tonne), a move designed to try and boost iron ore exports that have fallen for the past year.

That has hurt the railways which depends on freight for 70% of its revenue, with iron ore a major part of that total. Hence the first cut in rail freights for two years.

But iron ore shipped to domestic steel plants will rise for a second time.

Media reports say steel makers will boost their prices by $US20 a tonne, adding to the already high levels of domestic inflation in an economy facing a sharp fall in growth over the next year.

Not helping was a rise in import duty on flat-rolled steel to 7.5% from the current 5%, which will cut competition for local producers.

The Railways Minister Dinesh Trivedi also announced a fare increase, the first in 8 years and designed to improve the finances of the railways (as were the freight increases, but not the freight cuts), then was criticised and resigned on Sunday, another sign of the policy instability gripping the country.

Dinesh Trivedi's decision to resign, and the fare rollback that is likely to follow, is in a pattern in recent months of India's leaders announcing economic reform but being too weak to enforce it.

Remember last year the government changed the rules and said it would allow big retailers such as Walmart to set up wholly-owned operations (instead of partnerships), then backtracked when local businesses and politicians opposed it.

Then earlier this month the government banned cotton imports, then rescinded that ban, then reintroduced it selectively, leaving the global cotton market and Indian processors and growers confused.

In the budget the government removed duties on imported coal and natural gas which should benefit some domestic thermal power companies, lifted sales tax on tobacco products and interest income on bank savings accounts will be allowed to rise.

The budget also plans a 2% increase in the tax on Indian manufactured goods, including for car companies, so they announced price hikes in the wake of the announcement.

That will also add to domestic inflation, as will the increase in steel prices and domestic freight costs.

More worrying was the move by the government to change the tax laws on cross border transactions.

The Financial Times reported at the weekend:

"Legal experts say the move is designed to ensure that transactions between international companies with Indian subsidiaries are liable to pay domestic capital gains tax, effectively overturning the Supreme Court's decision in January (in a case involving a big takeover by Vodafone which the court ruled should not have to pay $US3 billion in tax on the transaction because it was done outside of India).

"The documents also state that the "amendments will take place retrospectively from 1st April, 1962", meaning many closed tax cases after that date could theoretically be re-examined, including Vodafone's.

"Dinesh Kanabar, the chairman of KPMG India's tax practice, said: "The implication of this decision is simple. Vodafone's tax is now likely to be re-opened, while half a dozen other similar deals waiting in the courts could now be treated as taxable.

"The ruling may have implications for a series of other pending court cases involving merger and acquisition deals between international companies with Indian subsidiaries, including AT&R, E*Trade, GE and SABMillar.

"Any decision to reopen the case could have wider implications for Vodafone, which has invested at least $15bn to become India's third-largest mobile group by subscribers, but also endured a business environment marked by intense competition and unpredictable regulation.

"International investors are already concerned about the state of India's slowing economy and growing budget deficit, and the amendment decision is likely to exacerbate concerns about the country's reputation for policy paralysis and erratic legal rulings.

"The planned legal changes involve amendments to various clauses of India's Income Tax Act. The budget documents include explanatory notes designed to clarify the intent of the various moves as they relate to cross-border deals and international taxation.

"One of the explanatory notes reads: "For the removal of doubts, it is hereby clarified that an asset or a capital asset being any share or interest in a company or entity registered or incorporated outside India shall be deemed to be and shall always be deemed to have been situated in India."

That's what you call sovereign risk.