Narendra Modi’s National Democratic Alliance government unveiled its first budget for India on 10 July 2014. Presented by Finance Minister Arun Jaitley, the budget is primarily aimed at increasing investment, improving infrastructure and reviving manufacturing. The budget has largely adhered to market expectations by delivering investor-friendly policy initiatives. We set out some key areas below.

Foreign Direct Investment

The new budget has raised foreign direct investment (FDI) caps in defence manufacturing from 26% to 49%. The ownership of such joint ventures will remain with Indian companies. The FDI cap for the insurance sector will also be hiked to 49% from 26%. The domestic insurance sector, which has suffered from lack of adequate investment, will now be able to tap on a larger base of foreign investment.

Another key aspect of the new budget is to meet the long-standing demand for liberalising FDI norms in the post-2008 realty sector, allowing developers better access to FDI. In 2005, the Indian government allowed 100% FDI under an automatic route for real estate and construction, subject to conditions that included a minimum area for development of 50,000 sq meters, minimum capitalisation of USD 10 million and a 3 year lock-in period from completion of minimum capitalisation. The minimum built-up area and capital conditions for FDI are now reduced to 20,000 sq metres and USD 5 million respectively. In addition, projects which commit at least 30% of the total project cost for low cost affordable housing will be exempted from the minimum built-up area and capitalisation requirements. These measures aim to boost the development of ‘smart’ cities. The new budget has also proposed to introduce incentives, including tax pass-through status to avoid double taxation, for the introduction of real estate investment trusts.

Clarity on Tax Treatment

The budget has also eased on tax treatment for foreign investors. In particular, foreign portfolio investors, the largest investor group in India, will be taxed under capital gains tax rules and not under the higher business income tax rates. One of the key concerns of these investors had previously been the uncertainty in taxation on account of characterisation of their income, with many of their fund managers remaining outside India under the apprehension that their presence in India may have adverse tax consequences. The liberal tax regime is expected to attract fund managers to India, thereby creating more tax revenue and job opportunities.

Know Your Client Requirements

Furthermore, the introduction of uniform know-your-client (KYC) norms and a single demat, or paperless, account for all asset classes will also help boost the financial sector and encourage foreign investment. The KYC process will be streamlined such that the procedure of identification is only required once, improving customer convenience. A single demat account will also be introduced. Through the single account, investors may access and transfer all their financial instruments, as well as track their entire financial history. Again, customer convenience is improved with investors no longer required to juggle different entities. A demat system would also eliminate the risk of loss of physical papers and reduce exposure to fraudulent acts.

Public Private Partnerships

The budget also proposes the establishment of an institution to provide support to mainstream public private partnerships (PPPs) procedures. As Mr. Jaitley has recognised, India is currently the largest PPP market in the world, with over 900 projects in various stages of development. These business ventures, funded and operated through a partnership of government and private companies, are expected to finance most of India’s infrastructure projects. The new institution will be tasked with improving the lack of coordination, legal issues and delay in clearances which have made it difficult to for private investors to enter projects under the PPP model. The increased contractual flexibility will encourage more investors to enter into the PPP framework, providing more finance for government projects.

Criticisms of the Budget

However, retrospective tax, one of the biggest concerns among domestic and foreign investors, has yet to be addressed. By the logic of the retrospective amendment, past deals concluded  years  before become taxable, serving as a huge deterrent for investors and creating huge uncertainties. The law has not been repealed. A committee has instead been formed and tasked with examining all pending cases of retrospective tax. With the amendment left standing, foreign investors may continue to be discouraged from conducting their deals in India.

Critics of the budget have also pointed out the lack of clear moves to reduce subsidies and rein in spending, with only an expenditure reform commission being set up by the Finance Minister to review the sizable subsidy bill.

Conclusion

The government’s refusal to dole out populist giveaways demonstrates an encouraging grasp of the need for fiscal prudence in the budget. These are important signals which will go some way towards assuaging investors. By sending out an overall positive tone, Modi’s budget will likely keep sentiment in the equity market buoyant. The policy measures have also been calibrated carefully, steering clear of drastic changes or politically contentious minefields. Instead of a ‘big bang’ of change, the budget represents a cautious but promising step along the journey towards India’s economic development.