Infrastructure, taxes top govt reform priorities

The government will use its political clout to push tax reforms that would boost revenues but could put other policies, such as insurance and pension changes, on the backburner for several months.

Investors had hoped the easy re-election of the centre-left Congress party in May would clear the way for market reforms. But managing the impact of the global financial crisis and a failed monsoon have diverted much of the government's attention.

Now, the way is clearer. But the government is making signals it will give priority to building roads and power plants and pushing through a goods and services tax (GST) to broaden the tax base and simplify a notoriously inefficient revenue structure.

India faces a fiscal deficit for the current financial year of 6.8% of GDP, its highest level in 16 years, which it is funding through record borrowing of about $97 billion.

Moves to open up pensions and insurance to foreign investors are not vote winners and may take longer than some hoped.                                            Despite having a large majority in parliament, Prime Minister Manmohan Singh must still juggle the interests of his coalition partners, many of whom are regional parties which give priority to their own local interests rather than national policies.

The aim of reforms is more efficient deployment of capital in a country of more than 1.2 billion where the savings rate is nearly 40% of GDP. An underdeveloped financial system means relatively little is funnelled into capital markets to fund the big-ticket infrastructure projects India desperately needs.

"There are so many things of much greater priority, most of all getting investment in infrastructure," a government official involved in setting policy told Reuters.

Implementation of the GST, which will streamline the tax structure and raise revenue by an estimated $15 billion a year, is the other priority. India had hoped to have the tax in place on April 1, but the start is likely to be pushed back amid opposition from states wary of losing out on revenue.

"That is a reform that will require a lot of political manoeuvring with state governments. I would unhesitatingly say that if it came to limiting how do we use our political capital for legislative change, I would do that," the official said.                                            It made little difference, the official said, how quickly pension or insurance reform was enacted.

Whatever it does, the government will husband its political capital carefully, and the benefits of liberalisation must be clear in a country that remains mostly poor and rural.

Increasing foreign investment in banking and retail, which local players oppose, is far down the government's to-do list. Retail policies have already sparked protests in many states, wary that millions of small shopkeepers could suffer.

"There has to be a socially or politically palatable objective in advocating these reforms," said Abheek Barua, chief economist at HDFC Bank.

India's escape from the worst of the crisis, thanks to its relatively closed financial sector and a domestically driven economy, also eroded the case for liberalisation and hardened opposition to reforms from left-leaning quarters of the party.

Singh's challenge was made clear last month when thousands of farmers from Uttar Pradesh, India's most populous state, denounced low sugar cane prices, forcing a postponement to the reopening of parliament and a government backtrack on prices.

"Inclusiveness will have to be there," said DK Joshi, director and principal economist at ratings agency Crisil. "That means basically some Robin Hood-ing will happen," he said.

India is eager to return to economic growth of 8 or 9% after expansion slowed to 6.7 percent last year, and removing infrastructure bottlenecks is key to accelerating growth.

India is simplifying land acquisition to help its goal of building 20km of roads per day, although it still must overcome red tape and corruption.

Expanding the corporate bond market, increasing participation in pensions and raising the cap on foreign holdings of insurers to 49% from 26% now would also create domestic sources of long-term funding.

Goldman Sachs has predicted India's growth will accelerate to 8.2% in the year ending March 2011 and 8.7% the following year, but said that was predicated on reforms.

India has not been standing still.

This year, it allowed trading in interest rate futures and is expected soon to allow repurchase deals (repos) on corporate bonds, enabling investors to borrow short-term funds by pledging securities as collateral, all of which will help develop an anaemic bond market.

More controversially, India plans to sell stakes in state firms, and could raise roughly $10-$15 billion over three years. 

Given the opposition of rival parties and labour groups, however, most proceeds will be used for social programmes — and not to pay down the deficit, as some investors would prefer.