Budget, as seen from the other side of earth

It’s important to note that more often than not, the market declines in response to the annual ritual called the budget, a Superbowl-like news event upon which India’s economic performance is projected for the year.

Both domestic and foreign investors carefully watch India’s macro economic picture and the nation’s projected fiscal deficit is a key metric.

As a foreign investor, it was gratifying to hear the FM declare a lower than forecast fiscal deficit at 4.6% of GDP in the next fiscal.

This was achieved by leaving total receipts and total expenditure essentially unchanged resulting in a marginal increase of 3% in the absolute fiscal deficit number. This calculation was aided by a higher nominal projected GDP for next fiscal, compressing the relative fiscal deficit number.

The budget was a mixed bag of policies with meaningful increased spending for the food processing industry, power and railways, while heavy industries and public enterprises saw one of the highest cut backs in expenditure.

Coupled with announced tax policies, the budget was clearly intended to be responsive to populist interests.

As agriculture employs an estimated 70% of the Indians, in combination with high food inflation, any policies that benefit food output, processing and distribution are critical to not only feed the population, but to also mitigate “food security” concerns.

India has inadequate post-harvest storage, particularly cold-storage facilities that are essential to reduce the estimated 30% to 40% loss due to spoilage. The budget’s tax policies in connection to power will benefit companies involved in power transmission and distribution.

Domestic power equipment manufacturers will still be facing stiff competition from Chinese firms offering prices 20%-25% lower.

An excise exemption of 10% for Indian manufacturers is intended to keep them competitive. Ironically, however, the new budget increases the benchmark price of coal supplied by 30%.

Infrastructure has been a major investment theme for the past 5 or 6 years and has been hampered by the lack of long-term financing. The budget provides for a 24% increase in infrastructure spending as well as increasing the limit that foreign institutional investors can invest in corporate bonds.

By including agriculture and fertiliser under the broad category of Infrastructure, much of the increase will be absorbed by these key industries.  This kind of political manoeuvre should be familiar to most American investors.  Real estate development and especially those firms focused on affordable housing will benefit from increased loan subsidies and 100% tax deductions for certain expenditures.

What we didn’t hear enough about are education, transparency and inclusive financial growth. We view raise in education budgets to be essential to achieving the country’s potential as the second largest economy in the world.

With a young population, and a majority living in rural India, expanding educational facilities and increasing access to education beginning from kindergarten to advanced degrees can not be emphasised enough.

Due to poverty, many children end up dropping out of school. Programs need to be funded to keep children in school till at least grade 12. Training and skills building needs greater emphasis.

The success of the trillion dollars of infrastructure spending over the next 20 years will be dependent upon the capacity of labourers, supervisors, engineers and management to achieve this goal. Despite an unfriendly stock market so far in calendar 2011, we remain as enthusiastic and focused upon India as ever.

Our view is that India is at the beginning of a not-so-long marathon to become the third, if not second-largest economy in the world. For investors that can stomach volatility, not only are there financial rewards to be gained, but also the knowledge of having participated in the emergence of this complex and fascinating country.

As leaders in the environmental, social and governance research and investment implementation, we believe foreign investors have a responsibility to assist the country and not just rake off profits.
Seth Freeman is CEO and CIO of EM Capital Management, LLC, San Francisco, California. Lincoln Rathnam, CFA, also works with the firm.