Modi Reaches Out to Indians With Tax Cuts Before Key State Polls

(Bloomberg) -- Targeting rural voters with increased social welfare spending, Prime Minister Narendra Modi has unveiled a budget aimed at giving his party an edge in looming state polls and lay the groundwork for his re-election in 2019.

In a bid to boost growth for those hurt by his cash ban, Modi on Wednesday promised increased infrastructure spending and jobs training and slashed taxes for companies with a turnover of less than 500 million rupees ($7.4 million). Accounting for 96 percent of all registered companies, these firms employ 40 percent of Indian workers and vast numbers are based in Uttar Pradesh which goes to the polls this month.

Results from Uttar Pradesh -- India’s most populous state -- can embellish or scuttle Modi’s re-election prospects come 2019. Luring voters without worsening public finances puts Modi’s Bharatiya Janata Party in a sweet spot politically and may also open room for an interest rate cut when the central bank meets next week.

"This is a smart move to get rural votes," said Raghbendra Jha, an economics professor at Australian National University. "It’s tried to soothe the effects of demonetization."

While global leaders such as U.S. President Donald Trump are playing on populist sentiment, Modi is attempting to regain momentum with the rural, disenfranchised voters who lifted him to power in 2014 and who suffered the most after his decision to ban high currency notes.

But at a time of rising uncertainty over U.S trade policies, Modi’s budget is almost exclusively focused on boosting domestic consumption and investment. "There doesn’t seem to be any effort to deal with the headwinds that the world trading system will confront -- say, in the worst case, if a trade war breaks out," said Manoj Joshi, a distinguished fellow at the Delhi-based Observer Research Foundation. 

The tax cuts will encourage small firms to scale up and hire more people, especially if demand improves, said Anil Bhardwaj, secretary general at the Federation of Indian Micro and Small & Medium Enterprises.

Some factors, however, remain outside Modi’s control, such as the direction of the U.S government under President Trump, who has abandoned the Trans-Pacific Partnership agreement and signaled the possibility of adopting other, more protectionist policies that could hit India’s global IT professionals.

"How it behaves towards imports of textiles and leather for instance will impact our informal sector, which is very labor intensive," Bhardwaj said. "The government of course cannot predict that. But the next best thing is to revive domestic demand and I think this budget addresses that.”

Big Picture

Modi has budgeted to boost overall spending 6.6 percent to 21.5 trillion rupees in the year starting April 1, funded by a 13 percent increase in tax collections. The budget deficit is forecast to be 3.2 percent of gross domestic product, wider than the previous target of 3 percent.

This fiscal stimulus, together with an expected cut in interest rates when the central bank announces its decision Feb. 8, stands to support growth that government advisers said may dip as low as 6.5 percent -- the slowest in four years -- as Modi’s cash ban dents demand and deters investment.

Delivering the budget Wednesday, Finance Minister Arun Jaitley cut the tax rate for firms that report a turnover of less than 500 million rupees to 25 percent, benefiting 96 percent of the country’s registered companies.

Jaitley also doubled the credit target to unfunded and underfunded firms to 2.4 trillion rupees, said the government will seek to provide a record 10 trillion rupees in loans to farmers and boosted allocations for a rural jobs program. He lowered income tax rates for people earning less than 500,000 rupees.

Rural Voters

Uttar Pradesh is home to the highest share of rural dwellers -- some 155 million people -- and almost half of these are directly employed in agriculture. Elections will also be held in four other states, including Punjab, called the ‘bread basket of India.’ All results will be announced on March 11.

"I’d be very surprised if these measures weren’t repeated ad infinitum in the prime minister’s rallies in months to come," said Saksham Khosla, research analyst at the Carnegie Endowment for International Peace India. 

"The government’s done a great job of laying down a great political foundation from which it can make electoral plays. By 2018 and 2019, a lot of these effects will come into play -- setting the stage for a BJP groundswell."

To contact the reporters on this story: Iain Marlow in New Delhi at imarlow1@bloomberg.net, Archana Chaudhary in New Delhi at achaudhary2@bloomberg.net. To contact the editors responsible for this story: Ruth Pollard at rpollard2@bloomberg.net, Jeanette Rodrigues