Why Investors Have High Hopes For India's First Modi Budget

Next Next week should see the first federal budget from new Indian Prime Minister Narendra Modi and his finance minister, Arun Jaitley. It will be the first clear indicator of whether the almost 20% rise in India's stock market this year has been justified or just election-fuelled hype.

Why has the market risen so heavily, first on the expectation of a Modi victory, then on its confirmation? The markets believe India has voted in a more business-friendly government that will boost the national economy. They believe this is a reform-minded administration that will take tough decisions, get infrastructure development underway and support growth.

Are the markets right? The presence or absence of the following initiatives will give us a clue.

Firstly, investors want to see tax reform. Many foreign investors in India have been deterred by tax disputes, with Vodafone Vodafone a prominent example (the glo

bal telco has sought international arbitration out of frustration with India's government). This is a complicated field, but a central part of it is the issue of retroactive tax measures; foreign investors would welcome an assurance that the government will respect tax laws that are already in place.  On top of that, there is the expected goods and services tax: the budget is expected to include a clear plan for its implementation and collection.

Secondly, there is the perpetual frustration around Indian infrastructure. It is said that the last government lost power partly because of its inability to get stalled projects moving again, and this one will be judged on its efforts to improve the situation in power, roads and ports. This point is not necessarily central to the budget, but it would be a surprise if the budget announcement were not accompanied by a pledge to improve project completion.

Third, like any budget, this one will announce the direction of new spending. Will it go on subsidies or on infrastructure, healthcare and education? Reducing subsidies is politically difficult anywhere, but particularly in a country with deep and entrenched poverty. Yet investors seem to expect it. "LPG and kerosene are the primary sources of energy for a large portion of households in India and are therefore politically sensitive," says Sonal Varma, analyst at Nomura. There are suggestions there will be a staggered hike in the prices of both kerosene and LPG cylinders. "It would take several years to completely eliminate the subsidy," Varma says. "At the moment these are just proposals, but if the government does decide to announce such a move we believe it would send a positive signal to the markets, make the government's fiscal condition much more credible, and increase fiscal space for capital expenditure."

Finally, and vitally, the budget will be expected to lay out measures for job creation. This might include tax breaks for factories, or measures to create a more skilled workforce.

The thing is, market expectations have been built up so much that even the slightest hint of slow progress may lead to a sell-off, whether justified or not. The long-term future may be bright for both India and its stock markets, but it is going to take something special to sustain the ardour of recent months.