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The FY24 Union Budget will be tabled on February 1, marking the last full presentation before 2024 general elections.

Tailwinds to the FY23 fiscal math

In midst of the pandemic, additional spending needs and adverse economic impact on revenues pushed fiscal deficits sharply higher. The centre’s deficit jumped from -4.7% of GDP in FY20 to peak at -9.2% in FY21 and is thereafter expected to return to -6.4% in FY23.

The FY23 fiscal math has benefited from: a) strong nominal GDP growth of around 16% vs budgeted 11%; b) above target tax collections due to better growth, reopening boost, formalisation, and tighter compliance; c) pick up in nominal GST collections, which have helped to offset lower RBI dividends, fuel excise cuts, higher subsidies, and divestment miss. 

In the first eight months of FY23, the central government deficit reached 59% of the full-year target, higher than 46% in Apr-Nov21. Revenues, especially taxes, have been strong, with direct tax collections up 24% yoy, helped by corporate and income tax collections. Under indirect taxes, average monthly GST receipts are up 20% yoy (see chart), benefiting from a lift in economic activity and import earnings. Non-tax revenues (weaker RBI dividends) and divestment proceeds are up at a slower pace, with non-tax reaching 74% of the end-year target by Nov22 vs 92% the year before. Dividends from CPSEs, especially in the energy sector which benefitted from high commodity prices, and banks are expected to make up for the shortfall in RBI’s surplus transfer.

Run rate of overall expenditure is broadly on par with the corresponding period last year, at 62% vs budgeted target vs 60% last year. Capital disbursements have hastened, at ~60% mark by Nov vs 49.4% last year, whilst revenue spends are close to last year’s pace. On yoy terms, capital spending up a sharp 63% yoy, compared to 11% yoy rise in revenue spends by Nov22.

Under revenue expenditure, the centre’s subsidy bill in FY23 might be the second highest after the pandemic-driven record high INR7trn in FY21. The centre sought additional INR 3.26trn (=net cash outgo i.e., gross INR 4.36trn minus INR 1.1trn savings) as supplementary demands for grants for FY23 in December. This includes the need to finance, i) additional INR 1.09trn for fertilizer and urea subsidies due to a sharp rise in global input prices; ii)~INR 800bn for the Department of Food and Public Distribution, 75% earmarked for the Pradhan Mantri Garib Kalyan Anna Yojana, and iii) INR 220bn for oil marketing companies for losses on LPG cylinder sales; iv) extra outlay towards the national rural employment guarantee scheme.

As of Nov22, overall subsidy outlay stands at 95% of the budgeted scale, up sharply vs 69% same time last year. Urea fertiliser has surpassed at 154% of full year target and nutrient fertiliser at 129%, followed by food (71%). Correction in global commodities and rejig in food subsidies is expected to result in some savings in FY24.

Cushion provided by an overshoot in revenue projections and stronger than budgeted nominal growth will help absorb higher spending needs, helping to stick with the budgeted deficit target at -6.4% of GDP (see table for details).

Growth backdrop for the Budget

We outlined our growth expectations in India 2023 Outlook: Strategic opportunity. An interplay of dissipating boost from the reopening dynamic from the pandemic, high cost of financing, base effects, and a tougher global environment are set to moderate the pace of pick-up in growth in rest of the current fiscal year and the next. While the lagged impact of 2022 reopening and festive tailwinds coupled with better employment generation will help, household savings have returned to normalcy (pre-pandemic). Farm output will be exposed to weather vagaries (subject to climate change and related disturbances), notwithstanding a consistent increase in the proportion of gross irrigated land.

Corporate books are healthier due to lower leverage levels but face uncertain demand, which will see the public sector play a bigger role towards incremental capex generation. Share of capex in the spending mix is the highest in over 13years and more is in the offing in FY24.

Global growth is expected to slow in US, Europe, and UK. As we discussed in India’s evolving trade dynamics, nominal goods exports carries a strong positive correlation with the demand-side driver i.e., global imports, with a slowdown in the latter to weigh on trade performance, with some tail-end impact on private investment cycle as well. Lagged impact of (global and domestic) monetary policy tightening, as well as less conducive liquidity conditions are likely to be reflect next year. Our real GDP estimates stand at 7% for FY23 and 5.8% in FY24.

FY24 Budget: macro stability and populism

Besides routine interest on the annual presentation, the FY24 Budget comes ahead of a busy state poll calendar in 2023 followed by general elections in 2024.

Fiscal consolidation will dominate the narrative despite economic and political compulsions. Four priorities will be in focus:

• Rural economy and social welfare push

Most key GDP components have returned to pre-pandemic levels, including private consumption (up ~4%), even if lagging the pre-pandemic potential growth trend. As idiosyncratic tailwinds dissipate, authorities will be keen to support consumption. The rural economy is likely to be one of the focus areas, especially after real wage growth stagnated in 2022 due to high inflation, increase in input prices and volatility in weather conditions (farming community).

Recent easing in rural inflation and a strong start to rabi sowing will help the near-term momentum, besides non-farm rural sector benefiting from backward linkages to a pick-up in urban business activity, but policy support is also likely. One potential area is increasing allocations towards the rural employment scheme, MNREGA vs FY23’s INR 730bn (0.3% of GDP). Besides this, further impetus to allied schemes such as crop insurance, rural road infrastructure, low-cost housing, power and utilities, food-processing industry etc. are other focus areas. Backstopping urban employment focus by channeling resources towards skill/ vocational training and upgradation.

Higher investments into health and education are likely to remain one of the key demands. There have been calls for the income tax exemption limit to be raised from the current INR250k, but this demand might revive the debate over lack of a wider tax base to make up for missed revenues. Core and core of core schemes are likely to be in focus as the economy recovers from the pandemic, with a preference for reallocation of resources rather than across-the-board increase in spends.   

Reorienting food subsidies

There were a few changes to the food subsidy arrangement in late-2022, which provide clarity for the FY24 math.

In Dec22, the government discontinued the free food program referred to as PMGKAY, which was unveiled to provide food relief during the pandemic. This free program was introduced in Apr20 and was extended multiple times, intending to provide additional 5kg of food grains to an estimated 815mn beneficiaries.

While the PMGKAY will be ceased from Jan23, the existing food public distribution system (PDS) under which 5kg foodgrain was being distributed to the same beneficiaries at a low cost, has now been made free until Dec23. These changes provide clarity on which way food subsidies are headed next year.

The fiscal impact of this reorientation of the food subsidy program will be net positive compared to the FY23 math, resulting in a smaller outlay of INR150bn (0.1% of GDP) in FY24, whilst resulting in savings of around 0.6-0.7% of GDP which was being spent towards the extra food allocations under the pandemic-era support.
 

• PLI/ manufacturing push

 
As outlined in India 2023 Outlook: Strategic opportunity, we expect the manufacturing push and supply chain reorientation to be a priority in the year ahead. Fiscal incentives, like the Production linked scheme has been beneficial for many sectors, especially electronics including mobiles production. Self-sufficiency in chip production is the other area of focus, where many economies such as the US, Europe and Japan also seek to localise production facilities. Authorities plan to extend this incentive to green hydrogen manufacturing. Other demands have included an extension of the capital support for the electronics sector (under SPECS) and higher outlay. Understandably, these announcements are not limited by the Budget timing and will be fine-tuned along the way.

Concurrently, investments into traditional sectors including textiles, auto components, metals, and mining, etc are also gaining traction. As on December 2022, 650 applications have been approved under 13 Schemes and more than 100 MSMEs are among the PLI beneficiaries in sectors such as Bulk Drugs, Medical Devices, Telecom, White Goods and Food Processing, according to data from the government (link).

Other efforts could also focus on improving the ease of doing business by administrative (e.g., National Single Window System) and supply side measures, for instance ironing out inverted duty structures, clarifying import duty policy, FTA pipeline, amongst others.
 

• Total public sector capex in view

 
The need to spur a revival in the investment cycle still rests on the public sector, as a slowdown in global growth and tighter financial conditions emerge as speedbumps for private sector activity.

Budgeted centre’s capex stood at INR 7.5trn in FY23 (including INR 1trn loans for the states), up ~27% vs INR 5.9trn in FY22 (actual), with 60% disbursed by Nov22. We expect the FY24 target to be in the region of INR 9.0-9.5trn, higher by ~0.2% of GDP.

Focus will also be on public sector capex contribution, including state governments and central public sector enterprises.

The move towards higher transparency in the budget math by onboarding off-budget spending (e.g., FCI) has translated into an increase in the share of centre’s capex, whilst moderating that of the CPSEs, leaving overall public sector growth largely steady. Big ticket capex by CPSEs  (link) reached 60% of the INR 6.62trn target by Nov22.

Next, state governments capex spending has been modest yet far in FY23, notwithstanding the centre providing two instalments of tax devolution (INR 1.17trn) as well as majority of the budgeted 50y capex loans. Data from eighteen states show a budgeted capex of INR6.3trn in FY23 (link).

Adding the centre’s capex to CPSE and states, overall public sector capex (not excluding one-off contributions), is likely to average 6.5-6.9% of GDP in FY24, vs above 7% in FY23.

Likely focus will be on – a) supplementing existing institutional structures to support a strong infrastructure push via the National Infrastructure Pipeline (NIP) and funding mechanisms such as the asset monetisation program and National Bank for Financing Infrastructure. Press reports suggest that budgetary support to infrastructure ministries might be linked to their asset monetisation performance in FY24 after the FY23 target of INR 1.62trn might be missed (link).

1. b) on the sectoral end, tech start-ups/ new economy/ digital economy players; c) commitments towards climate change and COP27 initiatives will require a strong thrust towards non-fossil energy sources, including renewable energy, hydrogen and other clean energy spends.

• Prioritising macro-stability

We expect the central government to prioritise macro stability by sticking with the fiscal consolidation path, and steer clear of overtly populist measures. Deft populism might be the preferred route, which skirts outright measures to boost short-term consumption, helping to keep additional spending and incremental inflationary impact in check. Instead moves might include fine-tuning existing measures and focus on medium-term demand boost.

Revenue projections for FY24 is likely to assume further improvement but the scale of increase will be muted, given anticipated moderation in nominal GDP growth (forecast FY24 GDP at 10%). Under non-debt receipts, next year’s divestment target might be set around the more reasonable FY23 goal at INR650bn rather than previous ambitious INR 1trn plus levels. As it stands, the full year FY23 target might also be undershot, after a substantial fund raising through an IPO buttressed collections in first half of the year. Dividends from commodity-CPSEs these sub-heads might moderate next year, leading the budget math to carry a lower reliance on non-tax revenues on aggregate.

We expect the upcoming FY24 Budget to peg the deficit at -5.9% of GDP vs FY23’s -6.4%. States’ fiscal strain has also risen, with deficits shooting up to -3.8% of GDP in FY21, before likely easing to -3% this year.  For FY24, the states’ combined deficit is estimated at -2.7%.

Participants will look for medium-term macroeconomic projections, including the revised Fiscal Responsibility and Budget Management Act (FRBM). At the FY22 Budget, the government projected the fiscal glide path to lower the deficit to -4.5% of GDP by FY26, implying an average of 60bps reduction in the deficit annually. We expect the target to be maintained to signal that the authorities are keen to preserve ongoing fiscal consolidation, but without adverse cutbacks which will be negative for growth.

Market implications

Despite concerns, centre’s borrowing in FY23 has gone smoothly to date, raising gross INR 11trn (net INR 8.3trn) by Dec22, higher than INR 9.9trn (net INR7.76trn) in the comparable period last year. States borrowings are lower on gross and net basis vs year ago.

Even as borrowings progress, costs have risen. Bond yields, especially shorter tenors, rose by over 200bp in CY22 on the back of a shift to a tighter policy regime, sticky inflation, and upward movement in global rates, while 10Y yields are up ~100bp. This has led the INR yield curve (2-10Y) to flatten compared to 2021, with the short-end driven up the RBI MPC’s hawkish overtures, while demand from domestic investors helped the rest of the curve – commercial banks, provident funds, corporates supportive of the long-end. Foreigners trimmed their exposure.

Liquidity conditions were conducive whilst credit offtake was modest, besides the RBI relaxing the held-to-maturity dispensation for banks.

In recent months, the balance has narrowed led by active FX intervention, slower pick up in deposit growth vs loans, a tightening cycle limiting the room for open market operations and temporary drivers such as festive demand and lags in government spending. The central bank’s stance points in the direction of a neutral to small surplus in CY23.

Forward-looking direction for bond yields will hinge on the make-up of the FY24 borrowings. Working with our estimate of the deficit scale, gross bond issuance is likely in the region of INR 15.5trn (includes INR 4.4trn repayments due in FY24, not net of GST compensation). Conditions might be less conducive. Firstly, after a slow start to the borrowing calendar for the year, states plan to sell a record INR3.4trn in the Mar23 quarter, after borrowing INR 4.57trn in 1QFY-3QFY (vs planned INR 6.55trn). States will watch for continuation of the interest-free loans and devolution details for the upcoming fiscal year before gauging their revenue/ borrowing needs for FY24. Secondly, liquidity surfeit is narrower than last year. Lastly, banks’ credit pickup has lifted the incremental credit deposit ratio, restricting banks’ appetite for incremental supply of bonds.

Either way, domestic investors will be key in the bond markets, much like recent years, while markets eye announcements to facilitate inclusion of INR bonds into global indices. Towards borrowing costs, the nominal GDP on average is likely to be higher than nominal borrowing costs (10Y as proxy) in FY24, for a second consecutive year.

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