Has Budget scored on the three Cs?
An analysis in terms of consolidation, credibility and central bank policy
Ahead of a busy election calendar and the need to preserve macro-stability, the Budget mixed prudence with some populism, seeking to balance economic and political imperatives. While there was emphasis on social and rural sector schemes, these were balanced with plans to raise revenues.
Here’s an assessment of the Budget from a macro-economic perspective based on the three Cs — Consolidation path, Credibility of the numbers and policy implications for the Central bank.
Pause, not reversal
Following recent years of fiscal consolidation, Thursday’s Budget was a mixed bag. The outgoing year marked a fiscal slippage, with the government revising up the FY18 fiscal deficit target to 3.5 per cent of GDP (vs targeted 3.2 per cent) and FY19 at 3.3 per cent (the medium-term fiscal roadmap had envisaged a deficit of 3 per cent GDP).
But these were capped at FY17’s 3.5 per cent, affirming that the latest signs of fiscal slippage are a pause rather than a reversal in the consolidation process. But the decision to push back the 3 per cent deficit target by two years to FY21, coupled with higher minimum support prices, is likely to be viewed as a negative move.
In the short term, equity market sentiments are likely to be depressed by the government’s move to reinstate the Long-Term Capital Gains tax on investments (despite the grandfathering provision).
A few amendments were proposed to the Fiscal Responsibility and Budget Management (FRBM) recommendations, with fiscal deficits and debt to be targeted simultaneously, whilst retaining the fiscal deficit target as the operational goalpost.
Public debt to GDP ratio is projected to be lowered from 50.1 per cent in FY18 to 48.8 per cent in FY19. Banks’ recapitalisation bonds, while kept below the line for the fiscal calculations, will add around 1 per cent of GDP to the public debt over these two years.
Who will spur consumption?
The credibility of the fiscal math is a closely watched aspect of the Budget. For starters, the assumption of 11.5 per cent nominal GDP growth appears reasonable, assuming a 7-7.5 per cent real GDP growth and 4-5 per cent inflation range. However, we find the FY19 revenue collections to be optimistic, after a shortfall this year due to slower GST-related and non-tax receipts.
Likely hoping for improving growth outlook, the government is banking on a notable pick-up in collections, with gross tax revenues forecast to improve by 0.5 per cent of GDP in FY19, while non-tax revenues and non-debt receipts (divestments) moderate.
In contrast, plans to lower overall expenditure outlays by 0.2 per cent of GDP, ahead of a busy political year, might turn out be an under-estimation. Interest payments (likely due to the recent rise in borrowing costs) and subsidies (on higher food and fertiliser allocations) are projected to rise next year.
The overall fiscal impulse, inferred from the primary deficit (excluding one-off revenues), is mildly contractionary. If this path is adhered to, the government will play a smaller role in lifting growth, with the onus shifting to the rural/farm sector to spur consumption.
The central bank is likely to factor the Budget’s projected fiscal slippage at its February 7 review.
We expect the monetary policy committee to maintain a cautious stance, but the fiscal math is unlikely to tip the balance towards rate hikes, this month.
A key aspect of interest is the extent of increase in the proposed minimum support prices, which has spillover impact on rural/farm wages and, by extension, demand conditions. Details are scant at the point of writing, though in the past, instances of a sharp increase in MSPs have coincided with high food inflation, spurring concerns over generalised price pressures. For now, we reckon that the RBI will flag the projected fiscal slippage, oil and higher MSPs as risk factors, but not prematurely tighten rates. The evolving inflation path will be a more important determinant of policy action.