New Delhi: If President Pratibha Patil’s parliamentary speech setting out government policy was a pointer, fiscal prudence this year may play second fiddle to growth and populist schemes for the new Congress-led government.
The President’s speech on Thursday gave little away on how the government intended to rein in the fiscal deficit, which at a decade high threatens to choke private investment and boost interest rates, much to the chagrin of the Reserve Bank of India (RBI).
The main part of the speech were broadbrushes over reviving economic growth and helping millions of poor with higher spending and expansion of social programmes.
“She was definitely talking about growth with a human face. She has also admitted that we are losing some control on the fiscal side,” said NR Bhanumurthy, an economist at New Delhi-based Institute of Economic Growth (IEG).
“They have realized that getting back to fiscal discipline will be tough this year.”
Fears of massive government borrowing to feed its fiscal deficit have already rattled the bond market this year, forcing up long-term rate expectations and pushing the yield curve on Friday to its steepest in a decade.
February’s interim budget ahead of the election aimed to limit the fiscal deficit to 5.5% of gross domestic product in the current fiscal year to March 2010.
But sluggish tax receipts during the downturn and expansion of populist schemes mean the deficit may reach 6.5%, analysts said.
Borrowings could surge to Rs4 trillion ($85 billion) in 2009-10 from an initial estimate of Rs3.6 trillion. That could prompt investors to demand higher yields in return for lending cash to the government through bonds.
In turn, the higher rates would discourage the private investors vital to helping revive growth from raising funds and counter the central bank’s rate cuts.
The RBI has cut its main lending repo rate by 425 basis points to 4.75% since October to try to boost growth. But fears of government borrowing pushed the yield spread between 1-year bills and 10-year government bonds out to 260 basis points on Friday from just 47 basis points at the end 2008.
Ten-year yields alone have risen 127 basis points this year.
The finance minister plans to present the 2009-10 budget in early July, which should include more details of borrowing needs and the deficit, as well as a possible time frame to cut it.
Some analysts say the government is hoping to generate enough growth to increase tax revenues and so relieve pressure on the budget deficit. But that may be risky.
“What matters now is -- are we clear in our mind that as the economy recovers we will return to fiscal prudence?” said Saumitra Chaudhuri, a member of Prime Minister Manmohan Singh’s economic advisory council and an adviser at rating agency ICRA.
Borrowings to Support Spending
The government has front-loaded its borrowing this year so that it can spend more to revive an economy hit harder than expected by the global slump and slowing domestic demand.
It intends to borrow Rs2.4 trillion, or two-thirds of its initially estimated full-year borrowing, in the first half. The economy is expected to grow at about 6% in 2009-10, its slowest in seven years.
An increase in the size of three bond auctions in late May and early June fuelled speculation the government may overshoot the deficit target and end up borrowing more than forecast.
“Borrowings could be higher by Rs600 billion to cross Rs4 trillion this fiscal year,” said A Prasanna, an analyst with ICICI Securities Primary Dealership, who expects the fiscal deficit to be 6-6.5% of GDP in 2009-10.
In 2008-09, the Congress-party led coalition announced steps including a debt waiver for small farmers, increase in purchase price of grains and an expanded rural job scheme to lure voters.
Pressure is now building up on the new government, which has returned to power with a stronger majority, to deliver its promises to millions of voters.
Policy makers say there was a need for more stimulus to lift growth, but private analysts see little fiscal space for that.
“Any further fiscal expansion will increase borrowing and crowd out private investment,” said Bhanumurthy.
The other alternative is more monetary easing by the central bank and prodding banks to lower lending rates, but expansionary fiscal policy was already hindering efforts to cut rates further.
“The mandate of the new Congress-led government is actually quite ambiguous,” Sebastien Barbe, the head of emerging markets research and strategy at Calyon, wrote in a research note.
“On the one hand, there are hopes that reforms will be accelerated, in a business-friendly way, which would favour foreign investment and the private sector. However, on the other hand, it should not be forgotten that Congress has been elected on a pro-poor and pro-growth platform,” he said.