Keep expectations realistic
Budget may be a mix of statements of intent and actual announcements; fiscal deficit may be higher
The 10 July budget will be the government’s first formal statement of intent. This budget is significant because it is the first official platform for the government to lay out its strategy and governance agenda for the next five years. However, expectations need to be realistic as unrealistic expectations (such as dismantling of subsidies in the budget itself) have led to disappointment. Not all reforms can be announced in the budget and a number of policy changes will happen outside of it. The finance minister is likely to present the government’s strategy. Hence, it may contain a mix of statements of intent (talk) and actual announcements (walk).
The fiscal deficit may be higher in financial year (FY) 2015, but medium-term fiscal consolidation backed by a plan for lowering subsidies and implementation of goods and services tax (GST) along with stable tax policies, a focus on boosting investment and lack of unnecessary populism should make this a good budget, in our view.
More importantly, the pace of activity outside the budget is picking up. Approvals are likely to pick up speed given the government’s intention to approve environment, forest and other applications online. Firms have started to raise equity capital, enabling them to deleverage their balance sheets. Sentiment has turned positive and the pick-up in May and June auto sales indicates that discretionary consumer demand is starting to see a gradual revival. Meanwhile, the government’s decision to raise minimum support prices by around 2%, much lower than the last five-year average, along with moderating nominal rural wages suggests that the process of dis-inflation is gradually getting under way, notwithstanding the bumps caused by monsoons. Therefore, India is at an inflection point and the medium-term economic prospects look positive. Real gross domestic product (GDP) growth may go from around 5% in FY15 to 6.5% in FY16.
Fresh impetus to rupee appreciation
The budget may pose significant event risk to near-term rupee performance, especially as it will be considered a bellwether of medium-term policy focus. Nonetheless, a budget in line with economic expectations would provide positive impetus to rupee appreciation. The newly established government is likely to commit to medium-term fiscal consolidation while improving the quality of public spending to boost the growth outlook. Such an outcome would improve the prospects of foreign portfolio inflows given its positive implications for the local equity as well as the government bond market. Although the current account deficit is likely to widen marginally on the gradual relaxation of gold import curbs, it should remain within sustainable levels of under 2% of GDP. That should be easily financed by foreign capital inflows. Furthermore, any announcement related to increasing foreign direct investment (FDI) limits or higher FY15 disinvestment target would also be encouraging for the rupee. Apart from the likely positive budget, the rupee outperformance in the region is expected to be supported by the increased monetary policy credibility, easing inflation and rising local, global growth and potential sovereign credit rating upgrades.
Equity strategy
In terms of expectations, the market believes that the budget will lay down a clear path towards fiscal consolidation. The market also expects the budget to mark a clear shift away from entitlement-spending to growth-spending. Tackling subsidies is high on the list of market expectations alongside tax reforms such as GST.
At the same time, the market expects the budget to signal the government’s concrete steps in reviving the investment cycle—here expectations are hazy in terms of specifics. But given the slow growth, the ability of the government to enhance expenditure is extremely limited as revenue growth is correlated with economic growth.
The intent to enhance growth can be signalled through fiscal concessions and by means which allow easier flow of funds in physical investments, with emphasis on infrastructure. Opening up of the economy for easing entry of both private-sector and foreign investments in these areas will be a positive.
Finally, we note that the budget is only a small part of the overall governance. The fiscal blowout in India was a part of a policy which favoured entitlements. The slowdown in investments was a result of a dysfunctional government in which ministries were working at cross purposes.
The budget can, therefore, be at best, a signalling tool of the policy shift towards right of centre. It is difficult to expect miracles given the paucity of resources and the limited time the new government has been in power.
Edited excerpts from report titled “India: Expect a good budget".
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