With the credit policy behind us, the focus of the markets now shifts to the Union Budget. The big question is: After the monetary tightening, what will be the extent of fiscal tightening?
The central bank has made no bones about the need for lowering the fiscal deficit. The governor’s statement says: “A bigger risk to both short-term economic management and to medium-term economic prospects emanates from the large fiscal deficit. As the recovery gains momentum, it is important that there is coordination in the fiscal and monetary exits. The reversal of monetary accommodation cannot be effective unless there is also a rollback of government borrowings. It is imperative, therefore, that the government returns to a path of fiscal consolidation which can begin with a phased rollback of the transitory components.”
Simply put, the governor is saying that the Budget should start the process of rolling back the tax concessions.
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There’s reason enough to be worried, simply because the budgeted fiscal deficit for 2009-10, at 6.8% of gross domestic product (GDP), is the highest in 15 years, and unless the government pares its deficit, there’s a risk of interest rates starting to go up once liquidity really tightens. Banks’ credit-deposit ratios are high, bond yields are much higher than they were at this stage of the recovery during the last cycle and, as Gaurav Kapur, senior economist with ABN AMRO Bank NV, points out, the Reserve Bank of India (RBI) doesn’t have much ammunition up its sleeve in the shape of market stabilization scheme securities to smoothen liquidity if it gets too tight. So the government will have to deliver on fiscal consolidation if it wants the recovery to be sustained.
RBI governor D. Subbarao has said that he has, while formulating the credit policy, assumed that the government will roll back its fiscal deficit to 5.5% of GDP in the Budget, an assumption based on the mid-term fiscal policy statement of the government. The central bank has also assumed that government borrowing, at the net level, will be about the same as last year, although the gross amount of borrowing will increase, because redemptions are higher in 2010-11. And the governor’s press statement says bankers “felt that if the government borrowings next year are large, they could put pressure on resources and interest rates as credit is expected to pick up significantly”.
A. Prasanna, senior economist with ICICI Securities Ltd, points out that the gross amount of government borrowing affects sentiment in the bond market. He feels that with the borrowing programme being front-loaded, bond yields may rise during the first two quarters of the next fiscal. That’s a concern the government must address.
What will GDP growth be like in the next fiscal? The medium-term fiscal policy statement had assumed real GDP growth at 6.5% in 2009-10, which would increase to 8% in 2010-11. But here’s the catch—the statement also says that gross tax revenues would go up from 10.9% of GDP in the 2009-10 budget estimates to 11.9% of GDP in 2010-11. That’s even higher than gross tax receipts of 11.6% of GDP, according to the revised estimates for 2008-09, and a clear indicator that, at least at the time of the last budget, the government envisaged a rollback of the stimulus.
But as Sujan Hajra, chief economist with Anand Rathi Securities, says, it’s unlikely that the government will move excise duties back to 12% if it wants to introduce a goods and services tax later on at around 8%. Instead, he points to one-off expenses in the 2009 budget that will not recur, which will save the government quite a bit. According to a presentation by RBI deputy governor Subir Gokarn, the total stimulus amounted to 2.4% of GDP in 2008-09 and 1.8% of GDP in 2009-10. Of this 1.8%, the medium-term fiscal statement talked of a rollback of 1% of GDP. In other words, not all the stimulus needs to be rolled back. Hajra also says that RBI’s dividend payment to the government could be substantially larger, given the fact that it has already attained its target for building up a contingency reserve. There’s also government divestment of its stake in public sector undertakings, the list of which is already available. And, finally, tax receipts should rise given the higher growth.
The market will also be watching the quality of government spending. Vetri Subramaniam, head of equity funds at Religare Mutual Fund, says that in spite of higher growth investment, demand is still not robust and continued government support for infrastructure is essential.
Unlike last year, we no longer have a rising tide of excess global liquidity that will lift all boats. One of the reasons for the euphoria when the election results came out was that the government would be a pro-reform one, resulting in a premium for the country’s markets. That hope has largely been belied. In this Budget, without the crutch of stimulus spending, there’s all the more reason for the government to do its bit to maintain the India premium.
Manas Chakravarty takes a weekly look at trends and issues in the financial markets. Your comments are welcome at firstname.lastname@example.org