The fiscal math defies summing up any which way. Just when it seemed that heads in the finance ministry were doing just that, a rude jolt was dealt to the bond markets last week with the announcement of a higher than budgeted market borrowing in the second half of the year. Yields shot up by 10 bps to 8.44%, a stormy turn from a steady sail of past two months. This is a shock markets could have done without, given the already troubled macro dynamics from inflation, current account and fiscal deficits even as the global environment deteriorates by the day.
The negative surprise only consolidates expectations of a fiscal slippage this year, although the fiscal deficit target (4.6% of GDP) remains unchanged: The additional borrowing of Rs 528 billion (bn) is in lieu of a Rs 350 bn shortfall in small savings, caused by savers’ migration to higher-return bank deposits, and a Rs 170 bn drop in start-up cash reserves. But the change in composition of budgetary financing does little good to the government’s credibility. This is yet another instance of its sums going wrong, earlier ones being the overoptimistic growth forecasts, the countless hits and misses of the inflation trajectory and the unexpected issuance of cash management bills to tide over the gap caused by the unprecedented tax refunds by the government’s own revenue wing.
Then again, the harder effects of this upset: Long-term yields are now expected to range anything between 8.5-8.7% - close to the 8.8-9.4% of June-September 2008 when WPI inflation raged at 11% year-on-year. Private sector demand could be potentially crowded out as the festival season begins; markets expect the central bank to inject liquidity through open market operations and contain bond yields, although there’s low probability of that at the moment – nonfood credit growth is currently 13-14% month-on-month on a seasonalized, annual basis, and banks are highly liquid with statutory reserve holdings at 31%, way above the mandated 24%. But a return of the familiar hand-in-glove, fiscal-monetary operation is a potential headache for an inflation-worried central bank.
What about the fiscal deficit target? Annual growth in gross tax revenues (26%, direct; 24%, indirect) exceeds the budgetary assumption of 18.5% growth so far, but the real miss is the disinvestment target of Rs 400 bn, against which only Rs 11 bn stands realized. Actually, a stock market revival could offset poor macroeconomic management in a stroke: the current account deficit via higher capital inflows; fiscal deficit through successful asset sales and a stronger currency support to oil subsidies and inflation. No wonder, serious attention is being paid to revive it, viz. possible lowering of the securities transaction tax (STT), uniform stamp duty rate structure, etc.
With India’s unfailing capacity to surprise, the target could well be met by a stretch even as tax revenues slow ahead but falling commodity prices attract capital back into the economy.
Renu Kohli is a macroeconomist and a former staff member of the International Monetary Fund and the Reserve Bank of India.