UBS warns that there is a risk of the central government breaching its fiscal deficit target of 3.3% of GDP by at least 20 bps in FY19 unless it adjusts expenditure or non-GST revenue collection is higher than budgeted
Mumbai: India’s fiscal position is likely to worsen ahead of the general election in 2019, UBS Securities India Pvt. Ltd said. As global uncertainties escalate due to trade wars and rising global crude oil prices, emerging market economies running twin deficits, including India, are likely to face financial market volatility and downside risks to their growth outlook, the brokerage said in a report.
“Even as the central government remains committed to fiscal consolidation, the lower-than-expected GST collection, rising states’ fiscal deficit, and the risk of populist spending ahead of 2019 polls is keeping markets on tenterhooks regarding possible fiscal slippage," economist Tanvee Gupta Jain and analyst Gautam Chhaochharia wrote in a report on 8 August.
India’s trade deficit widened to a five-year high in July and the local currency tanked to a record low of 70.40 to the US dollar. On Thursday, the home currency ended at 70.16 a dollar, down 0.38%, from its Tuesday’s close of 69.89. Trade deficit widened to $18.02 billion in July, government data showed on Tuesday.
UBS warned that there is a risk of the central government breaching its fiscal deficit target of 3.3% of GDP by at least 20 basis points in FY19 unless it adjusts expenditure or non-GST revenue collection is higher than budgeted. State governments also need to fund additional spending needs (including farm loan waivers, higher wages and salaries), which are likely to keep their balance sheets stretched.
Excluding one-off revenues like divestment and UDAY (a scheme to financially turn around state electricity boards), UBS estimates indicate that the consolidated deficit widened to 7.2% of GDP in FY18 from 6.6% of GDP in FY17 and will likely remain high at 6.9% of GDP in FY19.
UBS said that while the government can use a fiscal push to support growth and meet political objectives ahead of elections, any increase in government spending to boost consumption could delay a much-needed recovery in the investment cycle, which is crucial for sustainable growth. “While India’s weaker fiscal position and higher public debt relative to peers do not pose any immediate threat to the country’s debt sustainability, we believe they are inflationary," the note said.
UBS expects the Reserve Bank of India to keep interest rates on hold over the next six months, and that any worsening in the government’s fiscal position and the quality of public spending could lead to more tightening later. It feels that higher bond issuance would also put pressure on the longer end of government securities’ yields for both the centre and the states.
Pursuing a tight fiscal policy will hold down inflationary pressure and facilitate a much-needed recovery in the investments cycle, which is crucial for sustainable growth.
UBS also said if the global crude oil prices rise further, the government will be under pressure to lower the excise duty on gasoline and diesel, which will further constrain its balance sheet. It estimates that every Re1/litre cut in the excise duty reduces government revenue collection by $2 billion (0.1% of GDP).
Meanwhile, India Ratings and Research has revised down its FY19 gross domestic product (GDP) growth to 7.2% from its earlier forecast of 7.4%. The key reason for this is the upward revision in the estimation of inflation for FY19 because of increasing crude oil prices and the government’s decision to fix the minimum support prices of all kharif crops at 1.5 times of the production cost. The rating agency said that rising trade protectionism, depreciating rupee and no visible signs of the abatement of the non-performing assets of the banking sector are major headwinds for the economy.
However, it expects the central government to meet its fiscal deficit target of 3.3% of GDP in FY19.
So far this year, the rupee has weakened 9%, while foreign investors have sold $140.10 million and $5.34 billion in equity and debt markets, respectively. Crude prices have increased 6% in 2018 so far.
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