Budget 2020 India: Fiscal policy has already played a counter-cyclical role in FY20. Because of low growth, revenues are weak and expenses haven't been forcibly cut, resulting in a higher fiscal deficit. FY20 fiscal deficit will likely come in at 3.8% of GDP, higher than the 3.3% budgeted for the year, but under the FRBM escape clause, the government can let the deficit widen by up to 0.5% of GDP.
Alas, the 0.5% of GDP slippage is not where it ends. Over the last few years, some on-budget expenditures have been pushed off-budget. Including investments by National Small Savings Fund in PSUs, bank recapitalisation bonds, special bonds issued by the government and other fully serviced bonds, the 'true' fiscal deficit of the Centre in FY20 is around 5% of GDP. Once the state government fiscal deficit and PSU borrowings from all sources is added, the overall public sector borrowing comes in at an elevated 8.6% of GDP in FY20.
The 'investible resources' are also likely to be about 8.6% of GDP. At these levels, the public sector is exhausting all domestically available savings, leaving no investible surplus for private investment.
FY21 will be challenging because 1) growth is likely to remain under potential, resulting in clamour for more government spending, 2) the one-time special RBI dividend (of 0.3% of GDP in FY20) will not be around anymore, and 3) room for extra borrowing is narrowing-G-sec spreads are elevated and incremental market borrowing may be too costly. Also, the Centre relied heavily on NSSF over the last few years.
Fiscal consolidation will be tough. But the Centre may attempt it, with plans to strengthen GST and the announcement of a large asset sales plan, perhaps double the privatisation receipts in FY21. Despite the best of efforts, the government may only be able to consolidate marginally. We are assuming a fiscal deficit of 3.7% in FY21, versus 3.8% in FY20. The risk to this view is that the Centre may go with a more ambitious consolidation plan on February 1, but that may be difficult to achieve.
These steps can help achieve a more stable and welcoming environment for investment and growth:
Better implementation of existing schemes: PM Kisan can be extended to more rural Indians and qualification can be made simpler. Asset sales must be sped up. The GST regime must move towards a single-rate system with very few exemptions.
Credible numbers and medium-term consolidation plan: The budget should be based on realistic numbers. While the fiscal deficit is likely to widen in FY20, a credible plan will likely be brought to consolidate gradually over the medium term.
Certainty in tax and other policy: The budget would do well to signal the likely trajectory of different tax rates or the thinking around them for the next few years, as also certainty on FDI and trade policies.
Clear overdue payments: The government is likely to find a way to enforce timely payments to vendors.
The government can look at imparting a demand stimulus, but only if supported by asset sales. There is a clamour for cuts in the personal income tax rate. A cut in indirect taxes would reach much of the population, but that can't be easily done given decisions are made by the GST Council.
There could be some relief on the personal income tax front. But this will come at a cost. Such relief, say, in the form of raising the exemption threshold, would contract further the already small number of people paying income tax (about 4.5% of the population). Rough calculations show that if the threshold is raised from Rs 2.5 lakh to Rs 4 lakh, it would contract the income tax net by about a third. The focus also has to be on strengthening the bankruptcy regime, untangling stalled investments and reducing government mandates on PSBs, to revive credit offtake sustainability.
FY21: Impact on growth, borrowings and policy rate
With the Centre's fiscal deficit at 3.8% of GDP, a large positive fiscal impulse has been imparted in FY20. If the fiscal narrows next year, will the impulse become negative? Not necessarily. If a higher proportion of revenues come on the back of asset sales, it will not be as taxing to growth. Asset sales will likely double in FY21, and, thus, fiscal impulse will be neutral in FY21. Capex bill in FY21 is unlikely to rise beyond the current level of 1.7% of GDP.
Given a large fiscal deficit in FY 20, the pressure on net market borrowings have risen. The Centre, so far, has cancelled its buyback plans, and is likely to rely more on NSSF than budgeted. This may cap some of the rise in net market borrowings. Still, new borrowings are likely to grow faster than nominal GDP growth. This has been weighing on the markets. Moving on to FY21, with limited incremental space left at the NSSF, the reliance on market borrowings could rise again. With substantial switch/ conversion auctions, the government has been able to lower the repayments bill for FY21. As a result, gross market borrowings are likely to remain unchanged in FY21.
Inflation may fall from 7.4% in January to c4.5% by mid-2020. This will be above the 4% target, but RBI will likely prioritise growth, and cut rates by a final 25bps in the June meeting, taking the repo rate to 4.9%.
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Co-authored with Aayushi Chaudhary, economist, India, HSBC Securities and
Capital Markets (India) Private Limited
Edited excerpts from HSBC Global Research's India Budget
Preview, January 24, 2020