Slower deficit re­duc­tion raises risk of rate hikes

The Pak Banker - - FRONT PAGE - Kaushik Das

We had hoped that the FY18-19 Union bud­get would sur­prise mar­kets pos­i­tively by set­ting a fis­cal deficit tar­get of 3% of gross do­mes­tic prod­uct (GDP). In­stead, the au­thor­i­ties chose to adopt a slower con­sol­i­da­tion agenda to sup­port the on­go­ing re­cov­ery in growth; tar­get­ing fis­cal deficit at 3.3% of GDP for FY19, with an up­ward re­vised 3.5% of GDP in FY18.

The FY19 bud­get tar­gets rev­enue at 9.7% of GDP, un­changed from the likely FY18 out­turn, while to­tal ex­pen­di­ture is ex­pected to re­duce to 13% of GDP (from 13.2% of GDP in FY18). The rev­enue es­ti­mates are broadly re­al­is­tic and cred­i­ble; in­deed, rev­enue as a share of GDP is ex­pected to re­main un­changed at 9.7%, while nom­i­nal GDP growth is ex­pected to im­prove to 11.5% year-on-year (y-o-y) in FY19 (from 9.5-10% y-o-y in FY18). The au­thor­i­ties have tar­geted a 0.3% per­cent­age point GDP in­crease in net tax rev­enue (to 7.9% of GDP in FY19 vs 7.6% of GDP in FY18), but to­tal rev­enue re­mains un­changed at 9.7% of GDP, as non-tax rev­enue is es­ti­mated to be lower by 0.3% per­cent­age points of GDP in FY19 com­pared to FY18 (1.8% of GDP vs 2.1% of GDP).

Set­ting the dis­in­vest­ment tar­get at Rs80,000 crore (0.4% of GDP), lower than the likely FY18 out-turn (Rs1 tril­lion; 0.6% of GDP), is a pru­dent strat­egy as this year's strong per­for­mance may be­come dif­fi­cult to re­peat in FY19, if fi­nan­cial mar­ket volatil­ity in­creases.

On the ex­pen­di­ture front, the bud­get an­nounced in­creased al­lo­ca­tion in growth-crit­i­cal ar­eas of ru­ral de­vel­op­ment, in­fra­struc­ture, agri­cul­ture, and roads/trans­port/high­ways but even then the over­all spend­ing tar­get has been set lower at 13% of GDP for FY19 ver­sus 13.2% of GDP ex­pected out-turn in FY18. To­tal spend­ing is ex­pected to in­crease 10% yo-y in FY19, lower than the nom­i­nal GDP growth rate (11.5% y-o-y), and hence does not give rise to fis­cal sus­tain­abil­ity con­cerns. Bud­get­ing, as a share of GDP, lower out­lays for key items such as in­ter­est pay­ments, de­fence and sub­si­dies (th­ese three items to­gether con­sti­tute half of to­tal ex­pen­di­ture) is com­mend­able, but th­ese items are sub­ject to un­cer­tain­ties, given the un­cer­tainty re­gard­ing the global oil price trend, in­ter­est rate tra­jec­tory and var­i­ous geopo­lit­i­cal risks. Nev­er­the­less, the pro­jec­tions on the ex­pen­di­ture side broadly re­al­is­tic.

But is the fis­cal stance sup­port­ive of growth? In­dia's fis­cal pa­ram­e­ters tend to be some­what un­con­ven­tional, with some one-offs treated above the line. It is im­por­tant to con­trol for them to as­sess the true fis­cal stance. Based on the bud­get num­bers, we es­ti­mate that once pri­va­ti­za­tion (or dis­in­vest­ment) rev­enue and bank re­cap­i­tal­iza­tion costs Rs10,000 crore likely bud­getary sup­port) are ex­cluded, the true pri­mary deficit works out to 0.9% of GDP in FY18, which is ex­pected to come down to 0.6% of GDP in FY19. Con­se­quently, the fis­cal im­pulse on growth (which we cal­cu­late by tak­ing the dif­fer­ence of pri­mary deficit be­tween each suc­ces­sive year) is likely to be mildly neg­a­tive (0.3% of GDP) or, at best, re­main neu­tral (if the cal­cu­la­tion is done on the ba­sis of head­line pri­mary deficit) in FY19, in line with the trend of the last sev­eral years. The re­vised es­ti­mates for FY18 show that the fis­cal stance was pos­i­tive for growth this year, with­out which eco­nomic mo­men­tum may have been hit fur­ther. But even with a higher-than-ex­pected bud­get and pri­mary deficit tar­get for FY19, the fis­cal stance is un­likely to be in­cre­men­tally ex­pan­sion­ary in the next fis­cal year, as per our anal­y­sis.

We also find that the qual­ity of fis­cal con­sol­i­da­tion (as mea­sured by rev­enue deficit to fis­cal deficit ra­tio) has de­te­ri­o­rated in FY18, af­ter im­prov­ing steadily since FY10. The rev­enue deficit to fis­cal deficit ra­tio was 81% in FY10 and was bud­geted to re­duce to 59% in FY18; in­stead, the ra­tio has in­creased to 74% as per the re­vised es­ti­mates. As per the FY19 bud­get es­ti­mate, the ra­tio is ex­pected to re­duce to 66.6% in the next fis­cal year, but will still be higher than the out-turn achieved in FY17 (59%).

It is en­cour­ag­ing to note that the gov­ern­ment has agreed to ac­cept the Fis­cal Re­spon­si­bil­ity and Bud­get Man­age­ment Act's rec­om­men­da­tion of stick­ing with a medi­umterm fis­cal con­sol­i­da­tion path. The re­vised fis­cal deficit tar­gets are 3.1% for FY20 and 3.0% for FY21, which are achiev­able given the ex­pected eco­nomic re­cov­ery and higher rev­enue po­ten­tial from the goods and ser­vices tax (GST).

From an out­put gap per­spec­tive, there is not enough jus­ti­fi­ca­tion for a rate hike in the near term; con­se­quently, an ear­lier-than-an­tic­i­pated rate hike cy­cle could po­ten­tially slow down the pace of re­cov­ery ex­pected in FY19.

The rev­enue es­ti­mates are broadly

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