11:35 March 07, 2010
The backdrop in which the finance minister will present the second budget of the current UPA government will be markedly different from the last budget. In June last year when the FM presented his budget, the world was staring at a very severe recession. India too had seen a sharp deceleration in economic activity, exports were declining and confidence was low. In the 9 months since, the world economic outlook has stabilized and is gradually turning for the better. Even in India, economic growth has accelerated and inspite of the drought FY10 will see higher growth than previous year. Exports are showing signs of turnaround, capital inflows have resumed and business confidence has recovered. Companies which had put on hold their capex plans are starting to revive them.
With the economic backdrop improving significantly especially domestically, India must now address its biggest medium term macro headwind – the bloated government finances. Central government fiscal deficit of ~7% for FY10 will be ~2x that of the level just two years back. Combined (centre + state) fiscal deficit will be above 10% in FY10 for the second consecutive year and public debt after declining (as % GDP) for 5 consecutive years is rising. Large government borrowings will raise serious questions about crowding out of private investment as well of upward pressure on interest rates threatening the recovery. Anemic demand from private sector for credit meant that the crowding out was not an worry in FY10 but that could change in FY11 onwards where private sector demand for credit will pick up. These high deficits were understandable when economy was growing at sub-par rate of 6-7% but with growth likely to be above 8% in FY11, the high fiscal deficit is unsustainable and needs to be brought back to sustainable levels (~3%) on a priority basis. We think the central government needs to start this process by announcing at least a 1ppt reduction in fiscal deficit for FY11 from ~7% of GDP for FY10. We think the government is cognizant of the need to reign in government finances and the whole focus of this year’s budget will be fiscal consolidation.
Though, this reduction in fiscal deficit will have to come about via both revenue augmentation and expenditure control, we expect revenue augmentation to play a larger role given the rigidities in government expenditure. Consequently, we expect the government to partially rollback the fiscal stimulus which would imply an increase in both excise and service tax rates. We expect excise duty to increase by 4% to 12% (still lower than the 14% rate before the fiscal stimulus) and service tax rate to go back to pre-fiscal stimulus level of 12%. While there is an understandable anxiety that a removal of fiscal stimulus might impact growth in sectors like Autos, we do not foresee any decline in growth rates beyond a couple of months. We also expect government to set an aggressive disinvestment target for FY11 (~Rs250-300bn). These two measures along with the conclusion of the much delayed 3G auctions should by themselves help reduce fiscal deficit by ~1ppt.
On the expenditure side, we expect the government to continue its rural focus with stepped up spending on key rural focused schemes like the National Rural Employment Guarantee Act, Bharat Nirman, and National Rural Health Mission etc. Increased spending on these schemes will offset the rollover of expenditures like Pay commission arrears and Agri-debt waiver which will not be there in FY11. Thus we do not expect any material reduction in government expenditure relative to the GDP.
On tax policies, we do not expect any major changes in direct tax rates either for individuals or corporate. However we do expect greater clarity on the direct tax code in terms of time line for implementation as well as possible amendments to the code based on feedback from the industry especially as relates to items like MAT. Similarly, on the indirect taxes, we expect a revised schedule for the implementation for the GST to be announced along with the rate structure as well as resolution of the contentious issue of compensation to the state governments for revenue loss incurred, if any, on transition to the GST. Given the importance of these two legislations towards having a simple, efficient and less litigious tax structure, lack of a clear roadmap for implementation of both the statutes would be a big negative in our view.
The other key issue we expect the budget to tackle is the issue of petroleum subsidies. Although subsidies are lower this year (FY10) because of lower crude oil prices globally, they are likely to rise next year due to sharp increase in demand due to positive outlook for the global economy, thereby frustrating government’s hope for fiscal consolidation. Consequently, we expect the government to act on the report of the Kirit Parikh committee and at least partially de-regulate petroleum product prices starting with petrol if not diesel.