ICRA expects a miss in the disinvestment target to cause the Government of India’s (GoI’s) fiscal deficit to print at Rs. 16.6 trillion or 7.1% of the GDP in FY2022, overshooting the budgeted target. With the state governments’ fiscal deficit projected at a relatively modest 3.3% of GDP in FY2022, the General Government fiscal deficit is estimated at ~10.4% of the GDP.

In the base case for FY2023, ICRA sees the GoI’s fiscal deficit moderating to Rs. 15.2 trillion or 5.8% of GDP. Although the planned ceasing of GST compensation could cause the state governments’ fiscal deficit to rise to the cap of 3.5% of the GSDP set by the Fifteenth Finance Commission, the General Government deficit would still compress to 9.3% of the GDP in FY2023.

According to Ms. Aditi Nayar, Chief Economist, ICRA Ltd: “With a palpable buoyancy in tax collections, we expect the GoI’s gross tax receipts to overshoot the budgeted amount by a healthy Rs. 2.5 trillion in FY2022. However, the net tax revenue gains to the GoI would be nullified by the expected large miss on receipts from disinvestment and back-ended spending, especially on those items that were included in the Second Supplementary Demand for Grants, such as food and fertiliser subsidies, export incentives/remissions under various export promotion schemes (such as MEIS and RoSCTL), equity infusion into Air India Assets Holding Limited, etc. Consequently, we expect the GoI’s fiscal deficit to print at Rs. 16.6 trillion in FY2022, exceeding the budgeted amount of Rs. 15.1 trillion”.

“The Union Budget for FY2023 will face some constraints owing to an expected slowdown in the growth in indirect taxes following the excise relief provided recently, and the moderation in nominal GDP growth to ~12.5% from the ~17.5% expected in FY2022. Besides, macro-economic uncertainty would linger on account of the potential emergence of new mutations and fresh waves of Covid-19, which may eventually necessitate additional spending by way of extension of free foodgrains scheme and higher spending on MGNREGA. Given this backdrop, the GoI’s ability to cement higher growth in direct taxes and garner disinvestment receipts would play a critical role in determining the extent of the fiscal consolidation that is feasible in FY2023,” Ms. Nayar added.

“Notwithstanding the lingering uncertainty, we believe that the Union Budget FY2023 should ring-fence the funds that can realistically be absorbed for capital expenditure and infrastructure spending. Such outlays will help fuel the investment cycle, create employment opportunities and improve domestic demand. At the same time, rationalising of Centrally-sponsored schemes and Central sector schemes would enhance fiscal space, and further improve the quality/efficiency of expenditure,” Ms. Nayar said.

Given the uncertainty, ICRA has highlighted two scenarios for the fisc – a base case (impact of current Covid wave limited to Q4 FY2022 and no fresh Covid wave in FY2023) and an adverse case (moderate Covid wave in FY2023). In the base case, the GoI’s fiscal deficit is pegged at Rs. 15.2 trillion or 5.8% of GDP, with net G-sec issuance placed at Rs. 9.1 trillion.

In the adverse case, ICRA projects the fiscal deficit at a higher Rs. 17.9 trillion (or 6.9% of GDP), driven by two major outlays intended to bolster confidence amongst households, amidst lower indirect taxes and compressed disinvestment flows. First, a likely distribution of free foodgrains for a period of six months under the Pradhan Mantri Garib Kalyan Anna Yojana (PMGKAY) could cost Rs. 0.9 trillion, while spending on the MGNREGA to support the rural economy could necessitate an additional outlay of Rs. 0.3 trillion over and above our baseline estimate.

“While ICRA believes that the continued formalisation of the economy would protect the downside in direct taxes, curtailed consumption could dampen indirect taxes. In the adverse scenario, we foresee a potential net loss of revenue receipts of Rs. 1.0 trillion, along with a shortfall of Rs. 0.5 trillion in the disinvestment receipts. In this scenario, the GoI’s net market borrowings are placed at a higher Rs. 10.7 trillion,” Ms. Nayar added.

Assuming that 80% of the states’ estimated fiscal deficit of Rs. 9.1 trillion is funded by the State Development Loans (SDLs), suggests a net issuance of Rs. 7.3 trillion. This entails total Centre and state net dated market borrowings for FY2023 in a range of ~Rs. 16.4 trillion (base case) to Rs. 18.0 trillion (adverse case). Adding the redemption of G-sec and SDL indicates substantial gross borrowings in the range of ~Rs. 22.6 trillion to Rs. 24.3 trillion in FY2023, up from an estimated Rs. 20.9 trillion in FY2022. The rise in dated borrowings will exert upward pressure on yields, exacerbating the impact of the expected hike in the repo rate of 50 bps in the coming fiscal.

The higher deficits and continued lack of clarity on medium-term consolidation plans in India’s latest budget add risks to Fitch Ratings’ projection of a downward trajectory in government debt/GDP. The degree to which planned higher capex supports GDP growth and offsets these risks is an important consideration for the sovereign rating. Risks around the sustainability of the downward debt trajectory were a key factor behind our decision to maintain a Negative Outlook when we affirmed India’s ‘BBB-’ rating in November 2021.

The Union budget presented by the government on 1 February 2022 continued to emphasise support for growth over fiscal consolidation. Deficit targets were slightly higher than we had anticipated when we affirmed the rating; the budget flags a revised deficit of 6.9% of GDP for the fiscal year ending March 2022 (FY22), against our 6.6% forecast. The planned 6.4% of GDP FY23 deficit is also higher than our 6.1% forecast. The borrowing allowance for states, which was maintained at 4.0% of gross state domestic product in FY23, keeping it above the pre-pandemic level of 3.0%, poses further risk to our fiscal forecasts.

The higher deficit in FY22 reflects greater capex, which is partly to clear Air India’s liabilities, as well as increased spending in response to Covid-19 virus outbreaks and shortfalls on divestments. Revenue receipts, excluding divestments, were 16% above the targets in last year’s budget.

The government plans to raise FY23 capex by 24% above the revised FY22 estimates to around 2.9% of GDP. The budget sees revenue receipts, excluding divestments, increasing by about 9.6% from revised FY22 estimates and the divestment target is set at INR650 billion (0.3% of GDP), against a revised estimate of INR780 billion in FY22.

We believe the budget offers a degree of confidence in the near-term fiscal outlook. The nominal GDP growth target for FY23 of 11.1% looks credible and revenue targets, including those for divestments, are realistic. The government also appears to be following through on its efforts to improve budget transparency by keeping previously off-budget spending on budget, limiting downside surprises.

However, there is less clarity around the medium-term outlook. The broad target of reducing the deficit to 4.5% of GDP by FY26 remains, but the budget offered few details on how this will be achieved. The higher FY23 deficit also implies significant fiscal tightening between FY24 and FY26 to meet the target. Fiscal consolidation tended to fall short of government goals prior to the pandemic, suggesting risks to the medium-term target and debt trajectory.

The planned acceleration in infrastructure capex will provide a fillip to near- and medium-term growth, if fully implemented. This could offset downside risks to our real GDP growth forecast, which stands at 10.3% in FY23 and about 7% on average through to FY27. The downside risks include disruption to economic activity associated with the Covid-19 pandemic, recent reform slippage and weakness in household income growth, which may constrain the capacity of private consumption to support growth. The budget provided no significant new transfers to households or major structural reform initiatives.

India’s public debt/GDP ratio, at about 87% in FY21, is well above the median of around 60% for ‘BBB’ rated sovereigns. We revised the Outlook on India’s rating to Negative, from Stable, in June 2020, partly owing to our assumptions about the impact of the pandemic on public finance metrics. The government has little fiscal headroom at its current rating level to respond to possible shocks to growth.