First, today's bad news: India's GDP growth for the quarter ending December 2011 fell to 6.1%, below market expectations. That's the worst in three years and reflects a broadbased slowdown in manufacturing, mining and the services sector.
On the plus side, market consensus is that the business cycle has probably bottomed out. The rupee has rebounded somewhat from its precipitous decline from the end of last year and capital flows have returned in keeping with the resurgence in risk appetite for emerging markets.
Against this backdrop, the jury is out on whether finance minister Pranab Mukherjee will throw caution to the wind and implement populist measures for the budget for 2012/13, due to be presented on March 16. This time last year, Mukherjee unveiled a suitably populist budget with a view to shoring up support ahead of state elections.
The backdrop at that time was grim: high inflation, tight liquidity, a large fiscal and current account deficit and a slowdown in reforms. And, to varying degrees, these issues remain today: a large fiscal overrun, reforms stalled and the Congress-led coalition still battling to win back the electorate.
So at in the upcoming budget, the finance ministry will probably seek to balance inclusive, pro-poor growth measures with the need to be seen as fiscally responsible. It looks a difficult task - but the government might have more wriggle room than the bears expect. Here are some expected highlights, courtesy of Credit Suisse's crystal ball:
| Budget measures. As such, we believe Finance Minister Pranab Mukherjee is likely to announce an increase in the breadth of the services tax and, possibly, a rise in the excise and services tax rate itself, as well as an increase in subsidised fuel prices on 16 March. He may also set out a medium-term fiscal consolidation plan, involving further details concerning the introduction of the Direct Tax Code (DCT) and Goods and Services Tax (GST), both of which have been delayed. The finance minister will, however, do well to convince stakeholders of the credibility of such a program, in our view. Fiscal forecasts. Taking all this into account and building in our own, more pessimistic, economic growth forecasts, we expect the central government budget deficit to come in at 5.8% of GDP in 2012/13 (8.3% for the general government). This is actually a slight reduction from our previous 6% forecast, reflecting a more optimistic assumption about divestment and telecom spectrum receipts, but very similar to the probable outcome for 2011/12. We believe a further period of sub-par economic growth will continue to keep a firm lid on revenues, while the funding of the Food Security Bill, assuming it begins during the 2012/13 fiscal year, will put upward pressure on the deficit as well. |
So a couple of tax tightening measures are expected if they finally manage to get off the ground – the Goods and Service Tax (GST) has already been pushed back several times, while the Direct Tax Code is still being scrutinized by the slow-moving parliamentary standing committee.
More generally, the fiscal picture in India – the highest budget deficit and gross government debt relative to GDP in Asia - is not as grim as bears contend, giving the finance ministry some breathing space, according to Credit Suisse:
| Contrary to the belief of many, India is a long way from experiencing the kind of fiscal horror show that has engulfed many developed world countries in recent times. While the country’s (central and state) budget deficit is running at around 8% of GDP, similar to that of many western countries, India has the huge advantage of double-digit money GDP growth. With bond yields pegged back by captive buyers, in the form of the commercial banks, this means general government debt is falling rather than rising as a share of GDP in India. |
In fact, government debt/GDP ratio has been falling for eight years now:
What’s more, the Reserve Bank of India – which acts as government debt manager – “will keep a firm lid on bond yields even in the context of rising sovereign issuance”, ensuring that debt interest rate costs don’t rise sharply, keeping the debt to GDP ratio stable, says the CS analysts.
As an additional aid to containing yields, there is pent-up demand among foreign fixed income investors for Indian government paper. Foreign purchases of domestic bonds jumped to $8.4 billion between the end of November and late February, up from $2 billion in the previous ten months, after the government partially liberalized access to shore up the balance of payments position.
Of course, the deficit comes with a litany of opportunity costs. Government borrowing crowds out the private sector while inflationary nature of the fiscal gap has mitigated against the Reserve Bank of India's bid to lower interest rates and stabilize banking liquidity. However, it’s an open question about whether foreign fixed income portfolio managers will care about these macro-economic technicalities given the juicy 8% yield on offer for 10-year Indian government paper in a rapidly expanding economy with its own printing press.
Further reading:
Indian states: The first among equals - EM
Coverage of India - EM