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India Budget: Time to shape up
Indian federal budgets are like pregnancies – the uncertainty in the run-up
to the delivery typically has little to do with the eventual outcome. The
forthcoming Budget 2011-12 takes place at a time when there are low
expectations from the government, which has been mired in a series of
corruption scandals, governance issues, mismanagement on food inflation,
and a general disappointing delivery on reforms. With economic growth
having rebounded, the government cannot use the same liberal spending
script of the last two budgets. Indeed, the most important message from the
upcoming budget should be that of fiscal consolidation, which is vital for
near-term inflation management and for medium-term fiscal sustainability.
The fiscal deficit for 2010-11 is likely to be 5.0-5.2% of GDP (Budget: -5.5%),
and the target for 2011-12 will probably be in 4.6-4.8% of GDP. Agriculture,
rural and urban infrastructure, and the employment guarantee scheme will
be the key focus. While corporate and personal income tax rates will remain
unchanged, the exemption limit for individuals (INR160,000) could be
raised slightly due to higher inflation. As in recent years, the government
will again widen the coverage of the service tax (10.0%), and also reverse
the stimulus measures that were announced to deal with the global
downturn. Net borrowing by the government, which is what ultimately
matters for the local bond market, will be marginally higher at INR3.6trn
but won’t cause any heartburn. The government will signal its commitment
to implement the direct tax reforms and the GST from April 2012.
Rajeev Malik
Need for restraint on spending
The federal budget for 2011-12 scheduled for 28 February takes place in the
background of a dramatically different domestic and external economic setting
than was the case with the previous two budgets of the Congress-led
government headed by Prime Minister Manmohan Singh. Given the
unprecedented uncertainties due to the global credit crisis, fiscal measures were
liberally used by India to cushion the hit to growth. Indeed, the federal
government’s fiscal deficit, which had been on an improving path, reversed
course in 2008-09 as the government undertook counter-cyclical measures to
deal with the downturn (Figure 1).
Consequently, the federal government’s fiscal deficit jumped to 6.0% of GDP
in 2008-09 and to 6.7% in 2009-10 (2007-08: -2.5% of GDP). The
consolidated fiscal deficit, which includes the states’ fiscal deficit, increased to
8.5% of GDP and 9.7% in the same years (2007-08: -4.1%). The results of the
aggressive fiscal and monetary policy measures were favourable, with GDP
growth of 6.8% in 2008-09, the fiscal year that captured the brunt of the hit
from the global crisis, and improving to 8.0% and 8.6% in 2009-10 and 2010-
11 (as announced in the official advance estimate), respectively.
However, now the global recovery appears to be gradually on the mend,although there are still meaningful risks to the economic outlook. Also, India’s
growth has rebounded despite an uninspiring recovery in investment (thanks
partly to some ministries), and a combination of cost-push and demand-pull
factors have reignited worries over inflation. Indeed, the script used in the
previous two budgets cannot be used again, and the government’s consolidated
debt/GDP of around 74% is high and needs to be reduced.
A key part of the multi-pronged strategy to tackle inflationary pressures has
to be faster reduction in the fiscal deficit, especially via spending restraint.
Related to the fiscal consolidation is the need for fiscal policy to be working
in tune with monetary policy to ensure a sustainable and elevated noninflationary
economic growth. So far, the bulk of the heavy lifting on policy
normalisation has been done by the RBI, and it is time for the government
to deliver its share. Ironically, the government’s actions are partly
responsible for adding to the current inflationary pressures due to a
combination of pumping up aggregate demand via heavy spending and from
inaction in removing structural rigidities that have only worsened the
supply-demand imbalances.
Lower fiscal deficit on the cards
The fiscal deficit in the current fiscal year (2010-11) is actually shaping up
to be much better than the assumption in the budget that was announced in
February 2010. While the windfall from the spectrum auction was initially
expected to narrow the fiscal deficit, the additional increase in spending of
around 1.6% of GDP via two supplementary demands for grants reversed
that expectation. However, the actual pace of that spending has been slow.
Consequently, the fiscal deficit’s run rate through December has been much
better than expected.
In April-December 2010, the fiscal deficit was only 44.9% of the fullyear
budget target, compared to 77.3% in the same period last fiscal year. In
April-December, total spending increased 11.2%YoY, while total revenue
surged 54.8%, led by tax revenues (+27.2%) and non-tax revenues
(+136.4%). Divestment of INR227bn (around 57% of the budget
assumption of INR400bn) has been booked through December. The slower
growth in personal income tax collection should be viewed in the context of
the broadening of the tax slabs that was announced in February that would
have lowered the revenue intake.
The 2010-11 fiscal deficit is expected to be around 5.2% of GDP (inclusive of allsubsidy payments), lower than the fiscal deficit of 5.5% of GDP that was announced
in Budget 2010-11. However, there are two factors that need to be taken into account
in interpreting that better-than-expected outcome: (1) the advance annual nominal
GDP for 2010-11 is estimated to be 14% higher than what was assumed in the
budget; and (2) the original budget was underfunded for subsidies.
The fullyear total revenue and spending will likely be higher than what was
assumed in the budget, but the fiscal deficit will still show an improvement.
Further, it is expected that the government will tactically end the year with a
higher-than-usual cash surplus, which will be used towards the financing of next
year’s fiscal deficit.
What matters more from the perspective of the local bond market is the net
borrowing by the government as that is not affected by the revision to nominal
GDP. Net borrowing by the government for 2010-11 was marginally revised
lower during the year by INR100bn to INR4.47trn (Figure 3). We expect the
government’s net borrowing for 2011-12 to be around INR3.6trn (+4%) in
2011-12, while gross borrowing will be lower by 5% at around INR4.3trn
mainly because of lower redemptions next year. If actual borrowing is close to
our expectation, the local bond market is unlikely to react negatively
Low expectations from the upcoming budget
Ironically, everyone wants the fiscal deficit to be fixed but no one wants to
pay for it. Overall, the government will stay the course with a gradual pace
of fiscal consolidation. Last year it had guided for shrinking the fiscal
deficit in 2011-12 to 4.8% of GDP, but it could strive to better this at 4.5-
4.8% given the recent upward revision in nominal GDP (Figure 4).
Attaining that goal will be challenging in the absence of the spectrum
auction intake of around 1.4% of GDP 2010-11, and will have to rely on tax
buoyancy and spending restraint. Even at a slightly lower fiscal deficit (as
% of GDP) next year, the borrowing by the government will be sizeable,
and will create headaches for the RBI on liquidity management, especially
if capital inflows are more subdued.
Among the key initiatives, the government’s flagship rural employment
guarantee scheme, along with rural and urban infrastructure and
agriculture will be the thrust areas. As is always the case in India, effective
implementation will be as important as higher spending. However, spending
is where the government’s commitment to fiscal consolidation will have to
take a litmus test, and the surge in expenditure in recent years has to be
corrected now (Figure 5). The government also needs to move ahead with
the reform agenda and make a convincing case of its action plan towards
encouraging FDI, injecting life into the corporate bond market and
infrastructure that must be low on sound bites and high on action.
A part of the policy response in managing food inflation has to be with
reforming the local agriculture pricing mechanism, shrinking the big gap
between retail and wholesale prices, promoting greater investment in
agriculture infrastructure to increase productivity and boosting irrigation.
Liberalizing FDI in retail will also help in checking overall inflation, not
just food inflation.
Divestment: This will probably be pegged at slightly higher than this year’s
INR400bn to take into account divestment not done in the current year.
Individual exemption limit: It is possible that, given the public uproar over
higher-than-expected inflation, the government might announce a small
increase in the exemption limit (currently at INR160,000) for individuals,
with a bigger adjustment already scheduled for 2012-13 (to INR190,000)
when the Direct Tax Code (DTC) is expected to be implemented.
Service tax: The government in recent years has been widening the
coverage of the service tax (currently 10.0%), and will again widen its
coverage to include more services. Still, rather than focusing on a list of
transactions on which the service tax is applicable, it is far more efficient to
have the service tax on all transactions except for a short list of exemptions.
Excise duty: The government could either reverse the cut in the excise
duty (currently: 10.0%) by 2ppt to the pre-crisis level of 12% or, rather than
increasing the excise duty, it might lower the excise exemption as a step
towards eventual rationalisation under the GST. The latter option should be
preferred, in our opinion.
Subsidies: Subsidies (food, fertilizer, and fuel) will probably again be
underfunded in the budget. In 2010-11, the government had budgeted direct
subsidies of 1.7% of GDP, but the actual outcome is likely to be around
2.3%. Cutting subsidies will remain a pressing issue, and, rather than wait
for the right time, the government should at least move forward in small
steps if a full one-off deregulation of fuel prices is not feasible.
There is little flexibility that the government has in certain categories of
spending such as defence, debt servicing and subsidies, which together account
for around 46% of the government’s total expenditure (Figure 6). The
government can move to cut the subsidy bill either in a managed manner or it
could be forced on it in the form of a crisis-like situation that will also extract
high political and economic costs.
GST implementation remains uncertain
Weak fiscal dynamics have always been India’s Achilles’ heel. Fiscal reforms
in the pipeline cover both direct and indirect taxation, and the expected reform
of subsidies. Of the two tax reforms, the government has already submitted the
Direct Tax Code (DTC) Bill in Parliament. It will likely become effective from
1 April 2012 (one year later than initially believed).
The reform of indirect taxes, via the introduction of a Goods and Services Tax
(GST), is moving more slowly. That is mainly because it requires the federal
government and the states to agree on several terms. Latest indications are that
the government proposes to introduce the Constitutional Amendment Bill in the
second half of the Budget Session of Parliament. This could pave the way for
the implementation of GST from 1 April 2012. However, as experience shows,
things in India are not done until they are actually done.
Separately, the government last year adopted a partial deregulation of the
administered prices of petroleum products. This is a positive for long-term
fiscal consolidation, despite the short-term one-off impact on inflation. It goes
without saying that a big-bang elimination of subsidies is unlikely given the
current inflationary pressures. Indeed, in the near-term, additional spending
owing to the launch of a Food Security Bill will increase the subsidy burden.
Much more needs to be done to cut subsidies, but it will probably occur at a
glacial pace that is dictated by a combination of inflation, fiscal and politics.
Sharply higher oil prices remain a key risk
India is vulnerable to rising oil prices, and the impact on the fiscal from higher
oil subsidies is a critical risk to the sustainability of fiscal improvement. The
impact on the fiscal position is partly driven by the government’s decision to
pass higher oil prices onto consumers.
As crude oil price rises, the government will not be able to avoid increasing
retail prices at all, despite the political pressure of the upcoming state
legislative elections. However, the magnitude and timing will be held ransom
to the political setting, fiscal trends and the pace of increase in crude oil prices,
and the government will probably do the least that is possible.
On our calculations, the impact on the fiscal deficit of a USD10/bbl increase
in crude oil will be an additional INR100-150bn (approx. 0.2% of GDP).
That assumes that the government foots a third-to-half of the increase in the
revenue foregone by oil companies because of selling fuel at administered
prices. Oil subsidies are generally underfunded in the budget at the time of
its announcement, although all subsidy payments during the year will be
included in the revised budget estimate.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
India Budget: Time to shape up
Indian federal budgets are like pregnancies – the uncertainty in the run-up
to the delivery typically has little to do with the eventual outcome. The
forthcoming Budget 2011-12 takes place at a time when there are low
expectations from the government, which has been mired in a series of
corruption scandals, governance issues, mismanagement on food inflation,
and a general disappointing delivery on reforms. With economic growth
having rebounded, the government cannot use the same liberal spending
script of the last two budgets. Indeed, the most important message from the
upcoming budget should be that of fiscal consolidation, which is vital for
near-term inflation management and for medium-term fiscal sustainability.
The fiscal deficit for 2010-11 is likely to be 5.0-5.2% of GDP (Budget: -5.5%),
and the target for 2011-12 will probably be in 4.6-4.8% of GDP. Agriculture,
rural and urban infrastructure, and the employment guarantee scheme will
be the key focus. While corporate and personal income tax rates will remain
unchanged, the exemption limit for individuals (INR160,000) could be
raised slightly due to higher inflation. As in recent years, the government
will again widen the coverage of the service tax (10.0%), and also reverse
the stimulus measures that were announced to deal with the global
downturn. Net borrowing by the government, which is what ultimately
matters for the local bond market, will be marginally higher at INR3.6trn
but won’t cause any heartburn. The government will signal its commitment
to implement the direct tax reforms and the GST from April 2012.
Rajeev Malik
Need for restraint on spending
The federal budget for 2011-12 scheduled for 28 February takes place in the
background of a dramatically different domestic and external economic setting
than was the case with the previous two budgets of the Congress-led
government headed by Prime Minister Manmohan Singh. Given the
unprecedented uncertainties due to the global credit crisis, fiscal measures were
liberally used by India to cushion the hit to growth. Indeed, the federal
government’s fiscal deficit, which had been on an improving path, reversed
course in 2008-09 as the government undertook counter-cyclical measures to
deal with the downturn (Figure 1).
Consequently, the federal government’s fiscal deficit jumped to 6.0% of GDP
in 2008-09 and to 6.7% in 2009-10 (2007-08: -2.5% of GDP). The
consolidated fiscal deficit, which includes the states’ fiscal deficit, increased to
8.5% of GDP and 9.7% in the same years (2007-08: -4.1%). The results of the
aggressive fiscal and monetary policy measures were favourable, with GDP
growth of 6.8% in 2008-09, the fiscal year that captured the brunt of the hit
from the global crisis, and improving to 8.0% and 8.6% in 2009-10 and 2010-
11 (as announced in the official advance estimate), respectively.
However, now the global recovery appears to be gradually on the mend,although there are still meaningful risks to the economic outlook. Also, India’s
growth has rebounded despite an uninspiring recovery in investment (thanks
partly to some ministries), and a combination of cost-push and demand-pull
factors have reignited worries over inflation. Indeed, the script used in the
previous two budgets cannot be used again, and the government’s consolidated
debt/GDP of around 74% is high and needs to be reduced.
A key part of the multi-pronged strategy to tackle inflationary pressures has
to be faster reduction in the fiscal deficit, especially via spending restraint.
Related to the fiscal consolidation is the need for fiscal policy to be working
in tune with monetary policy to ensure a sustainable and elevated noninflationary
economic growth. So far, the bulk of the heavy lifting on policy
normalisation has been done by the RBI, and it is time for the government
to deliver its share. Ironically, the government’s actions are partly
responsible for adding to the current inflationary pressures due to a
combination of pumping up aggregate demand via heavy spending and from
inaction in removing structural rigidities that have only worsened the
supply-demand imbalances.
Lower fiscal deficit on the cards
The fiscal deficit in the current fiscal year (2010-11) is actually shaping up
to be much better than the assumption in the budget that was announced in
February 2010. While the windfall from the spectrum auction was initially
expected to narrow the fiscal deficit, the additional increase in spending of
around 1.6% of GDP via two supplementary demands for grants reversed
that expectation. However, the actual pace of that spending has been slow.
Consequently, the fiscal deficit’s run rate through December has been much
better than expected.
In April-December 2010, the fiscal deficit was only 44.9% of the fullyear
budget target, compared to 77.3% in the same period last fiscal year. In
April-December, total spending increased 11.2%YoY, while total revenue
surged 54.8%, led by tax revenues (+27.2%) and non-tax revenues
(+136.4%). Divestment of INR227bn (around 57% of the budget
assumption of INR400bn) has been booked through December. The slower
growth in personal income tax collection should be viewed in the context of
the broadening of the tax slabs that was announced in February that would
have lowered the revenue intake.
The 2010-11 fiscal deficit is expected to be around 5.2% of GDP (inclusive of allsubsidy payments), lower than the fiscal deficit of 5.5% of GDP that was announced
in Budget 2010-11. However, there are two factors that need to be taken into account
in interpreting that better-than-expected outcome: (1) the advance annual nominal
GDP for 2010-11 is estimated to be 14% higher than what was assumed in the
budget; and (2) the original budget was underfunded for subsidies.
The fullyear total revenue and spending will likely be higher than what was
assumed in the budget, but the fiscal deficit will still show an improvement.
Further, it is expected that the government will tactically end the year with a
higher-than-usual cash surplus, which will be used towards the financing of next
year’s fiscal deficit.
What matters more from the perspective of the local bond market is the net
borrowing by the government as that is not affected by the revision to nominal
GDP. Net borrowing by the government for 2010-11 was marginally revised
lower during the year by INR100bn to INR4.47trn (Figure 3). We expect the
government’s net borrowing for 2011-12 to be around INR3.6trn (+4%) in
2011-12, while gross borrowing will be lower by 5% at around INR4.3trn
mainly because of lower redemptions next year. If actual borrowing is close to
our expectation, the local bond market is unlikely to react negatively
Low expectations from the upcoming budget
Ironically, everyone wants the fiscal deficit to be fixed but no one wants to
pay for it. Overall, the government will stay the course with a gradual pace
of fiscal consolidation. Last year it had guided for shrinking the fiscal
deficit in 2011-12 to 4.8% of GDP, but it could strive to better this at 4.5-
4.8% given the recent upward revision in nominal GDP (Figure 4).
Attaining that goal will be challenging in the absence of the spectrum
auction intake of around 1.4% of GDP 2010-11, and will have to rely on tax
buoyancy and spending restraint. Even at a slightly lower fiscal deficit (as
% of GDP) next year, the borrowing by the government will be sizeable,
and will create headaches for the RBI on liquidity management, especially
if capital inflows are more subdued.
Among the key initiatives, the government’s flagship rural employment
guarantee scheme, along with rural and urban infrastructure and
agriculture will be the thrust areas. As is always the case in India, effective
implementation will be as important as higher spending. However, spending
is where the government’s commitment to fiscal consolidation will have to
take a litmus test, and the surge in expenditure in recent years has to be
corrected now (Figure 5). The government also needs to move ahead with
the reform agenda and make a convincing case of its action plan towards
encouraging FDI, injecting life into the corporate bond market and
infrastructure that must be low on sound bites and high on action.
A part of the policy response in managing food inflation has to be with
reforming the local agriculture pricing mechanism, shrinking the big gap
between retail and wholesale prices, promoting greater investment in
agriculture infrastructure to increase productivity and boosting irrigation.
Liberalizing FDI in retail will also help in checking overall inflation, not
just food inflation.
Divestment: This will probably be pegged at slightly higher than this year’s
INR400bn to take into account divestment not done in the current year.
Individual exemption limit: It is possible that, given the public uproar over
higher-than-expected inflation, the government might announce a small
increase in the exemption limit (currently at INR160,000) for individuals,
with a bigger adjustment already scheduled for 2012-13 (to INR190,000)
when the Direct Tax Code (DTC) is expected to be implemented.
Service tax: The government in recent years has been widening the
coverage of the service tax (currently 10.0%), and will again widen its
coverage to include more services. Still, rather than focusing on a list of
transactions on which the service tax is applicable, it is far more efficient to
have the service tax on all transactions except for a short list of exemptions.
Excise duty: The government could either reverse the cut in the excise
duty (currently: 10.0%) by 2ppt to the pre-crisis level of 12% or, rather than
increasing the excise duty, it might lower the excise exemption as a step
towards eventual rationalisation under the GST. The latter option should be
preferred, in our opinion.
Subsidies: Subsidies (food, fertilizer, and fuel) will probably again be
underfunded in the budget. In 2010-11, the government had budgeted direct
subsidies of 1.7% of GDP, but the actual outcome is likely to be around
2.3%. Cutting subsidies will remain a pressing issue, and, rather than wait
for the right time, the government should at least move forward in small
steps if a full one-off deregulation of fuel prices is not feasible.
There is little flexibility that the government has in certain categories of
spending such as defence, debt servicing and subsidies, which together account
for around 46% of the government’s total expenditure (Figure 6). The
government can move to cut the subsidy bill either in a managed manner or it
could be forced on it in the form of a crisis-like situation that will also extract
high political and economic costs.
GST implementation remains uncertain
Weak fiscal dynamics have always been India’s Achilles’ heel. Fiscal reforms
in the pipeline cover both direct and indirect taxation, and the expected reform
of subsidies. Of the two tax reforms, the government has already submitted the
Direct Tax Code (DTC) Bill in Parliament. It will likely become effective from
1 April 2012 (one year later than initially believed).
The reform of indirect taxes, via the introduction of a Goods and Services Tax
(GST), is moving more slowly. That is mainly because it requires the federal
government and the states to agree on several terms. Latest indications are that
the government proposes to introduce the Constitutional Amendment Bill in the
second half of the Budget Session of Parliament. This could pave the way for
the implementation of GST from 1 April 2012. However, as experience shows,
things in India are not done until they are actually done.
Separately, the government last year adopted a partial deregulation of the
administered prices of petroleum products. This is a positive for long-term
fiscal consolidation, despite the short-term one-off impact on inflation. It goes
without saying that a big-bang elimination of subsidies is unlikely given the
current inflationary pressures. Indeed, in the near-term, additional spending
owing to the launch of a Food Security Bill will increase the subsidy burden.
Much more needs to be done to cut subsidies, but it will probably occur at a
glacial pace that is dictated by a combination of inflation, fiscal and politics.
Sharply higher oil prices remain a key risk
India is vulnerable to rising oil prices, and the impact on the fiscal from higher
oil subsidies is a critical risk to the sustainability of fiscal improvement. The
impact on the fiscal position is partly driven by the government’s decision to
pass higher oil prices onto consumers.
As crude oil price rises, the government will not be able to avoid increasing
retail prices at all, despite the political pressure of the upcoming state
legislative elections. However, the magnitude and timing will be held ransom
to the political setting, fiscal trends and the pace of increase in crude oil prices,
and the government will probably do the least that is possible.
On our calculations, the impact on the fiscal deficit of a USD10/bbl increase
in crude oil will be an additional INR100-150bn (approx. 0.2% of GDP).
That assumes that the government foots a third-to-half of the increase in the
revenue foregone by oil companies because of selling fuel at administered
prices. Oil subsidies are generally underfunded in the budget at the time of
its announcement, although all subsidy payments during the year will be
included in the revised budget estimate.
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