Strategy/Economy: Politics and populism versus pragmatism and people: Kotak Sec

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Strategy/Economy
Politics and populism versus pragmatism and people. We have low expectations
from the FY2012E union budget but hope for reform-oriented policy announcements. If
the government acts constructively on much-needed reforms, it would be a welcome
surprise for the people of India. If the budget is simply a presentation of national
accounts, political pandering and financial finesse, we will have to wait for favorable
extraneous factors for investment sentiment to improve for India.
Politics and populism will likely hold sway; little leeway on cutting expenditure
Five state elections in CY2011, an inflamed political environment, an uncooperative opposition
and continued trust in socialist policies within the ruling coalition will likely restrict the
government’s ability to initiate much-needed reforms on subsidies, pricing and FDI. The
government will likely enhance spending on social welfare programs and subsidies will likely stay
high. This will leave the onus of fiscal consolidation on revenues.
Logic dictates higher excise and service tax rates, more service areas, amnesty scheme
We expect the government to target higher tax revenues through a combination of tax increases
(2 ppts on excise and service tax), additional taxes (more service areas) and one-off revenues. We
do not rule out an amnesty scheme for unaccounted money although this may be tricky given the
current public disenchantment with corruption in high places. The imposition of high import duties
on gold imports is unlikely to find favor though it may serve to (1) stop large outflows (which
creates large CAD imbalances) and (2) convert black money into gold.
Budget numbers may look fine thanks to inflation and under-providing for fuel subsidies
We expect the government to budget GFD/GDP at 4.8% (FY2011E at 4.6%) with gross fiscal
deficit at `4.3 tn (FY2011E at `3.7 tn) and net borrowing program at `3.9 tn (FY2011E at `3.35
tn). We note that a high nominal GDP base of `90 tn (14.5% growth in FY2012E) and likely
under-provisions for certain expenditure items such as subsidies on fuels (an open-ended item) will
result in optically comforting numbers. However, we compute GFD/GDP at 5.1% and net
government borrowing at `4.15 tn after factoring in fuel subsidies based on US$85/bbl crude oil
and status quo in retail selling prices. It may be higher.
Policy reforms matter more; will be a positive surprise given current low expectations
We hope the finance minister takes the opportunity to provide a medium-term vision for the
economy and to outline measures in that direction. The government has displayed fortitude in
raising prices of subsidized fuels and implementing a new scheme to reduce subsidies on fertilizers
and is keen to implement GST. Coalition politics, corruption issues and a spike in global crude oil
prices have unfortunately stalled the process of fuel price deregulation, perhaps the single biggest
challenge for the Indian economy, and the implementation of GST. The government has plans to
introduce a slew of economic bills in the parliament in the budget session.