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The FY12 (fiscal year ending March 2012) budget seeks a significant reduction in the fiscal
deficit to 4.6% of GDP from a downwardly revised estimate of 5.1% previously.
We expect the FY12 target to be missed – both the revenue and expenditure estimates
appear aggressive.
The borrowing programme is commensurately lower. However, given our view on the fiscal
situation, this is likely to be breached.
The government has doubled the aggregate foreign investment ceiling in corporate bonds to
USD40bn by increasing the share that can be deployed into infrastructure bonds. While this
may be a temporary positive for the INR, longer term, we expect fundamental issues such as
the high current account deficit to dominate.
In the fixed income space, there are few immediate implications until the slippage becomes
evident. However, as the issuance programme resumes in April, we expect a bear steepening
of the yield curve as supply will likely be concentrated at the long end of the curve.
Financial markets have reacted favourably to the FY12 (fiscal year ending March 2012) central
government budget. Market participants were particularly gratified by the FY12 deficit target of
4.6% of GDP as opposed to the 4.8% level mandated by the 13th Finance Commission and the
attendant reduced size of government borrowings. Net borrowings have been forecast at
INR3.43trn compared with market estimates of INR3.65bn.
Whether we should be gratified or not depends on the feasibility of the FY12 fiscal target. The
fiscal target is built on a nominal GDP (NGDP) growth assumption of 14%, comprising of real
growth of 9% and a deflator of 5%. This follows an unusually strong expansion of 20.3% in the
previous year. Based on this NGDP estimate, the government expects aggregate taxes to rise
18.5%.
Our concerns with this tax estimate are two fold. GDP growth and more importantly, nonagriculture
growth is peaking. Typically, tax collections tend to accelerate in the first year of a
recovery and stabilise thereafter. In FY11, the faster than expected recovery provided an
increase of 24% in aggregate tax collections i.e. the tax buoyancy was 1.2. The FY12 budget
assumes further acceleration to 1.3. Second, the two types of taxes which accelerated most
rapidly were customs and excise duties. In FY11, customs and excise taxes had increased 56%
and 29% compared with targets of 36% and 29% respectively. Now if imports are to taper off (as
has been the case recently), consumption has stabilised and base effects have become more
demanding, we think that growth in both categories will slow to a more moderate pace of around
12%. By contrast, the budget assumes growth of 15% in customs duties and of 19% in excise
duties.
The second is that there are no new tax radical measures. If anything, new tax exemptions offset
the new measures. Through new measures such as an increase in the minimum alternative tax
(MAT) from 18% to 18.5% and imposition of a 1% excise duty on 130 new products is offset by
relaxations in personal taxes and a reduction in the corporate tax surcharge.
In the area of capital revenues, the government has retained the dis-investment target of
INR400bn. While a number of this order is not unattainable, much will depend on the state of
capital markets. For FY11, the government has scaled down its expectations from INR400bn to
INR227.4bn i.e. a slippage equivalent to 0.2% of GDP. Should this be the case, the deficit would
be at the mandated level of 4.8% of GDP.
We also find expenditure forecasts to be overly aggressive. As such, expenditures are expected
to rise only by 3.4% from the FY11 level. This is not necessarily conservative stance, in our view,
as in FY11, expenditures materially overshot budgeted targets (see Table 1 for details). The
modest increase should be view in the context of this overrun.
The overrun was on account of higher development spending as well as subsidies. While the
development spending overrun is digestible in that it is growth augmenting subsidies were an
outcome of higher food and crude oil prices. Now with crude oil prices even higher, a subsidy
overrun can not be ruled out. Several types of fuel including diesel, cooking gas and kerosene
remain price controlled.
Interestingly, the government has budgeted only INR236bn as fuel subsidy compared with
INR383bn in FY11. This appears inconsistent with the fact that international crude prices have
hardened significantly over the last three months. We also understand but are unable to confirm
that the government has provided for fuel subsidies only for the first three quarters of FY12.
Therefore, barring a major collapse in crude prices, a subsidy overrun seems inevitable.
Overall, the point we are making is that there is scope for slippage on both the revenue and
expenditure front. The slippage will most likely surface in the second half of the fiscal year.
We now turn to the borrowing programme and its market implications. As mentioned at the
outset, the net borrowing programme of INR3.43trn is lower than market expectations. The
overall impact on the market should however, be viewed against the following:
Fiscal slippage from the target will elevate the borrowing programme.
Unlike in the first half of FY11, the credit cycle is considerably advanced now with the
incremental credit-deposit ratio at above 100%. There should be some degree of crowding out.
Bank holdings of government bonds are already above than that prescribed by the statutory
liquidity ratio.
Unlike in FY11, we are not certain whether the RBI would provide support to the issuance
programme.
Overall, we continue to expect overall liquidity conditions to remain constrained. What does it imply for the bond curve? We note that the bond curve has bear-flattened over the past two
months to price in further rate hikes. The curve has become kinked at around the 4yr region and
is extremely flat from the belly out to the long end (Figure 4). With a larger supply likely in the
long–end upon commencement of the borrowing programme in April, we expect greater pressure
in/around the 10yr region. Long-end bonds are also looking relatively rich compared to the OIS
curve, as bonds benefited from RBI’s buyback programme. The 10y bond swap spread has
hardly stayed negative for prolonged periods and could invert back into the positive region with
the resumption of the borrowing programme.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
The FY12 (fiscal year ending March 2012) budget seeks a significant reduction in the fiscal
deficit to 4.6% of GDP from a downwardly revised estimate of 5.1% previously.
We expect the FY12 target to be missed – both the revenue and expenditure estimates
appear aggressive.
The borrowing programme is commensurately lower. However, given our view on the fiscal
situation, this is likely to be breached.
The government has doubled the aggregate foreign investment ceiling in corporate bonds to
USD40bn by increasing the share that can be deployed into infrastructure bonds. While this
may be a temporary positive for the INR, longer term, we expect fundamental issues such as
the high current account deficit to dominate.
In the fixed income space, there are few immediate implications until the slippage becomes
evident. However, as the issuance programme resumes in April, we expect a bear steepening
of the yield curve as supply will likely be concentrated at the long end of the curve.
Financial markets have reacted favourably to the FY12 (fiscal year ending March 2012) central
government budget. Market participants were particularly gratified by the FY12 deficit target of
4.6% of GDP as opposed to the 4.8% level mandated by the 13th Finance Commission and the
attendant reduced size of government borrowings. Net borrowings have been forecast at
INR3.43trn compared with market estimates of INR3.65bn.
Whether we should be gratified or not depends on the feasibility of the FY12 fiscal target. The
fiscal target is built on a nominal GDP (NGDP) growth assumption of 14%, comprising of real
growth of 9% and a deflator of 5%. This follows an unusually strong expansion of 20.3% in the
previous year. Based on this NGDP estimate, the government expects aggregate taxes to rise
18.5%.
Our concerns with this tax estimate are two fold. GDP growth and more importantly, nonagriculture
growth is peaking. Typically, tax collections tend to accelerate in the first year of a
recovery and stabilise thereafter. In FY11, the faster than expected recovery provided an
increase of 24% in aggregate tax collections i.e. the tax buoyancy was 1.2. The FY12 budget
assumes further acceleration to 1.3. Second, the two types of taxes which accelerated most
rapidly were customs and excise duties. In FY11, customs and excise taxes had increased 56%
and 29% compared with targets of 36% and 29% respectively. Now if imports are to taper off (as
has been the case recently), consumption has stabilised and base effects have become more
demanding, we think that growth in both categories will slow to a more moderate pace of around
12%. By contrast, the budget assumes growth of 15% in customs duties and of 19% in excise
duties.
The second is that there are no new tax radical measures. If anything, new tax exemptions offset
the new measures. Through new measures such as an increase in the minimum alternative tax
(MAT) from 18% to 18.5% and imposition of a 1% excise duty on 130 new products is offset by
relaxations in personal taxes and a reduction in the corporate tax surcharge.
In the area of capital revenues, the government has retained the dis-investment target of
INR400bn. While a number of this order is not unattainable, much will depend on the state of
capital markets. For FY11, the government has scaled down its expectations from INR400bn to
INR227.4bn i.e. a slippage equivalent to 0.2% of GDP. Should this be the case, the deficit would
be at the mandated level of 4.8% of GDP.
We also find expenditure forecasts to be overly aggressive. As such, expenditures are expected
to rise only by 3.4% from the FY11 level. This is not necessarily conservative stance, in our view,
as in FY11, expenditures materially overshot budgeted targets (see Table 1 for details). The
modest increase should be view in the context of this overrun.
The overrun was on account of higher development spending as well as subsidies. While the
development spending overrun is digestible in that it is growth augmenting subsidies were an
outcome of higher food and crude oil prices. Now with crude oil prices even higher, a subsidy
overrun can not be ruled out. Several types of fuel including diesel, cooking gas and kerosene
remain price controlled.
Interestingly, the government has budgeted only INR236bn as fuel subsidy compared with
INR383bn in FY11. This appears inconsistent with the fact that international crude prices have
hardened significantly over the last three months. We also understand but are unable to confirm
that the government has provided for fuel subsidies only for the first three quarters of FY12.
Therefore, barring a major collapse in crude prices, a subsidy overrun seems inevitable.
Overall, the point we are making is that there is scope for slippage on both the revenue and
expenditure front. The slippage will most likely surface in the second half of the fiscal year.
We now turn to the borrowing programme and its market implications. As mentioned at the
outset, the net borrowing programme of INR3.43trn is lower than market expectations. The
overall impact on the market should however, be viewed against the following:
Fiscal slippage from the target will elevate the borrowing programme.
Unlike in the first half of FY11, the credit cycle is considerably advanced now with the
incremental credit-deposit ratio at above 100%. There should be some degree of crowding out.
Bank holdings of government bonds are already above than that prescribed by the statutory
liquidity ratio.
Unlike in FY11, we are not certain whether the RBI would provide support to the issuance
programme.
Overall, we continue to expect overall liquidity conditions to remain constrained. What does it imply for the bond curve? We note that the bond curve has bear-flattened over the past two
months to price in further rate hikes. The curve has become kinked at around the 4yr region and
is extremely flat from the belly out to the long end (Figure 4). With a larger supply likely in the
long–end upon commencement of the borrowing programme in April, we expect greater pressure
in/around the 10yr region. Long-end bonds are also looking relatively rich compared to the OIS
curve, as bonds benefited from RBI’s buyback programme. The 10y bond swap spread has
hardly stayed negative for prolonged periods and could invert back into the positive region with
the resumption of the borrowing programme.
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