As we had expected, not only did the government meet its budgeted fiscal deficit for FY14 (year ending March 2014) but actually beat it, with the deficit pegged at 4.6% of GDP versus a budgeted level of 4.8% of GDP. On a cyclically-adjusted basis, the deficit has been reduced by 1.2% of GDP over the last two years which constitutes admirable fiscal restraint in the run-up to elections. A return to fiscal discipline has been critical in warding off any sovereign ratings downgrade threat, restoring confidence and macroeconomic stability, and thereby contributing to the Rupee’s relative outperformance over the last few months.
That said, as was feared, the quality of the consolidation – for a second successive year – was worrisome, with tax revenues missing targets by hefty margins, disinvestment targets being offset by extra-ordinary dividends from public enterprises, and Plan expenditures being slashed by 0.7% of GDP.
All this makes next year’s consolidation that much more challenging. The government has pegged the FY15 deficit at 4.1% of GDP , though this will be revisited when the new government presents its first full budget in July. However, current estimates are revealing in how challenging the task could be. Tax-revenues would need to grow at 19% (compared to less than 12% this year), subsidies would need to be rationalized by 0.3% of GDP, disinvestment revenues would need to be more than doubled and, unlike this year, there isn’t too much padding in terms of Plan expenditures to absorb overruns elsewhere. For now, however, markets appear to be willing to give authorities the benefit of the doubt, given the strict adherence to targets over the last two years. All this, however, calls for more fundamental fiscal reform (GST, de-duplication of subsidies) if fiscal consolidation is to sustain and remain credible.
FY14 deficit beats budgets estimates
As we had increasingly come to expect (see, “India Budget Preview: admirable fiscal restraint, but pivot needed from quantity to quality,” MorganMarkets, February 14, 2013) the FY14 fiscal outturn avoided any fiscal slippage and, in fact, beat budget estimates printing at 4.65% of GDP (JP Morgan 4.7%). This is the second year in a row that the Finance Minister has beat budget estimates, despite growth printing below 5% in both years (the first time in 28 years) and capital market sentiment remaining weak thereby depressing proceeds from the government’s disinvestment program. All told, the cyclically-adjusted consolidation over the last two years has been 1.2% of GDP which – in the run-up to general elections – constitutes admirable fiscal restraint.
Questions remain about quality of the consolidation and therefore its sustainability, as we discuss below. But, for much of this year, that remained a second-order issue. The fact that the fiscal target was met – and increasingly seen to be met – has been a key contributor to the restoration of macroeconomic stability in recent months. Fiscal discipline has quelled any destabilizing talk of a sovereign ratings downgrade, played its part in containing the current account deficit, and through all these channels contributed to the Rupee’s relative outperformance in recent months.
Quality of the consolidation remains a concern
That said, this is the second successive year that the manner of the consolidation raises serious questions about sustainability. For starters, gross tax collections missed budget targets by a whopping 0.7% of GDP, as we had feared, with misses registering across direct and indirect taxes. This was both because estimated nominal GDP (11.9%) will be below what had been budgeted (12.4% after adjusting the previous year’s base), as well as lower tax buoyancy from weaker real growth and corporate profitability.
Even non-tax revenues have came under stress all year. Less than half the disinvestment target was met, but this was offset by a stronger-than-budgeted telecom auction and extraordinary dividends from public-sector enterprises at year-end. Yet, these extra-ordinary dividends from public sector enterprise (PSUs) both eat into potential public investment and cannot be relied upon year after year.
All told, total revenues were about 0.5% of GDP less than budgeted. This, was, therefore offset by slashing budgetary spending by 0.6% of GDP with all of the burden being experienced by Plan expenditures (0.7% of GDP) even as non-Plan slightly actually exceeded budget estimates (0.1% of GDP).
There are obvious issues with this approach. For starters, there is an adverse compositional impact. For example, capital expenditures were squeezed 0.3% of GDP, even as subsidies exceeded budgeted targets by 0.3% of GDP. That said, total spending on subsidies – at 2.3% of GDP – was less than the 2.5% of outturn the previous year. Recall, however, each year the government is also liable for arrears to the tune of 0.3% of GDP.
Second, Plan expenditures could be squeezed this year because enough of a buffer had been built in. These expenditures was budgeted at 4.9% of GDP versus an outturn of 4.2% the previous year (FY13). After the squeeze, therefore, Plan expenditures are estimated to print at 4.2% of GDP in FY14. However, no such luxury exists next year. Expenditures have been budgeted at 4.3% of GDP so, for example, if they are squeezed more than 0.5% of GDP, this would be the lowest Plan spend in 10 years.
One can argue, however, that given the external imperative to stick to budgeted deficit targets the government had little option but to choose the course it did. That is undoubtedly true. The simple point, however, is that this approach is unlikely to be available year after year, and sustained future consolidation would necessitate either a sharp upturn in growth or genuine fiscal reform as discussed below.
Excise duties selectively cut…..
As we had discussed in the Budget preview , the interim budget is by its nature constrained in scope and scale with proprietary demanding that major tax initiatives or policy proposals be deferred to the first Budget of the new government in July. The Finance Minister adhered to all these protocols, only announcing changes to select categories of excise (production) taxes in the consumer durables and capital goods area to try and jumpstart abysmal growth in these sectors. Specifically, he announced a reduction in excise duties :
- from 12 % to 10% for all capital goods and consumer durables
- from 12% to 8% for small cars, two wheelers, and commercial vehicles
- 30% to 24% for sports utility vehicles (SUVs)
- 27/24 % to 24/20% for large and mid-segment cars
Theses proposals are set to expire on June 30th and will likely be reviewed in the full-year Budget. If, however, they are renewed and apply for all of the next fiscal year, they will result in foregone tax revenue of under 0.1% of GDP.
FY 15 deficit set at 4.1% of GDP -- math looks challenging
Despite this, however, achieving next year’s fiscal deficit target of 4.1% of GDP – which constitutes 0.5% of GDP in fiscal consolidation -- will be challenging to say the least. To be sure, the FY15 estimates are not binding. The new government – in its budget in July -- can alter these estimates. But the math currently laid out illustrates the magnitude of the challenge. To get to next year’s deficit, tax revenues – which grew less than 12% this year -- will have to grow at a whopping 19%, which seems very improbable barring a sharp upturn in growth.
Similarly, disinvestment proceeds have only been able to manage Rs 250 billion in each of the last two years. Yet, next year they are again budgeted at a whopping Rs 570 billion.
Finally, subsidies have been budgeted at almost the same level as this year’s outturn in absolute terms – but this constitutes a meaningful reduction as a percent of GDP (2% in FY15 versus 2.3% in FY14). With food subsidies expected to surge under the Right to Food Security Act, one will have to see appreciable rationalization of LPG, kerosene and urea prices – apart from the ongoing diesel price increases – to stay close to subsidy targets.
And, given the much more modest elbow room that next year’s Budget provides for Plan expenditures (as discussed above) the ability for Plan cuts to absorb tax-shortfalls or subsidy overruns is much more limited in Fy15. The bottom line is next year’s consolidation looks challenging barring a sharp upturn in growth.
The need for true fiscal reform
All this underscores a more fundamental point : that genuine fiscal reform is needed if the FY17 target deficit of 3% of GDP – reiterated by the Finance Minister today – is to be met. This involves adoption of the long-overdue goods and services tax (GST) that truly makes India a common market and promotes allocative efficiency, as well as extending Aadhar (Unique Identification ) to all subsidies – so that, even without cash transfers, the de-duplication benefits of eliminating ghost beneficiaries can accrue. Without these reforms, it’s hard to envision fiscal consolidation can sustain or remain credible.
Gross borrowing surprises positively
The government’s gross borrowing number of Rs 5.97 trillion for FY15 was lower than market estimates Rs 6-6.3 trillion because (i) the assumed fiscal deficit was slightly lower (4.1% of GDP versus 4.2%), (ii) a slightly smaller fraction of the deficit (87%) will be financed through bonds, compared to the usual average of 90%; and (iii) the government assumed further buy-backs of bonds redeeming next fiscal. However, bond yields seem unimpressed because this math could change when the full-year budget is revisited in July.
Federal Fiscal Balances
|
2013/4
|
2013/4
|
2014/15
| ||
(% of GDP)
|
RE
|
Actual
|
Budget
|
RE
|
Budget
|
Total revenue
|
8.8
|
9.1
|
9.9
|
9.4
|
9.6
|
Tax revenue
|
7.0
|
7.3
|
7.8
|
7.4
|
7.7
|
Gross tax revenue
|
9.9
|
10.2
|
10.9
|
10.2
|
10.7
|
corporate
|
3.6
|
3.5
|
3.7
|
3.5
|
3.5
|
income
|
1.9
|
2.0
|
2.2
|
2.1
|
2.4
|
excise
|
1.6
|
1.7
|
1.7
|
1.6
|
1.6
|
customs
|
1.7
|
1.6
|
1.6
|
1.5
|
1.6
|
services
|
1.1
|
1.4
|
1.6
|
1.5
|
1.7
|
Less states' share
|
2.8
|
2.9
|
3.1
|
2.8
|
3.0
|
Non-tax revenue
|
1.8
|
1.8
|
2.1
|
2.0
|
1.9
|
Total expenditure
|
14.5
|
13.9
|
14.6
|
14.0
|
13.7
|
Current expenditure
|
12.7
|
12.3
|
12.6
|
12.4
|
12.1
|
Interest payments
|
3.0
|
3.1
|
3.3
|
3.4
|
3.3
|
Wages
|
1.1
|
1.1
|
1.1
|
1.2
|
1.2
|
Direct subsidies
|
2.4
|
2.5
|
2.0
|
2.3
|
2.0
|
Other
|
6.1
|
5.5
|
6.2
|
5.6
|
5.6
|
Capital expenditure
|
1.8
|
1.6
|
2.0
|
1.7
|
1.7
|
Civilian
|
1.0
|
1.0
|
1.3
|
1.0
|
1.0
|
Military
|
0.8
|
0.7
|
0.8
|
0.7
|
0.7
|
Primary balance
|
-2.7
|
-1.8
|
-1.5
|
-1.3
|
-0.8
|
Fiscal balance (GOI)
|
-5.7
|
-4.9
|
-4.8
|
-4.6
|
-4.1
|
Less
| |||||
Divestment & spectrum sales
|
0.2
|
0.5
|
0.7
|
0.4
|
0.6
|
Subsidy bonds
|
0.0
|
0.0
|
0.0
|
0.0
|
0.0
|
Fiscal balance (standard)
|
-5.9
|
-5.3
|
-5.5
|
-5.1
|
-4.7
|
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