We expect finance minister Chidambarams 28 February budget to err on the side of prudence, incorporating a modest tightening of the underlying fiscal stance after a bigger squeeze in 2012-13. This should help pacify the rating agencies as well as the RBI, leaving us more confident of our continuing bullish view of the bond market. The larger than previously expected fiscal tightening has, however, led us to further reduce our GDP growth forecasts for the current fiscal year and next.
What are the main measures likely to be announced On the assumption that the FM will indeed deliver a net fiscal tightening in the order of - % of GDP in the budget, we have summarised what we believe are the most likely expenditure and revenue measures. Based on his past budgets (he has been finance minister on two previous occasions) and other statements, we expect Chidambarams approach to be governed by an ideological preference for spending constraint over direct tax rises. We should probably also think of him more as a technocrat than a conventional politician, although clearly he wont and cant ignore the political angle altogether, not least because this will be the last full budget before the general elections. It looks very much as though the Food Security Bill, the financing of which Chidambaram is likely to provide for in the budget, will be the governments flagship welfare programme as it attempts to win another term in office.
Prudence to the fore: The FM has made it clear that achieving a 5.3% of GDP central government budget deficit in 2012-13 and a further improvement to 4.8% in 2013-14 are of crucial importance.
A focus on spending constraint rather than tax increases: Following an aggressive fiscal tightening, equivalent to more than 1% of GDP in the current fiscal year, we estimate that a further squeeze in the order of -% of GDP would be enough to achieve the Finance Ministers 2013-14 deficit objective, probably with some room to spare. This is the sort of tightening we envisage, with Chidambaram set to focus more on spending restraint as opposed to tax increases to achieve his objectives. There is, however, likely to be some provision made for the Food Security Bill.
Further encouragement for RBI cuts and unchanged sovereign ratings: No doubt the government will also be hoping that a budget incorporating credible tightening measures will persuade the rating agencies to maintain India as an Investment Grade credit, while encouraging the RBI to cut interest rates further. We suspect it is right to do so and continue to anticipate another 100bps of repo rate cuts by the end of calendar 2013.
More downward GDP growth revisions: At the same time, however, we have cut our GDP growth forecasts for 2012-13 to 5.3% (from 5.7%) and for 2013-14 to 6.7% (from 6.9%). The latter is still comfortably above the consensus projection, while we continue to expect 7.5% average growth in 2014-15.
Still bullish about bonds: Our bond strategist expects the budget to be bullish for the local currency sovereign bond market and continues to anticipate a 7.5% 10-year yield during the March quarter followed by a period of consolidation. He is looking for Rs 4.7 trillion of net bond issuance to be announced.
Key expenditure measures
* Level of overall public spending increased only 3-4% in nominal terms from 2012-13, implying a sizeable real terms cut. Defence and development projects to be hard hit. Modest increase in existing welfare benefits.
* Fertiliser subsidy likely to be cut, saving 0.1-0.2% of GDP. Diesel subsidies to be phased out by mid-2014.
* Provision for introduction of the Food Security Billroughly 1% of GDP in a full fiscal year.
* Additional capital to public sector banks to help them meet Basel III requirements 0.2% of GDP.
* Payment to states for loss of central sales tax revenues prior to the introduction of GST, possibly in December 2013 about 0.1% of GDP
Key revenue measures
* No change in income or headline corporate tax rates. Tax slabs likely to be increased in line with inflation. Promises to clamp down on tax evasion and extend the tax net.
* An increase in the breadth of excise duties and the service tax.
* Government to target divestment receipts of R400bn, up from R300bn in 2012-13. Equivalent to 0.4% of GDP. Sale of additional telecom spectrum0.1-0.2% of GDP.
* More generous tax incentives for equity investment and savings in bank deposits designed to channel a greater share of funds into financial assets as opposed to gold for example
* Possible removal of cap on how much Indian corporate and infrastructure related debt foreign institutional investors can buy. Simplification of other rules governing foreign investment in equities and government bonds with the aim of making it easier to fund the current account deficit, albeit via the portfolio route.