Continuity of fiscal reforms crucial

Updated: Feb 25 2013, 21:02pm hrs
India fiscalThe 2013-14 Union Budget is expected to provide much-needed impetus to growth by accelerating investment and continuing popular policies while not loosening fiscal discipline. (AP)
Budget could be a mix of growth enablers, populism & fiscal discipline

Pratik Pant

The 2013-14 Union Budget is expected to provide much-needed impetus to growth by accelerating investment and continuing popular policies while not loosening fiscal discipline. We expect this budget to introduce a roadmap of further fiscal discipline and to focus on increasing government resources, though not at the risk of hampering a recovery in growth. We expect growth to improve in the second half of the year, which should enable policymakers to introduce a slew of policies designed to appeal to the electorate.

Maintaining the pace of measures announced over the last five months to contain the fiscal deficit, we expect further reductions in unplanned expenditure. The key towards achieving this would be a roadmap for expanding the ambitious programme of direct cash subsidy transfers from currently 10% of districts to 40-50% of districts. This scheme directly credits the bank accounts of verified beneficiaries, with the aim of plugging systemic leakages in social spending schemes, thereby helping reduce the fiscal deficit.

To boost government resources, the finance minister could expand the tax base or raise tax rates. Given the state of the economy, however, raising tax rates is unlikely as it would hamper growth. Expanding the tax net has been under consideration for a while and appears the more likely option. While most hurdles have been overcome to allow implementation of the Goods and Services Tax and direct taxes code, there is unlikely to be enough time to enact these two key tax reforms before the elections. However, the crucial provisions of these reforms could form part of this years budget, as could be bringing more products and services within the scope of central excise and service tax.

The budget is also likely to amend the direct taxes code, for example, raising the ceiling of taxable income, taxing the returns from maturing savings schemes, amending inheritance tax and commodities trading tax, and raising the minimum alternate tax rate to 20%.

We expect the rail budget to initiate the process of deregulation of railway passenger and freight tariffs by setting up an independent regulator, which would de-politicise ministry finances and contentious decision-making. Furthermore, removing the monopoly in ownership of railway lines could help attract large investment, as has happened in other transport infrastructure.

The governments advance GDP estimate suggests that growth has fallen to below 5% in the second half of the current fiscal year. This emphasises the need for strong policy intervention to revive growth. Making matters worse have been severe capacity constraints, which have heightened inflationary concerns. Against this backdrop, we expect initiatives to encourage investment in public- private partnerships, for example, increased viability gap funding (grants) to attract infrastructure projects.

While keeping control of the purse strings, the budget is likely to continue spending on popular policies, such as the UPA governments flagship Bharat Nirman programme for creating basic rural infrastructure. Within the Bharat Nirman programme, emphasis is likely to be given to projects that can deliver quick results in a election year, such as social housing, roads and electrification. Such measures would benefit companies involved in capital goods and projects.

Interest rate subvention (under which the government pays part of the interest cost) could be increased to encourage farmers to repay their crop loans. While this would add to government expenditure it would reduce bad loans and provide an electoral sweetener to the rural masses.

There could be specific announcements to categorise low-cost housing within infrastructure and raise limits on priority sector home loans, which could make housing more affordable to the urban poor. These measures would support real estate and housing finance companies.

Authorising the National Investment Fund to capitalise public sector banks (PSBs) would ease PSBs capital constraints ahead of implementing Basel-III. Weaker external demand for export goods could see interest rate subventions and other encouragements extended for a further year, specifically to support the textiles industry the second largest employer in the economy.

Overall our expectations are that provided the budget is not expansionary, it would be welcome from a macroeconomic management perspective and should attract the interest of external investors.

Domestic macroeconomic indictors suggest that growth is bottoming at current levels and is likely to recover in the second half of the year to an average of 6.3%. As inflationary pressures ease further, RBI is likely to pursue rate cuts in the coming months. We expect a 100-basis point cut to leave the policy rate at 6.75% this year.

As growth recovers, risk assets such as equities and industrial commodities should be in demand. We further expect improvements in corporate profitability in the second half of the year, with cost pressures easing and demand recovering from the lag effects of fiscal and monetary policy measures. Hence, we would recommend portfolios maintaining overweight positions in equities, subject to investors risk profile.

The writer is director, products & services, RBS Private Banking