The Government seeks to attain a 4.6% GFD/GDD for FY2014RE and indicates a process of fiscal consolidation by targeting a GFD/GDP of 4.1% in FY2015BE. However, the quality of deficit remains an issue with a massive squeeze in the plan expenditure to achieve the numbers for FY2014RE. Going forward, we think that the Government has overestimated its revenue numbers for FY2015BE and the GFD/GDP number could be higher for FY2015E at 4.5%. Higher gross borrowing numbers under FY2015BE and little expectations of policy rate easing by the RBI imply that benchmark G-Sec yields will remain sticky on the higher side.
4.1% GFD/GDP for FY2015BE
The vote-on-account budget paints a rosy picture of the fiscal scenario for FY2015E with the GFD/GDP at 4.1% against a GFD/GDP of 4.6% for FY2014, better than the FY2014BE of 4.8%. However, we contend that this is an interim budget and the real picture could emerge in the budget to be presented by the new Government, sometime in June 2014, which is also likely to include a full plan from the Government to stabilize the economy as also kick-start growth. The current numbers for FY2015BE are predicated on a nominal GDP growth of 13.4%, with a real GDP growth of ~6%. This in itself indicates that the gross tax revenue collections targeted in the FY2015BE at 19% could be at risk. Given our lower nominal GDP estimate at ~11.1%, we think that the Government will be able to garner a 15% growth in the gross tax revenues, immediately implying a slippage of ~Rs480 bn on the revenue side. With the total expenditures broadly on target, this is likely to lead to a GFD/GDP for FY2015E at 4.5%.
Structural changes for fiscal consolidation continue to be missed
While the FM attempts at a numerical correction of the GFD/GDP, the absolute GFD for FY2015BE remains almost unchanged when compared to FY2014RE. The interim budget tries to provide some small sops for the capital goods sector and the auto sector in the form of an excise tax rate reduction. Overall, the structural adjustments to the fiscal remain unattended as the GST and the DTC fail to be introduced in FY2015BE and the reliance on enhanced tax collections is mostly through improved compliance. Further, on the expenditure side, the wasteful expenditures in the form of interest payments and subsidies remain at a cumulative 5.3% of GDP as per FY2015BE compared to 5.6% of GDP in FY2014RE. Our own estimate for this ratio is at 5.5% of GDP for FY2015E.
Bond market is not too happy with the numbers
Despite the consolidation shown in the GFD/GDP to 4.1%, the net borrowings budgeted by the Government is at Rs4.57 tn compared to the net borrowings of FY2014 at Rs4.69 tn. However, due to the higher redemptions in FY2015BE, the gross borrowings are at Rs5.97 tn compared to Rs5.64 tn in FY2014. With the gross borrowings being higher than FY2014, there is little reason for the rates market to be buoyant about the 4.1% GFD/GDP ratio. Consequently, the 10-year benchmark bond yield rose to the days high of 8.85% but closed lower at 8.81%.
With the inflation pressures continuing in the economy, especially as there was no comfort in the core WPI and the core CPI numbers as per the latest inflation data releases, there is little reason to expect any easing of the monetary policy stance by the RBI. Further, the borrowings per week of the Central Government could be higher than Rs160 bn each week, assuming that the Government could target to finish 65% of its gross borrowings in 1HFY15E. We stick to our earlier estimates that the 10-year benchmark yield could remain very sticky in a range of 8.50-9.00% for most part of FY2015E. Risks to the yields also come from probable higher borrowings by the next Government to meet its expenditure needs.
Interim budget seeks to contain GFD/GDP at 4.1% in FY2015BE
Exhibit 1 gives the Governments FY2015BE revenues and expenditure and compares them with our FY2015 estimates and FY2014RE of the Government. In the Interim budget FY2015BE, the Government intends to progress on the fiscal consolidation by budgeting GFD/GDP at 4.1% after having successfully capped the FY2014RE GFD/GDP at 4.6%. While the Government may have achieved this outcome by cutting back on plan expenditure and via special dividend accretion, we think that this method of achieving fiscal targets may not be sustained year after year.
In particular, the Governments revenue estimates for FY2015BE look optimistic that has been based on a nominal GDP growth assumption of 13.4% and predicated on real GDP growth of ~6%. We are more conservative on our growth estimation and peg real GDP growth at 5.1% for FY2015E. On the other hand, the estimates of the Government on expenditures look more reasonable. Further, we need to keep in mind that this budget is an interim one and the real test for fiscal consolidation will be in the full budget, to be presented after the national elections. On a realistic basis, we think that the GFD/GDP in FY2015E will print at 4.5% (~Rs5.6 tn) implying limited consolidation from FY2014RE.
Revenues: Government target of 19% growth in taxes looks high
The Government expects total revenue receipts to grow 13% in FY2015BE based on 13.4% nominal GDP growth. The growth target for the gross tax revenues is at 19% while the target for non-tax revenues is at Rs1.8 tn. Overall tax-GDP ratio is budgeted to have increased to 10.7% in FY2015BE as against 10.2% in FY2014RE. On divestment front, the Government has factored in divestment of Rs569 bn compared with Rs258 bn in FY2014RE and Rs558 bn in FY2014BE. We discuss the key contributors to the revenue side below.
* Direct tax. There were no changes on the direct tax side given that it this was an interim budget. Government expects corporation tax receipts to grow by 15% in FY2015BE, as against 10% in FY2014RE. Meanwhile, the Government expects income tax to grow by 27% in FY2015BE from 20% in FY2014RE. We think that even as the corporate taxes growth assumptions are reasonable, the buoyancy assumed in income tax looks high and expect the growth to be lower at ~20% in FY2015E. Overall, we expect direct taxes to grow at 16% (Rs7.38 tn) as against Governments estimate of 19% for FY2015BE (Rs7.58 tn).
* Indirect tax. On the indirect tax side, the Government cut the excise duty to 10% from 12% on some capital goods, consumer durables and cut excise duties for the auto sector. Overall, the Government expects 19% uptick in indirect taxes in FY2015BE after achieving only 9% growth in FY2014RE. Service tax growth expectation looks too high at 31%. We expect 14% growth in indirect taxes in FY2015E, with slippages coming mainly from the service taxes and the customs duty collections. * Disinvestment proceeds. The Government has estimated Rs569 bn of divestment proceeds in FY2015BE compared with Rs258 bn in FY2014RE (against a Rs558 bn in FY2014BE). Even as divestment targets have been consistently missed in the past years, we provide the benefit of doubt to the Government at this point and expect that it might be able to achieve its targets. Companies where the Government wants to divest in FY2015 are Hindustan Copper (HCL), India Tourism Development Corporation (ITDC), Metal and Mineral Trading Corporation (MMTC), National Fertilizer (NFL), Neyveli Lignite Corporation (NLC), State Trading Corporation (STC), Power Grid Corporation of India (PGCIL), NHPC, IOCL, BHEL, HAL, etc.
Expenditure: Plan expenditure continues to be pushed back
FY2015BE puts total expenditure at Rs17.6 tn, a growth of 11% over Rs15.9 tn in FY2014RE. We see limited surprises in this category unless (1) oil prices shoot up again significantly or INR depreciates, (2) oil sector reforms in the form of a regular pass-through on diesel prices come to a halt, and (3) plan expenditure get a massive boost under the new Government.
* Plan expenditure. Given the strained revenue side, most of the adjustment for meeting the budget target has been through curtailment of the plan expenditure over the past two years. This is also because most of the expenditures on the non-plan side are non-discretionary in nature. Against a 34% growth target in FY2014BE, the Government has only been able to achieve a 15% growth in FY2014RE. The plan expenditure targets in FY2015BE at ~Rs5.55 tn is exactly the same as in FY2014BE, a 17% growth over the FY2014RE. We, however, expect that for a third consecutive year, the Government might have to be content with a lower growth of plan expenditure at 15%, given the lack of buoyancy on the revenue side.
* Interest payments. Government estimates interest expenditure of Rs4.3 tn in FY2015BE against Rs3.8 tn in FY2014RE. Interest payment bill of the Government as an entity have not received the same type of focus as did the subsidy bill, even though it has remained above the 3% of GDP, around 1%pt higher than the subsidies as a proportion of GDP. We believe this endogenous component of expenditure is likely to remain a big concern without structural fiscal consolidation, given a consistent rise in Central Government borrowings over the years, especially after the Lehman crisis.
* Subsidies. We expect overall subsidies to slip marginally from the Governments FY2015BE estimate of Rs2.6 tn, with slippage coming from fertilizer subsidies on account of higher gas prices. Like last year, the Government continues to articulate a vision to restrict overall subsidies at 2% of GDP in FY2015BE after missing this target by printing 2.3% in FY2014RE. With the overshoot likely on account of fertilizer subsidy, the subsidy bill as a proportion of GDP is likely at 2.1% for FY2015E.
(1) Food and fertilizer subsidies. On food subsidies, the Government has provided for Rs1.15 tn keeping in mind the implementation of the Food Security Act after Rs920 bn allocation in FY2014RE. Meanwhile, fertilizer subsidies are pegged at Rs680 bn in FY2015BE, same as last year. We expect slippages of ~Rs100 bn on account of fertilizer subsidies.
(2) Fuel subsidies. The Government has shown significant slippage in FY2014RE in fuel subsidies front (Rs855 bn as against Rs650 bn budgeted). For this year, the Government has provided Rs634 bn for fuel subsidies in FY2015BE with Rs350 bn rolled over from FY2014. For FY2015E, we expect the Government to probably be able to do a tad better on the targeted oil subsidies given (1) our estimate on crude oil prices of US$102.5/bbl for FY2015, (2) the Rupee remaining broadly in a stable range, and (3) the new Government being able to continue with gradual diesel price deregulation even after taking over. Consequently, we expect fuel subsides at Rs619 bn in FY2015E.
Optically positive GFD/GDP fails to cheer bond players: yields to stay on the higher side
We had been consistently indicating that Indias economic structure remains weak even as there are signs of improvement in the CAD. The recently announced inflation numbers also failed to provide much cheer, given that the core inflation was on the higher side for both the core-CPI and the core-WPI. The hazy economic atmosphere and the uncertainties of the elections has been clearly a negative for the bond market recently. Further, the fiscal consolidation indicated by the FY2015BE at GFD/GDP of 4.1%, has failed to bring any cheer to the bond markets as the markets probably question the efficacy of these numbers in the light of the fact that a new Government will announce a fresh borrowing program when it presents its budget for FY2015.
As per the current scenario, the net borrowings budgeted by the Government is at Rs4.57 tn compared to the net borrowings of FY2014 at Rs4.69 tn. However, due to the higher redemptions in FY2015BE, the gross borrowings are at Rs5.97 tn compared to Rs5.64 tn in FY2014. Assuming that the Government would like to target to finish around 65% of the gross borrowing program in 1HFY2015E, the borrowing requirements are likely to be at around Rs160 bn each week.
* We stick to our earlier estimates that the 10-year benchmark yield could remain sticky in a range of 8.50-9.00% for most part of FY2015E. The risk to the yield comes from the fact that the next Government who presents the full year budget could be looking at a higher GFD/GDP ratio for FY2015E. As per our current estimates, we think that a more realistic GFD/GDP for FY2015E could be at 4.5%, leading to a gross borrowing number of Rs6.3 tn.
* The other worry for the market probably comes from larger net borrowings under the T-bills, targeted for FY2015BE at Rs346 bn compared to the FY2014E of Rs227 bn.
* Further, the worry for the market comes from the rate at which liquidity is made available by the RBI to the banking sector. Even as we think that the RBI is unlikely to change the repo rate and the MSF from the current 8% and 9% respectively, the liquidity positions on a day-to-day basis has led to wild fluctuations in the overnight money market rates. This has led to pricing of liquidity of the banking sector difficult and hence a relatively sticky sovereign 10-year yield.
* The attempt of the Government from FY2014 has been to reduce the maturity amounts in the immediate next couple of years, via debt buy-back or switching of maturities. The Government had, in the recent past, performed such a switch operation with a market participant to the extent of Rs270 bn. The FY2014RE indicates that the Government also intends to do a debt buy-back amounting to Rs150 bn in the current financial year itself. FY2015BE also indicates another debt buyback / switch by the Government for Rs500 bn. This could also be leading to some nervousness for the market participants as a debt buyback increases the borrowing program of the Government by a similar amount.
By Indranil Pan, Chief Economist, Kotak Mahindra Bank