0.1% of fiscal consolidation!

Caught between the devil (political constraints) and the deep sea (the need to consolidate), the FM chose to take a middle path to keep the economy afloat. The FY13 Budget was always going to be a test of the government?s resolve to return to active policymaking after nearly a year of being distracted by scandals and governance problems. While the market may have been disappointed by the lack of ambition, it was at least more credible than last year?s heroic estimates.

Given the constraints, and as one had expected, the government chose to reduce the deficit from 5.9% of GDP in FY12 to 5.1% of GDP?mostly on higher taxes. The excise and services tax rate was raised from 10% to 12% and the base of the latter was expanded, again as widely expected. Duties on a number of infrastructure-related items were reduced, but increased on other items, including gold and cars. On a projected nominal GDP growth of 13%, tax revenue has been estimated to increase 19.5%, which does not look unreasonable. On the other hand, the Budget expects disinvestment and spectrum sales to yield about 0.7% of GDP, which on the face of it and without details look a bit on the high side.

As this was the first year of the 12th Five-Year Plan, capital outlay was raised markedly and overall expenditure growth was kept to 13% by underestimating severely, as has been the tradition with India?s Budget, subsidy outlays. The FM with great sincerity underscored the need to rein in subsidies and his plan to limit them to 2% of GDP this year, and eventually bring them down to 1.7% of GDP in the next three years. This is clearly commendable. But in the absence of any concrete plans as to how this reduction is to be achieved, the subsidy allocation in the FY13 Budget remains its Achilles? heel. Food subsidy has been raised by a paltry R3,000 crore, when the most conservative estimate of the additional expenditure arising from the Food Security Bill is R30,000 crore! Last year, the government allocated R24,000 crore for oil subsidy assuming crude oil to average $90/barrel. Instead, crude prices averaged $115/ barrel and the eventual subsidy bill was R69,000 crore. Unless GoI knows something about geopolitics that the rest of us do not, crude prices will likely remain significantly higher. And the Budget allocated R25,000 crore less! This suggests the government plans to raise retail petroleum prices massively. This looks like a tall order.

Separately, as nearly 0.7% of GDP is the estimated asset sales proceeds, the true fiscal consolidation attempted is just 0.1% of GDP. It isn?t clear that this will assure RBI that the withdrawal of stimulus by the government is adequate for it to make deep cuts in the policy rates. Perhaps a 25 bps rate cut in April is all that we will get by way of interest rate reduction by RBI. Moreover, even the 0.7% of GDP from asset sales looks a bit ambitious, given that telecom companies are already highly leveraged and domestic financial markets are pretty tight. Thus, realistically the deficit out-turn is likely to be around 5.5% of GDP for FY13.

The government did have a bunch of proposals to help ease the cost of funding for infrastructure and other core sectors. Explicitly budgeting for bank recapitalisation (1.5% of GDP), lowering withholding tax on ECBs, allowing airlines, low-cost housing, road sectors to access ECBs even for rupee expenditure, removing sector restrictions for venture capital, doubling allocation for tax-free infrastructure bonds, and allowing QFIIs into corporate bond market are important steps to increase availability of funding and lower cost of funds.

However, like several years now, instead of reforming the domestic capital markets so that India?s very large pool of savings is intermediated at a lower cost by reducing irritating barriers that exist in the name of prudential regulations, the government has once again resorted to pushing corporates to seek cheaper foreign funds. While it is not clear how much access Indian corporates have to cheap funds aboard at present, this trend of preferring the private sector to increase its foreign liabilities while keeping the government sector protected (foreigners have access to only $10 billion of government bonds) could end up in tears as has happened in several Latin American economies and in Korea. Foreign liabilities of India?s corporate sector have been rising rapidly in recent years and while they are yet to reach alarming proportions, India?s rising short-term foreign debt has been one of the reasons why even a modest increase in global risk aversion has had a disproportionately large impact on the exchange rate. Reforming domestic capital markets is a far safer option, something the government and the regulators appear to have forgotten for some time now.