Having generally exceeded expectations since his return for a third stint as finance minister last August, P Chidambaram underwhelmed on his big day, at least relative to aggressive market expectations. In a series of investor road-shows earlier this year, the FM had made clear that he intended to hit, if not improve upon, his Budget targets of 5.3% of GDP for FY13 and 4.8% of GDP for FY14. He duly delivered but, as always with Budgets, the devil was in the detail. In time-honoured fashion, the assumptions on both tax and spending, particularly on subsidies, underpinning FY14?s deficit target look highly questionable.
With subsidy spending running well ahead of estimates and economic growth disappointing, the FY13 deficit looked on course to be closer to 6% of GDP only a few months ago. Since returning to North Block, Chidambaram has exerted extraordinary tight spending control of ?plan? spending and overall capital spending by the government. Relative to last year?s Budget estimates, total capital spending for FY13 is now expected to be some 18% lower, leaving it up only a meagre 5.7% on FY12?s outturn. Total ?plan? spending for FY13 was now budgeted to be squeezed around 17.5% relative to last year?s Budget estimates, leaving it up only 4% yoy on FY12 levels. These aggressive spending cuts were necessary given spending on subsidies are estimated to rise 35.6% (or 0.7% of GDP), and the disinvestment target and GDP growth relative to last year?s Budget targets are also unrealistic. So eye-wateringly tight has been the departmental spending restraint of recent months that Chidambaram was able to slightly beat his target and unveil a revised deficit target of 5.2% of GDP for FY12. While aggressive, unscheduled cuts to investment spending to offset subsidy and transfer payment overshoots is obviously poor quality fiscal adjustment, it is however fiscal adjustment nonetheless.
Impressive as these achievements are, they had been largely factored in by financial markets, leaving the focus primarily on the FY14 Budget arithmetic. This is where the FM for once underwhelmed market expectations. A deficit target of 4.8% of GDP for FY14 was inevitably unfurled, however the mix of tax and spending assumptions underpinning this target look as questionable as those employed by his predecessor. In short, the FM is optimistically hoping that FY14 will prove to be a mirror image of FY13 with tight subsidy control, buoyant tax revenue and strong disinvestment proceeds financing a capital boom-let. Government capital spending is pencilled in to roar back in FY14, rising by 36.6%; the strongest since India?s overshooting bout in FY11. This putative capital boom is budgeted to drive an overall 16.4% increase in government spending to R16.65 trillion; faster than nominal GDP?s assumed (and realistic) 13.4% increase for FY14. Total spending is budgeted to pick up to 14.6% of GDP from 14.3% of GDP. FY14?s assumed 0.4% of GDP decline in the deficit hinges on a budgeted 0.8% of GDP jump in receipts from 9.1% of GDP to 9.9% of GDP, and another 0.3% points are assumed to come from much faster disinvestment proceeds (possible, but difficult) while revenues are also set to be boosted by headline-grabbing ?rich? surcharges on wealthy individuals and corporations, which may deter capital inflows more than they boost government receipts.
Perhaps most concerning is that Chidambaram has chosen to maintain the tradition of recent years of making wholly implausible assumptions on subsidy spending. Old habits die hard, it seems. Led by an assumed 33% drop in fuel subsidies, overall spending on subsides is budgeted to decline by just over 10%. Relative to GDP, subsides are assumed to tumble by 0.6%, falling back to 2% of GDP; easily their lowest level since FY08. Overoptimism on subsidy spending has been a serial feature of Indian Budget assumptions for the last 5 years with an average overshoot of 0.6% of GDP relative to initial forecasts. Diesel prices may have been deregulated but the assumptions on food subsidy spending in particular look optimistic. A decline in cash spending on subsides is not impossible but it certainly has not happened before by our reckoning. Unless faster GDP growth rides to the rescue, it is unlikely to be long before Chidambaram?s FY14?s Budget arithmetic is blown off course.
The Budget, therefore, marks a watershed: Chidambaram?s extended 6-month honeymoon now appears over. Certainly financial markets showed little affection with the stock market sold off by around 1.5% and the rupee falling by over 1% versus the dollar. RBI will similarly be scouring the Budget math and will likely draw similar conclusions over its plausibility. The Budget is unlikely to open up additional policy space for the central bank to ease policy in FY14. While the sharp pull back in WPI inflation in recent months should allow RBI to trim the repo rate by 25bps at its March policy review, sticky inflation, household inflation expectations, recalcitrant food inflation and the yawning CAD mean that the scope to cut the policy rate much beyond that remains limited. The much-needed recasting of India?s policy mix will therefore continue only slowly.
