Dont count on easy money

Written by Indranil Pan | Updated: Mar 3 2008, 05:50am hrs
Faster and more inclusive growth continues to be the mantra for Union Budget 2008-09. In his opening comments, the FM acknowledges some downside risks to growth, given the global economic outlook. The implications to emerging economies of the financial market turbulence in developed economies are not yet clear. Thus, a key challenge for the Budget was to ensure sustained growth while watching inflation risks arising from high international commodity prices.

The Budget seeks domestic consumption-led growth. An increase of 27% in allocations for the Bharat Nirman and the social sector will boost domestic consumption. Adjustments in the tax slabs for personal income-tax and raising of the exemption limit will put more money in the hands of consumers and help achieve the same outcome. Furthermore, case-specific reductions in excise duties, such as on small and hybrid cars, two and three wheelers and items of mass consumption, will help both contain price pressures and boost consumption.

The taxation targets appear to be quite realistic in view of the onset of a growth slowdown. The FM budgets an increase of 17.5% in gross tax revenues after a stellar performance of 25% growth in 2007-08. While IT receipts had grown by 43% in 2007-08, concessions here for 2008-09 are likely to reduce the growth in collections. But still, the fiscal consolidation process appears to be intact. As a proportion of GDP, the fiscal deficit was targeted at 3.3% of GDP for FY08, but is expected to finish the year at 3.1%. Under FRBM guidelines, the FM was obliged to bring down the fisc to 3.0% in FY09, but he envisages bringing it down to 2.5% instead.

This huge fiscal correction has led the Centres gross borrowings to be pegged at Rs 1,44,599 crore, much lower than Rs 1,55,455 crore of last year. This is also better than capital market participants expectations for the year of around Rs 1,60,000 crore to Rs 1,75,000 crore. Given the historical trend of the first half of the year taking up 60-61% of gross borrowings, the estimated borrowings in the first half of 2008-09 are likely to touch Rs 88,205 crore, which is less than the Rs 97,000 crore that was borrowed during the first half of 2007-08. And with liquidity conditions expected to be comfortable in April, there does not appear much risk that interest rates on government securities will move higher.

However, the above scenario is unlikely to lead to any significant softening of interest rates, and there could be large volatility in yields of government securities in FY09. The inflation scenario has already turned adverse, at around 4.9%. Given the stated price stability objective of both the FM and RBI, any signal for an easing of monetary policy is unlikely, even as interest rates in developed countries (read: the US) head lower.

What of the Centres borrowings First, the Budget does not factor in any payout under the Sixth Pay Commission that is expected to table its report in the next couple of months. The liability of the Fifth Pay Commission award in 1997-98 was an annual Rs 18,500 crore. The annual outgo on account of the Sixth Pay Commission is estimated in a range from Rs 18,000 crore to Rs 20,000 crore.

Further, the Budget is also silent about repayments of oil bonds that mature in March 2009, and estimated at around Rs 13,000 crore, even as the FMs speech points out that significant liabilities of the government on account of oil, food and fertilizer bonds are currently below the linethere is need to bring these liabilities into our fiscal accounting.

The Budget proposal of waiving farm loans of Rs 60,000 crore, with liquidity support for banks from the government, is still hazy as far as the modalities of the mechanism go. Will it involve cash support from the government Or will another round of bonds be issued Will it be some new combination of measures, as some observers have suggested We have to wait for the fineprint.

Even leaving aside the financial implications of the huge loan waiver announced by the FM, the borrowing programme of the Centre can easily slip out of controland to the tune of around Rs 33,000 crore. This would push up the fiscal deficit to 3.1%. This is even beyond the 0.5% headroom claimed by the FM.

But these borrowings will not be scheduled now and will only be back-ended towards the end of the fiscal year. Still, market sentiment could get spooked. Overall, fiscal consolidation is not as secure as it is portrayed. This is also apparent in the FMs own speech: I intend to request the 13th Finance Commission to revisit the roadmap for fiscal adjustment and suggest a suitably revised roadmap. The understanding that I have today is that if all off-Budget liabilities (oil bonds, food and fertilizer bonds etcetera) are added, the fisc could bloat by 2-2.5%. This is bad news for interest trends in India.

The author is chief economist, Kotak Mahindra Bank. These are his personal views