By Richard Iley, Chief Economist, Emerging Markets and Asia ex-Japan, BNP Paribas
Finance minister Arun Jaitley wisely eschewed political pressure to relax the Centre’s commitment to lower government borrowing, and reaffirmed the commitment to a fiscal deficit target of 3.5% of GDP in FY17. By doing so, he should open up space for RBI to extend its rate-cutting cycle.
Given the expected 0.6% GDP deterioration in the deficit in FY17, thanks to the 7th Pay Commission, this is no mean feat. Impressively, Jaitley was still able to announce expanded irrigation and crop insurance programmes, and a record allocation to MGNREGA to mitigate rural distress.
Low oil prices have obviously been a boon, increasing the fiscal space available to offset both FY16’s sluggish nominal GDP growth and the prospective surge in revenue spending in FY17 triggered by the pay panel.
Low oil prices improved public finances by curbing subsidy bill (from 2.1% in FY15 to 1.9% in FY16) and boosting excise duties, as the government lifted petrol duties to maintain pump prices even as wholesale prices collapsed. With prices set to remain low, these effects will spill over to FY17. The subsidy bill is forecast to dip to 1.7% in FY17, its lowest since FY08. After a stellar 36% growth in FY16, excise duties on petrol are forecast to gain by a further 9.8% in FY17.
The rest of the Budget ‘maths’ looks credible. Nominal GDP growth is pegged at 11% in FY17. Its recent acceleration to 9.4% in Q2FY15, as the depressing impact starts to fade, makes this assumption broadly plausible.
Overall, a revenue tax receipt growth of 11.2%—broadly in line with nominal income—looks reasonable, particularly given the announced 10-15% increase in tobacco excise duties. One questionable element is the anticipated 24.9% surge in non-tax revenue receipts, largely hinged on a bullish assumption of proceeds from spectrum sale, of Rs 99,000 crore versus FY16’s R56,000 crore.
Other revenue assumptions, however, also look plausible—disinvestment proceeds are pegged at R56,500 crore, versus FY16’s disappointing out-turn of R25,300 crore. Key to realising the FY17 target will be the government’s ability to generate R20,500 crore from its SUUTI holdings.
The awkward trade-offs in sticking to the deficit target are obvious on the spending side. The impact of the pay panel is clearly seen in the assumed 20.4% increase in planned revenue spending in FY17. That overall expenditure growth is budgeted to rise by 10.8% largely reflects the plans for much slower capex growth. Nugatory growth of just 3.9% for total capex has been pencilled in, with plan capex spending assumed to be just 2.9%. Given the R2.18 lakh crore commitment for rail and road, and the 5.9% assumed growth in non-plan defence capex, further capex in FY17 looks set for a squeeze. Overall capex is set to fall from 1.75% of GDP to 1.64%.
The choice to shun populism and deliver a Budget that sticks to fiscal consolidation is intended to trigger a quid pro quo from RBI, in the form of additional monetary easing. With states’ borrowing likely to widen this year, governor Raghuram Rajan has explicitly linked any extension of the rate-cutting cycle to continued fiscal consolidation by the Centre. While RBI would have preferred deficit reduction to be less reliant upon squeeze in capex, quibbling over the ‘quality’ of reduction would be churlish. Expect Jaitley’s prudence to be rewarded with a reduction in repo rate, perhaps as soon as this week.
Financial markets are betting that the Budget will trigger further easing, with the one-year swap rate dropping by around 15 bps. A 25 bps rate cut is most likely but a more impactful 50 bps cut cannot be completely ruled out. If RBI trims the repo rate by the expected 25 bps, a second 25 bps should follow later in FY17, assuming this year’s monsoon does not produce a fresh spike in food inflation.