By Gautam Chhaochharia, Head, India Research, UBS Securities India
The Budget has maintained the policy stance of fiscal consolidation, with a view to sustain India’s macro stability parameters. This would be reassuring to global investors, especially in the context of global macro environment. The government faced the impossible trinity of (1) fiscal consolidation; (2) higher capital expenditure; and (3) implementation of the 7th Central Pay Commission (CPC). It clearly chose the first, while apparently diluting/delaying CPC implementation. This may dampen some expectations of consumption demand boost, which were anyway misplaced.
The FM focused on efforts to revive rural economy. The planned measures are arguably robust—farm insurance, irrigation, national market etc. These will help reduce volatility in farm incomes and thus food inflation. However, the boost to rural incomes in the near-term may not be material, vis-a-vis stimulus seen late last decade, as the absolute amounts involved are not large. It would likely ensure a bottoming out of the rural economy though, especially if we get normal monsoon rains.
The quality of consolidation, not just the quantity, matters. Due to CPC adoption pressures and still muted economic environment, fiscal quality is worsening, with a lower proportion of spending on capex. This will be a bigger issue for states. This may hurt long-term growth potential, unless we see extra-budgetary resources being mobilised to support capital spending. Both railways and roads are forecast to generate more of the same in FY17.
The minister also made some other reassuring commitments on ease of doing business (presumptive taxes, penalty redressal mechanism etc), reiterating no retrospective taxes ahead. Delay in corporate tax reduction was disappointing. The bigger fiscal challenge is with states. They are in no position to implement CPC, as the payout for them is much bigger (1.2% of GDP versus 0.4% for the Centre). If this results in fiscal expansion (states allowed to expand beyond statutory limits), it may hurt macro stability (external balances, currency, inflation, interest rates).
Fiscal consolidation despite CPC (states’ limits enforced too) may underwhelm market expectations of a fillip to growth and consumption—as this would merely be a transfer from one section of the economy to another, with no boost in aggregate. Historically, a boost from CPC was seen only in 2009 but not in 1990 and 1998—the market’s expectation of an uplift is anchored around the more recent experience, which also had lumpy arrears and quite a broad fiscal expansion.
The recent correction has improved risk-reward for Indian markets, with Nifty trading at one-year forward PE of c14x, near the five-year average. Poor-quality fiscal consolidation may affect long-term growth potential, while value ascribed to long-term growth in India is still above historical mean.