Budget 2019 India: To achieve the fiscal deficit target, gross tax revenues need to grow at an ambitious 15% over last year’s actual outturn, even after adjusting for tax rate increases for high-income individuals and excise/custom duty increases.
By SajJid Z Chinoy
Budget 2019 India: The first Budget of the government’s second term was always going to be a delicate balancing act. The growth momentum in India—and indeed, around the world—has slowed markedly in recent months. And, there was no space for a fiscal stimulus, as some had clamoured for. The broader public sector is already eating up virtually all household financial savings. Bond yields have finally witnessed a rally in recent weeks. Any widening of the fiscal deficit would have reversed those gains, pushed up interest rates more generally, and thereby undermined the efficacy of the RBI’s monetary easing cycle. How, then, should the government have tried to boost growth, investment and savings without any fiscal latitude?
Given difficult constraints, the budget is well-intentioned and hits all the right chords. But, the key is going to be execution. The devil will, eventually, lie in the details.
First, let’s talk about the intentions. There is a concerted effort to attract foreign capital to augment declining domestic financial savings. Increasing FDI limits in insurance, aviation and media are on the anvil. Domestic sourcing requirements for single-brand retail are expected to be eased; FPIs will now be allowed to invest in REITs and InVITs, and KYC norms for FPIs are expected to be rationalised. Authorities may float a dollar bond to access a broader international investor base. With some caveats, these are welcome moves. In a world of low and negative interest rates, with capital desperately searching for productive use, seeking foreign savings to augment domestic savings is understandable.
The area that deserves the most immediate attention is the financial sector. Credit markets for NBFCs are frozen, PSBs have the liquidity but not the growth capital, private banks are stretched to their limits with rising credit-deposit ratios. Here, too, the government has tried to strike the right note. PSBs will be recapitalised by another Rs 70,000 crore; some of this will hopefully translate into growth—and not just resolution—capital. On the NBFC front, a temporary and partial credit-guarantee will be offered to PSBs to purchase high-rated pooled assets from “financially sound” NBFCs, to inject liquidity and break the logjam.
Eschewing the clamour for a stimulus, the government has shown admirable restraint by pegging the deficit at 3.3% of GDP.
All told, the budget appears well-intentioned on fiscal discipline as it tries to unclog the financial sector and attract foreign capital flows. But, intentions apart, much will depend on execution. Take fiscal math, for example. To achieve the fiscal deficit target, gross tax revenues need to grow at an ambitious 15% over last year’s actual outturn, even after adjusting for tax rate increases for high-income individuals and excise/custom duty increases. To put this in context, gross taxes grew at less than 9% last year. Therefore, unless growth rebounds sharply and/or GST collections are tightened meaningfully, tax targets are going to remain under pressure all year long, with questions about expenditure having to be addressed again at the end of the year.
Disinvestment targets are higher, but questions linger. Will the approach be true strategic sales/asset recycling to the private sector, which is more efficient at operating them? Or will one government arm simply buy out another? Will asset sales fund more public investment, or simply cover for tax shortfalls, akin to selling the family silver to pay the credit card bill?
On the financial sector, bank recapitalisation is positive. But only if (i) the allocation of capital is meritocratic, to ensure incentives and monies are aligned; and, (ii) bank governance reforms (read PJ Nayak Committee Report) proceed in tandem. Capital without reforms risks engendering another PSB NPA crisis down the line. On the NBFC front, there is a fine line between ensuring illiquidity does not spawn insolvency crisis and stoking moral hazard. The credit guarantee should be temporary and very targeted. And, if this does not work, one cannot ignore the long-run fix anymore: an asset quality review.
On the external front, attracting foreign capital is well and good. But, FPI flows are notoriously fickle and pro-cyclical—elusive when needed. They can temporarily substitute for boosting domestic savings. While the sovereign dollar bond could attract a new class of investors, it risks cannibalising existing FPIs that hold Rupee assets. A small issuance in international markets may not materially change things, but if FPIs are willing to hold rupee assets, why not further liberalise and induce FPI flows into the domestic market so that they—not the sovereign—bear the currency risk? What we don’t want over time is a dollar bond in international markets, without control of policymakers, disproportionally impacting domestic yields, as investors eventually arbitrage across the two markets.
All told, the budget has performed an artful balancing act against a difficult macro backdrop. The big themes—financial, external, fiscal—are all well-intentioned. Now, the authorities must walk the talk with equal skill.
The writer is Chief India Economist, JP Morgan