Union Budget 2020: We welcome finance minister Nirmala Sitharaman’s decision to relax fiscal targets to support recovery. The Centre’s fiscal deficit target has been expectedly revised up to 3.8% of GDP (from 3.3% earlier) in FY20, and kept at 3.5% in FY21. The net borrowing of Rs 5.4 lakh crore (including T-Bills and adjusting for buyback) is also in line with our expectations. The Rs 0.4 lakh crore/0.2% of GDP cut in income tax, at lower levels, should provide a boost to consumption in the near term.
We see 30 bps of GDP upside risk to the Centre’s fiscal deficit target given the extremely high divestment assumption of Rs 2.1 lakh crore in FY21, almost triple of FY20’s Rs 0.65 lakh crore. This only reinforces our call that RBI will have to step up OMOs to clear the G-sec market by buying FX in forward to create further headroom for funding the fiscal deficit. Against this backdrop of limited fiscal slippage, we expect a second dovish pause from the RBI MPC given that CPI inflation is peaking off to 6.7% in January from 7.3% in December, with onion prices falling. Although nominal MCLR has come off 45 bps, real MCLR has shot up 85 bps on falling core WPI inflation.
We firmly believe that expansionary counter-cyclical fiscal policy is the need of the hour. We strongly support the finance minister’s decision to target higher fiscal deficits of 3.8% of GDP (up from 3.3% budgeted) in FY20, and 3.5% in FY21 (up from 3% in the FRBM path). After all, the 0.8% of GDP corporate tax rate cut will be a recurring source of fiscal slippage till it boosts growth another year or two later. It is, thus, only apposite to take the NK Singh committee’s flexibility to deviate 50 bps from the fiscal path target of 3% of GDP in FY21. Even then, the Centre’s fiscal deficit will be below the long-run average of 4.5% of GDP. With FY20 growth, at 5%, running at a whopping 250 bps below potential, it is inconceivable that this can hardly push up inflation.
We welcome the three overarching themes for today’s budget—Aspirational India, economic development for all, and a caring society. The thrust towards boosting consumption demand by cutting income tax rates at Rs 0.15 crore levels by Rs 0.4 lakh crore, or 0.2% of GDP, will support recovery. The ministry of finance has also cut dividend distribution tax, costing Rs 0.25 lakh crore, or 0.1% of GDP.
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The ministry of finance has also signalled its support for financial sector reforms by deciding to sell off the government stake in IDBI Bank, and do an IPO for a part of LIC. Budget 2020 also took a baby step towards inclusion in global benchmark indices by removing limits on certain specified categories of government securities for non-resident investors. That said, we continue to point out that any ‘index inclusion’-related FPI inflows would be counter-balanced by a parallel reduction in RBI OMOs, with RBI buying the FX leg.
We reiterate our call to expect RBI to step up OMO purchases to contain yields to bring down lending rates. Net borrowing of Rs 5.4 lakh crore (including T-Bills, and adjusting for buyback) is broadly in line with our fiscal deficit projections. Our liquidity model forecasts that RBI will need to inject $45 billion of durable liquidity into the economy in FY21. Our balance of payments estimates place RBI FX intervention at $20.5 billion, assuming i) $63/bbl, and ii) $12 billion of FPI flows. Resultant RBI OMO, of $24.5 billion, turns out to be lower than our estimated G-sec market gap of $29.6 billion. To make room for higher OMO, we expect RBI to buy FX forward, and sell FX spot.