Budget 2020-21: Fiscal consolidation ahead means govt will have little room to reverse slowdown. RBI, which has to do the heavy-lifting, may cut 25 bps in Q2FY21.
By Sonal Verma & Aurodeep Nandi
Budget 2020-21: In the run-up to the Budget, speculation was rampant over whether the sharp slowdown in growth would trigger consumption-oriented fiscal activism. It instead adopted a “middle path”, which will be growth-neutral in the short run, while the return of fiscal consolidation as a broader policy objective should be a medium-term positive. In FY20, the government used the full fiscal deficit slippage of 0.5% of GDP allotted in its “escape clause”.
For FY21, by setting a more conservative fiscal deficit target of 3.5% of GDP, the government signaled that it sees limited scope for consumption-led stimulus and limited its intervention to improving agricultural productivity, the ease of doing business, infrastructure promotion, disinvestment and attracting foreign risk capital. A key surprise was the absence of anything substantial for the beleaguered financial sector and the housing market. The revised medium-term ‘glide path’ was set at 3.3% of GDP by FY22 and 3.1% of GDP by FY23.
Between corporates and individuals, the former continues to be more favoured, with the government acquiescing to a long-standing industry demand to withdraw the tax on dividend distributions, over and above the corporate tax cut announced last year. On personal income tax cuts, individuals were left with the non-choice between continuing with the present tax rates or lower tax rates amid the loss of a host of lucrative exemptions. Overall, it remains a budget ideal for medium-term growth prospects, but largely neutral for the short term, with little to offer in terms of near-term quick fixes to the ongoing growth slump.
The fiscal deficit target of 3.8% in FY20 and 3.5% in FY21 are largely along expected lines. There will be no extra borrowing this year, and the budget aims to borrow Rs 7.8 lakh crore next year. The nominal GDP growth basis for FY21 at 10% is reasonable. The tax assumptions are also reasonable, with the direct tax buoyancy coefficient pegged at ~1.3 and the indirect tax buoyancy coefficient at ~1.1—modest by historical standards. However, these may seem a tad ambitious compared to the sharp plummet in tax buoyancy in FY20, especially in corporate taxes, GST and custom duties, impacted by the slowdown and the corporate tax cut.
Among non-tax revenues, the government’s assumption of a further Rs 74,000 crore (~0.3% of GDP) increase in communications revenues seems to be in line with the higher payouts from telecom companies expected under the recent Supreme Court judgement on AGR dues. However, telecom companies may struggle to cough up this amount and could renegotiate a lower payout next year, which could hit the exchequer (~0.1% of GDP). The government has taken a slightly less ambitious target on dividends from public sector entities, expecting ~`1.6 lakh crore (~0.7% of GDP; versus ~`2 lakh crore last year buoyed by a one-time transfer from RBI).
The government has set a massive disinvestment target for next year at Rs 2.1 lakh crore (~0.9% of GDP), including disinvestment pending from FY20 (`40,000 crore) and fresh plans to disinvest a part of the government’s stakes in LIC and IDBI bank. This is could very well disappoint by as much as Rs 1 lakh crore (~0.4% of GDP). The budget assumes that revenue expenditures will grow by ~12% y-o-y (versus 17% in FY20), while capex growth will pick up to 18.1% from 13.4% in FY20. The growth assumption is reasonable, and will most likely be again axed towards the end of the year, if revenue collections become compromised. On capex, given the government’s ambitious infrastructure investment pipeline of `102 lakh crore over the next five years, with the Centre funding 39% of the cost, the allocation of ~1.8% of GDP isn’t unreasonable.
There is a risk of a fiscal slip of ~0.5% of GDP, if disinvestment and telecom dues disappoint. We expect a fiscal deficit of 3.7% of GDP in FY21, a slip of 0.2pp.
Despite a smattering of positive news from high-frequency indicators, GDP growth is likely to slide further to 4.3% y-oy in Q4 from 4.5% in Q3. In Q3, government spending contributed a substantial 1.9 pp to the 4.5% GDP growth print. Given fiscal trends until December, government spending should continue contributing sizeably to the Q4 GDP growth print (~1pp).
Given the budget’s focus on consolidation, there isn’t much upside risk to our projection of a sub-par recovery of FY21 GDP growth to 5.7% from 4.7% in FY20. From a slightly longer-term perspective, the priortisation of fiscal consolidation bodes well for macro fundamentals. However, the further delay in achieving the fiscal deficit target of 3% of GDP may raise medium-term fiscal concerns by credit rating agencies.
Given the largely neutral impact on growth, the fiscal trajectory is unlikely to have significant implications for inflation. One of the key reasons the MPC decided upon a surprise pause at the December policy meeting was to evaluate the government’s budget, with some MPC members either explicitly or implicitly hoping that the government would ease fiscal policy and share the burden of the growth recovery with RBI.
The choice of fiscal consolidation over activism should signal that the government has limited space to reverse the growth slowdown, and RBI continues to have some obligation towards policy heavy-lifting. Despite this clarity, a rate cut in February is highly unlikely, owing to the inconvenient rise of the inflation trajectory over 7%, driven partly by higher food prices.
Instead, RBI will maintain its accommodative stance and offer forward guidance to emphasise that it sees the current inflation spike as transitory, with headline inflation likely to head back towards and then below its 4% target over the next 12 months. Also, RBI is likely to project growth to pickup sequentially but to highlight that it will remain below potential over the year. Such dovish communication should set the stage for a 25bp repo rate cut sometime in Q2.
The FY20 gross borrowing target was maintained at Rs 7.1 lakh crore, with no additional borrowing, while gross issuance for FY21 at Rs 7.8 lakh crore was largely in line with our forecast (Rs 7.6-7.9 lakh crore). In financing the FY20 deficit, we note a sharp increase in securities from small savings from Rs 1.3 lakh crore (budgeted) to Rs 2.4 lakh crore, which has been maintained for FY21 (Nomura forecast Rs 1.6 lakh crore for FY21). Offsetting this is smaller “other receipts” while cash balances have not been drawn down in FY20 (a risk we highlighted in our budget preview piece). For FY21, 68% of the budget deficit is expected to be financed by net dated securities issuance, in line with previous years, while budgeted buybacks of Rs 30,000 crore is a positive surprise. Offsetting the higher collections from small savings in FY21 is a rebuilding of cash balances, while “other receipts” are expected to increase to Rs 50,800 crore. Overall, there were few surprises on financing side of the budget (besides the higher small savings), which should on balance be taken positively by the bond market/ however, the government’s aggressive assumptions on disinvestment could be a headwind.
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The government’s continued fiscal consolidation could be viewed as positive for the rupee; however, the weak external environment driven by concerns over the spread of the coronavirus remains a near-term headwind. RBI’s continued FX intervention could also limit the rupee’s gains. Locally, the potential for improved capital inflows amid accommodative global monetary policy can support the rupee in the medium term. We see limited direct implications for the rupee from the budget; however, the increase of the limits on corporate debt (from 9% to 15%) and tax exemptions for SWFs (in certain sectors) can be seen as a marginal positive for capital inflows.
Edited excerpts from Nomura’s Asia Insights report, dated February 1, 2020.
Verma is chief India economist and Nandi is India economist, Nomura