By Sonal Verma & Aurodeep Nandi 

The Budget FY23 assumptions are largely realistic. Our real GDP growth assumption for FY23 is lower (7.8% vs. 8.7% in FY22), as we expect India’s cyclical growth recovery to peak around mid-2022 and then enter a downward trend. However, we expect higher nominal GDP growth (13.3% vs the government’s 11.1%) due to our expectation of higher inflation. The government has proposed direct tax buoyancy of 1.2 and indirect tax buoyancy of 0.5, which is realistic in our view: we expect direct tax buoyancy of 1.2 and indirect tax buoyancy of 0.6. The disinvestment target for FY23 has also been kept modest compared with more ambitious targets in the recent past, again suggesting a realistic assessment, especially given tightening global financial conditions and greater market volatility.

On the expenditure side, the allocations for fertiliser subsidies and rural employment will be higher than is currently budgeted, due to rising global fertiliser prices and higher demand for work under MGNREGS, respectively. However, as we have observed in FY22, the government may struggle to spend the allocated amounts on capex due to execution challenges, leading to some potential fiscal savings from underspend as the year progresses. Overall, we expect the government to meet its fiscal deficit target of 6.4% of GDP in FY23.

The budget is unambiguously focused on reviving growth, via higher public capex. Capital expenditure generally results in a higher growth multiplier, so the continued focus on infrastructure spending, including support to states to spend on capex, is important at a time when private capex is sluggish. For FY23, we estimate that the fiscal impulse from the budget will be around 0.77pp, marginally up from 0.68pp in FY22. Adjusting for the business cycle, the structural fiscal deficit (for the Centre) will rise to 6.6% of GDP in FY23 from 6.4% in FY22.

However, we see challenges ahead. First, the ability of the government—both the Centre and the states—to spend 2.9% of GDP on capex will face execution hurdles. Identification of projects, on-the-ground implementation, coordination with different agencies—all typically lead to a smaller amount being spent than allocated.

Second, if revenues disappoint or other expenses rise (higher subsidies or more allocation towards rural employment, for example), then there is a risk of the capex amount being pruned. Third, we see other growth challenges. India is currently in the midst of a business cycle recovery. However, we expect India’s growth to decelerate from H2 CY2022 onwards, reflecting weaker consumption demand from low-income households (due to scarring effects and high inflation), weaker export growth and continued sub-par private capex due to low capacity utilisation. Rising oil prices (a negative terms of trade effect) and tighter global financial conditions are also growth headwinds. Hence, if the capex-led push is not fruitful, then the growth slowdown could be material. We currently expect GDP growth of 8.7% y-o-y in FY22 (reduced recently from 9.2% owing to the impact of Omicron) and FY23 of 7.8%, below the government forecasts (8-8.5%).

We continue to expect higher inflation and wider current account deficits, largely due to rising commodity prices, although an expansionary budget may also play an incremental role. On inflation, while food prices appear in check, core inflationary pressures are rising across clothing, household goods and services and personal care items. Firms are passing higher input prices onto consumer prices. Domestic fuel prices are currently on hold, but will likely be adjusted higher after the state elections. We expect services price inflation to also rise as the economy opens. Overall, we expect CPI inflation to average 5.9% y-o-y in 2022, near the upper end of RBI’s target range (2-6%). We expect elevated global commodity prices, high inflation and steady domestic demand to result in higher imports, widening the current account deficit to 2.6% of GDP in 2022, up from a deficit of 1.3% in 2021.

For FY22, there was no change to the gross borrowing target of Rs 12.05 lakh crore, including the disbursement to the states for GST compensation. However, two things stand out for us, first, net short-term borrowings are estimated by the government to be Rs 1 lakh crore versus our estimate of a net maturity of Rs 50,000 crore. The current Q4 auction calendar has scheduled just Rs 3.34 lakh crore, implying a net maturity of around Rs 50,000-60,000 crore. Therefore, we believe the government will need to revise this up by around Rs 1.5 lakh crore for the remaining eight auctions in this fiscal year. Second, ‘net other receipts’ were originally budgeted at an approximate Rs 54,200 crore; however, this has now been revised to –Rs 90,100 crore, a swing of around Rs 1.4 lakh crore. So despite the larger-than-expected small savings scheme receipts (Rs 5.91 lakh crore revised estimate v Rs 3.92 lakh rore FY22 budget estimate) the large negative on other receipts means the government will need to rely more on short-term borrowing. Turning to FY23, the clear stand-out figure was for gross market loans. The government’s target for gross borrowing is Rs 14.95 lakh crore versus our estimate of Rs 13.3 lakh crore. On a net basis, the government estimates Rs 11.2 lakh crore versus our Rs 9.9 lakh crore. However, this doesn’t include data from RBI switch undertaken on Tuesday, where out of the Rs 1.2 lakh crore of switches, Rs 63,600 crore are bonds maturing in FY23. Therefore, we believe the government will need to revise its gross borrowing target down by at least Rs 63,600 crore and possibly more if it manages to successfully switch any further FY23 bonds in February or March this year. The government has pencilled in Rs 1 lakh crore of bond switches for FY23, which is marginally positive.

In terms of other receipts for FY23, the government estimates small savings receipts of Rs 4.25 lakh crore, close to our Rs 4.5 lakh crore estimate. This is more in line with the originally budgeted FY22 number and not the revised estimate as it was noted in the press conference inflows have surprised to the upside owing to the interest rates on offer. The FY23 T-Bill borrowing estimate was in line at Rs 50,000 crore. Finally, the government estimates just a Rs 750 crore drawdown of the cash balance in FY23 which is significantly below where the market had it estimated, and in view of the current high cash balance we see scope fora further reduction in gross borrowing via utilising the cash balance.

The government also announced it will start issuing green bonds. The size or timing of these are yet to be announced, but the amount should not be linked to the capex budget and will likely be part of the gross borrowing figure. Furthermore, we also assume the Rs 1 lakh crore payment to the states in the form of an interest free 50-year loan is included.

A clear omission from the budget was any announcement on the capital gains tax (CGT) for non-resident holders of Indian bonds. In the press conference, the government said conversations are ongoing, though it didn’t sound like we are close to a solution. The government seems to retain its stance that the capital gains tax should be paid for bonds issued by the government of India regardless of the end buyer. We would not rule out an announcement sometime during the financial year; however, this clearly creates uncertainty and delays to our original timeline. We do not think Euroclear will give the greenlight while CGT still exists, and while not a requirement for the index providers, it remains unlikely that Euroclear would choose to add India bonds at this juncture. Overall, we retain our cautiousness over India’s index inclusion and are not expecting a meaningful amount of flows to help finance the FY23 borrowing schedule.

The market has repriced significantly since the budget announcement, with the 10yr IGB yield hitting 6.89% intra-day and the curve steepening. We continue to believe yields will move higher for Indian bonds, and because of RBI’s absence in the bond market, the much higher borrowing figure will likely continue to weigh on market sentiment. While we see the current borrowing figure as pessimistic and likely to be revised downwards, we are unlikely to see this materialise in the near term. Furthermore, the absence of any bond index inclusion announcement provides another headwind for bonds.

Respectively, chief economist, India and Asia e-Japan, and India economist, Nomura

Edited excerpts from Nomura’s Global Markets Research: Asia Insights report dated February 2