With the government set on the path of fiscal consolidation, RBI may cut rates
We expect Budget FY16 to lead to lower rates. This, in turn, should support recovery. Although India is growing at 7.4% in FY15, and is targeting 8% levels in FY16, it is still below its potential of 8.5%. This supports our view that India’s GDP growth will cross Brazil’s and Russia’s in 2015.
Finance minister Arun Jaitley has pulled the fiscal deficit target down to 3.9% of the GDP, from 4.1% last year, although he has marginally extended the path of fiscal consolidation to 3% fiscal deficit by a year, to FY18. An outlook upgrade from rating agencies for India is expected.
The finance minister did the best he could to strike a balance between the need for fiscal consolidation, the necessity of supporting growth and the 14th Finance Commission’s recommendation of passing an additional 10% of Central taxes to the states.
In line with the BJP manifesto, the overall thrust of the Budget was on irrigation, ‘rurbanisation’ and operationalising Make-in-India. While the finance minister has promised to rationalise the corporate tax rate to 25%, cutting the existing rate by 500 bps, the need is to watch what the phasing out of exemptions imply.
We expect RBI to cut rates on April 7 with the government set on the path of fiscal consolidation. Budget FY16 should also support G-Secs as the net borrowing, at R4,900 billion, is marginally lower than last year. Banks should cut lending rates by 50 bps in the April-September slack season.
From a longer-term standpoint, we welcome the Monetary Policy Framework Agreement with RBI, which clearly states the objective of keeping inflation below 6%. The decision to set up an independent Public Debt Office will also help the process of price discovery in the Indian G-Sec market.
We see the Budget as currency-neutral. We welcome the government’s initiatives to monetise gold, an idle asset so far.
The gold monetisation drive should, at the very least, attract jewellers to park their inventories with the banks. The sovereign gold bond may also help attract savings into the banking system, although it remains to be seen how far the government can fund it if gold prices rise.
We expected the Budget to cut import duty on gold by 2-4%, but that did not materialise. On balance, we continue to expect RBI to hold the rupee at 60-65 to the dollar and buy forex reserves at every opportunity.
By Indranil Sen Gupta, India economist, Bank of America Merrill Lynch