Budget details will influence upcoming monetary policy action and will focus on rural India and continued support for MSMEs.
India’s Central government will present its budget for FY20 on February 1. Because this is an election year, the budget is likely to be replaced by a new one once the new government takes over after national elections. Yet, it holds significance, because it gives a sense of what the likely fiscal package could be if the current government remains in power, and it provides a template that any new government could potentially use. In order to get a better understanding, it is important to put the budget in context. This is a national election year, which has traditionally been associated with a looser fiscal stance. There are also legitimate concerns that growth is slowing, but it is slowing to a more sustainable pace and it is slowing because of ‘yesterday’s’ problems, which are likely to reverse.
There are risks of slippage on the deficit target, arising from a shortfall in GST revenues, the oil excise duty cut, weak income tax revenues, weak spectrum sale proceeds and a high oil subsidy bill. And yet, there are some notable offsets that could still help the 3.3% number to be achieved. Even though GST slippage of ~Rs 450bn for the Central government is likely to happen, assuming trends similar to last year, a healthy cess collection (already 80% of budget estimates) and an option to dip into the GST cess fund should help offset half of this slippage. A tad higher interim dividend from RBI, given that RBI profits in the ongoing year are likely to be higher than last year, could also help offset some tax revenue slippage and likely cuts in the (non-subsidy, non-interest) current expenditure, especially as the 7th Pay Commission pressures are behind us, could help, too.
Raising rural incomes and supporting small businesses are likely to be the important themes for the budget for the next year. Rural incomes have been weak. Following a seemingly successful experiment in Telangana, three other states have announced a direct cash transfer scheme for rural India which is likely to cost Rs 300 bn per year, besides 10 others announcing farm loan waiver schemes of Rs 1.9 trn.
Recent research shows that a direct cash transfer scheme is perhaps more effective in terms of helping the intended beneficiaries. If the government were to enact a similar direct cash transfer scheme nationwide, it could cost around Rs 2 trn (1% of GDP in FY20). However, if it were to subsume some pre-existing schemes, and is a shared burden with India’s states, the additional burden would be lower. In recent months, the authorities have been announcing schemes to help India’s micro-, small- and medium-sized enterprises (MSMEs). This theme may continue into the budget, though spending more and running higher deficits to help small businesses can sometime prove counterproductive. Higher deficits could actually hurt the MSMEs as, if the government continues to dis-save, it is the smaller enterprises that will face higher borrowing costs and risk getting crowded out.
Any meaningful rural package is likely to lead to funding problems. Instead of the pre-announced FY20 fiscal deficit target of 3.1%, it is estimated the Central government will announce a number closer to 3.3% of GDP, because, if it announces a new package for rural India, fiscal slippage to 3.3% is likely. Only a very slight increase in capex (0.1% of GDP) is expected, since it is a year when reviving rural incomes is the main objective. With the FY20 fiscal deficit at 3.3% of GDP, net borrowing by the Central government is likely to grow much faster than nominal GDP. Adding to this (1) the fact that RBI’s
OMOs may not necessarily be as high as in FY19, and (2) the large repayments bill in FY20, and bond yields could potentially feel some pressure. Of course, any RBI rate cuts could relieve some of the pressure but let’s pause to look at what is going on with inflation first.
Inflation in 2019 will display two distinct phases. Under 4% in the first half of the year since the period is likely to be characterised by growing demand for rate cuts given that inflation is under target and over 4% and rising in the second half given estimated rising economic growth and a low base for food inflation Given that inflation will be under 4% for about 12 months in a row (mid-2018 to mid-2019), it will be difficult to ignore the chorus for easing. However, those looking over a medium-term horizon may argue that inflation is likely to rise to 4% by the end of the fiscal year, and as such, rates should be kept on a prolonged pause.
The deciding factor between these two outcomes will probably be the FY20 budget. If the budget imparts a sense that the fiscal consolidation outlook is unclear, and rural incomes are likely to rise on the back of a credible rural package, RBI may choose to keep rates on hold. However, if the sense is that the fiscal path is broadly in control, and low rural incomes and food prices will linger for longer, space for a slight easing (of about 25-50 bps) could emerge. This is yet another reason why this budget is important, despite being an “interim” one.
-The author is Chief economist, India HSBC Securities and Capital Markets.
Co-authored by Aayushi Chaudhary, economist at HSBC Securities and Capital Markets. Edited excerpts from HSBC’s India Budget Preview (January 28)