High government borrowings, not all reflected in budget, will raise interest rates; that will dampen investment
The government’s expansionary stance, reflected in the slippage of the fiscal deficit both in FY19 and FY20, may bring succour to some, but will drive up inflation and interest rates that will end up hurting growth. The extra fiscal impulse of 30 basis points in FY20 (the deficit was originally pegged at 3.1%) will most certainly compel RBI to not just stay put on rates, but could also prompt it to alter its current neutral stance to one of calibrated tightening. Going by the fairly sharp spike in yield on Friday, of 13 basis points, the bond markets are already very nervous. That is understandable, given the government plans to borrow around Rs50,000 crore more in FY20 in comparison with FY19, with the total net borrowing pegged at Rs4.73 lakh crore. Indeed, given the appetite in the markets, the government will most certainly crowd out private sector investments, while leaving the cost of money elevated.
It is not just the market borrowing that is worrying the bond market. The bigger concern is the huge extra-budgetary borrowing that the government has resorted to. If one added in the off-budgetary borrowings, the deficit would be significantly higher; what matters is not just central borrowings, but those of the states as well as central and state PSUs. Sajjid Chinoy of JPMorgan estimates India’s total public sector borrowing requirement (excluding that of state PSUs since the data is incomplete) remains above a hefty 8.5% of GDP in both FY18 and FY19. Given how the growth in household savings has slowed sharply over the years, from 23% of GDP to 17%—net financial savings are just 7% of GDP—this is a big problem since private borrowers will now find themselves being crowded out of the market. The irony is that, despite this massive borrowing, there isn’t enough capex happening. Indeed, the government expenditure itself may need to be pruned because many of the revenue-growth assumptions are quite optimistic.
For example, aggregate GST collections have grown at barely 7% over the last six months—the total collections have struggled to hit Rs1 lakh crore a month—but the CGST has been budgeted to grow at 21% next year. While there has been a fair bit of buoyancy in personal income tax collections—at a growth of 16%—the target for even this year looks difficult. Under the circumstances, given much of the benefits from better compliance would have kicked in, hitting next year’s target of Rs6.2 lakh crore or a growth of 17% could be a tall ask. Should there be a shortfall in tax collections—or non-tax revenues for that matter—the government will be left with very little fiscal room and, therefore, will need to cut expenditure.
Since the scope to trim revenue expenditure is limited, it is capital expenditure that will take a hit. The current run rate for capex, as Chinoy points out, is a modest 4%, and could end the fiscal year at close to 1.5% of GDP. That is lower than the 1.6% seen last year and the expectations for the current year of 1.6% of GDP. The target for FY20 is 1.5% of GDP, but could slip to lower levels should the revenue assumptions not play out as planned. Consequently, overall capex could remain sluggish given the private sector is unlikely to make meaningful big-ticket investments in the next couple of years. While large companies will be able to cope with rising interest rates, smaller companies will feel the pinch. That is unfortunate because, while the revised GDP may show the economy is doing well, the reality on the ground and data from non-government sources suggests a very different picture.