The Indian budget released this past Saturday contains both positive and negative elements from a sovereign perspective. While the budget shows this government’s continued orientation on implementation of structural reforms, it could have been more ambitious on the fiscal front, especially given India’s high public debt burden.
Making this observation Thomas Rookmaaker, Director in Fitch’s Asia-Pacific Sovereigns Group adds the central government has projected a budget deficit target of 4.1% for FY2015. It seemed quite a difficult task to reach this target as the revenue targets were overoptimistic from the start – even though India uses cash-based accounting, so bill payments can more easily be deferred to the next fiscal year than in an accrual-based system, Rookmaaker points out.
The targets in the budget, according to Rookmaaker, generally look more credible than in last July’s intermediate budget. Disinvestments are targeted to be more than double this year’s realization, so may again prove difficult to reach, but the government should be able to reach the tax revenue target, as it rises by only 1.3% in nominal terms. The tax revenue drive could have been more ambitious, for instance as this government has chosen additional benefits for the middle class instead of a strategy to generate more revenues, for instance by broadening the income tax base.
Rookmaaker further states that the medium-term fiscal consolidation strategy is less aspiring than in the past, which is negative from a sovereign rating perspective. Gradual consolidation towards a central government fiscal deficit level of 3.0% of GDP is still the aim of the government, but in FY16 the targeted deficit reduction is just 20 basis points to 3.9%. If disinvestment would be treated as a “below the line” financing item – as is international best practice – instead of a revenue item, the fiscal deficit would actually rise from 4.3% in FY15 to 4.4% in FY16.
Instead of fiscal consolidation, the government has chosen to increase capital expenditures to stimulate investment, and subsequently, GDP growth. We see some merit in this approach, states Rookmaaker adding as the government’s capital expenditure can crowd in private investments. At the same time, the fiscal position is a longstanding key weakness in India’s sovereign rating profile. The public debt burden in India – which has a ‘BBB-‘ sovereign rating – is close to 65% of GDP, much higher than in many of its peers. The median of the ‘BBB’ category – of the sovereigns with a ‘BBB-‘, ‘BBB’ or ‘BBB+’ rating – is 39% of GDP.
Rookmaaker points out that the budget undescroes continuation of the reform process set in motion when the Modi led Central government came to power with a focus on getting the economy to take off again. This includes the aim to improve governance and the business environment, and to reach structurally lower inflation levels. A gradual implementation of many small reforms is likely to have a significant impact on growth. At the same time, many persistent obstacles to higher growth remain in place, including labour market rigidities and infrastructure bottlenecks. The budget aims to reduce these bottlenecks.
The budget, according to Rookmaaker, mentions a new monetary policy framework agreement with the RBI. While the impact of such a framework will depend on the exact details, it shows this government’s greater focus on bringing down inflation. The budget speech mentions the objective of keeping inflation “below 6%”. A target of 6% would be on the high side compared with the levels in a number of India’s peers.