Gambling on growth

In the run-up to the FY15 Budget, the expectation was of many big bangs. Instead, what the economy seems to have got is many little bangs. The middle class got a token tax exemption. Farmers got a national market for farm produce, Rs 8 lakh crore by way of farm credit, a Rs 5,000 crore warehousing fund and a Rs 500 crore price stabilisation fund.  To revive manufacturing, companies got an expanded investment allowance and medium and small businesses got a Rs 10,000 crore venture capital fund. 

 While presenting his maiden budget, finance minister Arun Jaitley very clearly has made the most of the positive sentiment around the NDA government. Now that there have been no big bangs, most market analysts are being chided for having unrealistic expectations from a government that has been just sworn in. “It is good with respect to whatever little time he had”, goes a popular defence. “This is only the semi-final, the final will be in end-February 2015”, goes another. 

Those having high expectations may feel thwarted by the budget but the finance minister himself seems to be playing for a totally unrealistic target in terms of the fiscal deficit not only for FY15 but also the years thereafter. His grand proclamation in the Budget speech, “My predecessor has set up a very difficult task of reducing fiscal deficit to 4.1% of GDP in the current year. Considering that we had two years of low GDP growth, an almost static industrial growth, a moderate increase in indirect taxes, a large subsidy burden and not so encouraging tax buoyancy, the target of 4.1% is indeed daunting. Difficult as it may appear, I have decided to accept this target as a challenge. My road map for fiscal consolidation is a fiscal
deficit of 3.6% for FY16 and 3% for FY17.”

 Unclear roadmap

 The budget being a statement of the spendthrift government’s finances, the biggest item of interest is the fiscal deficit. While the targeted number is an ambitious one, there is no clarity on how it will be achieved. “If wishes were horses, beggars would ride” is an old English proverb that points to the futility of daydreaming. The finance minister sticking to the 4.1% target not only plays to the gallery of analysts and rating agencies but his bravado also takes into account that the market itself is discounting a more realistic 4.5% of GDP or even higher. For now, the rating agencies have maintained a polite façade, only murmuring that more details could have been provided about how various subsidies would be dealt with in FY15. 

Rajeev Malik, senior economist, CLSA, says it is highly unlikely that the fiscal deficit target of 4.1% of GDP will be met. “The number was unachievable when the former finance minister announced it; it remains so. The budget would have been more credible if greater necessary adjustments had been made. Not having more specifics on fixing the subsidy mess was disappointing. The subsidy bill cannot be open-ended and what is spent should also be better targeted.” 

The finance minister’s gamble is even bigger considering that the previous government’s eyewash had more to do with reducing plan expenditure and under-reporting subsidies. Thus, at the cost of growth and deferred entries, the fiscal deficit was reduced from 5.7% in FY12 to 4.5% in FY14. If this mathematical jugglery was not enough, the outgoing government then decided to project a fiscal deficit of 4.1% in FY15, a legacy that the current finance minister decided to accept as a ‘challenge’. 

"Either the FM will have to cut spending or justify slippage while ensuring a constructive budget in Feb" - Rajeev malik, senior economist, CLSA

 He is now banking on a growth revival to meet this challenge. The assumptions naturally are rosy and prime among them is the near 20% growth expected in tax collections. This assumption of buoyant collections is despite creaky growth, a weak monsoon and lack of clarity on GST implementation. Dharmakirti Joshi, chief economist, Crisil, says, “The targeted tax collection is unlikely to happen in a weak growth environment, which is why we feel the fiscal deficit will be closer to 4.5%.” Malik of CLSA agrees, “The optimistic tax revenue assumption is what makes achieving the fiscal deficit target less credible. Either the FM will have to cut spending or justify a slight slippage while ensuring a more constructive budget in February based on expectations of improved outlook, as growth in FY16 will rebound sharply.”

 Cashing in 

Divestment is the one wild card that the skeptics may not have factored in, with respect to the fiscal deficit of 4.1%. Through stake sales in PSUs over the next eight months, the government aims to raise Rs 43,425 crore of the overall #63,625 crore divestment target. Right now, despite the resurgent fear of instability in the Eurozone, sentiment is unabashedly bullish and investors seem willing to throw money at every kind of paper. 

If this sentiment stays, given its strong mandate, the government might decide to make the most of it if tax revenues fall short. Malik says, “Whether or not the divestment target can be met will be a function of the buoyancy in the market. In fact, I wouldn’t be surprised if it surprises positively.” Abhay Laijawala, head of research, Deutsche Equities, points out that the pace of selling from domestic institutions has slowed considerably and they could well turn out to be net buyers in the months to come. If that indeed happens, it will provide an additional fillip.

 Laijawala is also confident that the government will figure out a way to rationalise subsidies by making diesel prices market-based. He is hoping that a fortuitous drop in crude prices will help in reducing the deficit. “The budget has factored in a price of $110 a barrel, which has actually fallen to $106 a barrel. If crude continues to be benign and goes further lower, under recoveries will be much less and that itself will provide significant leeway,” he adds. Joshi does not have as sanguine a view and given the hostility in west Asia, his skepticism is understandable. “A potential spike in the price of crude oil is a big risk, be it for the current account, inflation or the fiscal deficit. We are fortunate that despite the turmoil, crude has not moved much as the US has reduced import dependence through shale gas. But it is an uneasy calm,” he cautions.

"A likely spike in crude oil prices is a big risk, be it for the current account inflation or fiscal deficit" - Dharmakirti Joshi, chief economist, Crisil

 And even if it decides to rationalise fuel subsidy, how much can a government that has promised achhe din increase diesel or LPG prices without stoking already high inflation? Not only will it bite into household budgets, even food prices at restaurants and food joints will go up as they are major consumers of LPG cylinders diverted from households. Taming high inflation will continue to be tricky, believes Joshi, “Sustaining low inflation is a tough task. Assuming a partial monsoon failure, we expect GDP to grow by about 5.5% in FY15. Even on low growth, our inflation has remained high due to supply-side shocks.”

Poll hurdle 

 Any hike, be it in LPG or diesel prices, will have to wait till the assembly elections in Maharashtra, Delhi and Haryana are done and over with. That could be well till October or even beyond that date. It effectively means that any further reduction in fuel subsidy in FY15 can well be ruled out. 

Then, given that the monsoon has not been normal this year, any steps to reduce fertiliser subsidy could well be perceived as anti-farmer. All this could well roll into FY16 where, surprise, the deficit target is 3.6%. 

"Beyond the budget, there is a lot that the government can do in the form of executive education" - Abhay Laijawala, head of research, Deutsche Equities

 As it is, given its cash-strapped position, the government really isn’t in a position to provide additional stimulus to spur growth. Now that this year’s action plan is short on specifics, the hope is that much action will happen outside the budget. “Beyond the budget, there is a lot that the government can do in the form of executive decisions. If we see acceleration in project clearance, there could be a tailwind of confidence,” says Laijawala. Amidst this optimism, the wait for achhe din continues.