Budget 2020: Steering fiscal ship back to consolidation

By Sonal Varma  

Budget 2020 India: The government may miss its FY20 fiscal target of 3.3% by 0.4pp due to a combination of sharply lower nominal growth (7.5% vs budgeted 11%); slowdown in tax revenues compounded by a corporate tax cut; and lower-than anticipated disinvestment proceeds (0.24%). Thus, the government is looking at a potential shortfall of 1.5% (Rs 3.1 tn) in gross tax revenues, with a comparatively larger shortfall expected in indirect taxes.

There are three sources of fiscal aid available to somewhat address this strain. First, the government received higher RBI divided an additional 0.25% (Rs 530bn). The government may seek an interim dividend in FY20 out of its potential dividend to be declared later in FY21. Second, a recent SC ruling has accrued at least 0.7% of GDP (Rs 1.45tn) to the government from telecom companies. Given the severe stress this is likely to impose on the existing companies,the government will eventually acquiesce to reflect Rs 300bn in the FY20 budget and stagger the rest.

Finally, the government is likely to save on expenditures as it had budgeted an aggressive target of 20.5% y-o-y in FY20 vs actual spending growth of 12.8% (April-November). Slower expenditure in the last quarter should aid further savings (0.7% of GDP).

With the growth outlook still subdued and any recovery likely to be sub-par, the government has two options to choose from for the FY 21 fiscal trajectory. It can either decide to further delay its consolidation to stimulate the economy. Or, it can clarify that the FY20 fiscal slip was ‘inadvertent’ due to the unanticipated slowdown, and that the consolidation is back on track, especially with expectations of improving nominal growth.

On balance, we attach a higher probability to the outcome wherein the government avoids the choice of slipping further, and overburdening the bond markets, and in the process increasing the risk of sovereign rating downgrade. The government may choose the path of consolidation over growth, although the pace of consolidation (fast vs slow) is a close call.

In line with this, we believe the government will announce a trimming of its fiscal deficit target to 3.4% in FY21 vs 3.7% in FY20. It will most likely declare this owing to the assumption of higher nominal GDP growth (11% vs 7.5% in FY20), improved tax buoyancy, higher disinvestment targets (carrying forward unfulfilled FY20 plans to FY21), continued obligations of telecom companies, and aggressively seeking elevated dividends from public sector companies and RBI. News reports suggest that it may separately state off-budget borrowings to support the fiscal arithmetic

However, the government will encounter strong headwinds as it aims to achieve a potential fiscal target of 3.4% in FY21. Downside risks to real GDP growth remains material (Nomura: 5.7% in FY21, 4.7% in FY20), and while tax collections will likely improve, they may struggle to remain as buoyant as budget assumptions. We also expect RBI to find it challenging to match a similar profit level next year so as to be able to distribute higher dividends. Finally, the clubbing of FY20 and FY21 disinvestment agendas promises to set an overly ambitious target. Consequently, the government will most likely run the risk of slipping by 0.2%, if it decides to keep the fiscal deficit target for FY21 at 3.4%.

In the past, it has advocated a migration to an investment- and export-focused growth model instead of incentivising short-term consumption. More recently, an infrastructure investment pipeline of Rs 102tn over the next five years was announced, with the centre looking to fund 39% of the cost and with expectations from private sector to deliver 22%.

In line with this, capital expenditure may be at 1.79% of GDP in FY21 vs 1.66% expected in FY20; with focus on roads, railways and power. In addition, while there may be the temptation for the government to take ‘countercyclical’ steps like lowering income tax rates, the broader theme of fiscal conservatism may prevail. Rather than income tax cuts, more measured steps like possible tweaking of the basic exemption limit, or deductions against approved investments or mortgage interest payments may happen. The government may also allocate more resources to welfare schemes and choose to expand PM Kisan.

For the financial sector, news reports suggest a ‘big bang’ intervention, styled like the US’ TARP for troubled shadow banks. However, in light of the government’s reluctance thus far, the probability of such a scheme being announced is low. Rather the government may infuse additional capital into public sector banks.

On the real economy side, real estate has been a key sector affected and is likely to find mention. Proposals being discussed include measures to clear unsold inventory, a one-time GST exemption for first-time buyers, tax holidays for new projects, incentives to take on distressed projects, and increased outlay for last-mile funding of stuck projects. There is an urgent need to unlock new capital to fund growth. As a result, the government may look to ease constraints to attract new capital. For capital markets, LTCG tax of 10% and DDT for corporates may see some easing.

A roadmap for inclusion in global bond indices—a close call—may be outlined. Manufacturing sectors concerns may be addressed. It may also consider increasing custom duties on items like paper, footwear, rubber items and toys.

Gross borrowing for FY21 will be in the range of Rs 7.6-7.9tn, based on assumption that 67-70% of the fiscal deficit is financed via net dated securities. For FY20, the fiscal slippage of Rs 500-600bn could be financed by skipping the budgeted Rs 500bn buybacks; however if an additional borrowing of Rs 200-300bn is announced, this is unlikely to surprise the market.

While there are several moving parts, one reason why the government could opt for the higher proportion (70%) is the relatively low cash balance. We estimate cash balances of around `750bn in end-FY19, with a `511bn drawdown in the FY20 budget, leaving a relatively small balance to draw upon in FY21. Our estimate of net dated security supply in FY21 ranges from Rs 5.2-5.4tn—a y-o-y increase of 9-14% on FY20 net borrowing (FY20 was 12% higher than FY19).

While this represents a significant increase in supply, we believe market expectations have adjusted to the higher deficits/supply, while RBI’s ongoing operation twist lends support to bonds. Indeed, should the budget materialise in line with expectations, then bonds could see a relief rally, with 10y potentially trading towards the lower end of the 6.5-6.7%. Further support for bonds could come from announcements on bond inclusion. However, this could be part of a longer-term programme.

Overall, our base-line case remains one where the government will reiterate its commitment to medium-term growth consolidation. While a slip in FY20 looks likely (3.7% of GDP), lower government expenditure growth in Q4FY20 could be a downside risk at a time when we expect a nascent recovery to finally take shape after further slowdown in Q3FY20 (Nomura: 4.3%, 4.7% in Q4 FY20). Looking further, a fiscally conservative deficit in FY21 (3.4%) implies that the Budget will largely be neutral for both growth and inflation, and as such growth profile for FY21 (Nomura: 5.7%) should remain largely unaffected. The FY21 fiscal deficit is expected to be 3.6%, even with a faster consolidation (3.4%) in the upcoming Budget.

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Co-authored with Aurodeep Nandi, economist, India, Nomura Global Market Research.

Edited excerpts from Asia Insights, Nomura Research, January 24, 2020.

Source: Financial Express