- a) additional spending commitments;
- b) higher public investments and,
- c) weak tax/divestment proceeds.
Higher capital infusion into public-sector banks is the other priority.
During a mid-year review, funding needs were raised by two-thirds of this year’s budget. Another 0.2% of GDP needs to be set aside in FY16/17 as part of a roadmap to meet banks’ capital needs.
These funds are meant to ease the banks’ burden of rising stressed advances which jumped past 11% (of total advances) as of Sep15. Risks are that additional bank recapitalisation needs crop up in the year, particularly as other fund-raising avenues are hurt by financial market volatility.
Next, the government assumed a pro-growth approach by boosting capital expenditure by 25% in FY15/16 budget. Higher public-sector participation in jump-starting the investment cycle is needed to compensate for a sluggish private sector.
While capital investment as a percentage of GDP has bottomed out, project commissioning and new investment announcements slowed in the Dec’15 quarter. Overcapacity across sectors has also lowered appetite for greenfield investments.
Against this backdrop, higher public expenditure is necessary to maintain growth momentum. The National Investment and Infrastructure Fund (NIIF) will also help finance the construction of public infrastructure projects. From an estimated 1.7% of GDP, DBS expect capital expenditure to rise to 2.0% of GDP in FY16/17 surpassing the share of subsidies – a first in many years.
At the same time, further rationalisation in subsidies will also be needed. Further reduction in fuel subsidies is unlikely after last year’s allocations were halved to 0.2% of GDP. Diesel and petrol prices have now been de-regulated, with only LPG/ kerosene remaining under the umbrella.
Some adjustment in food subsidies is likely. An official high level committee estimates about INR 300bn (0.2% of GDP) in savings on such changes.
Lastly, weakness in direct tax collections has been a long-standing concern. While tax buoyancy in 1H FY1516 was encouraging, income and corporate tax collections are running below this year’s budgeted pace. Corporate taxes are due to be lowered by 5% over four years FY16/17 onwards. A roadmap towards this end is likely in February, but will be revenue neutral as tax exemptions/ holidays are scrapped simultaneously.
In the meantime, indirect revenues improved sharply in FY15/16 and a replay is likely in FY1617. Any further increase in fuel excise duties/ import duties /and service tax adjustments would also help.
Under non-tax avenues, divestment proceeds continue to disappoint.
In the first nine months of FY15/16 only a third of the public-sector asset sales target has been met. Earlier indications of a new strategy to regularise asset sales proved to be a challenge given the volatility in the financial markets and free-fall in commodity prices. There is a need to be realistic on this front.
DBS suspect that a smaller but more realistic target of 0.3% of GDP will materialize (vs FY15/16’s ambitious 0.5-0.6%).
Deficit risks
All told, the bank see the risk of that the FY16/17 target is adjusted higher to 3.7% of GDP. Such would dispel doubts over the quality of consolidation, while also minimising a negative shock on growth due to lower public expenditure.
Investors and rating agencies are unlikely to punish the economy for these missed targets, given the improvement in external balances, growth prospects and the fact that they follow largely from lower inflation.
However, wider deficits carry risks: i) delays to rating upgrades; ii) stalls the improvement in the public debt-to-GDP ratio; and iii) narrows room for monetary stimulus.
Delays in fiscal consolidation for a second year mean rating upgrades are unlikely for at least a year.
Second, the room for monetary stimulus will narrow to ensure demand-driven inflationary pressures stay in check.
Finally, the favourable public debt dynamics that India has enjoyed in recent years could also reverse as nominal GDP growth falls below the government’s borrowing costs (i.e. 10y bond yield), as highlighted by the Finance Ministry’s mid-year review.
India’s public debt-to-GDP ratio has been easing in recent years, before stabilising around 60% of GDP.
Longer-term, structural improvements are required to put fiscal balances on a stable footing. The need to lift tax revenues from the current 10% of GDP is a priority. Passage of the nationwide Goods and Services tax at the upcoming parliamentary session is being watched in this regard. Its passage would help the government stay on the medium-term roadmap, even if the FY17/18 deficit goalpost of 3% of GDP is delayed by a year.
Sources: All data are sourced from CEIC Data, Bloomberg, government agencies and central bank. Transformations and forecasts are DBS Group Research. Fii-news.com.