Below Is The Views On Post budget by Mr. Arvind Chari, Head-Fixed Income & Alternatives, Quantum Advisors.
We had headlined our last year’s budget report as India Budget: Neither Popular nor Populist. The government had then committed to the 3.2%/GDP Fiscal Deficit target and had thus reigned in any populist expenditure. As we have now found out, it was a tough ask and the Government has had to increase the Fiscal Deficit to 3.5% for Fiscal Year 2018 with a marked increase in government expenditure over its budgeted estimates.
This year, although we find it strange, the reaction of the bond and currency markets to the announcement suggests to us as a Popular and a Populist Budget. A plain look at the budget numbers and the budget documents does not suggest any populism:
* Overall expenditure is slated to grow only by 10%. Lower than nominal GDP growth of 11.5%.
* Many major / flagship schemes of the government despite the rhetoric has seen a decrease or minor increase in allocations (See Table I below)
The budget assumptions also seem realistic: (See Table II below)
* Direct Tax revenue growth though pegged higher but with the increase in cess, tax on capital gains and the general increase in tax base and buoyancy in the last 2 years, it does not seem out of line • Corporate tax is muted at 10% again lesser than nominal GDP
* Non Tax Revenue are frankly lower than our estimates and can have upsides to it
* GST numbers though are budgeted higher, but we have to wait and see on how that plays out. The introduction of E-way bill and increase in compliance should pave way for better revenues.
The 10 year bond yield though rose by more than 20bps intra-day to end the day at 7.6%. This is after the bond market having already priced fiscal populism since October and bond yields having risen by close to 1% since the August 2017 (post RBI rate cut) lows. Not all the increase in bond yields is due to fiscal worries; higher oil prices, rising inflation, global bond yields and a hawkish central bank has played its part in the bearishness.
The continued bearishness seen in the last 4 months has sucked the joy out of bond buyers and the bond market continues to reel under supply – demand imbalance. Thus despite Gross and Net Borrowing numbers in line with market expectations the bond yields spiked.
The bond markets clearly seemed spooked by the government’s intention to remunerate farmers by 1.5x (times) their cost of production for all major crops. PM Modi had announced doubling of farm incomes by 2022 and with the re-election due next year, the government seems to have played the poll bugle early to fulfill its promises. To be honest, rural and India farm sector remains in distress and needs government and market support. Despite rising production, nominal farm incomes are dropping and thus the move to assure farmers income through the Minimum Support Prices (MSPs.)
But this announcement like many others by the government seems more popular than populist. We find that for major crops (Rice, Wheat), the ruling MSP is either higher or very close to the 1.5x (cost of production). So it does seem like a statement to show farmers that they are been looked out for but the actual increase in MSP may not amount to much.
This unless they want to make it a populist move also. In that case, they can announce MSPs of above 10% for the major crops which then leads to serious questions on the inflation forecast. If Cereal and other crop MSPs are indeed hiked by more than 10%, then we would expect the CPI inflation to increase and average around the 5.5% mark for the year ahead. With the RBIs inflation target of 4%, this will definitely get RBI on the hiking table. We had not expected the RBI to hike anytime soon, but given this development, the RBI will turn even more hawkish.
We recognize the challenges of getting the fiscal deficit around the 3% of GDP mark. With Tax/GDP ratios well below EM peers India’s fiscal deficit is expected to remain at 3%/GDP for some more years. But in a scenario where macro-economic risks are rising (oil prices, higher current account deficit, changing global monetary policy cycle), one would want the government and the RBI to be conservative and prudent.
The government did try to restrain its populism but the bond market clearly does not believe it. Bond yields get even more attractive now but we have been saying that for a while and yields have continued to rise relentlessly and term spreads have remained wide. Demand –supply needs to improve in the bond market and/or oil prices need to fall, until then bond yield trajectory will remain volatile.
Foreigners have remained heavy net buyers on higher yields and stable currency and we need to watch for signs on their behavior. The Indian Rupee did depreciate today on the back of higher than expected fiscal deficit and if it depreciates more, it may trigger some selling by foreigners in the local bond market.
We would though expect the RBI to increase limits for foreign investors in a calibrated manner and provide an opportunity for greater participation in the local bond markets. Foreigners still own less than 5% of outstanding bonds and there is a merit to slowly allow them to invest upto 10% of outstanding over the next 5 years.
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