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Between the interim and the final budget, there is typically little change, especially in terms of fiscal arithmetic, because macro realities do not change much in a few months. In the July 2014 final budget, the National Democratic Alliance (NDA) government had retained the fiscal targets set in the interim budget of the UPA II government, despite weakness in the economy. Today, again, economic growth is weak. However, the need to stimulate the economy has intensified since the interim budget of February 2019.
The question before finance minister Nirmala Sitharaman was whether the budget needed to be less restrictive than the commitment in the Fiscal Responsibility and Budget Management Act (FRBM) in view of the growth slowdown.
The fiscal deficit target for fiscal 2020 set in the interim budget was 20 basis points higher than the original set as per the medium-term glide path mentioned in the fiscal 2019 budget. The combined debt-to-gross domestic product (GDP) ratio for the Centre and the states is one of the highest among similarly rated sovereigns. So there was hardly any space to ease the target. The government has wisely re-emphasised its commitment to fiscal consolidation by setting a marginally lower target of 3.34% of GDP for the current fiscal from 3.36% earlier.
The budget has taken considerable initiatives to address some of the pain points without losing sight of medium-term strategic issues needed for faster growth. Support to real estate and non-banking financial companies (NBFCs) will alleviate some of that. The proposed recapitalization of public sector banks will improve their ability to lend.
The current fiscal deficit target of 3.3% of GDP will be a challenge to meet if growth decelerates. The Centre has budgeted only a modest growth of 9.5% in tax collections, which is lower than the nominal GDP growth of 12% assumed by the budget. Now it needs to front-load efforts on divestment and asset recycling/monetization to ensure capital spending is not compromised.
That said, the first implication of fiscal restraint is that it will encourage monetary policy to be dovish because fiscal policy is the key signal to the Reserve Bank of India (RBI) under the inflation targeting regime. RBI has cut rates by 75bps in 2019 and we expect another rate cut in the forthcoming policy.
Lower fiscal deficit is good news for government bond yields as well, which have softened in the past few months following the rate cuts by RBI, low crude oil prices, and dovish stance of central banks in advanced countries. That, and the expressed intent of foreign sovereign borrowings meant 10-year yields fell below 6.7%.
The budget and the monetary policy will provide mild support to private consumption. Growth momentum will pick up in the second half of the current fiscal as the lagged impact of rate cuts will kick in by then. Money in the hands of small farmers (income support scheme) and the middle class (tax breaks) will spur consumption demand as they have a higher propensity to consume compared with higher-income households.
The growth outlook for fiscal 2020 will be shaped more by extra-budgetary forces. For fiscal 2020, monsoon and crude oil prices will hold sway.
We believe India’s GDP growth can grind up to 7.1% this fiscal year if the monsoon rains turn out to be near-normal for the fourth season, and Brent crude oil prices average around $70 per barrel. At present, the risks are tilted to the downside because of uncertain global scenario and risk of inadequate rain. What matters for agricultural output is normal and well-distributed rains in July and August. That, and some pick-up in food inflation (remuneration to farmers), should lift sagging rural demand and overall GDP growth.
The budget rightly focuses on infrastructure, while trying to create a more investment-friendly environment for manufacturing by encouraging more foreign investment in sunrise areas through tax incentives rather than through increased allocations. This will help attract incremental foreign investments and supply chains that could potentially move out of China over the medium run due to US-China trade conflict.
The budget lays emphasis on divestment. The centre needs to revisit the private-public-partnership model in a way that risk-sharing between the two is more balanced. This is critical to bring back private sector interest into infrastructure development.