Believe it or not, there is a silver lining in the sell-off in local equities following the Budget announcement. Investors’ feet are now firmly on the ground after the euphoria over the game-changing poll outcome. But I believe that Budget details are not as bad as the magnitude of the decline in equity prices might indicate.
The Budget is pro-growth and appears to be designed to ensure the improving momentum on economic growth even if it is at the expense of delayed— but not forgotten—fiscal consolidation. Importantly, the government has taken some steps towards fiscal reforms that are positive but these seem to have been ignored by the market.
The key negative is the fiscal deficit of 6.8 per cent of GDP for 2009-10 compared to 6.2 per cent of GDP in the last fiscal year, and its implications for debt sustainability. However, it is worth bearing in mind that this is not a taxand-spend Budget. The increase in the Budget deficit is due to higher spending that has not been offset by reversing the general excise and custom duties that were cut to deal with the economic downturn.
In fact, the government has actually removed the 10 per cent surcharge on personal income tax and also increased the standard deduction for some individuals. The combination of moves on direct taxes suggests that the government is perhaps more concerned about the growth outlook, especially in the wake of concerns that the monsoon may not deliver this time.
The Finance Minister, though, has indicated the need for fiscal consolidation, but should have also mentioned the path toward a deficit of 4 per cent of GDP by 2011-12 mentioned in the medium-term fiscal policy statement.
It will be challenging to finance the large government borrowing without hiccups. However, it is likely that the actual borrowing will be lower, if disinvestment and tax revenues surprise positively. The assumption of Rs 11.2 billion for disinvestment is so low that there can only be a positive surprise on the actual outcome.
Concerns over the impact of the large borrowing over long-term rates and inflation continue to be exaggerated. Crowding out of private investment becomes an issue when government borrowing increases while private sector demand is strong. However, in India’s case, the fiscal boost is meant to offset the weakness in private demand.
Anyone concerned about crowding out has to be pretty bullish on the growth prospects and over the anticipated rebound in loan growth over the next six to nine months— one cannot be bearish on growth prospects and be worried about crowding out at the same time.
Separately, the 10-year yield is lower today than it was in September last year, despite the bond market being beaten down by unprecedented scale of borrowing. This is mainly because of the RBI’s deft management of the borrowing calendar and the use of monetary instruments to ensure sufficient liquidity. The central bank should also move toward the shorter tenures to relieve the supply pressure at the long end.
A combination of strong economic growth, low inflation and low interest rates would be bliss but an improbable scenario. However, if there is no growth then a smaller fiscal deficit or low inflation or long-term rates are of little use. We are in unusual times that warrant unusual and non-conventional policy response.
Rajeev Malik is the head, Indian and Asean economics, Macquire capital