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Union Budget 2015: Will higher fiscal deficit at 3.9% change anything?

One of the important points for which the Budget was being closely watched was fiscal deficit target. So, fiscal deficit is slated to be at 3 percent of GDP in FY18, if things go as per finance minister Arun Jaitley’s plans and for the next year, the deficit is at 3.9 percent and not 3.6 percent.

Samiran Chakraborty, head – research at Standard Chartered India says the market won’t be too disappointed with a 3.9 percent against a 3.6 percent. But the thing is very little has been achieved on higher capital expenditure, it has gone up just 0.2 percent of GDP, he says.

So the issue is about the quality of fiscal consolidation and not so much about the quantity of it, he says.

Sajjid Chinoy, India Economist at JPMorgan says one needs to be a bit careful about inter-year comparisons because of the change in methodology. “This year what has happened is a far greater fraction of resources have gone to the states which reduces your net tax to the Center. There will be some compensating transfers that have gone as well but we are not quite sure what the magnitude of those transfers are,” he explains.

Below is the verbatim transcript of Sajjid Chinoy & Samiran Chakraborty’s interview with Latha Venkatesh on CNBC-TV18.

Q: Do you think the government can be forgiven for reneging on the deficit target?

Chakraborty: 3.9 percent against 3.6 percent was expected by the market. I do not think people will be hugely disappointed by that number but if you dig down into the quality of fiscal consolidation, I think what strikes out is there is very little that we have achieved on higher capital expenditure through this, in fact if you compare it with percentage of gross domestic product (GDP) terms, capital expenditure has only gone up 0.2 percent of GDP, which is not a very big number.

If you look at the other side, about 0.3 percent of GDP of additional money after adjusting for the lower transfers, the states have got. How well this 0.3 percent of GDP is going to be spent is anybody’s guess and that is where there is some question marks over the quality of the fiscal consolidation and not so much about the quantity of fiscal consolidation which probably we can still live with.

Q: Your thoughts on fiscal deficit and revenue deficit – not really falling?

Chinoy: We have to be a bit careful about inter year comparisons because of the change in methodology. This year what has happened is a far greater fraction of resources have gone to the states which reduces your net tax to the Center. There will be some compensating transfers that have gone as well but we are not quite sure what the magnitude of those transfers are. Therefore, I will be little bit wary about making comparisons between this year and last year in revenue deficit.

You spoke about the fact that 0.7 percent of GDP in oil savings have accrued this year and to think about this at a more simplistic level, about 0.2 percent of this has been used for fiscal consolidation, 0.5 percent has been spent. Our estimates are the bulk of that 0.5 percent about 0.35 percent towards public capex and the remaining 0.15 percent – I do not have problem necessarily with in any one year moving the target a bit from 3.6 percent to 3.9 percent. If it is seen as one-off an aberration and there is commitment to next year’s target.

For me the only concern is it reduces fiscal maneuverability and there are at least three sources of worry here (1) you said oil prices go up even USD 10 or 15 per bbl and oil subsidy bill goes up then what may happen is you are force to cut back on increased capital allocation (2) the tax revenues are certainly budgeted more realistically but it is not a slam-dunk. If you do all the adjustments, tax buoyancy for last year was 0.7 percent and this year assumed to be 1 percent, which is meaningfully higher and that means growth needs to pick up.

If growth doesn’t pick up then that tax buoyancy may not manifest itself again – what will suffer perhaps capital allocation and (3) suppose for example you need more public sector bank recapitalisation; it’s only Rs 8,000 crore. So if there is any kind of overshooting or under shooting in other places of the Budget, what may happen is your spending on capex may go down and you do not want to be in a situation later in the year where you end the year with a fiscal deficit of 3.9 percent and you haven’t achieved the public investment stimulus that you set out to do but these are all risk scenario. However, let me end by saying sometimes we get a bit too critical on the government, the fact is India does need a massive public sector, infrastructure boost and the government is serious about doing this both on the balance sheet and off it in this budget.

Q: I am more worried about what the RBI will do. You think this skews their position a bit? And you shouldn’t expect at least an inter-quarter policy rate cut you think?

Chakraborty: Well, that looks unlikely now because RBI will probably take a little while to understand the full implication of it. It is massive change in terms of the way to look at fiscal, how much money is going to states, how this is going to change the equation, would Centre plus states combined revenue deficit be lower or higher; these are very important questions and RBI might take a while to really form their answers to this. So, I am not expecting an intermeeting rate cut based on today’s Budget.

Q: How many rate cuts are you expecting?

Chakraborty: Well, given that inflation has been surprising us on the downside, not just in India but across the world, there could be a situation where at least in the next few months that trend still continues and we get another 50, 75 basis point of rate cuts from RBI. I do not think there is an urgent necessity to change that scenario because ultimately if we are moving towards a inflation targeting a framework then that 150-200 basis point of real policy rate; that would be more important determinant of our RBI policy action than the Budget. So, at some level I am still comfortable going with a 50,75 basis point but yes that urgency of rate cuts and the speed of rate cuts might actually be tempered because of some question marks on the quality of fiscal consolidation.

Q: Your thoughts on the same thing?

Chinoy: Before I answer that, one of the most and impressive aspects of today’s Budget was just institutional progress and foremost among apart from the bankruptcy law, the dispute resolution was the formalising of monetary policy frame work. That brings a great deed of credibility to inflation targeting in India.

On the issue of how many rate cuts, the likelihood now is of a next cut in April and the old adage is the more tightening of fiscal policy there is there would be proportionately more loosening of monetary policy. It is important to understand that net of asset sales, the fiscal has in fact expanded a little bit by 0.1 percent of GDP this year over last year. So, all told the RBI I would speculate would have been happier if the process of fiscal consolidation had continued I am not sure this is the deal breaker but we had 50 basis points of rate cuts penciled in; the risk of more than that goes down when there is some fiscal relaxation so, we will go with 50 basis points, 25 at the April review and 25 later in the year.

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