The good, the not-so-good and the tricky

In the aftermath of the Union Budget, the onus of igniting the animal spirit seems to be on the RBI. More rate cuts are on the cards

Writing on Union Budget two days after it was presented is a predicament akin to that of Larry Fortensky, the US construction worker — seventh and last husband of Elizabeth Taylor (by her eighth marriage). On their honeymoon in 1991 at Michael Jackson's Neverland Ranch, Fortensky knew well what exactly he was expected to do but his challenge was how to be different from Taylor’s previous husbands.

On a serious note, let’s focus on the good, the not-so-good and the tricky parts of Modi 2.0 government’s first Budget.

The good part is sticking to the path of fiscal consolidation. Finance minister Nirmala Sitharaman has even improved the fiscal deficit target — from 3.4 per cent of GDP in the Interim Budget to 3.3 per cent. How has this been done? The decline is based on an assumption that the nominal GDP will grow higher (11 per cent) that what was projected in the Interim Budget (10.5 per cent). The finance minister also expects higher dividend from the Reserve Bank of India (RBI) and more money from selling government stake in companies. The tax collections target is ambitious — implying a growth of 18.3 per cent in fiscal year 2020 versus 8.4 per cent achieved in 2019 (provisional). 

Then, there is a rounding-off effect. In the Interim Budget, it was 3.35 per cent which got rounded off to 3.4 per cent. Now, it is 3.34 per cent, rounded off to 3.3 per cent. 

Despite these, restraining the temptation to spend more and sticking to the fiscal consolidation path is a good omen. The shortfall in tax collections can be compensated by the money that the RBI may pass on the government, after Bimal Jalan committee signs off the report on this contentious subject.

Another good initiative is stripping off the National Housing Bank (NHB) of its regulatory responsibility and passing this on to the RBI. The NHB has failed as a regulator. It has been liberal in distributing licences to housing finance companies (HFCs) and giving them money (refinance) even if these entities have been chasing builders and realtors to make a quick buck. The share of riskier non-mortgage loans portfolio in total loans for top five housing finance companies rose from 29 per cent in March 2016 to 46 per cent in December 2018. 

The Budget has also empowered the RBI to change the management of non-banking finance companies (NBFCs) and supersede their boards if they are not doing their job. The banking regulator can even check the books of the non-finance subsidiaries of the NBFCs and remove their auditors for three years. Along with the stick, the carrot came in the form of incentives to banks for buying high-rated pooled assets of financially sound NBFCs up to Rs1 trillion. The government is offering one-time six-month partial credit guarantee for the so-called first loss up to 10 per cent. This window will address the crisis of confidence that the NBFC sector is suffering from.

The not-so good part is a blanket Rs 70,000 crore recapitalisation of public sector banks with no strings attached. This is more than what the industry had expected. Beyond keeping them alive by meeting the regulatory capital requirement, the finance minister has given them growth capital. They will start lending but how will we ensure prudent lending? The Budget document says “reforms will also be undertaken to ensure governance in public sector banks”. Let’s wait and watch. The boards of most public sector banks need to be recast, the performers need to be rewarded and the bankers’ fear of being hounded by investigative agencies for wrong credit or bad loan settlement decisions should be removed while the rotten apples must be taken away from the sack.

What’s the tricky part of the Budget? The government will start raising part of its annual gross borrowing overseas in foreign currencies. The finance minister has taken this call — historically an anathema for the RBI — since sovereign debt to GDP ratio in India is less than 5 per cent, among the lowest, globally. A finance ministry official has clarified that 10 per cent of the borrowing will be raised overseas in the second half of the year. Since the gross borrowing programme for fiscal year 2020 is Rs 7.1 trillion, roughly Rs 71,000 crore will be borrowed overseas. 
 

During the Asian financial crisis in 1998, the State Bank of India raised $4.8 billion through Resurgent India Bonds and again, in 2000, it raised $5.5 billion through India Millennium Deposits. In 2013, around $34 billion was raised by Indian banks from non-resident Indians. In all three cases, the idea was to shore up India’s foreign exchange reserve through a sort of proxy sovereign borrowings. Now, the government wants to borrow overseas directly to bridge the fiscal deficit of the country. Is it a good move?

Well, a tricky one. Countries of similar credit rating that India enjoys (the lowest investment grade) are raising money at around 1.5 percentage point higher than six-month London Interbank Offered Rate or Libor. The cost is in the band of 3.75-3.85 per cent. On a fully hedged basis, it will be more than 8 per cent, higher than around 6.75 per cent cost for raising money in the domestic market but one doesn’t expect the government to hedge the currency risk. So, it is cheap money and, to the extent of overseas borrowing, the pressure on the local bond market will ease. This is why bond prices rallied on Friday.

It’s an experiment to watch out for. On the flip side, it will impact domestic rates; expose the government to currency risks; and it can cannibalise the existing overseas investors. Instead of taking exposure to others, some entities from the pool may choose to invest directly in government papers. And, if the experiment is successful, the government can become bold and borrow more from overseas and care less about fiscal prudence. For the record, overseas investors can now invest up to Rs 2.35 trillion in central government bonds and Rs 49,700 crore in state government bonds. They have used 71 per cent of their exposure limit in central government bonds and less than 4.5 per cent in state papers.

Overall, the Budget has a good script and outlined a dream to reach a $5 trillion economy, buoyed not only by domestic consumption but also by exports. The burden of lifting the growth and igniting the animal spirit seems to be on RBI now. With low inflation and fiscal prudence, we will see more rate cuts in coming months.

The columnist, a consulting editor of Business Standard, is an author and senior adviser to Jana Small Finance Bank Ltd. His latest book, HDFC Bank 2.0: From Dawn to Digital will be released on July 10. 

Twitter: @TamalBandyo