Budget 2018 goals to range from deficit reduction to lifting capex

India’s Finance Minister Arun Jaitley is likely to deliver mostly good news on fiscal consolidation when he unveils next year’s budget on Feb. 1. The government is set to overshoot its deficit target in the current year through March, largely due to lower dividend payments from the central bank. The proposed budget for fiscal 2019 though, will look better -- for deficit reduction and investment plans.

The consensus view is that Jaitley has to choose between two competing goals: either purse its aim to cut the deficit to 3% of GDP, or boost investment needed to spur growth and reduce bottlenecks in the economy -- not both. Bloomberg Economics’ view is that the trade-off isn’t so stark. Sales of government-owned assets and increased revenue from goods and services tax reform mean Jaitley should be able to net sufficient revenue to meet both objectives.

Fiscal Consolidation Is Back

BE expects the budget deficit to come in at 3.4% of GDP in fiscal 2018, down from 3.5% in the previous year. That would exceed the government’s target of 3.2%, reflecting lower-than-expected revenue as demonetization squeezed profits of the Reserve Bank of India and the GST dented growth. That would still be within a relaxed limit of 3.5% of GDP afforded by a review committee that gave the government more wiggle room on account of those major structural reforms. And for the year starting in April, the government should be able to stick to its original target for a deficit of 3% of GDP, as the reforms clear the way for faster growth and stricter compliance -- improving tax buoyancy.

 
Deficit Target of 3% of GDP Achievable in Fiscal 2019

Key reasons for slippage on the budget deficit target in fiscal 2018:

·  Non-tax revenue is expected to fall short of target by about 530 billion rupees. Of that, 350 billion rupees is due to lower RBI dividend payments to the government, and about 180 billion rupees is due to lower telecom revenues as the sector suffered huge losses as a new entrant increased competition.

·  Providing a strong positive offset -- an aggressive disinvestment program that has seen the government net roughly 910 billion rupees already against a budgeted 725 billion rupees for fiscal 2018.

·  Revenue expenditure -- outlays on running government departments, providing services and interest payments and subsidies -- is estimated to overshoot the budgeted amount in fiscal 2018. One reason is an additional 440 billion rupees of supplementary grants that have been approved year to date. Another is rising crude oil prices, which have boosted the cost of subsidies for cooking fuel. Savings in some government departments and year-end curtailment of expenditure to contain the deficit should be positive offsets to some extent.
 
Tax Revenue Projections

BE’s view is that the government will be able to reduce the budget deficit to 3% of GDP in fiscal 2019 even while increasing capital expenditure by more than 20%. Following are the details:

·    Non-tax revenue is expected to rebound, increasing 23% in fiscal 2019 after decreasing 14% in fiscal 2018. The main driver -- higher dividend payments from the central bank, whose profits are likely to recover to pre-demonetization levels. Behind the better RBI earnings -- it no longer needs to incur costs of soaking up surplus liquidity (which has returned to neutral), and also stands to reap more income on higher foreign exchange reserves.

·    Net-tax revenues are projected to rise 12.8%, up from an estimated 13.1% increase in fiscal 2018. A previously announced reduction in corporate tax rates is likely to pull down direct tax growth to 12.2% in fiscal 2019 from an estimated 16.9% in this fiscal year. Simplification of the GST filing structure and implementation of new measures to counter tax evasion will improve compliance and boost indirect tax revenue. Based on year-to-date GST collections, BE estimates indirect taxes to increase 15.7% in fiscal 2019, up from an estimated 7.2% rise in fiscal 2018.

·    The government’s disinvestment target for fiscal year 2019 is likely to be 1 trillion rupees -- higher than 725 billion rupees for the current fiscal. Buoyant stock prices on an expected earnings recovery are likely to help the government meet its target again.

·   Revenue expenditure growth is set to slow in fiscal 2019, partly reflecting base effects -- payments of higher government salaries and increased allowances buoyed spending in previous years. As a proportion of GDP, interest payments on government debt and subsidies are expected to continue easing in fiscal 2019. This will open space for more spending on capex projects.
 
Expenditure Mix to Favor Capex Grow

Bloomberg