The central government is evidently suffering from regional shackles (exacerbated in the recent state elections) and, hence, major reforms such as GST, FDI in retail andland acquisition may take an extended period of time to get implemented. In the meanwhile, in the current budget, in our view markets will be happy even if the government at least delivers on one front – a credible commitment towards fiscal discipline.
For any fiscal discipline promises to be viewed as credible, in our view, the government would need to implement some concrete measures such as indirect tax increases, while refraining from any increase in populist programs at least in this budget (as against the next budget, which will be the last before general elections).
A 50-100bp reduction in fiscal deficit in FY2013 (aided by 2G re-auctioning and stepped-up disinvestments, apart from tax increases) would significantly improve the outlook on inflation, interest rates, monetary policy and private investments – a key positive for interest-sensitive sectors. Also, pick-up in infrastructure ordering activity by government bodies in roads, ports and power transmission, among others, is one of the low-hanging fruits that the government needs to grab hold of. Any measures incentivizing private investment in infrastructure and capex would also be welcome. On the flip side could be sectors on the receiving end of higher taxes such as FMCG and auto.
In our view, one of the most visible areas of policy inaction – though not necessarily in the ambit of the budget but where any form of clarity or roadmap would be welcome – are mining andland acquisition. As evident from the significant negative contribution to overall GDP growth in recent quarters, supply issues in coal, iron ore etc. are currently literally holding the economy to ransom. Any positive developments on this front could prove to be a bonus in this budget.
Fiscal consolidation is the need of the hour
Government finances are estimated to have come under severe strain in 2011-12. Up to January 2012, the accumulated fiscal deficit of the central government reached Rs 4,34,933cr, 105.4% of the budgeted amount, and made the task of containing revenue and fiscal deficit at the levels indicated in the budget impossible – in our view, there could be as much as 100-125bp slippage on the fiscal deficit front from budgeted levels. This is despite contained spend on flagship schemes and other expenditure heads within budgeted levels, mainly due to the higher subsidy burden (effect of lower estimates, higher crude prices and rupee depreciation) and lower disinvestment (weak equity market conditions) on one hand and lower direct tax collection due to GDP slowdown on the other.
Measures are expected to increase revenue: Fiscal consolidation can be achieved without compressing expenditure on much-needed social and physical infrastructure and populist flagship schemes by significantly increasing tax revenue and reducing subsidies. For this, in the medium term, it is of prime importance that the government implements global benchmarks of taxation such as GST. However, in the near term, at least in this budget, we would expect the government to a) increase excise duties and service tax by 200bp and further broaden service tax net and b) achieve high mobilization from albeit one-time items such as re-auctioning of 2G licenses and stepped-up disinvestments.
Also, while the government may, from a populist point of view, make announcements on Food Security Bill, in our view this bill may find it hard to get implemented as it seeks to replace states’ own schemes – something that the current political landscape may not allow so easily. So, we do not expect the bill to materially alter FY2013 fiscal calculations.
Imminent increase in tax revenue to ease fiscal pressures
India’s total tax revenue (Centre and State) to GDP in 2011-12 is expected to be around 15%, much lower than its own peak of 17.6% achieved in 2007-08 and significantly lower than other major economies. In the near term, this ratio could be given the necessary fillip by increasing excise and service tax rates and higher services tax net, as there is no headroom available for increasing direct taxes. In fact, we expect the government to refrain from increasing corporate taxes, considering the current stressed environment.
In the medium term, this ratio could be improved by GST implementation (we expect the budget to throw some clarity on the roadmap for implementing GST), as the tax base would be enlarged under the same. Meanwhile, in this budget, we expect the government to increase excise duties and service tax by 200bp and further broaden service tax net.
High time to contain subsidies
Subsidy-related spends form a significant part of our total expenditure and are a major hurdle in achieving fiscal consolidation. Subsidy bill for the current fiscal is likely to overshoot the budgeted amount on account of lower initial estimates, higher crude prices and rupee depreciation. Current high crude prices will further increase the burden on the exchequer unless pass-through policy is implemented by hiking prices of petroleum products. There is also an imminent need to rationalize fertilizer subsidies by decontrolling urea prices, which will promote investment apart from curbing fertiliser imports.
As far as food subsidy is concerned, we remain skeptical of passage of the Food Security Bill in the near term and, hence, do not see its impact on food subsidies in the coming fiscal, as state governments are not ready to accept the bill in its current form. The budget may also guide a roadmap for improving the food subsidy distribution mechanism via UID or similar technology-related mechanism, which apart from ensuring payment to the right person will also reduce the burden on the exchequer.
One-time revenue to aid fiscal calculations
On the non-tax revenue front, we expect the government to clarify its policy guidelines for monetization of its cash cows such as cancelled 2G spectrum and BWA spectrum. Disinvestment is also expected to see increased momentum in FY2013.
Infrastructure boost also required
Currently, the infrastructure sector has been plagued by severeheadwinds – depleting orderbooks, high interest rates, policy paralysis resulting in execution slowdown and shrinking bottom line of most infrastructure companies. Although last year the exchequer allocated 48.5% of the total planned expenditure to infrastructure, 23.3% higher on a yoy basis, new projects could not take off due to delays in approval and decision making.
Moreover, new project launches have dropped by 32% in 2011-12, owing to lack of clearances and no clarity on policy reforms for various sectors. Land acquisition and environment clearances continue to remain the two major bottlenecks hampering the timely execution of projects.
However, it is quite apparent that in order to achieve sustainably healthy GDP growth, a proportionate increase in investment in infrastructure is required. The government can ensure this by allocating higher funds for the sector in the budget and simultaneously introducing measures for facilitating PPP investments (such as improving the clearances mechanism, providing tax sops/benefits and channelizing long-term, low-cost funding for infrastructure projects via measures like creation of corporate debt market, dedicated infrastructure debt fund, tapping insurance and pension funds or attracting foreign investment).
Although Land Acquisition Bill is the right step in the direction of ensuring faster execution of projects but, on account of ongoing deliberations on the same, we do not expect it to become a reality in the near term.
Conclusion
Fiscal discipline is the key expectation from this budget With inflation and interest rates expected to come down, Indian corporates are poised for a better performance in FY2013 over FY2012, which saw high inflation as well as high interest rates dragging the bottom line. Markets will be more than happy even if the government is able to deliver only on the fiscal consolidation front in this budget, as it will lower interest rates and aid the declining trajectory of inflation.
However, it will be a bonus for markets if the government takes some positive strides towards key policy reforms in the mining and infrastructure sectors, which are vital for India’s sustainable and healthy growth.
