The Indian government's budget has pushed back fiscal consolidation, leaving much of the task of addressing the country's relatively weak public finances to the next administration, says Fitch Ratings. However, the budget target revisions are modest, and are balanced by positive reform momentum and a strong economic outlook.
The postponement of consolidation in part reflects policies to support the economy, which was held back last year by weak investment and disruptions from demonetisation and the introduction of the goods and services tax (GST). New spending initiatives include measures to boost rural incomes, an ambitious health insurance scheme intended to cover about 500 million people, and funding for the construction and upgrading of medical colleges and hospitals. This spending will benefit a large section of the public ahead of general elections due by May 2019.
The budget deficit target for the fiscal year ending March 2019 (FY19) is set at 3.3% of GDP, down from an expected 3.5% in FY18. This implies fiscal slippage of 0.3% of GDP in both FY18 and FY19 relative to last year's budget targets of 3.2% and 3.0% of GDP, respectively. The target for FY18 was missed largely because of higher expenditure. This government's initial fiscal plan, set out in 2014, aimed to reduce the deficit to 3.0% of GDP by FY18 - the level consistent with the Fiscal Responsibility and Budget Management (FRBM) Act of 2003. It now does not expect to hit that target until FY21, beyond its current electoral term.
Despite this slippage, the government stated in the budget that it plans to adopt a ceiling of 40% of GDP for central government debt, as recommended by the FRBM Committee in January 2017, compared to an estimated 50% of GDP in FY18.
This would be a positive step towards a more prudent fiscal framework, if eventually adhered to, even if debt is unlikely to fall below the ceiling by FY23, as recommended by the committee.
We have stated previously that implementation of fiscal initiatives to reduce general government debt over the medium term is one of the main factors that could trigger positive rating action. Weak public finances currently constrain India's sovereign rating of 'BBB-', with general government debt (including debt of the states) at 68% of GDP, well above the 40% median for 'BBB' rated sovereigns. The general government fiscal balance of -6.5% of GDP also compares poorly with the -2.5% 'BBB' median.
The forecasts underpinning the budget appear broadly credible. The 17% revenue rise expected in FY19 is notably higher than the government's nominal GDP growth forecast of 11.5%, but the GST may generate strong collections. Moreover, the roll-out of e-assessment, which reduces the face-to-face interaction between taxpayers and officials, may contribute to a higher income tax intake. That said, there is a risk the government may not be willing to cut expenditures to reach its deficit target in an election year if revenue disappoints.
The government's GDP growth forecasts of 6.8% in FY18 and 7%-7.5% in FY19 are not far out of line with our own. The temporary drag from demonetisation and the GST introduction will fade, while structural reforms should support productivity gains, provided they are implemented effectively.
Sluggish investment growth remains a drag on the economy, but a recovery might be supported by a corporate tax change that makes more companies eligible for the lower SME bracket, as well as the government's continued infrastructure investment drive. A large part of the infrastructure push will be financed off-balance sheet.
The decision to increase minimum support prices for agricultural goods to 1.5x the cost of production is likely to lift rural incomes, but could also push up inflation and bring forward monetary tightening.
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