Another Year Of Fiscal Disappointment

BMI View: India's central government has ploughed through 76% of its FY2013/14 (April-March) fiscal deficit target of INR5.43trn in just six months, and it is difficult to envisage the authorities making a concerted effort to rein in spending now that election season is upon us. While the deficit may be contained via greater-than-expected divestment proceeds and/or spending deferrals into next fiscal year, neither option gets to the heart of India's fiscal problem. A downgrade to junk status therefore, while unlikely, cannot be ruled out.

India's inability to put its fiscal house in order remains a key obstacle to a sustainable recovery in economic growth. Indeed, while the Reserve Bank of India (RBI) has been busy tightening interest rates in a bid to anchor inflation expectations and iron out macroeconomic imbalances, we have yet to see a similar resolve from the Indian government. According to latest finance ministry data, the central government has burnt through 76% of its FY2013/14 (April-March) fiscal deficit target of INR5.43trn in just six months of the fiscal year. As ever, the government's inability to keep non-planned expenditure (which includes interest payments, major subsidies, and social services) in check at a time of weak tax revenues has been the main culprit of the widening fiscal deficit ( see chart below).

It is difficult to envisage a major reduction in spending now that election season is upon us. India is constitutionally required to hold general elections before May 31 2014, when the current Lok Sabha (parliament) completes its four-year term. With the ruling United Progressive Alliance (UPA) facing an uphill battle to stay in office, it is difficult to see the administration of Prime Minister Manmohan Singh turning its back on the tried-and-trusted method of pre-election populist spending. In FY2008/09, ahead of the last general elections, central government current expenditures were ramped up by a remarkable 33.5%. While this is partially explained by counter-cyclical policy in the wake of the global financial crisis, much of the spending spree (most notably the Mahatma Gandhi National Rural Employment Guarantee Act) was actually introduced before economic activity started to head south. This time around, the government has announced another major social spending programme, the National Food Security Bill 2013, which again will put added strain on the fiscal coffers. With this in mind, the chances of a concerted effort to rein in expenditure look slim, in our view.

Too High For Comfort
India - Annualised Fiscal Deficit

BMI View: India's central government has ploughed through 76% of its FY2013/14 (April-March) fiscal deficit target of INR5.43trn in just six months, and it is difficult to envisage the authorities making a concerted effort to rein in spending now that election season is upon us. While the deficit may be contained via greater-than-expected divestment proceeds and/or spending deferrals into next fiscal year, neither option gets to the heart of India's fiscal problem. A downgrade to junk status therefore, while unlikely, cannot be ruled out.

India's inability to put its fiscal house in order remains a key obstacle to a sustainable recovery in economic growth. Indeed, while the Reserve Bank of India (RBI) has been busy tightening interest rates in a bid to anchor inflation expectations and iron out macroeconomic imbalances, we have yet to see a similar resolve from the Indian government. According to latest finance ministry data, the central government has burnt through 76% of its FY2013/14 (April-March) fiscal deficit target of INR5.43trn in just six months of the fiscal year. As ever, the government's inability to keep non-planned expenditure (which includes interest payments, major subsidies, and social services) in check at a time of weak tax revenues has been the main culprit of the widening fiscal deficit ( see chart below).

Too High For Comfort
India - Annualised Fiscal Deficit

It is difficult to envisage a major reduction in spending now that election season is upon us. India is constitutionally required to hold general elections before May 31 2014, when the current Lok Sabha (parliament) completes its four-year term. With the ruling United Progressive Alliance (UPA) facing an uphill battle to stay in office, it is difficult to see the administration of Prime Minister Manmohan Singh turning its back on the tried-and-trusted method of pre-election populist spending. In FY2008/09, ahead of the last general elections, central government current expenditures were ramped up by a remarkable 33.5%. While this is partially explained by counter-cyclical policy in the wake of the global financial crisis, much of the spending spree (most notably the Mahatma Gandhi National Rural Employment Guarantee Act) was actually introduced before economic activity started to head south. This time around, the government has announced another major social spending programme, the National Food Security Bill 2013, which again will put added strain on the fiscal coffers. With this in mind, the chances of a concerted effort to rein in expenditure look slim, in our view.

In the absence of major spending cuts, New Delhi will be eyeing up divestment proceeds and/or spending deferrals as a means to keep the budget deficit in check, but neither of these options gets to the heart of India's fiscal problems. The government has failed to realise its divestment goals for FY2013/14 to date. To be sure, at the time of writing, the authorities had raised just INR14bn of its full-year target of INR400bn. While there is still a strong pipeline of public sector undertakings (PSUs) due to hit the market, such as a 10% stake in state refiner Indian Oil Corp and miner Coal India, the lack of appetite amongst private investors has led to delays. Moreover, such one-off items merely gloss over the serious concerns with regards to the shallowness of recurrent revenue streams (a concern that can only be truly tackled by sweeping tax reform). In terms of spending deferrals, this was a tactical ploy used last fiscal year to 'improve' the full-year deficit numbers, but it is merely an accounting trick. Such expenditure postponement would eventually have to be acknowledged in FY2014/15, and would not be looked upon kindly by investors. It also fails to address the perennial spending pressures facing the government, particularly in the area of subsidy disbursements.

Three In A Row
India - Budget Versus Actual Fiscal Deficit, % of GDP

Another Year, Another Miss

With subdued economic activity likely to translate into persistently weak tax revenues, and given the lack of political will to rein in spending, we expect the country's fiscal deficit to miss the budget estimates for a third year running in FY2013/14. We are forecasting a central government shortfall of 5.6% of GDP, versus the official target of 4.8% of GDP. Of course, there is the potential for some variance in either direction based on whether the government can successfully pull off divestment strategies in late 2013/early 2014, and whether they decide to defer spending once more. Still, another year of fiscal disappointment would be huge concern for investors and ratings agencies alike. The 'Big Three' ratings agencies of Standard & Poor's, Fitch and, to a lesser extent, Moody's have all warned about the risks of a sovereign downgrade to junk status (India currently sits on the lowest investment grade rating). While we would view a demotion as harsh at this stage, given that a new administration may look to prioritise fiscal consolidation, it cannot be completely ruled out. Such a scenario would clearly bode ill for India's chances of a growth recovery in FY2014/15.

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