Dear Mr FM, is the 3.2% fiscal deficit feasible? The arithmetic looks too lofty

Finance Minister Arun Jaitley’s commitment to fiscal discipline in the Union Budget for 2017-18 and his determined bid to keep fiscal deficit below last year’s 3.5 per cent at 3.2 per cent won him a lot of accolades.

At least some analysts on Dalal Street attributed Wednesday’s nearly 500-point rally in the domestic equity benchmark to this number.

The narrower the deficit, the lesser is the pressure on liquidity from government borrowing, the brighter the chances of softness in interest rates and higher the chances of demand buoyancy in the economy.

“With the fiscal deficit contained at 3.2 per cent, yields will continue to be low and interest rates should be benign. This sets a stage for increased consumption across sections of the market,” Motilal Oswal, CMD of Motilal Oswal Financial Services, said in his Budget reaction on Wednesday.

Ridham Desai, MD, Morgan Stanley, said the bid to lower the debt-to-GDP ratio was one big thing in this Budget.

“The government’s commitment to reduce the debt-to-equity ratio was one 'wow' factor,” he said in an interview with ET Now.

But has the market missed the Budget arithmetic amid some kind of excessive exuberance?

First, the Finance Minister aims to achieve his deficit target with a lofty target of Rs 72,000 crore from disinvestment proceeds! Feasible?

The six-year average record for disinvestment proceeds is not even Rs 40,000 crore. This financial year, the government has managed to raise just Rs 27,432 crore by disinvesting its stakes in 14 state-run firms and launching a Rs 6,000 crore CPSE ETF.

In addition, the government sold 1.6 per cent of SUUTI Holdings in L&T for Rs 2,096.35 crore. Add all of this, and the government is nowhere near its FY17 divestment target of Rs 56,500 crore. What has come to its rescue is the Rs 33,000 crore bonanza it received from the sale of telecom spectrum.

The most optimistic estimate of economists for disinvestment proceeds in FY18 was around Rs 40,000 crore. Even if one were to let it bloat a bit with some hope of a good show with the divestment in general insurance companies, it remains to be seen if the government can really cross even the Rs 60,000 crore mark.

“The target for disinvestment receipts is too lofty. We estimate that the government will be able to collect Rs 50,000 crore against the budgeted target of Rs 72,000 crore,” analysts at brokerage Ambit Capital said in a Budget review.

Abheek Barua, Chief Economist at HDFC Bank, said some of the assumptions underpinning the Budget are likely to rankle.

“Miscellaneous capital receipts, an amalgam of conventional disinvestment, strategic divestment and ‘listing of insurance companies’ are projected to yield Rs 72,500 crore, a tall order indeed given the myriad uncertainties on the global front, specifically the problems of emerging markets that Mr Jaitley alluded to at the beginning of his speech,” he said.

Barua said Jaitley had legroom to fully utilise the escape clause provided by the FRBM committee (given the disruption caused by demonetisation) and keep the deficit target higher, given the need for fiscal elbow room to prop up both public investments and rev up the consumption momentum.

“There is certainly a risk that the government would face a funding constraint down the year,” he said.

But if the numbers are taken at face value, there is a case for the Reserve Bank of India (RBI) to cut interest rates as early as February 7, Barua argues.

Jaitley’s commitment to fiscal consolidation and the associated fiscal deficit target of 3.2 per cent of GDP has translated into a smaller net market borrowing number (Rs 3.48 lakh crore) than what the bond markets had predicted.

“This is with some help from a large increase in small savings that partly funds the deficit. Lower government borrowings should push interest rates down a tad and aid the consumption momentum. The commitment to consolidation also puts pressure on RBI to reduce the policy rate in the next monetary policy due on February 7,” he said.

Government bonds fell on Wednesday after the government widened its fiscal deficit target for the next financial year in the Budget. The benchmark 6.97% 2026 bond yield rose to 6.43 per cent from 6.41 per cent on Tuesday.

Secondly, a slippage of around Rs 10,000 crore is also estimated on the revenue expenditure front, mainly because revenue expenditure growth has been budgeted at a fairly modest quantum for FY18.

“Line items, such as Mahatma Gandhi National Rural Employment Guarantee Act (MGNREGA) could end up attracting higher expenditure as unemployment rises with the informal sector shrinking,” she said.

A combination of these two slippages is likely to mean that the government will deliver a fiscal deficit of 3.5 per cent of GDP against the budgeted of 3.2 per cent of GDP in FY18, the Ambit Economist said.

HDFC Bank’s Barua said both the nominal growth rate in GDP assumed for the current financial year of 11.6 per cent and 11.9 per cent for 2017-18 looked a trifle aggressive if one were to factor in both the impact of demonetisation and the continued sluggishness in investments and exports that is unlikely to improve soon.

“Mercifully, the revenue projections do not share the exuberance of the GDP assumptions at least at first glance. According to our calculations, the tax buoyancy shows a decline from 1.5 per cent in FY17 to 1.0 per cent in FY18. Further, the tax-to-GDP ratio remains unchanged from last year for FY18 at 11.2 per cent,” he said.

Barua said the government clearly wants to depend on the two Ds- demonetization and digitalization—to expand the individual and corporate tax base while the GST when (and if) implemented could help indirect tax collections.

“Given all this the 12.2 per cent growth in gross tax revenues seems to be reasonable. However, the impact of the GST both in terms of the impact on collection and sharing with states does not seem to be factored in at all. Thus these projections are at best tentative,” he said.