Fiscal deficit to GDP ratio targeted at 5.5% for FY11: HDFC Bank
The bank expects fiscal deficit to GDP ratio to be targeted at 5.5 per cent for FY11.
By ET Bureau |
MUMBAI: As the government will present its budget for the fiscal year 2010-11 on February 26, HDFC Bank has presented its expectations from the Finance Minister Pranab Mukherjee.
The bank expects fiscal deficit to GDP ratio to be targeted at 5.5 per cent for FY11. The centre’s fiscal deficit to GDP ratio has worsened from 2.6% in FY08 to 5.9% in FY09 and is likely to come in around 6.1-6.7% of GDP in FY10. Its primary balance (surplus of non-interest expenditure over receipts) is likely to have slipped back into a deficit of 2.5-3% of GDP in FY10 from a surplus of 0.9% of GDP in FY08.
While a large fiscal deficit is beneficial (even necessary in some cases) at a time when private demand is weak, the equation changes when private demand picks up and competes for productive resources with the government. In that regard, with domestic private consumption and investment picking up much faster than what a purely stimulus driven recovery might suggest, the case for a gradual withdrawal of fiscal expansion is gathering ground.
“Failure to return to the path of fiscal consolidation amidst rising inflationary pressures and recovery in private sector investment and credit demand will have obvious implications for macroeconomic stability. The rational response to this would be a move towards fiscal rectitude. Thus, we expect the Finance Minister to prune the fiscal deficit to GDP ratio to 5.5% in the forthcoming FY11 budget announcement as indicated in last year’s medium-term fiscal policy framework,” said Abheek Barua, Chief Economist, HDFC Bank.
Furthermore, efforts to cut down the fiscal deficit to GDP ratio from 5.5% to the FRBM long-term target of 3 per cent, however, will likely involve a greater degree of commitment on the part of the government. “While we are unlikely to see revenue enhancing tax reform measures such as the Goods and Services tax and Direct tax code in the forthcoming budget it is imperative that the Finance Minister lays down the roadmap for their implementation. Budget FY11 will have to extend beyond an annual accounting exercise if the government intends to stay a key growth driver in the next fiscal year and should use this opportunity to outline a medium-term fiscal consolidation path,” added Barua.
HDFC Bank’s key expectations from Budget FY11:
The bank expects fiscal deficit to GDP ratio to be targeted at 5.5 per cent for FY11. The centre’s fiscal deficit to GDP ratio has worsened from 2.6% in FY08 to 5.9% in FY09 and is likely to come in around 6.1-6.7% of GDP in FY10. Its primary balance (surplus of non-interest expenditure over receipts) is likely to have slipped back into a deficit of 2.5-3% of GDP in FY10 from a surplus of 0.9% of GDP in FY08.
While a large fiscal deficit is beneficial (even necessary in some cases) at a time when private demand is weak, the equation changes when private demand picks up and competes for productive resources with the government. In that regard, with domestic private consumption and investment picking up much faster than what a purely stimulus driven recovery might suggest, the case for a gradual withdrawal of fiscal expansion is gathering ground.
“Failure to return to the path of fiscal consolidation amidst rising inflationary pressures and recovery in private sector investment and credit demand will have obvious implications for macroeconomic stability. The rational response to this would be a move towards fiscal rectitude. Thus, we expect the Finance Minister to prune the fiscal deficit to GDP ratio to 5.5% in the forthcoming FY11 budget announcement as indicated in last year’s medium-term fiscal policy framework,” said Abheek Barua, Chief Economist, HDFC Bank.
Furthermore, efforts to cut down the fiscal deficit to GDP ratio from 5.5% to the FRBM long-term target of 3 per cent, however, will likely involve a greater degree of commitment on the part of the government. “While we are unlikely to see revenue enhancing tax reform measures such as the Goods and Services tax and Direct tax code in the forthcoming budget it is imperative that the Finance Minister lays down the roadmap for their implementation. Budget FY11 will have to extend beyond an annual accounting exercise if the government intends to stay a key growth driver in the next fiscal year and should use this opportunity to outline a medium-term fiscal consolidation path,” added Barua.
HDFC Bank’s key expectations from Budget FY11:
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• Fiscal deficit to GDP ratio to be targeted at 5.5% for FY11
• Roadmap for fiscal consolidation likely
• Gross market borrowings for FY11 likely at Rs 4,64,000 cr-Rs 4,94,000 cr compared to Rs 4,50,000 cr in FY10. Net borrowings at Rs 3,50,000-Rs 3,80,000 cr likely for FY11 compared to Rs 3,97,000 cr in FY10.
• We see nominal GDP growth expectations for FY11 to be revised higher to 14% from 12.4% listed in medium-term strategy statement
• Disinvestments likely to be budgeted close to Rs 20,000 cr through piece-meal government stake sale
• We expect tax buoyancy to pick up from 0.2 in FY10 to 1.3 on recovery in growth and partial withdrawal of tax cuts
• Service tax unlikely to be altered from current rate of 10% ; more services to be included under tax net.
• We see union excise duty increased by 2% to 10% and brought in line with service tax rate to help smoothen transition to GST
• Removal of select industries from list of export industries eligible for 2% interest subvention scheme
• We see gross budgetary support to plan expenditure increase by 15%
• Expenditure rationalization measures such as freeing up of domestic fuel prices unlikely immediately but ad-hoc fuel price hike expected by March,2010
• Road-map for Nutrient-based fertilizer policy on the cards
• Direct Taxes Code and Goods and Services Tax implementation to be delayed to FY12
• Additional funds over and above World Bank support likely to be allocated for recapitalization of public sector banks
Bond market implications
• Bond yields have shot up over the last two weeks on comments by RBI governor Subbarao that net borrowings for FY11 is likely to be the same as those for FY10.
• Net market borrowings announced is generally understood as the fraction of the fiscal deficit that is financed from the market.
• The initial net borrowing in last year’s budget was Rs 3,97,957 cr-99% of the fiscal deficit.
• However, if we adjust for Rs 33,000 cr provided from MSS desequestration (MSS cash balances with the RBI transferred to the government) , the actual net borrowings for FY10 was Rs 3,64,957 cr-91% of the fiscal deficit.
• Given our calculations, the fiscal deficit at 5.5% of GDP works out to Rs 3,86,494 cr. However, there is unlikely to be MSS support in FY11.
• If 99% of the deficit is indeed financed through market borrowings then the net borrowing figure (net gilt issuance) works out to Rs 3,82,629 cr.
• Thus, net G-sec issuance is likely to be higher this year and there is no scope for a bond rally on this count.
It is possible that the market will for a brief period compare the Rs 3,97,957 cr number with the Rs 3,82,629 cr number and this could trigger a rally. It is also possible that there will be alternative sources of funding the deficit and the net borrowing number could be a lower percentage of the deficit than 99%.
“Let us consider the case where it is say 91%. The corresponding net gilt issuance works out to Rs 3,52,000 cr which is lower than the net issuance of Rs 3,64,957 cr this year and this again could trigger a rally. In either case the rally is likely to be shallow. With RBI likely to tighten its monetary stance further and discontinue key setoffs for last year such as the OMO buy-back scheme, the market will eventually focus on the large quantum of borrowings likely to hit the market per week. This could be close to Rs 12,000-15,000 cr. Negatives such as rising inflationary pressures will also keep government debt offered. We therefore recommend selling into any run-up in gilt prices at this stage,” Barua concluded.
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