Union Budget FY13....a tight rope walk
It is a tough task to make both ends meet when things around are negative and complex. There has been a sharp slippage in fiscal deficit; estimated to end FY12 at 5.5-6.0% against budgeted 4.6% of GDP. It will be sharply higher on sequential basis against FY11 actual of 4.7% of GDP. The Government may not be blamed for this as the slippage was driven by external sector since July 2011 Euro zone crisis; exerting severe downward pressure on growth momentum from above 8.5% into 7% causing pressure on revenues. On the other hand, there has been cost escalation through increase in subsidies driven by high crude oil and fertiliser prices (and weak rupee). Over all, it is fair to assume that current poor fiscal position of India is triggered by imported factors from external sector on which the Government has little control.
Finance Ministry is in preparation of the FY13 Budget in the midst of woes across political, economic and monetary environments. The UPA (and the Congress) Government is unable to roll-out next generation economic reforms in the absence of support both from inside and outside of coalition. Economic woes are in plenty both from domestic and external sectors. The monetary situation is tough and anti-growth. The overshoot in fiscal deficit and resultant funding of the gap from the market is major cause for the liquidity squeeze and high cost of liquidity. The environment is definitely not in favour of delivery of “feel-good” Budget with no compulsion to deliver populist budget when the next General election is distant away.
The focus (and priority) for this year will be on critical factors to increase revenue to arrest further slippage in fiscal deficit and to maintain it around 5%; effect pass-through of subsidy to consumers to control cost; pull domestic and foreign investments to core sectors to spur growth momentum and boost exports (outside Services sectors) to address Trade deficit and its resultant impact on exchange rate. The need would also be to roll-out catalyst measures to Agriculture; infrastructure and Manufacturing sectors which have huge upside potential. It is important to maintain stock and exchange rate market in bullish undertone to shift domestic and foreign investors into “risk-on” mode. Therefore, it will be a two point agenda this time; to revive growth momentum and bring in fiscal consolidation.
The stake-holders may need to be prepared for higher excise duties and service tax (with higher coverage) to ramp up revenues. It is expected that pass-through of subsidies in the fuel sector will be aggressive while implementation of Food Security Bill will keep food subsidies at elevated levels. It has to be trade-off between fuel and food subsidies to arrest escalation on the cost side of the budget. Ideally, estimate for FY13 fiscal deficit will be maintained at mid-point of FY11 actual and FY12 estimates; which could be around 5.2% of GDP. There may not be additional pressure on the market with gross borrowing estimated at Rs.5.0-5.25 Trillion (and net borrowing of around Rs.4.5 Trillion). The down-side risk to this estimate will be on strong headwinds from external sector to push GDP growth below 7% (into 6.5%) and inability to attract long-term investments into core sectors.
What is the impact on Money and Bond market? RBI would need to support the government by maintaining system liquidity at adequate mode at affordable cost of liquidity. Having said this, it would be very tough for RBI to guide the operative policy rate from Repo rate to Reverse Repo rate till Government cuts its dependence on the market. RBI needs to maintain system liquidity within the tolerance level of 1% of NDTL to support growth. It is possible that CRR is brought down to 3% by Q3 of FY13 while keeping SLR unchanged. The supply side concerns in the Bond market will build-in tenor spread to the yield curve with gradual downtrend in 1Y yield into 7.5-7.0% and 10Y yield not below 8% during FY13. Over all, shift into FY13 will set up downtrend in short term money market rates for sharp reversal in 3-12M rate curve into 8.5-9.0% from current 10.25-10.75%.
The impact on stock market will be neutral to positive. There will be good investor appetite from external sector and follow-through buying by domestic investors will be needed to provide the desired upward momentum. The current pessimistic expectation on growth and inflation is keeping the domestic investors in “risk-off” mode with investments locked in low risk; high yield Fixed Income assets; aggressive shift into rate cut cycle will bring the funds back into equity market.
The belief (and expectation) is that of limited downside risks and significant upside gains into FY13 after disastrous H2FY12. The headwinds from external sector on domestic growth momentum will ease given the extent of financial support in the Western markets in the form of QEs with commitment to maintain near zero interest rate regime till 2014. On the domestic front, there will be improvement in fiscal deficit on sequential basis; expected to be down from above 5.5% of FY12 into below 5.5% in FY13. Given these limited expectations on the Budget FY13, FM is not expected to send “unpleasant surprises” into the market. Let us stay neutral to mildly bullish on run into Budget FY13.
Moses Harding
Executive Vice President
Head – ALCO and Economic & Market Research
IndusInd Bank, Mumbai
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