Economic gloom is behind but way to go to build hope for recovery
The Finance Minister has very limited “band-width” to deliver either a populist or growth-supportive Budget for FY14. The economic agenda is to dilute conflicts in play between growth-inflation dynamics. The growth momentum is sluggish while retail inflation is uncomfortably high. The economic woes have hit the fiscal balance hard pushing the Government to defer expenses and raise one-off revenues through distress sale of public investments/assets. The fiscal agenda is to cut fiscal deficit through ramp-up in revenues without deferring productive expenditure. The monetary agenda requires providing good comfort to RBI to maintain dovish and growth-supportive monetary policy. The current dynamics are complex; growth momentum is sluggish leading to poor fiscal condition which delays monetary support to growth. Budget FY14 should provide solutions to cut this vicious cycle (and conflicting momentum) among economic, fiscal and monetary dynamics. There is now a new dimension to this conflict from elevated Current Account deficit which has squeezed domestic liquidity, diluting monetary policy impact on money market rates. The need is also to provide comfort to Global Rating agencies on growth and twin-deficits to remove the fear of rating downgrade; junk investment grade status for India will be an economic, fiscal and monetary disaster. The Finance Minister is not in an enviable position at this stage to provide resolutions to all at the same time. The priorities however will be to revive growth momentum, remove supply-side constraints and spur long term foreign (and domestic) investments; resolution to these will dilute the impact of other evils on the economy. The actions (and measures) since September 2012 is encouraging, removing the doom and gloom on the Indian economy providing relief rally in Indian asset markets. These are good to prevent the worst but lot to be done to provide significant recovery; stake holders will watch for triggers to revive growth momentum, attract investments and achieve fiscal prudence.
Projection of moderate GDP growth momentum: The Advance Estimate of FY13 GDP Growth is low at 5% with expectation of Revised Estimate at 5.0-5.5%. While the Government can take comfort from the global economic gloom, its impact on revenues exposes the lack of fiscal prudence and very high composition of consumption expenditure. The Finance Minister is expected to set an ambitious target/FY14 estimate of around 6.5% deriving comfort from possible global economic recovery and adequate inflow of external capital and liquidity. The actions (and measures) to revive core sectors and roll out of non-financial reforms to attract investments and consumption will be critical. The economy is now in a state of sub-optimal capacity usage; the need is to fill up this gap and prepare for capacity expansion to get the growth momentum above 6.5% while shift to over 8% looks a distant away!
High expectation (and tall promises) on fiscal deficit: The Finance Minister is vocal on achieving the 5.3% fiscal deficit target for FY13 and has taken follow-up actions through extra-ordinary items such as accelerated disinvestment and deferral of productive expenditure. The projection for FY14 at 4.8% of GDP will look ambitious despite sharp reduction in subsidies during the course of the financial year; tax reforms and higher taxes on select group will help. The dependence on market borrowing to finance fiscal deficit is expected to stay steady.
Over-drive to contain expansion in Current Account Deficit: CAD has expanded since June 2012 to unmanageable levels around 6% of GDP. The Finance Minister has taken measures to discourage import of non-essential consumption and expanding investment opportunities for off-shore investors to bridge CAD diluting its impact on exchange rate and liquidity. While this is a structural issue with no quick-fix solutions, the Budget should focus on boosting exports, reduce external dependence on essential imports and expand opportunities in non-services sectors while removing the hurdles to ensure smooth and sustainable flow of off-shore liquidity and capital.
Focus on infrastructure and other cores sectors for capacity expansion: There is not much of attention to core sectors in UPA2 regime and few steps have been taken to remove hurdles (and administrative bottle-necks) to revive these sectors which contribute to expansion in consumption, increased economic productivity and employment generation. The Finance Minister is expected to address issues related to reforms, flow of capital and availability of liquidity to these sectors. This is the low-hanging fruit at this stage to set up acceleration in growth momentum.
Steady tax regime but additional burden on top of the pyramid: The Finance Minister has assured to stay steady on taxes with signals that the super-rich and the minority at the top of the pyramid should stay prepared for higher contribution to the exchequer. The efforts also will be on to broaden the tax payer’s base, remove slippages in tax collection and to cut tax evasion. There may be tax sops for essential (and critical) sectors contributing to growth and higher burden on non-essential sectors contributing to CAD and inflation. The focus will be more on revenues with limited scope to squeeze expenditure.
Expectations from Banking and Financial Services sector: The concerns emerge from lack of credit risk appetite and general liquidity squeeze. The huge excess SLR build-up by Banks to the tune of around Rs.5 Trillion (7% of NDTL) highlights the risk aversion with customer deposits being used to fund Gilts portfolio, given the draw-down from LAF/Repo counter at around Rs.1 Trillion. The slackness in deposit growth is adding to pressure on deposits rates, with lenders not inclined to ease lending rates in most products. The expectation will be from opportunities to lend at acceptable credit risk, build working capital lending opportunities through revival of core sectors and expand credit pick-up through higher capacity usage and expansion. These requirements highlight the need for RBI to either expand their Balance sheet and/or shift asset structure from rupees to dollars while staying moderate to dovish on monetary policy.
Impact on Financial Markets:
There may not be release of either shock or awe feeling into the Money Market. The market borrowing is expected to stay steady around Rs.5 Trillion while measures towards policy reforms, growth and fiscal consolidation will build bullish set up into the future. Budget is expected to provide monetary space for RBI, through acceleration in growth, moderation in fiscal position and containing supply side pressures on inflation. However, price appreciation in the Bond market is expected to be significant in the shorter end of the rate/yield curve, say 1 to 3/5 years with marginal gains in the longer tenors of over 10 years. 10Y Bond yield is expected to trade steady at 7.65/7.70-7.85-8.0% range in FY14. The shorter end of the Money Market rate curve will ease on shift into FY14 with 3-12M tenor rates steady at 7.75-9.0%. It will be an extended pause mode on rates as ability of RBI to shift system liquidity from deficit to surplus is limited.
Equity market is expected to shift into mildly bullish undertone on cues from measures to support growth, relaxation in investment rules for off-shore investors and improvement in domestic liquidity to pull in domestic investors who are expected to shift from Fixed Income into equities during the course of FY14. NIFTY is expected to extend gains beyond 6100 into 6350 (SENSEX at 21150) while any weakness in NIFTY into 5750-5825 will attract strategic investors.
Rupee exchange rate has become critical to dilute the conflict between growth-inflation dynamics. The elevated Current Account Deficit largely driven by higher commodity prices and subdued exports is there to stay. It is important to retain off-shore appetite for Indian markets and also provide signs of exchange rate stability to maintain forward market in dollar supply driven mode. It would be a period of consolidation in Rupee exchange rate at 53-55 which is seen good to balance inflation risks and export competitiveness.
Over all, Budget FY14 is expected to set course-corrective actions with intent to provide comfort to Global rating agencies to prevent downgrade and prepare for upgrade before end of financial year 2013-2014.
Moses Harding
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