Even as it projected an uptick in growth rate in financial year 2018-19, the Economic Survey presented by Finance Minister Arun Jaitley in Parliament Monday, two days before the presentation of the Union Budget, hinted at the government taking a “pause” at fiscal consolidation and possible slippage in the target this fiscal, relative to the previously announced fiscal deficit targets.
The statement forced bond yields to extend the hardening trend seen over recent weeks. Raising concerns over “elevated levels” scaled by stock markets in recent months, the Survey also advocated some “policy vigilance” as being necessary in the coming year, which comes in the backdrop of rising speculation in the market that the government may either introduce long-term capital gains tax on equities or increase the holding period for claim of such benefits.
Taking note of the fiscal developments, the Survey noted, “A pause in general government fiscal consolidation relative to 2016-17 cannot be ruled out”. In its outlook for the coming year, it said, “Setting overly ambitious targets for consolidation, especially in a pre-election year, based on optimistic forecasts that carry a high risk of not being realised will not garner credibility either. Pragmatically steering between these extremes would suggest the following: a modest consolidation that credibly signals a return to the path of gradual but steady fiscal deficit reductions.”
As the Survey called for a pause in fiscal consolidation, the bond markets took a hit. Bond yields rose 13 points as concerns mounted that the government could widen its fiscal deficit target when it unveils its annual budget Thursday.
The government had set a fiscal deficit target of 3.9 per cent for FY’16 and 3.5 per cent for FY’17 and 3.2 per cent for FY’18. There are expectations in the market that the government may miss this year’s target by around 30 basis points.
On December 27, the government announced that it would raise additional market borrowing of Rs 50,000 crore through dated government securities in the current financial year and then on January 17, it announced a change in plan and said, “Upon a review of trends of revenue receipts and expenditure pattern, it has been assessed that additional borrowing of only Rs 20,000 crore of government securities would be adequate to meet financing needs. Government did not accept borrowings of Rs 15,000 crore in last three auctions. Remaining Rs 15,000 crore would be reduced from the notified borrowing programme of ensuing weeks.” On Monday, the 10-year benchmark bond maturing in 2028 saw its yield move up to 7.44 per cent from 7.31 per cent.
Amid speculation in the market that the government may either introduce long-term capital gains tax on equities or increase the holding period for claim of such benefits, the Survey too raised caution on the fact that the markets are at elevated levels and it suggested that “policy vigilance” will be necessary in the coming year.
Asked if some changes in taxation rules are required, Chief Economic Advisor Arvind Subramanian offered an open-ended answer. “You know that those are questions that we cannot provide answers to, you will have to wait for the Budget for answers to questions like that.”
He pointed out that globally, when asset prices rise too much, they always tend to come back and so one has to be watchful. “Let me just say that higher the prices go, our vigilance should increase correspondingly,” he said. The Survey raised concern over a “sudden stall” in the market, induced by sharp corrections to elevated stock prices and which could in turn trigger capital outflows.
While extrapolating the rising oil price scenario, the Survey’s assumptions were based on the fact that the government may pass on the increase in oil price to consumers rather than absorbing it through excise tax reductions.
“Average oil prices are forecast by the IMF to be about 12 per cent higher in 2018-19, which will crimp real incomes and spending, assuming the increase is passed on into higher prices, rather than absorbed by the budget through excise tax reductions or by the oil marketing companies. And if higher oil prices requires tighter monetary policy to meet the inflation target, real interest rates could exert a drag on consumption,” the Survey said.
On the rural front, while giving his presentation, Subramanian called for supporting agriculture while listing out his “policy agenda for the year ahead”. He, however, said that this year there has been reduction in acreage under sowing and so the prices won’t get impacted as they did in previous years. He also said “we need to have a mechanism that will protect farmers against the downside. Last year we tried to do it in pulses with more effective procurement. We need to do more on that”.