Time for bold moves

Revenue growth is likely to be limited by lower nominal GDP growth in FY13 but indirect tax rates could be nudged up to provide revenue support. The new direct taxes code (DTC) and uniform goods and services tax (GST) are likely to be deferred until FY14 and only a few small steps are likely to be announced to smooth the transition. Dependence on divestment proceeds and other forms of non-tax revenue are likely to continue in the FY13 Budget.

The government urgently needs to reduce unproductive expenditure on subsidies to demonstrate its commitment to fiscal consolidation. Deregulation of all administered prices on fuel and fertiliser products is unlikely to happen immediately but some price increases are possible to reduce the subsidy burden and signal policy direction. Although in the near term these price corrections could be inflationary,the RBI is likely to focus more on the medium-term impact of fiscal consolidation to tame structural inflation pressures.

Monetary policy can only be eased substantially in FY13 if the Budget outlines a credible fiscal consolidation plan. Even if fuel subsidies are brought down,new pressures could emerge from food subsidies,allocations for bank recapitalisation and debt restructuring for power distribution utilities.

Overall,the expenditure-to-GDP ratio in FY13 might not improve substantially from FY12. We would view the Budget positively were the FM to improve the quality of fiscal spending by increasing the share of capital expenditure (13% of total expenditure in FY12) on infrastructure projects.

The outcome of state elections on March 6 will determine the final shape of the Budget. A positive result for the ruling United Progressive Alliance (UPA) could prompt the FM to take bold steps towards fiscal consolidation.

The announcement of a fiscal deficit below 5% of GDP is possible,but markets would closely scrutinise all the assumptions behind such an optimistic

projection. In our baseline scenario we expect gross market borrowing to be around R5.4 trillion,which is marginally higher than current market estimates. In such a case,we believe support from the RBI via open market operations (OMOs) will again be required in FY13 to avoid supply pressure in the rates markets.