The first budget of the government’s second term was always going to be a delicate balancing act. On the one hand, growth momentum in India — and indeed, around the world — has slowed markedly in recent months. On the other hand, there was no space for a fiscal stimulus, as some had clamoured for. The broader public sector is already eating up virtually all household financial savings. Bond yields have finally witnessed a rally in recent weeks. Any widening of the fiscal deficit would have reversed those gains, pushed up interest rates more generally, and thereby undermined the efficacy of the RBI’s monetary easing cycle. How, then, should the government have tried to boost growth, investment and savings without any fiscal latitude?
Given these difficult constraints, the budget is well-intentioned, and hits all the right chords. But the key is going to be in the execution. The devil will, eventually, lie in the details.
First, however, let us talk about the intentions. There is a concerted effort to attract foreign capital to augment declining domestic financial savings. Increasing FDI limits in insurance, aviation and the media are on the anvil. Domestic sourcing requirements for single-brand retail are expected to be eased, foreign portfolio flows (FPIs) will now be allowed to invest in real estate investment trusts (REITs) and infrastructure investment trusts (INVITs), and, KYC norms for FPIs are, more generally, expected to be rationalised. In addition, authorities may float a dollar bond to have access to a broader international investor base. With some caveats, these are welcome moves. In a world of low and negative interest rates, where capital is desperately searching for productive use, the Indian government’s intention to seek foreign savings to augment domestic savings is understandable.
Perhaps the area that deserves the most immediate attention is India’s financial sector. Credit markets for NBFCs are frozen, public sector banks have the liquidity but not the growth capital, and private sector banks are stretched to their limits with rising incremental credit-deposit ratios. Here, too, the government has tried to strike the right notes. Public sector banks will be re-capitalised by another Rs 70,000 crore, and some of this will hopefully translate into growth — and not just resolution — capital. On the NBFC front, a temporary and partial credit-guarantee will be offered to public sector banks to purchase high-rate pools of assets from “financially sound” NBFCs — as a means of trying to inject liquidity and break the logjam.
Also, eschewing the clamour for a stimulus, the government has shown admirable restraint by pegging the deficit at 3.3 per cent of GDP.
All told, therefore, the budget appears well-intentioned on fiscal discipline — as it tries to unclog the financial sector and attract foreign capital flows into India.
But intentions apart, much will depend on execution. Take the fiscal math for example. To achieve the fiscal deficit target, gross tax revenues will need to grow at an ambitious 15 per cent over last year’s actual outturn, even after adjusting for the tax rate increases for high-income individuals and the excise/custom duty increases. To put this in context, gross taxes grew at less than 9 per cent last year. Therefore, unless growth rebounds sharply and/or GST collections are tightened meaningfully, tax targets are going to remain under pressure all year long, with question marks about expenditure having to be slashed again at the end of the year.
Similarly, disinvestment targets are higher, but questions linger. Will the approach be true strategic sales/asset recycling to the private sector — which is more efficient at operating many of these assets/enterprises? Or will one arm of the government simply buy out another? Will asset sales fund more public investment or simply cover for tax shortfalls, which is akin to selling the family silver to pay the credit card bill?
On the financial sector, bank recapitalisation is positive. But only if (i) the allocation of capital is meritocratic to ensure incentives and monies are aligned; and, (ii) bank governance reforms (read the P J Nayak Committee Report) proceed in tandem. Capital without reforms risks engendering another public sector bank NPA crisis down the line. On the NBFC front, there is a fine line between ensuring illiquidity does not spawn an insolvency crisis and stoking moral hazard. The credit guarantee should, therefore, be temporary and very targeted. And if this temporary lifeline does not work, one cannot ignore the long-run fix anymore: An asset quality review.
On the external front, attracting foreign capital is well and good. But FPI flows are notoriously fickle and pro-cyclical — elusive when most needed. They can only temporarily substitute for boosting domestic financial savings. While the sovereign dollar bond could attract a new class of investors, there is a risk of it cannibalising existing FPIs that hold rupee assets. A small issuance in international markets may not materially change things but if FPIs are willing to hold rupee assets, why not further liberalise and induce FPI flows into the domestic market, so that they — and not the sovereign — bear the currency risk? What we don’t want over time is a dollar bond in international markets — over which policymakers have no control — disproportionally impacting domestic yields, as investors eventually arbitrage across the two markets.
All told, the budget has performed an artful balancing act against a difficult macro backdrop. The big themes — financial, external, fiscal — are all well-intentioned. But for it to move the economic needle, authorities must walk the talk with equal skill.
This article first appeared in the print edition on July 6, 2019 under the title ‘An artful balancing act’. The writer is chief India economist at J P Morgan. Views are personal.
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