“The biggest variable to track right now is the treasury that governments hold with the RBI, which is actually over 2% of GDP right now and this is mainly because the functioning of the government has been disrupted by the lockdowns and activity restrictions has been severely impacted,” he says Neelkanth MishraCo-Head of Equity Strategy, Equity Strategist Asia Pacific and India, Swiss credit.
Last time around, the market rallied post-budget and on budget day itself, the Nifty posted a nearly 5% bang. Can this magic be replicated?
What is happening right now is that the market is primed for higher deficits and therefore the expectation is that the center and states will have large deficits and tax revenues will increase but governments will not be able to spend money. The biggest variable to track right now is the treasury that governments hold at the RBI which is actually over 2% of GDP right now and this is largely because the way government is functioning has been disrupted by the lockdowns and activity restrictions has been severely impacted.
So when we go into the budget, and not just the central budget, but also the state budgets, it will also be presented in February and March. The key variable to watch for would be what they choose to spend, how much they can increase their spending because the tax revenue is good. There would be a strong temptation to consolidate aggressively, but at the same time the best way to reduce debt to GDP is to grow nominal GDP faster in general.
If the market is primed for higher deficits then it makes sense to spend a lot more and that would be the first area of focus. At the same time, one of the key takeaways from last year’s budget was that it was very progressive. It showed clean accounts. It showed parts where the government was very focused on growth, reforms, the privatization of PSU banks and several other such moves.
Even if there are no concrete steps that affect the fiscal numbers, the budget speech will also take such announcements about income taxes or the removal of tax exemptions very positively. I don’t know if that will be enough to offset some of the global market turmoil that we are experiencing. But yes, it will help India to hold its ground better.
Regarding the fiscal deficit consolidation path, this time there will be no oil tailwind that they had before with the consumption tax. At this point how would you look at the divestment program and the oil revenues that wouldn’t be there?
The combined center and state cuts at an annualized level. This happened in November, so four months have already passed in fiscal year 22. We will see eight months of reduction. The total was Rs. 1.5 trillion, which is a lot, but in the context of government taxation, I don’t think that’s a very large number.
This comes at a time when the tax-to-GDP ratio actually isn’t doing all that badly, even without the oil revenues, due to formalization and better compliance. Corporate profits are developing well. So corporate tax growth will be strong and therefore in theory the consolidation process can continue, although as I said before the objective should shift from simply managing the annual budget deficit to looking at and seeing the debt to GDP ratio how quickly they can be brought down because we are in a very difficult position at 90%. When borrowing costs rise the way they have, it’s very easy to fall into a trap where interest costs rise and then deficits start to rise. This will force a reduction in GDP and lower ratings, and many other risks may arise.
You have to get that 90% down to 70% over the next decade and I think the best way to do that is to increase the denominator and that has to be done with the center and the states coordinating how they can spend productively this way. Once the economy picks up steam, it can be withdrawn.
The easiest way to spend money, and some states may be tempted to do so, is to give government employees pay increases. I’m not saying it should be done or will be done, but that’s one way to increase spending, which while it will impact growth, will then create an enduring burden that can’t be avoided, huh happened 10 years ago and These are the main points when we turn to the budget.