Long-term fiscal prudence is the key

Despite short-term fluctuations, efforts to improve fiscal measures should continue

The targeted fiscal deficit and the resultant funding pattern for the same are the key Budget numbers that impact the debt markets. From this perspective, the Budget announcement has been broadly in line with market expectations.

The Budget targeted a slightly higher fiscal deficit than the pre-existing target for FY18, but with a promise to continue on the consolidation path. It aims to narrow fiscal deficit to 3.2 per cent in FY18 compared to 3.5 per cent in FY17 and to target 3 per cent from FY19. Revenue deficit will also be lowered to 1.9 per cent. The fiscal numbers are very credible, with tax buoyancy estimated at marginally higher than 1 on a nominal GDP growth projection of 11.75 per cent. The government has done a fine balancing act by keeping net market borrowings unchanged at ₹4.23 trillion for FY18 as compared with Budgeted estimate (BE) FY17. The lower withholding tax of 5 per cent applicable for Foreign Portfolio Investments has been extended for another three years.

Even with projected net market borrowings by the Centre within expectations, the overall net Statutory Liquidity Ratio (SLR) supply would still remain high as State Development Loans (SDL) supply is likely to be higher. In this context and the evolving global landscape, the bond market is likely to remain unimpacted by the Budget announcement in isolation in the near term.

Budget internals

With the State governments deciding not to access collections from the small savings fund starting FY17 onwards, the Centre has recourse to a larger pool of small savings collections which have been budgeted close to ₹1 trillion for FY18. The government’s decision not to review rates on small savings (which had to be indexed to government security rates) has enabled a larger collection under this head (both for FY17 RE and BE FY18) as well as reduction in market borrowings. For the coming year, it would be of interest to watch the trend in small savings rates as well as net collections under this head. It must also be mentioned that the access to larger small savings funds, which has advantages to the extent of reducing market borrowings, currently comes at the expense of government having to bear a higher interest cost. To the extent that interest payments of ₹5.23 trillion currently almost equal the fiscal deficit, the sustainability of such non-market high cost borrowings is doubtful.

Not budgeting for extra budgetary resource raising through Central public sector undertakings with interest and principal servicing by the government as in FY17 also materially improves the fiscal numbers. As regards the higher disinvestment amount budgeted at ₹725 billion, there could be a potential buffer available under other heads, especially with some collections under income declaration scheme (IDS) - 2 and higher dividend from the RBI.

Medium-term impact

The Fiscal Responsibility and Budget Management (FRBM) review committee has suggested to target General Government debt to GDP ratio of 60 per cent by 2023. This would envisage a reduction of around 6 to 7 per cent in general government debt (Central government and States combined) over the next five years. The benefits from a higher nominal growth and stated commitment to reduce general government debt can be significant for the bond markets. The focus on gradual reduction of public debt as announced by the Finance Minister as well as potential enhanced tax compliance arising out of more formalisation of economy and tax reforms such as Goods and Services Tax (GST) should enable public finances to be on a sound footing over the medium term. Overall, a steady shift to the formal economy of the large unorganised sector is envisaged, which eventually improves tax to GDP ratio seen in combination with GST implementation. This would have medium-term positive impact on the markets as public debt and market borrowings come down.

In this context, it is pertinent to note that net market borrowings through dated securities has been showing a downward trend since FY13. The net borrowings, which was at ₹4.67 trillion in FY13, is projected at ₹4.23 trillion in FY18. In the same period, nominal GDP has grown from ₹100 to ₹168 trillion. The progress made in reducing headline borrowing numbers can be further reinforced if the stated improvement in tax to GDP and public debt reduction is realised.

The writer is Head of Debt, SBI Mutual Fund

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