By Invitation. Focus on reviving economic growth

A Budget is a statement of revenue and expenditure over a period of time. In the context of the Government of India (GoI), the Union Budget holds greater significance than simply being an accounting exercise, as it unveils the tax policies for the coming fiscal. Moreover, the relative spending on different expenditure items provides clues to the government’s evolving priorities, although the Budget is not the sole occasion for announcing fresh expenditure. Additionally, the Budget signals the government’s commitment to fiscal discipline, which is keenly watched by various market participants.

The Union Budget for FY2018 will be the first after the watershed ban of specified bank notes (SBN), to which some sectors are continuing to adjust. Some targeted measures have already been announced to boost consumer sentiment for those groups that the note ban affected to a greater degree, such as interest relief for farm loans for 60 days and guaranteed 8 per cent interest for senior citizens on bank deposits up to ₹7.5 lakh for 10 years. The upcoming Budget is likely to further enhance social spending, through programmes and schemes such as NREGA, food security, insurance schemes and welfare pensions, and promote digital transactions to consolidate the shift to a less-cash economy.

The Budget will also introduce various changes, including the merger of the rail and union Budgets; the discontinuation of the classification of expenditure as Plan and non-Plan; and the possible quantification of expected indirect tax revenues under the Goods and Services Tax (GST).

The note ban has led to a temporary setback for demand growth, even as capacity utilisation remains moderate and the leverage levels of some corporates remain high. Given the likely delay of 1-2 quarters before the private sector concretises investment plans, the Budget may focus on boosting investment sentiment and reviving economic activity.

This could be done through substantially increasing the allocation towards infrastructure sectors with a larger multiplier effect on boosting growth, such as affordable housing, roads, renewable energy and railways, and allowing the Central public sector enterprises (CPSEs) to augment their capital spending by raising funds through market borrowings. Dedicated allocations for large infrastructure projects that have been announced previously, such as bullet trains, Bharat Mala, Sagar Mala, Smart Cities, inland waterways development, can also be made to expedite these projects.

We expect the Budget to include a substantial allocation for the National Investment and Infrastructure Fund (NIIF), and provide a timeline for this investment vehicle to raise funds from the market by leveraging its corpus. Additionally, we anticipate that the Budget may provide significantly higher funds for recapitalising public sector banks than the ₹100-billion indicated under the Indradhanush for FY2018, to support their balance sheets and enable them to participate in the economic recovery.

The aforesaid infrastructure and social spending would be partly funded through the augmentation of the GoI’s revenue base after the note ban, with one-time taxes and penalties being generated in the immediate term. Moreover, the proliferation of digital transactions, as well as the introduction of the GST, is expected to widen the tax base over the medium term.

It may be prudent to either defer a sizeable reduction in corporate taxes, or simultaneously trim exemptions, to protect the tax base. However, modest income-tax rebates or subventions to the lower income groups could be provided, to boost sentiment.

With the GST likely to be implemented by September 2017, we expect the Budget to restrict changes related to indirect taxes to aligning the service tax rate closer to the GST, simplifying and removing inverted duty structures, and introducing anti-dumping duty on segments adversely affected by cheaper imports.

The equity markets, which had undergone a correction after the note ban was announced, have recovered considerably, despite continued selling by foreign institutional investors (FIIs). A Budget that supports growth via targeted spending while balancing fiscal considerations may help draw FIIs back to the equity markets.

However, the combination of higher spending and tax cuts could lead to a rise in the fiscal deficit, which may exacerbate the FII outflows from the debt markets.

In our view, the GoI would budget a fiscal deficit range for FY2018 between 3.0 per cent and 3.5 per cent of the GDP, which would be equivalent to ₹5.1-5.9 trillion in absolute terms. In this scenario, the net long-term borrowings of the GoI could rise to ₹4.3-5.0 trillion in FY2018 from ₹4.1 trillion in FY2017. This, in conjunction with the limited scope for further monetary easing by the central bank and rising interest rates in the US, suggests that bond yields are unlikely to ease further after the Union Budget for FY2018 is presented.

The writer is Managing Director and Group CEO, ICRA