Straight from the Specialists
Budget 2011: List of measures that may be announced
(The views expressed in this column are the author’s own and do not represent those of Reuters)
The Union Budget is likely to look into the following themes: (a) Deficit reduction plan; (b) Measures to boost investment sentiment, particularly for the infrastructure sector; and (c) Redistribution focus to support lower income segment households.
• Theme #1 – Fiscal consolidation: In its medium fiscal plan published in 2010, the finance ministry indicated that the central government would aim to target a deficit of 4.8% of GDP in F2012.
Achieving this reduction in deficit will be difficult without a meaningful cut in government expenditure growth in F2012. Currently, our forecasts assume that the government will target expenditure growth of ~7.5% in F2012 (the lowest in seven years). Even at 4.8% of GDP, the government’s overall borrowing program will remain at broadly similar levels to F2011.
In F2011, the government had the support of US$35.5 billion, including US$23 billion from 3G and broadband wireless access (BWA) license fees and US$12.5 billion of open market operations (OMO) involving buyback of government securities by the RBI.
Why Fiscal Policy Reversal Is More Critical?
The credit crisis had a significant impact on investment in India. India’s investment trends tend to be highly influenced by the capital market environment.
As the global credit crisis impaired capital markets, investment declined from 38.1% of GDP in F2008 to 34.5% of GDP in F2009. More importantly, the most productive investment component — private corporate capex — declined to 11.5% of GDP in F2009 from a peak of 17.3% of GDP in F2008. In the face of this decline in investment to GDP, the central government pursued a massive 4% of GDP increase in total expenditure. The fiscal deficit has risen from 2.5% of GDP in F2008 to 6.3% of GDP in F2010.
While the headline deficit has fallen in F2011 thanks to one-off revenues, the central government expenditure relative to GDP in F2011 is expected to remain close to peak levels of 15.3% of GDP.
During the trough of the growth cycle this focus on consumption was necessary to revive confidence and capacity utilization, over the past nine months this has been only adding to inflation pressures.
While investment relative to GDP has risen from the trough levels, it is still far from pre-crisis peak levels. Hence, the continuation of such high levels of government expenditure in nature of consumption in F2012 will only add to inflationary pressures.
• Theme #2 – Efforts to boost investments to GDP:
It is important to have a maximum focus on boosting investment to ensure that GDP growth sustains above 8% without causing inflation pressures.
The government is conscious of the adverse impact of these issues on business confidence and hopefully this year’s budget will focus on pick up in policy action to encourage investments in agriculture, manufacturing and infrastructure.
The credit crisis in 2008 has resulted in a significant decline in total investment to GDP (excluding investments in gold by households) to 33.2% of GDP in F2009 from 37.1% of GDP in F2008.
More importantly, the private corporate capex, which is the most productive component of the total investments, declined from the peak of 17.3% of GDP to 11.5% of GDP in the same period. While there has been some rise over the last two years, the pace of increase in investments has been slower than warranted.
Total investments (excluding gold investments by HH) and private corporate capex has improved to 35.2% of GDP and 13.5% of GDP respectively in F2011, according to our estimates.
Post credit crisis, the corporate confidence to push for higher investments is taking time to rebound to the levels seen in 2006 and 2007. In 2009, companies were focused on repairing their balance sheets. In 2010, the corporate confidence recovered only gradually as the global macro environment was still not comfortable enough.
Right up to August 2010, the sovereign debt concerns in EU had meant that the companies were not ready for an aggressive capex plan. Just as the global environment improved, domestic factors such as corruption-related investigations and rise in cost of capital have held back the investment cycle.
Indeed, there was a recovery in order backlog for engineering and construction companies in the first half of 2010. However, since then, it has again decelerated during the quarter ended December 2010.
It is important to have a maximum focus on boosting investment to ensure that GDP growth sustains above 8% without causing inflation pressures. Corruption allegations over the recent months had disrupted the operation of parliament in the winter season affecting the pace of government clearance for key infrastructure and mining related projects.
However, the government is conscious of the adverse impact of these issues on business confidence and hopefully this year’s budget will focus on pick up in policy action to encourage investments in agriculture, manufacturing and infrastructure.
In this context, over the past few days the government’s action does raise our optimism that it will get back into initiating efforts to clear investment projects transparently.
For instance, the environment ministry has started to clear key projects. After long delay, POSCO’s steel project received approval in January 2011. Similarly, the ministry awarded approval for a 4000 MW power project in Orissa.
Recently, the government has approved the constitution of a ministerial panel (to be headed by the Finance Minister) to sort out environmental issues currently holding up the development of coal mines. In lieu of this, the environment ministry has recently cleared 16 coal projects that had seen little progress over the past year.
The government may do a major campaign style effort to revive the corporate confidence to ensure that private corporate capex picks quickly to achieve our recently downgraded GDP growth of 8.2% for F2012.
• Theme #3 – Redistribution focus to support lower income segment households
Strong demand and rise in food and other commodity prices have ensured that headline inflation (WPI) has remained above the RBI’s comfortzone of 5-5.5% for the past 14 months. Headline inflation averaged 9.2% during this period. CPI (Industrial Workers) has averaged 12.4% during this period.
While the rural population has been protected to some extent with subsistence farming and government’s large transfers to households via overall increase in spending and the national rural employment scheme, the urban poor has been hit the most.
There is a possibility that the finance minister may announce a reduction in income tax burden for the lower income segment in the budget.