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Budget Too Optimistic?

Monday, July 14, 2014
By Deepak Sahijwala

If the stock exchanges are a barometer of the economy and an indication of things to come, than one must clearly take the Union Budget and its implications with a pinch of salt. The market post the railway budget has trended sharply downwards witnessing its largest weekly fall in over two years, clearly giving both the budgets a thumbs down.

The “tax revenue projections outlined in the budget are too optimistic and no action plan for reducing subsidies was laid out... there is, in fact, a high possibility of an overshoot from budgeted levels if oil prices rise due to the ongoing strife in Iraq . And on GST, one cannot forget that earlier time lines for its roll-out have not been adhered to and progress cannot be taken for granted given the need for consensus among states on this issue. We believe the fiscal deficit is likely to print higher at 4.5% of GDP rather than the budgeted 4.1% in fiscal 2015, unless the government cuts back on expenditure” says Crisil Reasearch in a post budget analysis.

Giving due credit to the fiscal arithmetic laid out in the Budget and its positives, Crisil believes that “the scope for fiscal slippage however, remains high. Among others, the budget envisages the quality of expenditure to improve with an increase in capital spend, which is critical for a sustainable recovery in growth; subsidy rollovers lower than last fiscal; and Goods and Services Tax (GST) getting rolled out by the end of this fiscal.

It bases it's argument on the fact that “the budget assumes nominal GDP growth at 13.4%, up from 12.3% in the last 2 years. Growth in gross tax revenues has been budgeted at 17.7% (direct taxes at 15.7% and indirect taxes at 20.2%). This implies a tax buoyancy (percentage increase in tax revenue for every 1% increase in GDP) of 1.3 – which is higher than the last 10 years’ average of 1.0 and too optimistic given muted GDP growth expectations (5.4-5.9%), no increase in tax rates and cuts in excise and customs duties.

In particular, growth in corporation tax is budgeted to rise to 14.6%, up from an average 9.6% in the last three years. A kick to corporate tax collection is likely to come from an introduction of long term capital gains tax on debt-oriented mutual fund schemes, and through higher collections on account of dividend distribution tax (DDT). However, the expectations on customs and excise duties are aggressive as these are budgeted to grow at over 15%, up from less than 6% growth last fiscal”.

Indirect tax-revenue projections still too optimistic
(Tax revenues, y/y)

Similarly, Standard Chartered Bank in a post budget  analysis is also of the view that “Some of the budget’s assumptions around indirect tax revenue growth appear optimistic to us. This might worry markets about fiscal slippage later in the year, but we think that the divestment proceeds could surprise positively if equity markets remain buoyant. Although there is no concrete plan to reduce subsidies, the Finance Minister could cut expenditure marginally later in the year to meet the deficit target, if needed. Announcement of the direct and indirect tax reforms has been deferred, with the government still to resolve a few contentious issues with the relevant stakeholders. Markets had hoped for a more specific approach to the issue of public-sector bank recapitalisation, as this would have allayed fears of fiscal slippage”

It believes “The revised FY15 fiscal deficit math has two positive messages. First, sticking to the interim fiscal deficit target at 4.1% of GDP sends a strong message on the government’s intent to adhere to a fiscal consolidation path. Second, the improved composition of expenditure leaning more towards developmental instead of non-developmental or recurrent expenditure, in line with the interim budget approach, improves the quality of fiscal consolidation. However, markets may question the still ambitious tax targets, especially for indirect taxes”.

Scope to increase divestment proceeds further
Non-tax and capital revenue receipts, % GDP

It however goes on to say “The first budget of the National Democratic Alliance (NDA) government does not try to usher in radical changes, but keeps the hope of change alive by taking some meaningful steps in the right direction. The government demonstrates a strong resolve to stick to a medium-term fiscal consolidation plan while trying to support investment growth. The markets had high expectations about a reformist budget changing the course of the economy. Finance Minister Jaitley has been able to deliver on some of these while on others there was disappointment. In our view, some of the issues where the budget did not deliver specific measures could be taken up at a later date, since the Finance Minister got only a month to prepare his first budget.”

Says Kavita Chacko, Economist at CARE Ratings “Even though the finance minister has maintained the fiscal deficit target of 4.1% (for FY15) set by his predecessor, achieving the same looks challenging given that no drastic changes in the health of the economy are expected for the remainder of the year and thereby in its revenues... No major announcements were made on the reforms front. The budget only indicated that it would be bringing in reforms later on. Overall the budget can be viewed as one with a long term growth strategy and not one which can provide a quick fix for fixing the Indian economy.”

As regards the markets, which reacted nervously and dropped from its all time high of July 8 to register its biggest weekly fall in over two years , there are mixed opinions. While some analyst feel this knee jerk correction  is temporary others feel that there is still some downside left.

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