Building the backdrop for lower interest rates - Hindustan Times
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Building the backdrop for lower interest rates

Feb 05, 2024 08:00 AM IST

Focus on fiscal consolidation, moderate capex push and eschewed pre-election populism define the interim budget

Every budget, even if it is an interim one, creates its own set of expectations before and leaves its impression after. Although the finance minister (FM) maintained the tradition of an interim budget and refrained from making too many new announcements, there were a few surprises which have kept the conversation going even after.

New Delhi, India - Feb. 1, 2024: Nirmala Sitharaman, Union Minister of Finance along with Bhagwat Karad and Pankaj Chaudhary MOS Finance leaves the Finance Ministry carrying the Finance Budget ahead of the presentation of interim Budget 2024 in Parliament at North Block in New Delhi, India, on Thursday, February 1, 2024. (Photo by Sanchit Khanna/ Hindustan Times)(Hindustan Times) PREMIUM
New Delhi, India - Feb. 1, 2024: Nirmala Sitharaman, Union Minister of Finance along with Bhagwat Karad and Pankaj Chaudhary MOS Finance leaves the Finance Ministry carrying the Finance Budget ahead of the presentation of interim Budget 2024 in Parliament at North Block in New Delhi, India, on Thursday, February 1, 2024. (Photo by Sanchit Khanna/ Hindustan Times)(Hindustan Times)

There were three broad strands of expectations from the interim budget — continued fiscal consolidation, visible capex push and rural stimulus as a pre-election populism. While it was always difficult to deliver on all three of them, the interim budget opted to over-deliver on the first one, present a mixed bag on the second one and eschewed the third one altogether.

For context, the FM’s intent of bringing the fiscal deficit to 4.5% is almost equivalent to meeting the pre-Covid target of 3% of Gross Domestic Product (GDP) since some of the off-budget expenditure of the government has now been brought on budget.

The motivation for delivering on this fiscal consolidation could be from different directions. While meeting or bettering the medium-term fiscal target of 4.5% of GDP might seem to be the obvious one, we think that the fiscal conservatism of the government might have deeper roots. Preserving macro stability is often unglamorous but the most important long-term policy support to encourage investments, which, in turn, would keep India on a more durable high growth path. To achieve this, fiscal policy needs to be counter-cyclical, so that fiscal space is created in good times and utilised on a rainy day. As India is going through a business upcycle, it makes sense to have a more restrained fiscal stance. Also, the government hopes to convince the rating agencies of a better fiscal trajectory, though the decisions on a positive rating action could be deferred till the final budget in June. Now we are very close to meeting the twin conditions of fiscal deficit to GDP at below 5% of GDP and nominal GDP growth of more than 10%, which would keep the public debt to GDP trajectory firmly on a downward path.

Another motivation could be the crowding-in of private investment as the government is consciously ceding space in the funding market by reducing its own borrowing requirements. If the monetary authorities want to supplement this crowding-in effort of the government, then one can expect a more softened monetary policy stance, even in the February Monetary Policy Committee (MPC) meeting. The larger-than-expected fiscal consolidation with a sustained focus on improving the quality of fiscal spending, will provide comfort to the Reserve Bank of India MPC that there are now no material risks of sudden demand-side inflationary pressures from pre-election populism. A tighter fiscal policy usually creates room for an easier monetary policy.

Another expectation from the budget was a large capex push. To set the context, the central government capex to GDP ratio was averaging 1.7% in the pre-pandemic decade and in the FY25 interim budget, it has been pegged at double that amount at 3.4%. While this is a phenomenal turnaround in the quality of fiscal spend, there is some disappointment that the FY25 budgeted growth in public capex is not as spectacular as that in the last couple of years. This is particularly true if one considers the sharp fall in off-budget capex done by public sector units (PSUs) in the infra sector. For example, the off-budget spending of the railway ministry has dropped from 1.25 trillion in FY21 to just 130 billion in the FY25 budget and the pattern has been similar in the road ministry. This clearly improves fiscal transparency, but the quantification of the public capex thrust needs to take this variable into account.

By our estimate, overall central capex (budgeted plus off-budgeted) is likely to grow by a respectable 14% year-on-year (YY) in FY25 BE (budget estimates). However, there are quite a few reasons for calling it a mixed bag. First, compared to the growth of 32% pencilled into the FY24 budget, this is a sharp deceleration. Second, in key ministries, like roads, railways and defence, YY growth in budgeted spends has been minimal — roads 2.9% YY, railways 1.9% YY and defence 8.4% YY. Third, the overall capex growth is boosted by the finance ministry capex budget increasing by an astounding 75%YY (~ 1 trillion). These additional funds are going to be used for higher allocation of loans to states for capex (~ 300 billion) and a separate provision of ~ 705 billion for new hitherto undefined schemes. Part of these schemes could be linked to the government’s effort to create a fund for research and innovation activities and some others could be unveiled when the final budget is announced. Excluding this ministry of finance allocation to new schemes, growth in total infra capex could fall to 8% YY for FY25 BE vs 17.4% in FY24 RE (revised estimates). Fourth, in the last few years, actual capex by PSUs and utilisation of loans by state governments have been much lower than what was budgeted. This creates further uncertainty around the overall capex push from the FY25 budget.

It is possible that some of these allocations to key infra ministries are raised around the time of the final budget, but we cannot rule out the chances of the central government’s ability to continue such high growth in a handful of infra sectors getting to a point of saturation. That is why it is important to track the progress of the private sector in these areas while the central government diversifies to other areas like housing and water.

Not announcing any rural stimulus even in a pre-election year might have been disappointing for some in the market but this is no doubt good macro policy. Our estimate of spending on rural-oriented major schemes has dropped from 3.6% of GDP in FY24 RE to 3.3% in the FY25 budget, though it still stands higher than the pre-Covid trend of ~2.6%. In any case, part of the spending on these schemes is demand-led and could be adjusted during the year.

Overall, a faster-than-expected glide path towards the 4.5% medium-term fiscal deficit target, a much lower borrowing calendar, a gush of global bond index inclusion-related investor inflows and the hope of some monetary policy softening, build the right backdrop for lower interest rates going ahead.

Samiran Chakraborty is managing director and chief economist, India, Citigroup. The views are personal

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