Union Budget 2018-19: a Sum of Moving Parts

Budget 2018-19 will be critical from a number of perspectives

• First, it will be the first budget to fully exploit the benefits of demonetization (through enhanced direct tax buoyancy) and the indirect tax surge due to GST.
• Second, 2018 is state-election-heavy with eight states going to the polls.
• Third, it could be the last “full “budget before we head into the general elections of 2019 and certainly the last budget that gives the government the chance to make good on the election promises made in 2014.

Received wisdom might tell us that politics rather than economics will drive budget priorities. However, the government seems committed to fiscal discipline and the constraint of sticking to a conservative deficit target will limit its options. We now believe that the fiscal deficit for FY18 will print at 3.2 per cent and next year’s target will stick to the glide path and print at 3 per cent. What about the backdrop? The domestic economy is perhaps no longer in the clichéd Goldilocks scenario.

Rising oil prices for one is a key risk and could be a major contributor to a rising current account gap that could transmit to fiscal imbalances. Rural distress seems to have intensified across the country and will be a challenge that the government will have to address comprehensively. In fact, the farm sector is likely to figure on top of the list of budget priorities in FY19. Whether the schemes and allocations aimed at the rural sector are labelled as“populist” vote-seeking gestures or instead viewed as a genuine response to a genuine problem is a question of one’s biases and predilections.

Summary of the current fiscal situation

• As per the current available data (till Nov’17), India’s fiscal deficit has already breached the budgeted target and touched 112% of BE. At the same time last year, the deficit was 86% of the full-year target.
• While there could be a slippage in some items on the receipts side, improved buoyancy in direct tax collection, possibility of special dividend payout by the RBI and other PSUs and higher than budgeted disinvestment proceeds could come as a buffer.
• On the other hand, aggressive front loading of expenditure in H-1 FY18 could affect quality of expenditure in the second half.
• Overall, based on all these factors and given the reduction in government’s extra market borrowings from Rs 50,000 cr to Rs 20,000 cr, adherence to the budgeted fiscal deficit target now seems more probable. In FY19 as well, government is expected to stick to a 3.0% target.

Going forward, non –tax revenues could improve in FY19. The government is likely to factor in (we think legitimately) a significantly higher tax GDP ratio than this year. However it is still likely to be disinvestment that will do the heavy lifting both in the current year and the next. It is important to monitor how the plans of strategic disinvestment in 36 PSU units (that have been identified) will fructify.

From the perspective of the bond markets, the need to adhere to fiscal discipline is imperative. Redemptions both of regular and MSS bonds will rise sharply in 2018-19 and this will tend to inflate gross borrowings. The fiscal deficit determines the net borrowings and the higher that is, greater the draft on domestic savings. That should be kept under check to prevent high bond yields and interest rates from snuffing out economic recovery.

Specific Budget Expectations

• A push to the rural economy: Addressing rural distress could mean higher allocations towards doubling farm income by 2022, affordable housing for the rural economy, tying up various schemes with each other for better efficiency for instance MGNREGA with affordable housing, enhanced funding for schemes which are predominantly rural in nature for instance PMGSY etc.
• Lower corporate tax rate: Changes in corporate tax rates in line with the roadmap announced in the 2015 Budget along with a phasing out of exemptions could be announced especially given that rates are coming down internationally.
• Re-strategising disinvestment programme: Government is expected to sharply increase its asset-sale target for the next financial year with about 36 companies in line for strategic disinvestment. The government may also look at a second fund-raising exercise with the Bharat-22 ETF (comprising of 22 stocks).
• Pending solutions – Land monetization: Railway ministry likely to use raise resources through commercially using the vacant land lying with the Railway Land Development Authority - — estimated at 47,336 hectares.
• Recast of the Fasal Bima Yojana: A recast version of the currently existing Pradhan Mantri Fasal Bima Yojana addressing the problems and gaps that have prevented its effective implementation could be looked at along with enhanced budgetary allocation.
• Direct Benefit Transfer could be broadened: This could include fertilizer subsidy as well but only after gauging its likely performance (subsidy misuse for instance) through pilot schemes.
• Push to port privatization: Given that the Finance Minister has spoken in favour of privatization of state-run ports, the government may take a step forward in this regard through seeking funds from international sovereign and pension funds.
• Long term capital gains: A tax could be reinstated on long-term capital gains (LTCG) on listed shares. Another possibility could be extending the timeframe for listed equities to qualify for tax exemption under long term capital gains from the current 12 months to 24 - 36 months.
• Tax incentives on fixed deposits: This is likely to reduce systemic risk that has now shifted to the non-bank sector by bringing about a balance between fixed return instruments (FDs) and variable return instruments (mutual funds, direct portfolio investments etc.).