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India’s Union Budget likely to be balanced, fiscal discipline will remain a priority

In a week’s time, India will present the FY17/18 budget against a challenging backdrop. Apart from a busy state election calendar, there is considerable uncertainty over the impact of demonetization on growth. Implementation of the Goods and Services Tax (GST) is also pending for the second half of the year, reported DBS Bank in its research note.

These factors have raised expectations for fiscal consolidation to be postponed to next year. We expect a more balanced approach, with recent gains from fiscal consolidation unlikely to be frittered away. Yet, proceeds from one-off revenue boost including from demonetisation are likely to be channelled to support consumption and continue with social spending projects, they added in its report.

Despite the negative impact on growth from the demonetization, fiscal discipline will remain a priority. The government is likely to meet the fiscal deficit target of 3.5 percent of GDP for FY16/17, as bunched-up revenues catch up with frontloaded expenditure in the second half of the FY. There is a tail risk that the final deficit ratio/GDP ratio could still be upset by the growth outlook which is far from certain because of the demonetization. The Statistics agency estimated the nominal GDP at 11.9 percent with downside risks, compared to the budgeted 11 percent.

The DBS Bank in its research note mentioned that the committee to review the Fiscal Responsibility and Budget Management Act (FRBM) submitted its report yesterday. The contents were not made public and are widely expected to be a part of the 1 February union budget presentation. Press reports suggest the proposals leans towards providing the government with more fiscal room for development spending.

Understandably, much focus will be on the extent of deviation in the FY17/18 fiscal goals. We expect the deficit target of 3 percent of GDP is likely to be retained. There is, however, a possibility that the proposals of the FRBM committee provide the government with some fiscal flexibility. The committee might propose a shift in the budget deficit target from a point to a range. If adopted, the deficit target may be revised to 3.0-3.3 percent.

This could provide flexibility for more public investments to offset the drag on growth from the recent demonetization move. As for the fiscal math, indirect tax collections should continue to drive total tax revenues. Excise duties, the largest component of indirect taxes, could suffer if oil prices rally sharply and trigger fuel duty cuts.

The DBS Bank in its research note mentioned that an outright cut in personal income tax rates is unlikely, but exemptions might be tweaked. Corporate tax rates are already scheduled to be lowered by 5 percent to 25 percent over the next three years. To provide short-term relief, part of these cuts might be front-loaded. Non-tax revenues will continue to rely on RBI/public sector companies’ dividends and privatisation with the latter consistently missing targets.

The demonetization initiative is also likely to raise one-off revenues, which along with other measures (e.g. tweaks to the capital gains tax regime, revive cash transaction tax etc.) might be channelled to fund fresh spending plans. Apart from the fiscal math, the budget is also expected to provide direction in broader goals. This will entail scrutiny of the government’s take/impact of demonetization, agenda for Goods and Service Tax (GST) implementation, support measures for the banking sector. On demonetisation, in particular, we expect the government to reiterate the long-term benefits of the move on revenue generation, growth, formalisation of the unorganised sector and success in arresting corruption/ tax evasion.

Domestic markets are likely to be jittery in this holiday-shortened week, with uncertainties over a protectionist US trade policy and US rate policy also adding to the volatility.

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