India Budget: Balancing Growth, Inflation, Fiscal Deficit A Challenge In Fiscal Year Ahead

Singapore - 1 March 2011

India's government is likely to face a challenging year, trying to maintain economic growth, control inflation, and achieve fiscal consolidation, said Standard & Poor's Ratings Services today.

India's finance minister, in releasing the annual budget, has sought to rein in inflation by capping the increase in total expenditure. The budget has also stepped up social spending to soothe the pain for the economically weaker sections.

"However, we believe the government may struggle to meet its fiscal deficit target for 2011-2012 as pressure to step up spending mounts," said Standard & Poor's credit analyst Takahira Ogawa. "Unlike in the previous fiscal year, it will also not have any one-off revenues to fall back on."

In fiscal 2010-2011, the government benefited from revenues from 3G licensing and proceeds from divestment of state-owned corporations. Such inflows had boosted 2010-2011 revenues by about 1.5% of GDP.

Finance Minister Pranab Mukherjee has sought to cap the increase in total budget expenditure at 3.4% (over revised estimate for 2010-2011) to Indian rupees (INR) 12.6 trillion. The government has also targeted fiscal deficit for 2011-2012 at 4.6% of GDP, slightly less than 4.8% of GDP recommended by the 13th finance commission in December 2009, and the revised estimate of 5.1% for 2010-2011. The finance minister announced that amendments to the fiscal responsibility and budget management bill will be introduced in 2011-2012 to maintain fiscal prudence in the medium term.

Nevertheless, in our view, the extent to which the government can achieve its deficit targets depends on the pace of economic growth and the movement in global and domestic fuel, fertilizer and food prices, Mr. Ogawa said.

On the revenue side, the government plans to introduce the new Direct Tax Code (DTC) in 2011-2012, but effective from April 1, 2011. Nevertheless, no time frame has been set for the rollout of Goods and Services Tax (GST). We anticipate that GST will be introduced only after April 1, 2012. We expect these tax initiatives to significantly benefit the Indian economy and improve the fiscal position in the medium to long term. The government has also budgeted INR400 billion from divestment of state-owned companies.

"While DTC will simplify, reduce exemptions, which will widen the tax base, and lower tax rates, introduction of GST will ensure unified tax rates across the country," Mr. Ogawa said.

In our view, the government faces pressure to increase spending, at least in the near future. Fuel and commodity prices are rising, which will increase the need for subsidies on oil, fertilizer and food. Though the government has embarked on structural reforms in the subsidy systems, only a part of the plan has been implemented.

"In this context, we believe there is a risk that the size of key subsidies such as food, fuel and fertilizer will overshoot the budgets of INR606 billion, INR236 billion and INR500 billion, respectively," Mr. Ogawa said. "The implementation of Unique Identification Cards is a key initiative to improve the efficiency and effectiveness of the use of public funds."

The government also plans to step up measures to help lower-income households, particularly in rural areas, to deal with the recent sharp increase in food prices. Social sector spending is up 17% and it accounts for 36.4% of the government's total current expenditure. For example, the government linked payments under the National Rural Employment Guarantee Act to the Consumer Price Index for Agricultural Labor. As a result, the per-head monthly payment for workers and helpers under this scheme will double from April 1, 2011.

Separately from the budget speech, the government is preparing to implement the national food security bill this year.

"The food-subsidy burden could increase by INR200 billion-INR320 billion as the bill's coverage is wider than existing schemes'. Nevertheless, the magnitude of the increase will depend on the final contents of the bill," Mr. Ogawa said.

The budget also seeks to deregulate foreign investors' access to Indian capital markets and investment products. We expect these measures, if implemented in the near future, to increase the stability and depth of the country's financial and capital markets. The government will also come out with guidelines for new licenses by end-March. The government has also budgeted to inject INR600 billion capital into public sector banks.

In our view, the large size of the Indian government's fiscal deficit and the government's outstanding debt are two of the most significant constraining factors for the sovereign ratings on India (BBB-/Stable/A-3). There are other parameters such as economic growth ratio, inflation and commodity prices, which could affect the fiscal trajectory of the Indian government. Standard & Poor's will continue to monitor these developments.

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