Union Budget Preview: Reassessing The Fiscal Narrative

The presentation of the FY21 Union Budget faces a challenging macro backdrop with economic growth at decadal lows, inflation breaching the upper threshold of the targeting band, and business and consumer sentiment appearing extremely subdued

The Rs 2.8 trillion expected shortfall in net tax revenue collection in FY20, its Achilles' heel, which coupled with the likelihood of Rs 0.5-0.6 trillion slippage in disinvestment revenue will come in the way of the budgeted fiscal consolidation. We expect the government to invoke the FRBM escape clause and present the revised fiscal deficit for FY20 at 3.8% vis-à-vis the budgeted target of 3.3%. This would minimize the extent of required cuts in expenditure, the only bright spot in driving GDP growth momentum off late.

The anticipated 0.5% fiscal slippage is expected to be predominantly funded by additional market borrowing of Rs 400 bn and higher than budgeted accretion (by INR 234 bn) under small savings.

In FY21, we expect the government to revert to its objective of consolidation by targeting fiscal deficit at 3.6% of GDP

The fiscal consolidation process in FY21 would be receipt led and supported by moderate improvement in tax buoyancy, rolling over of the disinvestment pipeline, and telecom related revenue. We expect the Expenditure-GDP ratio to be maintained at 13.1% in FY21.

We expect gross and net g-sec borrowing in FY21 to come at INR 7.6 tn and INR 5.3 tn respectively

The FY21 Union Budget could potentially be used to signal fundamental shifts in fiscal credibility by focusing on realistic budget arithmetic, redesigning the FRBM roadmap, providing clarity on off-balance sheet expenditure, and also laying the groundwork for the establishment of an independent Fiscal Council

Growth Outlook

Key growth drivers of urban consumption, rural consumption, investment spending, and export performance continue to remain subdued in early part of Q3 FY20

Pickup in rabi sowing, accommodative monetary and liquidity stance, and some positive development on the global trade war front would enable a back loaded recovery in FY20

We expect sequential recovery with average growth in the second half of FY20 coming in at 5.1-5.2% vis-à-vis 4.8% in H1 FY20

Inflation Outlook

CPI inflation breached the upper threshold of RBI's inflation targeting band of 6% for the first time in Dec-19 by coming in at 7.35% YoY led by persistence of food price pressures, firmness in fuel prices, and re-pricing of telecom tariffs

We expect incremental food price pressures to start reversing from Jan-20 onwards on late arrival of kharif produce. However, recent firmness in global food prices along with crude oil prices needs to be watched.

Subdued core inflation continues to signal weak demand conditions in the economy. However, re-pricing of telecom tariffs and steep rise in few generic drugs will provide an upside

Basis three consecutive months of upside surprise in CPI inflation prints and after incorporating larger than anticipated pressure on food prices, we revise upwards our FY20 CPI inflation forecast to 4.7% from 4.2% earlier, and vis-à-vis 3.4% in FY19. Having said so, we believe, headline inflation will likely average close to 6.5% in Q4 FY20 before moderating somewhat towards 6.0% levels in H1 FY21. With favorable base effect kicking in thereafter, inflation could decelerate sharply towards 3.5% in H2 FY21.

Courtesy: Yes Bank