The lack of policy focus and fiscal soundness could well have prompted the RBI to hike rates in August
05-Sep-2014 •Saurabh Mukherjea
In its first major economic outing, the NDA lost an opportunity to reset the tone and tenor of policy in India. The lack of logic in fiscal arithmetic, the lack of clarity on how PSU banks will be recapitalised, the lack of clarity on the GST timeline…it all felt very UPA-esque. Whilst the FM did not commit any major blunders, his lack of policy focus and fiscal soundness could have prompted the RBI to hike rates in August. That in turn could have postponed the economic recovery and made those investing in high beta and low RoCE stocks rethink their investment strategy.
A mixed bag with some mystifying elements
The results to the 2014 General Elections triggered celebrations in the investment community and were hailed as being the harbinger of a much-needed policy reset. Whilst 10th July's budget did not administer any particularly self-destructive decisions (such as the decision to change tax rules retrospectively in 2012), it squandered a golden opportunity to roll-out a multi-year vision for India.
The budget for FY15 was a mixed bag with a part being reformist, a part being disappointing and with another part being plain bizarre.
The silver lining to the budget was the fact that the Finance Minister definitively established that the new Government was against the application of retrospective taxes. Arun Jaitely called for the creation of a High Level Committee that will scrutinise all fresh cases arising out of the retrospective amendments of 2012, thereby limiting the damage caused by the budget speech of 2012, which still lingers. Furthermore, the Government's decision to announce the liberalisation of FDI norms (up from 26 to 49 per cent) for Insurance as well as Defence (up from 26 to 49 per cent) were steps in the right direction.
The disappointing component of the budget clearly was the fact that two overdue reforms namely, the need to implement unified goods and service tax (GST) and the need to institutionalise fiscal discipline, were only given cursory mentions in the budget speech. On implementing the GST, the minister recognised the need for this piece of reform but resisted committing to a date. On the fiscal front, whilst he did commit to compressing the fiscal deficit to 3 per cent of GDP by FY17, the FM shied away from resurrecting the Fiscal Responsibility and Budget Management Act which could have almost ensured that sovereign credit rating agencies begin trusting the country's new management.
The bizarre component of the budget was the fiscal mathematics. Not only did the Government fail to trim the total expenditure bill by limiting spends on inefficient schemes, the new Finance Minister simultaneously failed to adequately rationalise the overtly optimistic tax revenue growth assumptions presented in the interim budget. In spite of neither cutting the fiscal outlay nor explaining where 19.7 per cent revenue growth in FY15 will materialise from, the fact that the new Finance Minister, Arun Jaitely stuck to the previous FM's 4.1 per cent fiscal deficit target is mystifying. My colleague, Ritika Mankar's fiscal maths suggests that the FY15 deficit will be closer to 4.4 per cent. This slippage is likely to materialise mainly owing to a lower than budgeted tax revenue growth materialising in FY15.
Whilst the Finance Minister acknowledged the need for recapitalising Public Sector banks, his speech did not provide any specifics on where the approximately US$50bn of funds for such a recap will be procured and by when.
Other than a few encouraging words about helping Indian retail investors increase their holdings of PSU bank stocks and about professionalising PSU banks, we were given no clarity as to how this all important sector will be revived. This lack of visibility on how the bank recapitalisation problem will be solved in a sustainable manner as well as the splintered focus on infrastructure meant that the budget speech for FY15 was an opportunity lost for the new Government.
The budget puts the RBI on a tricky wicket
If the RBI's maths also suggests that the Government is unlikely to be able to meet its ambitious fiscal deficit target, then a rate hike in August becomes that much more likely especially given the backdrop of a below par monsoon. Given the murky visibility on fiscal compression provided by the Union Budget statement, the budget makes it that much more likely that Raghuram Rajan, the RBI Governor, will have to hike rates, not once but most probably twice, in the remainder of FY15. In that context, the RBI's policy in the first week of August becomes the first real economic report card on the NDA (which should not to be the confused with corporate India's uniformly sycophantic response to the FY15 budget).
Saurabh Mukherjea is CEO of Institutional Equities at Ambit Capital. The views expressed here are personal.
This column appeared in the August 2014 issue of Wealth Insight.