Hyped Budget, low hopes

Great expectations, but... nemo dat quod non habet (no one can give what he does not have). In the days leading up to the Union Budget, it is fashionable for experts and opinion-makers of all hues to hold forth on what the budget 'ought to be'. This is natural. After all, divining the finance minister's mind, or lobbying openly till it rankles, or making a public display of one's 'expertise' in public finance is an annual indulgence of the financial and business chatterati. This year is all the more exciting as the Congress party has won (quite unexpectedly) the mandate to govern India for another five years in the midst of global financial and economic turmoil. I expect an early start to the budget season of Parliament and a late finish.

More chatter is not necessarily better chatter. While the appetite for revolutionary budget measures is understandably higher in the post-election euphoria, I am not sure whether this budget will usher in much of a revolution beyond creative accounting in public finance. The greatest problems (the ballooning government debt and a persistent fiscal deficit) and the greatest imperatives (welfare, subsidies and infrastructure creation) are pulling the government finances in opposite directions. Sadly, the former may eventually win even as the current budget addresses the latter. Simply put, the government has a 'structural' or 'balance sheet' kind of a problem, while we await the cheap and counter-cyclical thrills on the profit-and-loss or revenue front.

Almost all the governments of the top 20 economies in the world are facing financial challenges, mostly centering on the re-financing of failed banks. But for many of them, this is a one-time burden that will affect public finances adversely for a year or two. In India's case, things are different. The government has always been profligate and its recent sins have been luckily countered by strong tax revenues as the 'India story' played out over most of this decade. In just over a year of fiscal stress and economic upheaval, this veil of modesty has been ripped apart.

Public debt as in March 2009 is estimated to be over 75% of the country's GDP, and almost four times the annual revenue inflows of the government. The interest on public (or government) debt consumed 31.6% of revenue receipts in FY08; it rose to over 34% in FY09 and will get worse from now on as revenue sags and debt balloons. Expect a figure of around 38% for FY10e. The government is literally on a debt treadmill.

The revenue inflows for the government are not likely to increase significantly anytime soon given that the economic growth in India is taking a breather, unless tax rates are upped (yes, the unthinkable might be forced upon us, not in this budget perhaps, but soon enough). So let's rule out any easing of tax rates which have a major effect on the aggregate tax collection. There might be some tax sops for individuals, such as an increase in deductibles for home loans, tax-exempt bank deposits, etc, but these are likely to be measures intended for hiding the lack of material tax breaks. The implementation of VAT is already running into political and bureaucratic problems (what pragmatic measure doesn't in this blessed country?), while service tax might be increased to 12% again with wider 'coverage'. This is because a uniform GST is still at least a budget away.

On the expenditure side, the finance minister is under tremendous pressure to increase the welfare/subsidy spend. True, many subsidies are not reaching the intended recipients. However, this is not reason enough to cut PDS allocations, minimum support prices for foodgrain procurement, health, education and fertiliser subsidies. As for populist programmes, let's be realistic. A government that has been voted back to power on the strength of the NREGS (by any count, a positive contributor), the Sixth Pay Commission hikes and farmer loan write-offs, is surely going to preserve (if not pump up) subsidies.

It's on this basis that decontrol of petrol, diesel and LPG prices is also a probable non-starter, just as it has been all these years. Similarly, there is an urgent need to invest heavily in infrastructure creation and provide large budgetary support/allocation for irrigation schemes, highways, power plants, urban infrastructure, railways and ports. Does any government have the gall to cut back on the spend in this category?

As for the budget day (the actual deficit at the end of the year is usually worse), my back-of-the-envelope guess is that the real fiscal deficit for financial year 2010, including some invisible items that the government often sweeps aside, will probably be a shade under Rs 5 lakh crore a truly toxic figure when you consider that it is about 50% of the total budget and over 11% of the GDP. Obviously, the government will have to resort to a mix of PSU divestments, increased borrowings and printing (monetising) this amount over the year. Each option is fraught with financial danger and moral hazards.

Divestment is sensible if you can sell the loss-making units. Selling stakes in the profitable PSUs is akin to selling the family silver to fund wayward and footloose progeny. It also requires support from a reluctant DMK and Trinamool Congress. Monetising will bring back the ghost of inflation (it has been benign so far because of the high base effects from last year and soft oil prices, but both these factors can wear off soon). That leaves borrowing, which is theoretically easy as government paper is backed by a sovereign guarantee.

This time, though, it's different. The net incremental borrowings during the year (about Rs 3.5 lakh crore, increasing at 60% CAGR over FY08-10) will take government debt to over 80% of the GDP and weaken the rupee. This will also crowd out private sector borrowings and drive up interest rates. As a result, banks' bond holdings will deflate and put pressure on corporate profits and the stock market PE multiples. Where does that leave the investors in Indian stocks? Not in wonderland, I'm afraid.

Dipen Sheth is Vice-President, Institutional Equities, BRICS Securities Ltd.