India#39;s policy tightening to pressure fiscal numbers, deficit seen at 6.7% in FY23: UBS


As the country’s fiscal policy is moving in sync with the monetary policy amid the runaway inflation, the tightening measures along with rising subsidies imply that the consolidated fiscal deficit may remain elevated at 10.2 per cent of GDP in FY23, down 20 bps from FY22, according to a report.

As per the report, the central deficit is expected to be at 6.7 per cent and states’ at 3.5 per cent in the current fiscal.

The government has pegged the combined fiscal shortfall at 9.8 per cent of which the central deficit is seen at 6.4 per cent (down from 6.7 per cent in FY22) and states’ at 3.4 per cent for FY23.

While these measures may help soften inflationary pressures by about 50 bps over the coming months, that will not be enough to bring inflation within the RBI comfort zone of 4 (+/-2) per cent unless global commodity prices moderate significantly, UBS Securities warned in a note on Thursday.

The brokerage also maintained that CPI averaging 6.5-7 per cent in FY23 will force the RBI-MPC to gradually hike the repo rate to 5.5 per cent by FY23-end and to 6 per cent by FY24-end to help contain the second-round impact of higher input prices on the real economy, Tanvee Gupta Jain, UBS Securities chief India economist said.

She also noted that these steps imply that the consolidated fiscal deficit will be at an elevated 10.2 per cent of GDP of which the Central deficit may be at 6.7 per cent and the states’ at 3.5 per cent in FY23 from 10.4 per cent in FY22.

Listing out the reasons for the elevated deficit, she said over the past month, the government has announced additional expenditure on food, fertilisers and cooking gas subsidies; and also lowered the excise duty on fuel among other measures.

Another major reason is the much lower than budgeted surplus transfer by the RBI, which alone could widen the deficit by a heavy 30 bps to 6.7 per cent.

All this will keep government borrowings elevated and pressure bond yields, which may scale to 8 per cent by FY23-end.

The key challenge will be balancing social welfare spending with optimistic capex plans, she said.

However, the report estimated that the states will lower their average deficit to 3.5 per cent in FY23 from 3.7 per cent in FY22.

The biggest fiscal threat is the rising global commodity prices, which limits the government’s fiscal space, because if global commodity prices remain higher for longer, there is a risk of reallocation of limited fiscal space towards the provision of a social safety net to low-income households, leading to some capex cuts in H2.

Stating that returning to higher nominal GDP growth is the key to debt sustainability, the report said the country’s public debt to GDP ratio remains elevated at 84 per cent in FY23, which is the highest among its emerging market (EM) peers.

However, over 97 per cent of this public debt is domestic-funded and a significant share is held by local banks and the central bank, thus reducing the risk in a distress situation.

The report underlines that the key to debt sustainability is the ability and speed with which the government can deliver on promises, specifically with regard to higher public capex and a focus on structural reforms to help support growth, which should grow at least 10 per cent annually to help stabilise the public debt at the current level before reducing it and this does not appear to be a source of near-term concern.

However, the report said that there could be some positive surprises in the year as it expects gross tax collections to be higher than budgeted and so is nominal GDP growth, which should be clipping at 15.6 per cent, much higher than the budget estimate of 11 per cent, due to higher inflation and some likely capex cuts.