No economist, policy maker or even CEO of an Indian company believes that the government would be able to hold 3.3% fiscal deficit in 2019-20. Some leeway is bound to be there in a year when outlays are growing and inflows have been tepid. But there are four key issues to tackle with the fiscal deficit.
Stay within the leeway
This year the government may not have much of a choice but to offer a counter cyclical approach to growth. It will have to give some leeway on the fiscal deficit front to propel growth but the question is how much? Ideally, the government should stick to the limits prescribed by the NK Singh Committee which permits a maximum deviation of 50 bps in an exceptional year. If the government can hold the fiscal deficit at less than 3.8%, it will be seen as a positive move.
Where is the money going?
More than the fiscal deficit spillage, the markets will be more interested in the way the higher outlay is being spent. A boost to spending or to infrastructure will be viewed as positive since they have strong externalities. However, if the higher outlays are going towards bigger interest payouts and higher running expenses, it is not a great sign. Cutting investments in primary health and education to cut the fiscal deficit is never a good sign for Indian economy where basic services are still poor.
Beware the rating impact
Major chunk of the FPI flows post 2005 were in the light of the greater sense of fiscal responsibility shown by successive governments. Even at the height of the global crisis in early 2016 when global markets had lost $12 trillion in market value, the 2016 Union Budget stuck to its fiscal discipline. That was one of the key reasons that spurred the Nifty to virtually double from these levels over the last four years. Neither the global rating agencies, nor global portfolio investors are likely to take very kindly to a sharp spike in fiscal deficit. The onus will be on the finance minister to underline that fiscal deficit spillage is temporary and should revert back to normal levels in a time bound manner.
Hardening bond yields
The broader concern on the fiscal deficit front is the impact that it will eventually have on the bond yields. Higher fiscal deficit is a signal of a government hungry for borrowings and that could crowd out private sector. As the state borrowings increase, the immediate impact will be a spike in yield due to an increase in credit demand. The 10-year bond yield benchmark is the most risk-free instrument. That will mean; any spike in yields could directly impact the cost of funds for corporates. Higher bond yields could negatively impact bond and equity prices and that could be the real price to be cautious of! ©