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Budget to focus on fiscal tightening

Vasan Shridharan

FISCAL tightening is likely to be the focus of the Government when it unveils its annual budget statement for FY 2000/01 (year ending March 31) in two weeks. Over the past four years, the adverse combination of geo-political instability and economic slow down in varying degrees had led to a considerable deterioration in Central and State Government finances. Indeed, at a projected 10-10.5 per cent of GDP, India's cumulative public sector deficit is set to not only end FY 1999/00 at its highest level over the past decade, but also remain as one of the largest in the universe of emerging markets.

Redressing the situation urgently is crucial. Without improvement, at its very least, a weak fiscal position could prevent an upgrade in India's sovereign credit rating (currently Ba2/BB) this year. At its worst, it could snowball into a severe internal debt trap and eventually hinder economic growth in the long-term. The ruling BJP-led coalition Government is, however, aware of these risks. It will, therefore, take advantage of the current economic upswing and its own political stability to push throug h fiscal reforms aggressively in the coming annual Budget.

Fiscal Responsibility Law

At the heart of its financial consolidation strategy will possibly be a proposal to promulgate a Fiscal Responsibility Law (based on the New Zealand model) for disciplining government spending. This law is expected to place a ceiling on not only the leve l of public debt, but also more importantly, on off-balance sheet items such as Government guarantees. In addition, the Government will also move to lower the huge implicit and explicit subsidies (in particular, those on fuel products today) in the India n economy.

At the same time, to boost treasury revenues, the Budget will probably seek to widen the corporate and individual direct tax base, raise the indirect duty levies on `demerit goods' and vigorously sell the Government's equity stake in various public secto r enterprises. As such, the current `equity euphoria' sweeping local and global stock markets offers the Indian Government the most fertile ground to cash in on its `enriched assets'.

Bond market valuations underpinned

Likely to be credible, such a fiscal consolidation plan will continue to extend the unprecedented 12-month bull run in the domestic Government bond markets. So will a monetary easing on the Reserve Bank of India's part to make available cheaper cost of f unds for India's industrial sector in the current recovery phase of the economic cycle. It is as much as what the RBI Governor, Dr. Bimal Jalan, stated about ten days ago at a seminar in Mumbai.

To be sure, Dr. Jalan specified neither the magnitude nor the time-frame for the liquidity easing. Many bond bulls are pricing in at least a 100 bps cut in the benchmark Bank Rate and a similar reduction in the banking sector's cash reserve requirements (CRR) immediately after the Budget. Price action suggests so. But these bulls might have to wait slightly longer.

Tactical delay possible

The RBI is the treasury's merchant banker. The treasury seasonally borrows a lot of money at the start of the new fiscal year in April. Easing closer to then would be a tactically sounder option for the central bank than instantly in the first week of Ma rch. In the interim, some of the bulls could come to lose their patience. Technical factors might force them to book profits on their long positions. It is a splendid opportunity for others to buy. Fundamentals are very much on the side of Indian bonds. The same cannot be said for many of the developed economies (US in particular) where interest rates are destined to move higher through year 2000!

(The author is Treasury Economist, Standard Chartered Bank, India. These are his personal views.)