The FM, Arun Jaitley released the Economic Survey for fiscal 2013-14 in the parliament today. The survey is a document on the state of the economy and is presented one day before the budget.
The economic survey for 2013-14 speaks the language that currency and bond markets like and if words are put into practice, there is a strong case for bond yields to come off and the Indian Rupee to appreciate. Equity markets will take time to appreciate the Economic Survey, given that the focus is more on inflation and fiscal containment.
Low and stable inflation regime through fiscal consolidation
Fiscal consolidation is key for bringing down long term inflation expectations. Please read our analysis on “Dear FM, Suppressed Inflation is your Key Enemy, PUT IT DOWN” on why government spending on subsidies has not only failed to bring down inflation but has transmitted the suppressed inflation to the value of the Rupee and government bonds.
The Economic Survey (Survey) recognizes that inflation in India has been trending on a higher path largely due to supply size constraints brought about by poor allocation of resources. The government has been spending on subsidies at cost of creation of capacity. Subsidy as percentage of GDP has gone up from 1.42% to 2.26% over the last six years.
The Survey wants the government to take a relook at social schemes such as MNREGA, NRHM, SSA etc. as it believes that the schemes have not translated into outcomes due to poor delivery mechanism.
The Survey asks for a new FRBM (Fiscal Responsibility and Budget Management) act with more teeth and accountability. The UPA government threw away the FRBM at the first sign of economic crisis and fiscal deficit shot up from 2.5% of GDP in 2007-08 to 6.5% of GDP in 2009-10 before coming off to levels of 4.5% of GDP in 2013-14. The fall in fiscal deficit as percentage of GDP is largely due to rise in nominal GDP due to inflation. Table 1 gives you how inflation brings down debt to GDP ratio that has come off from levels of 54% to levels of 48% since fiscal 2008-09.
Table 1. Fiscal Deficit to GDP Ratio
The antidote to fiscal consolidation as per the Survey is introduction of tax reforms through DTC (Direct Tax Code) and GST (Goods and Services Tax), which would take up Tax to GDP ratio from stagnant levels of 10% of GDP. Subsidies would have to be cut to bring down wasteful expenditure.
Inflation expectations can be kept down by rationalization of subsidies that will enable fiscal consolidation, inflation targeting monetary policy and reforms in the food market to make it more efficient to keep down food prices. Food inflation that peaked at 11.94% in third quarter of 2013-14 is seen as a primary cause of headline inflation in the economy.
Bond markets have a reason to cheer the Survey, as a regime of falling fiscal deficit and low inflation expectations is highly positive for bond yields.
Currency markets will also cheer the Survey as strong Macros bring in portfolio flows. The Balance of Payments (BOP) position improved sharply in fiscal 2013-14 with CAD (Current Account Deficit) down from USD 88.2 billion or 4.7% of GDP to USD 32.4 billion or 1.7% of GDP, largely on the back of restrictions on gold imports. Gold imports fell 40% last fiscal. RBI opened a FCNR B swap window in September – November 2013 that brought in USD 34 billion of flows. The survey urges the government to maintain a strong BOP especially after the INR touched record lows of Rs 68.80 to the USD in August 2013.
Equity markets will have to look forward to a period of stable growth. GDP growth for this fiscal is expected at the lower end of the 5.4% to 5.9% range but is likely to pick up going forward as India’s macros strengthen.