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    Budget 2015 is likely to spur growth: Atsi Sheth, Moody's Investors Service

    Synopsis

    "The introduction of a scheme to monetize gold assets and planned simplification of the corporate tax regime could facilitate higher financial savings and investment respectively."

    By Atsi Sheth, Senior Vice-president, Moody's Investors Service

    Saturday's budget chose policies to spur growth over policies to reduce the fiscal deficit. This choice did little to change our view that India's growth will remain higher than in similarly rated countries and a sovereign credit strength, while its fiscal metrics will remain weaker than those of similarly rated countries, posing sovereign credit challenges. The budget is likely to spur growth.

    But whether this growth alleviates or exacerbates other macro-economic risks, such as fiscal, inflation, and balance of payments risks, will depend on whether it is driven primarily by government expenditure or whether it sets the stage for savings, investment, productivity and profitability increases. Why this difference matters is best illustrated by India’s own macro-economic story.

    Between 2003 and 2008, India's GDP growth accelerated to an average of 8% - 9% from 5.5% in the previous five years. The general (i.e. central + state) government deficit declined to about 4% in 2008 from above 10% in 2003, due to higher government revenues, particularly from corporate and indirect taxes. During this period, savings, investment and productivity rose.

    Starting in 2008, however, growth was prioritized over continued fiscal consolidation, partly to mitigate the effects of the global financial crisis. By 2010, India's GDP was again growing at an impressive rate of around 9% but the government deficit had increased to levels between 8% and 9% of GDP. Fiscal stimulus had pushed up demand without facilitating a supply response.

    This led to higher inflation and current account deficits, and lower savings and investment rates. Financial and economic turbulence marked the next few years, from which the economy is now slowly recovering. The difference over the two periods suggests that investment and productivity driven growth can reduce fiscal deficits through revenue buoyancy and that prolonged fiscal stimulus generates macro-economic imbalances that compromise the economic outlook.

    The government's fiscal roadmap acknowledges this. Yet it keeps deficit reduction goals modest. This reflects the difficulty in tightening fiscal policy in India, even under such supportive conditions as accelerating growth and lower oil prices. This difficulty is partly due to structural and legacy issues - low incomes limit the potential for increasing tax revenues, and the share of expenditures committed to relatively rigid items, like interest payments, pensions, and defense, leave little room to cut spending aggressively.

    So to meet its fiscal consolidation targets, the budget will have to engender growth that contributes to a decline in the fiscal deficit. There are several measures that could achieve such growth, if effectively implemented. These include greater public spending on infrastructure, as well as incentives for private sector investment.

    The implementation of the Goods and Services Tax in April 2016 will lead to scale and productivity gains and direct cash transfers for subsidy delivery could increase welfare and efficiency, although they won’t reduce subsidy spending. The introduction of a scheme to monetize gold assets and planned simplification of the corporate tax regime could facilitate higher financial savings and investment respectively.

    Nonetheless, even if the central government achieves its target of lowering its fiscal deficit to 3% of GDP over the next three years, India's general government deficit will likely fall somewhere between 5% and 6% of GDP by 2018. This would mark an improvement from the 7.7% average of the last five years, but would still be higher than the average for most Moody's rated sovereigns, including Indonesia and Romania, which have the same Baa3 rating, but general government fiscal deficits well below 3% of GDP.



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