Sharp increase in FY19 fiscal deficit could dampen market sentiment

As it is an Interim Budget, analysts and economists do not expect much from it.  But as it is a polling year, the major focus could be to boost the rural economy. The Interim Budget will be presented on February 1 and the full budget will be in July-August.

Generally, in every budget, the fiscal deficit as a percentage of GDP (gross domestic product) is keenly watched by Foreign Institutional Investors (FIIs) and institutional investors. It is also one of the main stimuli for the sovereign rating.

Likely higher pre-election spending could pose a risk to the fiscal deficit and would increase debt burden, said experts.

Most experts said this time the government is likely to exceed its fiscal deficit target of 3.3 percent set for financial year 2018-19 due to a shortfall in GST collection. However, some experts opined the government may manage to meet the target.

They further said the key things to watch out for would be FY20 target as the government last year said it would try to keep 3 percent of GDP in FY20, which looks difficult considering the government spending.

"With GST collection consistently remaining below the target and direct tax as well as other sources of revenues remaining closer to or lower than the target, fiscal deficit for FY19 is set to be higher than targeted Rs 6.24 lakh crore or 3.3 percent of the GDP," Shailendra Kumar, Director and CIO at Narnolia Financial Advisors told Moneycontrol.

According to an estimate by Ajay Jaiswal, President - Strategies and Head of Research at Stewart & Mackertich, Centre's revenue could fall short by Rs 1.1 lakh crore due to lower GST collection.

"It is averaging Rs 96,800 crore per month versus the budget estimate of Rs 1.08 lakh crore per month. Direct tax and non-tax revenue, however, is likely to meet targets. Revenue shortfall in FY19 will mostly be bridged by an increase in off-balance sheet expenditures. These could include pushing the food subsidy expenditure onto the books of FCI among other things. As a whole, we expect modest slippage on the fiscal target by 20bps to 3.5 percent of GDP," Jaiswal detailed.

Fitch Ratings also said populist spending would aggravate fiscal pressures, which are already building due to revenue shortfalls so far in FY19. "Revenue from the new GST—an important structural reform due to its removal of barriers to trade across borders—is well below target, for example," the agency said.

But the rating agency still believes the central government may be able to meet its fiscal deficit target of 3.3 percent of GDP for FY19, which would help support its fiscal credibility, although this may be achieved by deferring capital expenditure and postponing bill payments until after March.

Most experts said the likely increase in the fiscal deficit to some extent (around 10 bps more than 3.3 percent) seems to have priced in by the market, but if it is a sharp increase then there could be a negative reaction.

"A higher market borrowing by the government will imply an elevated interest rate at a time when industrial activities are slowing down. This would mean an adverse impact on growth and in turn on equity market returns," Kumar said.

The market has already priced in an overshoot in the fiscal deficit, Jaiswal said adding further damage is likely based only on marginal slippage of the fiscal deficit.