March 20, 2012 No.

39 Pauline GANDRE and Edgardo TORIJA ZANE

India: highlights of the 2012/2013 budget

The announcement of the central government's budget is a highly commented event by Indian economic players. Indeed, it is possible to infer from the budget, the priority areas for projected public spending and therefore the economic model, as well as the sources and ways of financing such spending. While the 2011-2012 budget deficit has turned out to be larger than expected (5.9% of GDP versus the projected 4.6%), the 2012/13 budget focuses on gradually trimming public financing needs. The budget will strive to reduce the deficit to 5.1% in 2012/13, to 4.5% of GDP by 2013/14 and to 3.9% by 2014/15. The draft budget was cautiously received by the markets. The budget consolidation effort primarily focuses on relatively uncertain variables (the dynamics of an increase in revenues) while on the expenditure side, the area for projected cuts (subsidies) will affect the purchasing power of consumers and may be fiercely challenged by political opponents. Lastly, no clear timetable has been given for reforms, and a delay in the application of measures could then imply noncompliance with the target.

The Indian government has announced its proposals for the 2012/13 budget
Total receipts

Table 1 Central government budget (billion INR) 2010-11 (actual) 8237,37 7884,71 5698,69 352,66 11973,28 10407,23 2340,22 19,5 1566,05 -3735,91 4,9 Revenue receipts of which Tax receipts Capital receipts Total expenditures Current expenditures Interest payments % of expenditures Capital expenditures Fiscal deficit % of GDP Source: India Budget 2011-12 (estimates) 7967,4 7669,89 6422,52 297,51 13187,21 11619,41 2756,18 20,9 1567,8 -5219,81 5,9 2012-13 (budget) 9773,35 9356,85 7710,71 416,5 14909,25 12861,09 3197,59 21,4 2048,16 -5135,9 5,1

On March 16, the Indian Finance Minister, Pranab Mukherjee, presented the central government's budget for financial year 2012/13 (starting April 1) to Parliament. The importance of this budget is heightened by the crucial issues currently at stake (sluggish growth, high budget deficit in 2011/12, th implementation of the 12 five-year plan and defeat of the government coalition in the latest regional elections). The government is aiming for a budget deficit of 5.1% of GDP in 2012/13 compared with a revised figure of 5.9% in 2011/12, much higher than the official target set at 4.6% of GDP. The Indian authorities include the following assumptions in their draft budget: 7.6% growth YoY for the 2012/13 financial year after a disappointing 6.9% estimated for 2011/12 (linked to the slowdown in the industrial sector) and inflation that is expected to continue decelerating in upcoming months before stabilizing (the assumption factored into the budget is 5.7% inflation measured by the GDP deflator). The government is targeting a 23% increase in total revenues (after an estimated contraction of 3.3% in 2011-2012) and 13% increase in expenditure compared with the previous financial year (Table 1), even though there will be cuts in areas such as subsidy spending.

The 2012/13 budget will strive to reduce the budget deficit in the medium term, with the goal of bringing it down to 4.5% of GDP for the 2013/14 financial year and 3.9% by 2014/15. 1- Revenues: programmed increase in tax revenues For financial year 2012/13, the central government's net tax revenues (excluding transfers to States and municipalities) are estimated at 7710 billion rupees and non tax revenues at 1,646 billion. The government also expects to generate around 300 billion rupees from its divestiture program (partial privatizations). The higher tax revenues are primarily expected from the anticipated growth recovery and secondly from the government's projected tax reforms. Indeed, it expects the tax revenues to be boosted by 20.1% (78% of total revenues

in 2012-2013) compared with revenues collected the previous year. Numerous tax reforms have been announced. With regard to indirect taxes, the government has programmed the final implementation of the GST, the unified Goods and Services Tax between Indian States. The purpose of the GST is to expand the tax base and minimize exemptions. The implementation of the GST has been discussed for years in India, while the "GST network" (a single platform for all Indian States, on which all participants can register, fill out tax return forms and make payments) should be established by August. Furthermore, the tax rate on services and the excise duty will be increased from 10 to 12%, while the tax rate on gold imports also goes up. With respect to direct taxes, the Indian government intends to implement the Direct Tax Code established in the previous budget but postponed to a later date. The government has announced an increase in income tax exemptions and the creation of new tax brackets. The minimum threshold for paying income tax has been raised from 180,000 to 200,000 rupees, an increase that remains relatively low compared to the pace of inflation (nominal GDP has increased by 16% in a year) and should therefore result in a broader basis for taxation. In total, the direct tax reform will lead to a net loss of 45 billion rupees for the government, while the net revenue linked to the indirect tax reform is estimated at 459.4 billion rupees. 2- Expenditure: reduction of subsidies, financing of infrastructures and "inclusive" growth Total expenditure is estimated at 14,909 billion rupees, corresponding to a 13% increase over the previous fiscal year. The government intends to reduce the amount of subsidies 2.5% of GDP in 2011/12- to less than 2% of GDP in the upcoming fiscal year (Chart 1), and to less than 1.75% of GDP within three years. The government estimates a total of 1,800 billion rupees for main subsidies in 2012/13, which means a cut of nearly 14% compared with the previous year. The cut in subsidy spending will primarily concern subsidies for fuel and fertilizers (fuel subsidies are estimated at 435.8 million rupees). Food subsidies will not be reduced and will reach 750 billion rupees. Therefore, for the 2012/2013 financial year, we expect the highest cuts in unplanned expenses (in other words expenses that are not included in the five-year Plan) to affect oil subsidies, followed by subsidies for fertilizers and lastly for food (Chart 2). Once again, the government has demonstrated its intention to achieve a broad consensus concerning the possibility of authorizing foreign direct investments of up to 51% in the multi-brand trading sector, after the failure of last fall.

4,5 4,0

Chart 1 Total subsidies (% of GDP)

3,5 3,0
Source: Indian Budget

2,5 2,0 1 ,5 1 ,0 0,5 0,0 2007/08 2008/09 2009/1 0 201 1 0/1 201 /1 1 2 201 3 2/1

C ha rt 2 . S ubs idie s (% o f GDP ) 201 0-201 (actual) 1 201 -201 (target) 1 2 201 -201 (actual) 1 2 201 2-201 (target) 3

2,5

1,5

Source : Indian Budget

1

0,5

0 Oil Fert ilizers Food Ot her Tot al

In the banking and financial sector, the government intends to allocate 158.88 billion rupees to finance the capitalization of public sector banks and financial institutions while reducing the tax rate on securities transactions from 0.125% to 0.1%. It also plans to simplify the formalities for initial public offers. The government also intends to apply a 50% tax reduction on income tax for new investors in the retail sector who invest up to 50,000 rupees in Indian equities and who report less than 1 million rupees in annual income. The 2012/13 budget clearly focuses on funding for infrastructures. The funds allocated to the Ministry of road transports and highways will be raised by 14%. Industries in the aerospace sector as well as electricity and low-income housing sectors will now be authorized to seek funding from foreign investors through external commercial loans. The government plans to implement a "National Manufacturing Policy", with the ambition of achieving a manufacturing sector representing 25% of GDP within ten years compared with the current 15%. A proposal has also been made to raise the spending budget allocated to the Ministry of Agriculture and Cooperation by 18%. Furthermore, the defense budget will increase by 17%. Lastly, the government has reiterated its intention to promote "inclusive" growth in India. The "National Food Security Bill", created to help poor people buy grains at a lower cost than the market price subsidized by the State, will therefore be examined by Parliament. The scale of this bill will make a
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huge dent in spending as it concerns more than 800 million Indians including roughly 75% of the rural population and 50% of the urban population. Furthermore, funds allocated to the least developed regions will increase by 22% compared with the previous year and new funds will be allocated to education, health and welfare. 3- Financing the deficit The central government's deficit in 2012/13 is expected to be around 5135 billion rupees (versus 4124 billion in 2011/12). 95% of funding for the deficit is based on bonds, which will be primarily issued on the domestic market (Table 2). A marginal part of the central government's funding needs will be met with resources from State Provident Funds and borrowings from the funds of Securities against Small Savings.
Table 2. Sources of financing (billion INR) 2011-12 (expected) External financing Market borrowings Securities against small savinfs State Provident funds Other receipts Cash Balance Sum (fiscal deficit) Source: India Budget 145,0 3580,0 241,8 100,0 -138,7 200,0 4128,2 2011-12 (actual) 103,1 5525,0 -103,0 100,0 -158,6 -246,6 5219,8 2012-13 (expected) 101,5 4880,0

announcement (the aggregate losses as of Tuesday March 20 was 2.3%). Although the 2012/13 budget deficit should be easily financed by the domestic financial system and even though thanks to the high nominal increase it will not result in higher public debt ratios (Chart 3), the bond market still had to integrate the projected increase in total public securities by lowering prices. The interest rate (10-year government bond) jumped by 18bp, rising from 8.24% to 8.42%.
C ha rt 3 . P ublic de bt ( % o f G D P )

85

85

80 75

80 75

70

70

65

65

60 55

60 55 General go vernment
Source : India Budget

12,0 120,0 22,5 0,0 5135,9

50

Central go vernment 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 1 1 1 1 1 0 1 2 3 4

50

Macroeconomic implications Although the target deficit of 5.1% of GDP seems reasonable and is based on an economic growth figure (7.6%) lower than the estimate in the 2011/12 budget (9%), it is not certain that the government has the capacity to reach these targets. The consolidation effort is primarily focused on relatively uncertain variables (the dynamics of the increase in revenues) while, on the expenditure side, the area for projected cuts (subsidy spending) will affect the purchasing power of consumers and could lead to fierce political resistance. The Finance Minister has given no precise timetable for the reforms, and a delay in the application of measures could imply non-compliance with the target. Markets initially reacted negatively to the budget. The Sensex index shrank by 1.2% on Friday March 16, on the day of the

The impact of macroeconomic policies on the price of the rupee remains uncertain. Some of the measures announced could be positive for the Indian currency. For example, the government has announced a hike in custom taxes on gold imports and raised the participation of non-residents in corporate bonds. The government's decision to authorize foreign borrowings for additional purposes (partial financing of the rupee-denominated debt of projects existing in the power sector, working funds in the aeronautic industry for a maximum of one year and capped at 1 billion dollars and lowincome housing projects) could also have a positive effect on foreign exchange through the increase in debt inflows. However, foreign investors may prefer to wait for the outcome to the implementation of budget discipline measures, after the significant lag with the target deficit observed in 2011/12.

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