The subsidy cap of 2% of GDP set out in today's Indian budget would be positive for the country. The government's willingness and ability to implement it will be an important component of our assessment of its rating. Implementation risk is high ahead of federal parliamentary elections in 2014.
The fiscal burden of subsidies has become more pressing due to the recent rise in oil prices. Alongside slowing economic growth, this means the budget forecasts India's fiscal deficit for FY12 to be 5.9%. That is higher than the government's previous 4.6% forecast but in line with our expectation of 5.5%-6.0%.
The projected deficit for the coming year is 5.1%. This would appear achievable, albeit not easy, if economic growth picks up (the Indian government forecasts real GDP growth of 7.6% in the coming year, in line with Fitch's forecast of 7.5% for calendar year 2012). We consider the slowdown in growth in recent quarters to be cyclical rather than structural.
The proposals to increase the excise duty to 12% from 10% and to tax all services except those on the negative list are also positive, and should enhance the government's tax take.
The budget speech indicated that two new measures to enhance revenue take that go beyond typical administrative measures to increase efficiency in tax collection - the introduction of a goods and services tax and a direct tax code - remain in the pipeline. However, the continuing absence of a clear timetable for adoption, while not a surprise, means that these reforms, which could help secure fiscal consolidation if domestic or external risks increased, will continue to be delayed.
As we noted in our recent Special Report on India's public finances, we do not think India is poised for another severe weakening in its public finances on the scale seen in 2009, which was caused by stimulus via indirect tax cuts and surging expenditure on subsidies. Nor do we think the more recent improvement in India's general government debt dynamics has been suddenly reversed. Nevertheless, public finances have been deteriorating and remain a key weakness in India's 'BBB-' rating. Our Outlook on the rating is Stable.
In his budget speech Finance Minister Pranab Mukherjee said that the government planned to cut oil and fertiliser subsidies to the point where total subsidy costs do not exceed 2% of GDP in the coming fiscal year - down from 2.4% in FY2011-12 - and fall further subsequently. The food subsidy will be fully funded in FY13.
