Unrealistic targets? 6 reasons why Sitharaman's Budget may be too optimistic

Amid concerns of growth slowdown, the fiscal strategy of the Union Budget remains conservative. It hopes for a revival in consumption demand, and an eventual pick-up in private investments aided by a continued step-up in government capex, thereby translating into a sustained growth cycle.

We think this hypothesis may be optimistic.

1)A lot of intent to revive the employment-intensive services sectors:
On the face of it, the budget appears to be addressing our thoughts pertaining to employment generation, as it focuses on sectors like health, education, tourism, and formalization in agri-sector services. In addition is the simplification of the income tax structure, with enhanced income tax slabs for the lower income bracket.

2)Fiscal math looks optimistic:
Firstly, the assumption of nominal GDP of 10.5% YoY is optimistic, given the high base effect of 15.4% growth in FY23 and pre-COVID average of 10.9% and the sharp deceleration in corporate sales growth.
Secondly, the projected gross tax collections growth of 10.5% in FY24BE implies an optimistic tax elasticity of 1.0x. Our estimates show that the medium-term tax elasticity is 0.9x, structurally lower than the 2007-08 peak of 1.6x.

The peak level of GST and indirect tax incidence and weak demand conditions in the lower income brackets will likely make it difficult to gain further buoyancy from indirect taxes.

Also, given that the profits of non-finance companies have been contracting in recent quarters, the current momentum in corporate tax collection could also fade.

Based on our assumption of 9% nominal GDP in FY24E and conservative tax elasticity estimate of 0.9x, growth in tax collections could be lower at 8.1% compared with projected 10.5%, implying a shortfall of INR 713bn.

3)Expenditure growth of 7.5% is effectively lower:
Total expenditure at INR 45tn for FY24E implies a growth of 7.5% YoY, higher than our expectation of 6-7%. The interest payment for FY23BE kept unchanged from BE at INR 9.4tn is understated by around INR 350-400bn, as we know that the interest spending of INR 6.8tn till 3QFY23 was higher than 20% YoY.

Accounting for this aberration, the actual growth in total spending would be just 6.8%. There has been a significant reduction in allocation under subsidies (down INR 1.5tn at INR 3.7tn, -28% YoY) and rural allocation (down INR 1.5tn at INR 6.6tn, -19% YoY).

Total revenue expenditure, net of interest payment, is budgeted to contract by 3.8% YoY at INR 24.2tn. This implies a negative consumption demand multiplier effect, which may accentuate the extant demand drag if the crowding-in effect of sustained expansion in capital expenditure continues to disappoint.

4)Continued reliance on crowding-in theme despite it lagging fruition:
The total capital allocation budgeted for FY24BE at INR 10tn is a continued rise from INR 3.4tn in FY20 and INR 7.3tn in FYT23RE, with a consistent focus on railways (up 51% YoY to INR 2.4tn), highways (up 25% at 2.6tn), and support to state governments (up 61% at 2.38tn).

These efforts signify the continuation of the crowding-in theme. However, we note that the revised capital spending for FY23RE at INR 7.28tn fell short of the budgeted allocation of INR 7.5tn.

Second, state governments have been lagging considerably on capex. Third, the revival in private capex remains elusive and given the risks to future demand situations and falling profitability, Indian companies may still be in a wait-and-watch mode.

5)The intended fiscal consolidation may not fructify:
The budget promises to continue its path of fiscal consolidation to attain a fiscal deficit to GDP of 4.5% till 2026, following a projected target of 5.9% in FY24BE and 6.4% in FY23RE.

As explained above, these targets seem optimistic based on a realistic case of slippages in both tax revenue collections and expenditure.

The optimistic projections imply more significant fiscal deficit and market borrowings in FY24 compared to the budgeted INR 17.9tn and INR 12.3tn, respectively, with revenue slippage alone contributing about INR 713bn.

Additionally, the final fiscal deficit for FY23 could be higher, given that the revised estimate for interest payments is understated. The combined fiscal deficit for the center (5.9%) and states (3.5%) is targeted at 9.4% of GDP, which is the same as last year.

Considering the less-than-projected nominal GDP and potential slippages for both, the states and the center, we perceive a high chance of overshooting fiscal deficit and public debt ratios.

6)Effective fiscal support is missing:
Amid concerns of growth slowdown and the spillover effects of tightening financial conditions, urban demand momentum peaking, weak rural conditions, and an elevated unemployment situation the fiscal strategy of the Union Budget remains conservative.

It hopes for an endogenous revival in household consumption demand, eventual pick up in private capex, and the multiplier effect translating into a sustained economic growth cycle. While the center’s emphasis on railways and highways remains intact, we remain unsure of the revival of private capex in the near term.

The assumption of 6.5% real GDP growth and 10.5% nominal GDP growth also implies inflation declining to 4%. Thus, with non-interest revenue expenditure contracting by 3.8% and 7.8% in real terms respectively, the negative multiplier effect (1.5x) on real expenditure GDP could be as high as -12% over 12 months’ time.

Hence, considering our less optimistic expectations on private capex, the fiscal drag from revenue expenditure contraction, and the slowing of global trade, the burden to lift India’s growth in FY24 will significantly fall back on the household sector, which is still fragile.

Hence, realistically speaking there is a significant probability of governments having to step-up fiscal support later in FY24. This would imply that the eventual fiscal deficit will need to be revised upward.

As it is, given that the combined fiscal deficit is budgeted to remain high in FY24BE at 9.4% of GDP, the intended fiscal consolidation will likely remain a mirage.