The Hindu Business Line : Budget hits all the right notes

The Finance Minister, Mr P. Chidambaram, presented a Budget that rides on the current upbeat growth momentum, significantly increases spending on social sectors, agriculture and infrastructure, while also emphasising fiscal consolidation.

The right notes

The Budget's focus on education, health, and agro-manufacturing, rural infrastructure and small car manufacturing hits the right notes. The Finance Minister deserves credit for lowering the budget deficit to 4.1 per cent of GDP; this owes mainly to tight control on operating expenditure. The Budget foresees total expenditure increasing to almost 11 per cent, while total revenues will rise around 15 per cent.

Optimistic outlook

The finance minister is assuming an optimistic outlook for tax revenues, especially corporate taxes, perhaps betting on improving compliance. The plan to cut fiscal deficit is on track. Given the narrower-than-anticipated fiscal deficit target at 3.8 per cent of GDP, the bond market would be somewhat dismayed at the INR1.14 trillion net borrowing plan for the next fiscal year.

Although the government has also budgeted to issue INR460 billion (INR700 billion, including redemptions) under the market stabilisation scheme (MSS), this is likely to depend on the extent of foreign capital inflows. Fewer redemptions under the MSS next year suggest a more challenging borrowing environment in the coming year. Total net market borrowing will rise by 55 per cent in FY2006-07 even if there is no further issuance under the MSS.

Special securities

Bond investors would be further discomforted by the government's intention to borrow another INR150 billion by end-March — before the end of the current fiscal year. The conversion of special securities issued to banks into trade-able government bonds is another negative for the bond market. This conversion will add to the potential government bond sales by banks, and will push further into the future the need for banks' to buy bonds to maintain their statutory requirements. The government also announced an increase in the ceiling for foreign institutional investors' investments in the domestic debt market.

The ceiling for investment in government securities has been raised by $0.3 billion to $2.0 billion, and for corporate bonds by $1.0 billion to $1.5 billion. Although welcome, these limit enhancements are small relative to the size of these markets, and will have only a temporary impact. On balance, the environment remains unfriendly for bond investors; the 10-year yield is likely to rise towards 8 per cent over the course of the year.

Focus on growth

The government's focus on agriculture, infrastructure and fiscal consolidation augurs well for India's growth prospects, and thus would keep foreign investors interested in investing in India. Consequently, we remain structurally constructive on INR over the long term.

We believe that the increasingly irregular sources of foreign capital inflows will be unable to offset the growth-fuelled deterioration in the current account, leaving INR vulnerable to a sell-off.

INR also continues to be expensive on an REER basis. Consequently, JP Morgan continues to forecast USD/INR will rise to 47.5 by end-December.

(The author is Senior Country Officer India and Sri Lanka, Managing Director, JP Morgan India.)