Staying the course on fiscal consolidation

After achieving its 3.5 per cent target for 2016-17, the Finance Minister chose to follow a prudent fiscal policy, upping its fiscal deficit target only marginally to 3.2 per cent of GDP for 2017-18, from 3 per cent earlier. The recommendations of the Fiscal Responsibility and Budget Management (FRBM) Committee report, released recently, has made a case for providing some flexibility to the Centre, by moving from a fixed fiscal deficit target to a range-bound one. But the Finance Minister, playing entirely by the book, pleased bond markets by sticking with a tight fiscal policy. The yield on the 10-year G-Sec remained flat.

While there has been no negative surprise for bond markets, yields are unlikely to fall significantly from hereon, offering limited upside to bond investors.

Fiscal deficit target of 3.2 per cent for 2017-18, implies that gross market borrowing stands at ₹5.8 lakh crore, almost flat from the previous year’s ₹5.82 lakh crore. The net borrowing at ₹4.23 lakh crore is only a marginal 4 per cent up from the previous year. Prima facie, the growth of 12.7 per cent in tax receipts (net to centre) appears achievable. While direct taxes are expected to grow by 15.7 per cent in 2017-18, indirect tax growth has been pegged at a lower 8.8 per cent (down from 20 per cent in 2016-17). Excise duties, the largest component of indirect taxes, could suffer if oil prices rally sharply and trigger fuel duty cuts.

The Budget assumes ₹46,500 crore divestment proceeds from stake sales in PSUs and ₹15,000 crore by way of strategic sales. Another ₹11,000 crore has been factored in by way of listing of insurance companies. After setting a target of ₹56,500 crore in last year’s Budget, the Centre raised about ₹45,500 crore in 2016-17 by way of disinvestments. The divestment target for the coming fiscal while not aggressive, can face some hurdles.

The Finance Minister has put to rest an ongoing debate on whether the Centre should stay the course on fiscal consolidation or deviate to accommodate capital spending. The Centre’s 6.6 per cent growth in expenditure is conservative. Staying on the fiscal track, amidst the ongoing uncertainty in the global markets is a prudent measure, one that RBI is likely to follow. Hence, rates on long-term government bonds are unlikely to fall substantially from hereon.

Bond investors should invest a chunk of their debt fund investments in short-term income funds that carry less volatility in returns. There is also a higher possibility of upside on the shorter end of curve given the surplus liquidity in the system.