Ahead of the Budget, speculations are rife on whether Finance Minister Arun Jaitley should deviate from the Fiscal Responsibility and Budget Management (FRBM) path and push up public spending significantly to spur economic growth. As Guest Editor, Reliance Capital’s Chief Investment Strategist Madhusudan Kela threw up some difficult questions to Morgan Stanley India’s Head of Research Ridham Desai.

Kela: What’s your expectation from the Budget?

Desai: If I were to point out the two-three things that I am looking forward to then I am looking for a big thrust on infrastructure spending. I think they (government) had a target for 30 per cent increase last year and they achieved a little less than that. Maybe they need to get more aggressive. The government has enough money in their coffers to actually spend. I am also expecting some spending in rural India — not just NREGA-type spending but infrastructure — because rural India has borne the brunt of the pain, which has happened on the fiscal consolidation in the last two years and it has also taken pain because of bad weather. Hopefully the weather is better this year, the early signals are that the worst El Nino is behind us and maybe it is time to give a little bit of a boost to rural India.

Kela: This time around if fiscal deficit becomes very important then what should the government attitude be towards fiscal discipline? There is a need to kick-start the economy. Since the private sector is not doing enough, the government needs to spend a lot of money…

Desai: In my opinion, I don’t think the Finance Minister is going to push for a higher fiscal deficit number. He is tracking below his estimates and well below actually because by the end of December it (fiscal deficit) was around 3.4-3.5 per cent of GDP. The likelihood is that he will close the year a little higher than that and budget for a slightly lower deficit for the next year. So I think the path towards fiscal consolidation continues.

Kela: Do you think the FM will stick to the FRBM target of keeping the fiscal deficit at 3.5 per cent of GDP for FY17?

Desai: Or it may be 3.7 per cent. But it won’t be an increase to what it was last year.

Kela: Do you think it is the right thing to do?

Desai: That is debatable. There are pros and cons of this. I think the world at large needs a very big fiscal boost. Everybody is focused on monetary policy — Japan has gone to negative real rate, there is a push in America, there is push in Europe and there is likelihood that a lot of countries will have negative real yields by the end of this year. I think the fix is really the government around the world come and spend money. Now I know that leverage is high and therefore governments are not spending money. But I think monetary policy tools are not working. And what will work is government spending. That may also apply to India. I think India’s main problem is not that the real GDP growth is weak, but it’s the nominal GDP growth that is weak. There are tools we have — we can, for example, let the currency to slide a bit. Rupee is overvalued. On RBI’s real effective exchange rate model, the rupee is overvalued by 6-7 per cent. So there is room for it to lose a little bit of ground. There is room on government’s balance sheet to recap the State-owned banks. You don’t need to do it through the fisc. You can do that outside the fisc.

Kela: One of the questions I have been struggling with is how to recap the PSU banks. In my own view, they should go for preference shares…

Desai: But that doesn’t get recognised as tier-I capital. The way I am suggesting is basically a recap bond issue like TARP (Troubled Asset Relief Programme of the US). You issue $20 billion of bonds free of cost to State-owned banks.

Then you open up the FII limit for bonds. And immediately, or in a staggered period, the banks sell these bonds and therefore accrue a $20 billion profit.

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