Arun Jaitley has surprised everyone pleasantly by sticking to the 3.5 per cent fiscal deficit target set in the previous Budget. While the financial markets are pleased, there are doubts about how prudent are the assumptions made while drawing up the Budget. Indranil Sen Gupta, India Economist, Bank of America Merrill Lynch, helps us understand how this feat was achieved and what it means for consumption, capex spending and interest rates.

While the Centre has adhered to the fiscal deficit target, it has been done by cutting back on capital expenditure. Do you think this is going to hurt growth? With the private sector not in a position to invest, there was an expectation that the government will spend more.

The government cannot obviously support recovery if it cuts down the fiscal deficit when growth is weak. In the old GDP series, growth is running at an anaemic 5-5.5 per cent. This puts the onus of recovery on the RBI in terms of cutting rates as well as stepping up liquidity. In a sense, that is inevitable. Given the global downturn, domestic demand will recover only after lending rates come off. This will lead to a pick-up in production and exhaust capacity. It is only then that firms will add to their capacity. To expect a turn in the capex cycle now is to put the cart before the horse.

It appears as if the entire provision for the Seventh Pay Commission has not been made in the Budget. Do you agree? If yes, will consumption still get a leg-up from this Budget?

The government is expected to implement the Seventh Pay Commission this year. While it appears that it has not been fully provided for, we still expect the payout in this fiscal. It also remains to be seen if the government is able to implement the tax amnesty scheme this year. The expectation is that it will raise around ₹800 billion this year. In our view, the Pay Commission award should be welcomed as a much-needed consumption stimulus in a weak global environment. To recall, the Sixth Pay Commission had cushioned the impact of the 2008 global financial crisis.

Is the deflator assumed for calculating the nominal GDP growth in this Budget correct? Will the nominal GDP growth move higher to 11 per cent in 2016-17?

We are working with 11.8 per cent nominal income growth. This assumes that commodity prices will bottom out in 2016.

Can you explain what will be the impact on the fiscal numbers if the price of crude oil moves higher? What is the crude oil price that the Finance Ministry is assuming?

We understand the government is working with $45/bbl. A lot depends on whether the government cuts oil import duty or passes the benefit to the consumer. In our view, oil prices and divestment will move together. The very risk-off that sustains low oil prices will also stall portfolio flows and limit the government’s ability to divest. If risk-on pushes up oil prices, we should also expect a revival of portfolio flows, helping the government to divest.

Is the growth budgeted in tax collections under direct and indirect taxes achievable?

It is achievable, in the non-oil part, although a lot depends on the global economic cycle. There are, of course, question marks over what happens to oil prices, telecom auctions and disinvestments. That said, I think that the discussion is academic. After all, the government is running a cash surplus of $15-20 billion (1 per cent of GDP) with the RBI. In case of a fiscal slippage, it will be able to fund the gap by drawing this down. As a result, there is no threat to the net borrowing announced or interest rates.

What is your opinion on how the RBI will act now?

The RBI is expected to cut rates by 25 basis points by April 5. At the same time, the space for further cuts is limited as the repo rate, at 6.75 per cent, has already dipped below the medium-term inflation rate of about 7 per cent. In any case, what matters far more is that the RBI injects sufficient liquidity into the system. We estimate that the RBI should put in about $30 billion of permanent liquidity this year. It has injected only about $17 billion. The RBI is expected to do open market operation of another ₹200 billion by March. Even then, the money market liquidity deficit will be, by end-March, very large at ₹2,000 billion.

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