See FY13 fiscal deficit at 5.5% of GDP: Moody's

The fiscal deficit in the first seven months of 2012-13 stood at 71.6 percent of the budget Estimates. This was slightly better than 74.4 percent in the same period a year ago. This improvement was on the back of some tightening on the expenditure front.

Atsi Sheth of Moody's Investors Service expects FY13 fiscal deficit to stand at 5.5 percent of GDP. "The risk to this forecast is the revenue profile. One is growth, over the next two quarters if growth plateaus or moves slightly upwards then revenues will remain in line and the other is implementation of divestment plan and 2G," she said in an interview to CNBC-TV18.

In absolute terms, the fiscal deficit gap between expenditure and revenue collection was Rs 3.67 lakh crore during April-October period of the current fiscal.

Meanwhile, the current account deficit is expected to remain at current levels of 3.9 percent in the near-term.

Below is an edited transcript of Atsi Sheth's interview on CNBC-TV18.

Q: The Finance Ministry has been claiming that they will be able to restrict fiscal deficit to 5.3 percent, but somehow the data does not add up, 75 percent of fiscal deficit already in first seven months up until October. What is your number? How do you think we will end the year?

A: Our own forecast for this year is that the deficit will probably come in somewhere around 5.5 percent of GDP which is modestly higher than what the government has presented in its most recent plan and the risk to this forecast is the revenue profile. Over the next two quarters if growth either plateaus or moves slightly upwards revenues will remain in line. The other risk of course is the implementation of the two big things that the government wants to do, the divestment and the 2G. So, depending on how those two things pan out you might have a 5.5 percent deficit.

Q: What about the other big deficit number; the current account deficit? Last time it was around 3.9 percent. How would you draw the current account deficit for the full year?

A: It will stay at around these levels largely because there are two things that drive India’s current account deficit. One is more benign than the other. The first is India’s growth tends to outstrip that of its trading partners. It is also an economy whose investment needs are high and imports a lot of investment goods.

At the same time the demand for its exports will never be the same as demand for imports within the country. So a modest current account deficit is something that we anticipate to be with India for the medium-term. The rise from 1-2 percent levels to 3-4 percent levels is driven partly by commodities and specifically two gold and oil. Demand for both is likely to be strong in India.  Over the near-term, at least the current account deficit will remain at current levels because exports will not rise to compensate for oil or gold imports and we do not expect oil or gold prices to fall to such an extent in the near-term.

Q: For the last two decades the current account deficit has remained within 2-3 percent. Since last year, we are seeing it in the region of 4 percent. Do you think it is a structural change or is it just a one-off? If it is structural change would you worry?

A: If it was a structural change it would tell you that somehow the competitiveness of India’s exports have been lowered and that would also account for rising imports. Right now it’s difficult to say much about competitiveness because global demand is weak. That seems more like a cyclical phenomenon. Looking ahead, inflation may make this structural story true. If Indian inflation remains above its trading partners, competitiveness suffers and would then become structural.

If Indian macro economic policies were such that aggregate demand remained well beyond what domestic supply could meet, you will have to import. These two are risks, last two years are not good years to assess that risk, because there have been cyclical and global factors at play. So, I would not take the trend of the last year and project it onto the next two.

Q: Our GDP is 5.3 percent and the average for the first half stands at 5.4 percent which is not very encouraging. So how have you forecasted growth for the rest of the year and even for FY14?

A: Our forecast is 5.4 percent and was made before the first half numbers came out. We are sticking to it because in the next two quarters growth might improve modestly, manufacturing growth we expect to improve. We still see some strains in agriculture depending on how the Rabi or the Kharif crop turns out.

Depending on how the global growth environment improves next year, manufacturing will slowly inch its way back up. If the fiscal deficit is contained to the 5.5 percent levels, if inflation abates, you might see some monetary easing in calendar year 13 and that would again support growth. So we see inching from 5.4 percent in this fiscal year to about 6 percent in the next fiscal year.

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Q: Do you think 7 percent plus inflation is structural for India, much higher than what we were 10 years ago? Is this 7-10 percent a one-off?

A: In India there is a structural issue that informs the inflation trajectory and there are supply constraints in the economy. Some of these supply constraints are related to policy, regulatory. Some are related to infrastructure and the lack of adequate infrastructure both social as well as physical. These supply constraints are not new, have been around for a long time, India has a very robust demand profile. So you have a demographic that is large and young and willing to consume and you also have a fiscal policy that tends to be in most stimulative rather than otherwise, of course that feeds aggregate demand.

When you have demand driven by these two factors and supply constrained by the other two factors you will revert to inflationary pressures when growth picks up. In the last cycle, growth has actually receded but inflation has remained high and that is partly due to certain one-off factors, the depreciation that we saw over the last year, commodity prices, both oil as well as food. So, those factors might abate and you see a slow decline in inflation. We do see inflation as a structural issue in India that fiscal policymakers as well as the monetary policymakers have to be very vigilant about.

Q: What will be the actual numbers for this year and next?

A: Considering the Wholesale Price Index (WPI) which is the commonly accepted metric, inflation will be between 7 and 8 percent which brings it to 7.5 percent. This is similar to the current level and will probably go down especially if you see a spurt in supply. If output comes up, you do not have another drought or a deficient monsoon next year, it could come down closer to the 6 percent levels over the next fiscal year.

Q: Where does all this leave the Reserve Bank of India and when can we expect a rate cut? Would it be in January?

A: This is the trade-off that the Reserve Bank has been looking at over the last year and is a difficult trade-off. You do not want to see growth and particularly the Reserve Bank manufacturing growth, which is very sensitive to domestic capital cost, that is responsible for the slowdown. The Reserve Bank has been very clear about not loosening policy when there are inflationary pressures, not just current inflation but even when inflation expectations are high.

Over the next year what might drive policy to ease a little bit is first measures taken on the fiscal front. The government has addressed some of the Reserve Bank’s concerns, not all but some and certainly every time you have a narrowing of a fiscal deficit from 5.9 percent to 5.5 percent or so that is consolidation. Secondly, commodity prices, if those do not suddenly spurt up that would give the Reserve Bank some comfort and thirdly if you are looking at the wage pressures that have been prevailing and the cost push pressures in non-food, non-fuel inflation those appear to now be abating a little bit. So that might be something that allows for a bit of easing.

Q: You said, current account pressures are at least partly cyclical. Do you think the rupee will be able to withstand the pressure?

A: It has come off now to the 54 levels. This has been a year when it has gone between 56-54 and the support has been given by capital flows, portfolio flows largely. The current account has not been a source of support, quite the opposite. If you look ahead to just the three months period there are risks to the capital account and these risks are largely global that you have in the United States.

Important fiscal policy decisions that could drive risk aversion. You have in Europe of course the ongoing sovereign and banking crisis that could drive risk aversion. It has been slowly resolved in bits and pieces, but that could pose some sort of modest risk, that could affect capital flows. If those risks do not come to fruition you could find that capital flows still play a supportive role. 

I do not see how the current account deficit, we have said before that it will stay at current high levels so it is unlikely to play a supportive role in the near-term over the next year or year and a half if one sees a narrowing of the deficit and this will happen largely because exports accelerate a little bit from current levels and imports, particularly oil and gold imports in value terms do not rise to the extent they have been rising then you might see some support coming in from the current account as well.

Q: Where does all the data leave rating agencies like Moddy’s? If the fiscal deficit comes in at 5.5 percent it is a bit of a consolidation from the 6 percent last year. Would you persist with your investment grade rating if we came at 5.5 percent?

A: One perception is that the rating outlook is equivalent to the outlook on macro economic trends. So the macro economic trajectory is going in a negative direction the outlook must necessarily go in that direction as well and in our case it has. Our outlook is stable even though we have long said that the macro economic trends are going in a negative direction. This is because ultimately the rating is about the governments’ ability to repay its own debt.

This ability is at the Baa3 level, not higher over the next two years and not lower over the next two years or so because the governments’ debt. If you look at the interest on the yields on government debt over the last several months when the headlines have been very negative about growth etc in the fiscal position as well those haven’t moved much. This is one thing that supports the profile that there is a captive pool of money due to the private sectors high savings rate intermediated through banks and insurance companies that allows the government to fund itself domestically.

This government is not dependent unlike many that we rate outside globally that are dependent on global capital flows to fund the government. So that’s one thing that gives us some support.  If you look at the governments own debt profile, its very long-term in nature. So they fund about 4 percent of GDP every year has to be refinanced which is a fairly modest number because if you look at even the Baa3 rating range some countries have to fund about 30 percent of their debt every year. So this is again something that gives India support in terms of its rating profile. So yes, the macro economic trends are negative but the government’s ability to finance itself and to repay its debt most importantly remains about what it was.