Budget 2023: Govt may target fiscal deficit of 5.7-5.8%, unlikely to cut income-tax rates, says Elara Capital’s Garima Kapoor 

Garima Kapoor

India’s central government may seek to lower its budget deficit by as much as 70 basis points in the next financial year even as it continues to boost capital expenditure, according to an economist at Elara Capital. “Given the glide path of reaching 4.5 percent of GDP by FY26, we do not think fiscal consolidation will be compromised,” Garima Kapoor told Moneycontrol in an interview.

“We believe the Budget would target a fiscal deficit of 5.7-5.8 percent for FY24 and focus mainly on capital spending. We expect capital spending allocation in the Budget to increase by 20 percent in FY24,” she added.

Finance Minister Nirmala Sitharaman is due to present the Budget on February 1 amid expectations that the Centre may keep pressing hard on the capex pedal. The government aims to lower its fiscal deficit to 6.4 percent of the gross domestic product this fiscal year, in line with its fiscal consolidation commitment. Sitharaman has said the government should be able to meet the budgeted fiscal deficit target for the current financial year.

In its Budget for 2022-23, the Centre set itself a record capex target of Rs 7.5 lakh crore — up 35 percent from the Budget estimate and 24 percent higher than the revised estimate for 2021-22.

Also Read: Budget 2023: Govt must shift focus to lowering fiscal deficit to 3%, says former finance secretary Garg 

Kapoor expects the capex cycle in select sectors to sustain going ahead despite the weakening global economy as the drivers for capex in some sectors are policy driven. Edited excerpts from the interview:

What do you expect from the upcoming Budget in terms of fiscal, tax and policy measures?

I expect the Budget to continue focusing on fiscal consolidation whilst enhancing allocation to capital expenditure. We do not expect any cut in income-tax rates nor enhancement of the limit for exemption.

We, however, expect a rejig of the custom duties to help reduce the cost of manufacturing by reducing the duties on component imports, especially for segments where the domestic value addition is gaining pace, for example, consumer electronics.

What is your assessment of the economic recovery? Are firms confident about making new investments?

India’s economic recovery remains steady led by buoyant demand in the services sector even as some nascent signs indicate that manufacturing sector growth may be facing headwinds from global growth weakness and weak demand for discretionary goods.

In terms of investments, we believe notwithstanding global growth weakness, many factors that were well aligned during the FY04-FY07 capex cycle seem to be gradually turning conducive for India such as cleaner bank balance sheets, lower debt/equity ratio for corporates and capacity utilisation, among others.

Capacity utilisation, according to the Reserve Bank of India, has improved drastically from the pre-Covid rate of 68.6 percent in December 2019 to 75.3 percent in March 2022, which eased marginally to 72.4 percent in June 2022, yet remaining above the long-term average of 73.2 percent. Even as the global growth slowdown may act as a headwind, the drivers for capex in some sectors seem to be policy driven.

For example, defence indigenisation, import substitution and production-linked incentives, green energy mandate and energy security and strategic (sectors) such as semiconductors. As such, we continue to believe that the capex cycle in select sectors in India may sustain even as the global economy weakens.

Would the government continue the path of fiscal consolidation, or does it need to boost spending more?

Given the glide path of reaching 4.5 percent of GDP by FY26, we do not think fiscal consolidation will be compromised. The high inflation episode in post- Covid era has shown that markets reward macroeconomic stability. This is aptly reflected by the performance of Indian markets over their EM peers this calendar year.

While MSCI EM is down 22 percent during the year, Indian equities have outperformed by a fair margin with a 6 percent down move in USD terms and a 6 percent up move in local currency terms (divergence driven by sharp depreciation seen in INR).

As such we believe the Budget would target a fiscal deficit of 5.7-5.8 percent for FY24 and focus mainly on capital spending. We expect capital spending allocation in the Budget to increase by 20 percent in FY24 and allocation under revenue heads for rural-focused schemes such as PM Awas Yojana-Grameen, Nal Se Jal and PM Gram Sadak Yojana to see higher allocation given the pre-election rural spending thrust.

What is your outlook for inflation and the external sector, and is that likely to be a constraint on what the government can do in the Budget?

We believe that India consumer price index inflation is on course to reach sub-6 percent by February-March 2023 and 5-5.25 percent by Q1FY24. China’s surge in Covid cases and its impact on supply chains may emerge as a key short-term risk for manufactured production inflation but its impact may get negated by softness in commodity prices, especially as crude and metals and demand from China remains weak.

With respect to the external sector, the recent decline in commodity prices, especially Brent crude (25.8 percent FYTD) and robust earnings of net services exports have eased external sector risks. We expect the current account deficit at 3.6 percent of GDP with risks balanced.

Also Read: Budget 2023: What is fiscal deficit and why is it a big deal

Do you expect the manufacturing slowdown to persist? What are the ways to encourage the sectors beyond the existing PLI schemes?

The manufacturing sector slowdown can be attributed to two factors: margin pressure and weak industrial output led by sluggishness in the unorganised sector. The Index of Industrial Production witnessed a contraction in September 2022 quarter by 2.73 percent versus a contraction of 2.12 percent in the June quarter.

Likewise, the profit before depreciation, interest and taxes for the non-financial corporate sector was down 10.3 percent YoY versus a growth of 11 percent in the previous quarter. We expect a part of this slowdown to reverse in the upcoming quarters, reflecting gains of commodity price correction, healthy festive demand, and pickup post sluggishness in monsoon.

While PLI schemes are encouraging the supply chains to shift into India, overall, the government’s focus on ease of doing business, relatively lower labour costs in India and rising risks of dependence on China would act as an automatic lever for a part of the supply chains to move to India — for example, Apple increasing its manufacturing capacity for iPhones in India. Moreover, PLIs are just policy enablers. Once an ecosystem develops, incremental investment in manufacturing capacities can take place outside the ambit of PLIs.

What is your outlook on the bond, FX and equity markets?

On the currency front, USD-INR tailwinds have started to emerge earlier than anticipated amid weak China commodity demand, especially crude oil, and pivot towards lower rate hikes by the Fed. DXY’s recent moderation and consolidation below 105 levels in December 2022 till date is positive for the INR, although sharp INR appreciation has been limited by the RBI’s intervention and forex reserve accumulation.

In this backdrop, we expect USD-INR to trade in a range of 82.5-83 in the near term. The risk to our call continues to singularly rest on the movement of the USD – If the Fed gives in to recession risks sacrificing the inflation fight and abandons the guided rate hike trajectory earlier than anticipated, we could see an appreciation bias to our USD-INR call.

Likewise, if the demand from China drives a reflationary impulse in crude oil prices amid a tightly supplied market, earlier than our anticipation of early FY2024, INR may come under renewed pressure.

Indian equities are closing the year close to their lifetime highs (Nifty is trading at 19.2x 12-month forward PE, 1SD more than the long-term average). As earnings are expected to provide downside support, valuations are expected to act as a headwind to upmove, thus keeping markets range-bound in the near term. The longer outlook remains bright though as domestically, bank and corporate balance sheets are in much better shape, and on the growth front as well most indicators remain steady.