Tuesday, March 3, 2015

India’s budget and China’s rate cut

In my post on India’s Economic Resurgence last week I said that fiscal consolidation would prove difficult.  Indeed in the Modi Government’s first Budget the fiscal consolidation target of a deficit of 3.0% of GDP has been pushed out a year to 2018 in exchange for higher spending on infrastructure.  In general though the budget has much in it to applaud but there were also a couple of missed opportunities.

Economic growth will get a boost from increased investment in roads, railways and power plants.  In total the capital expenditure budget is projected to be 25% higher in the new fiscal year (FY).  Implementation will be challenging and makes proposed changes to land acquisition rules all the more critical.  The higher spending means the FY16 deficit of 3.9% of GDP will be higher than the previously expected 3.6%, although will still be lower than the estimated 4.1% of GDP in FY15.

One area of disappointment on the spending front was subsidies.  While spending in this area will be lower in FY16 that’s mostly due to lower commodity prices.  Subsidy spending is ripe for a significant structural overhaul and the best time to do that is when growth is strong.

Changes on the revenue side were all positive and include the phasing in of a lower corporate tax rate from 30% to 25% over the next four years and the planned implementation of a Goods and Services Tax from April next year.

There was nothing in the budget on labour market reform.  As I said last week this is a critical area for the Government to make progress if it wants to meet its growth aspirations.  But on balance this is a good budget and supports our argument of an economic resurgence under way in India. 

While we’re on the subject of emerging markets China’s second rate cut announced over the weekend was a clear signal the government  is keen to put a floor under the growth slowdown.  Despite trying to suggest that its monetary stance remains unchanged, two rate cuts and a reduction in the required reserve ratio argues a shift away from PBoC’s previously stated neutral position.  Further rate cuts seem likely.