Mr Abheek Barua, Chief Economist, HDFC Bank

Fiscal deficit to GDP ratio to be targeted at 5.5% for FY11 Roadmap for fiscal consolidation likely Gross market borrowings for FY11 likely at Rs 4,64,000 cr-Rs 4,94,000 cr compared to Rs 4,50,000 cr in FY10. Net borrowings at Rs 3,50,000-Rs 3,80,000 cr likely for FY11 compared to Rs 3,97,000 cr in FY10. We see nominal GDP growth expectations for FY11 to be revised higher to 14% from 12.4% listed in medium-term strategy statement Disinvestments likely to be budgeted close to Rs 20,000 cr through piece-meal government stake sale We expect tax buoyancy to pick up from 0.2 in FY10 to 1.3 on recovery in growth and partial withdrawal of tax cuts Service tax unlikely to be altered from current rate of 10% ; more services to be included under tax net. We see union excise duty increased by 2% to 10% and brought in line with service tax rate to help smoothen transition to GST Removal of select industries from list of export industries eligible for 2% interest subvention scheme We see gross budgetary support to plan expenditure increase by 15% Expenditure rationalization measures such as freeing up of domestic fuel prices unlikely immediately but ad-hoc fuel price hike expected by March,2010 Road-map for Nutrient-based fertilizer policy on the cards Direct Taxes Code and Goods and Services Tax implementation to be delayed to FY12 Additional funds over and above World Bank support likely to be allocated for recapitalization of public sector banks
Bond market implications Bond yields have shot up over the last two weeks on comments by RBI governor Subbarao that net borrowings for FY11 is likely to be the same as those for FY10. Net market borrowings announced is generally understood as the fraction of the fiscal deficit that is financed from the market. The initial net borrowing in last year’s budget was Rs 3,97,957 cr-99% of the fiscal deficit. However, if we adjust for Rs 33,000 cr provided from MSS desequestration (MSS cash balances with the RBI transferred to the government) , the actual net borrowings for FY10 was Rs 3,64,957 cr-91% of the fiscal deficit. Given our calculations, the fiscal deficit at 5.5% of GDP works out to Rs 3,86,494 cr. However, there is unlikely to be MSS support in FY11. If 99% of the deficit is indeed financed through market borrowings then the net borrowing figure (net gilt issuance) works out to Rs 3,82,629 cr. Thus, net G-sec issuance is likely to be higher this year and there is no scope for a bond rally on this count. However, it is possible that the market will for a brief period compare the Rs 3,97,957 cr number with the Rs 3,82,629 cr number and this could trigger a rally. It is also possible that there will be alternative sources of funding the deficit and the net borrowing number could be a lower percentage of the deficit than 99%. Let us consider the case where it is say 91%. The corresponding net gilt issuance works out to Rs 3,52,000 cr which is lower than the net issuance of Rs 3,64,957 cr this year and this again could trigger a rally. In either case the rally is likely to be shallow. With RBI likely to tighten its monetary stance further and discontinue key setoffs for last year such as the OMO buy-back scheme, the market will eventually focus on the large quantum of borrowings likely to hit the market per week. This could be close to Rs 12,000-15,000 cr. Negatives such as rising inflationary pressures will also keep government debt offered. We therefore recommend selling into any run-up in gilt prices at this stage.

Mr Abheek Barua, Chief Economist, HDFC Bank