Narendra Modi has presented his election manifesto in Budget 2019 – but the maths doesn't add up

The 2019-’20 Interim Budget is essentially an election manifesto. Interim Finance Minister Piyush Goyal has promised to give Rs 75,000 crore to farmers. Indeed, the Budget will give farmers Rs 10,000 crore in 2018-’19 itself, using an unprecedented retrospective mechanism.

The Budget also offers an income tax rebate of up to Rs 12,500 each for individual tax-payers who earn less than Rs 6.5 lakh in 2019-’20. (Anybody who earns less than Rs 5 lakh will pay nothing; somebody who earns up to Rs 6.5 lakh will have to stash Rs 1.5 lakh in instruments permitted under Section 80C of the Income Tax Act and thus avail of the rebate). This will imply foregoing about Rs 18,500 crore in income tax revenues in 2019-’20. In addition, the government will make a larger contribution to subscribers to the National Pension Scheme.

All this of course, is subject to the National Democratic Alliance government coming back to power since this is an Interim Budget. Otherwise, the new government could, at least in theory, cancel all the giveaways in the full Budget that will be presented in June/July. That is unlikely to happen, however, as almost certainly, every other major political formation will commit to these sops and maybe, even top them, with extra goodies of their own creation.

This is a sort of “Bushido endgame”, as the game theorists call it – a situation where a nation losing a war uses its weapons of mass destruction, and exits in a blaze of glory. The reasoning here seems to be that if the National Democratic Alliance wins re-election, fine. It will then get five years to sort out the finances. Otherwise, balancing the books will be somebody else’s headache.

Expanding fiscal deficit

The primary danger with a populist Budget of this nature is that it could lead to an expansion of the fiscal deficit. The fiscal deficit – the difference between all expenditures and all revenues – is probably the one ratio that macro-economic analysts concentrate upon most, when a Budget is released.

The government has to borrow to meet the fiscal deficit. Hence a high fiscal deficit means that the government has to borrow more. The borrowing is done by issuing bonds or Treasury Bills, which are auctioned by the Reserve Bank of India. When borrowings are high, the lenders (banks and mutual funds and Foreign Portfolio Investors) want a higher yield.

Since government debt is the safest debt of all, government borrowing crowds out private commercial borrowings. This means corporates must pay even higher interest rates. A high fiscal deficit therefore, makes it difficult to bring down interest rates, even if inflation is low. Hence, a high fiscal deficit often cramps Gross Domestic Product growth since it often depends on the availability of cheap loans.

In addition, a high fiscal deficit can mean a more vulnerable currency. Since the government is already borrowing large sums, any contingency expenses that arise will put pressure on the rupee. For example, if the price of crude goes up and the Trade Deficit rises, the rupee may take a hammering.

Glib assumptions

More than the sops on offer in 2019-’20, the glib assumptions about the fiscal deficit in 2018-’19 might be a cause of concern for investors. The 2018-’19 Budget was originally estimated to run a fiscal deficit of 3.3% of the GDP.

The new estimate from Goyal says it will be around 3.4% and that the 2019-’20 fiscal deficit will be held at around the same level of 3.4%. In nominal terms, the 2018-’19 fiscal deficit will be Rs 6,34,398 crore (revised up from Rs 6,24,276 crore in the original estimate) while the 2019-’20 fiscal deficit will be Rs 7,03,999 crore according to the current estimates.

There is a near guarantee that those estimates will be revised upwards and may be revised upwards by quite significant amounts.

The fiscal deficit was running at Rs 7,16,000 crore by December, which is 113% of its revised full-year target. Since then, the 2018-’19 Budget has expanded by Rs 20,000 crore, so that has to be added to the expenditure side.

On the Revenue side, the revised estimates presented today indicated that Goods and Services Tax collections will be about Rs 1,00,000 crore below the original target indicated in February 2018. However, Corporate Taxes may be Rs 50,000 crore above target. (It’s possible that the Corporate Tax collections will surge, or that there will be large refunds reducing the amount.) Customs collections are estimated to be Rs 17,500 crore above original estimates. Dividends and profits will also raise Rs 12,000 crore more than the original estimates.

Put that all together and it is likely that, far from cutting back to close in on the revised estimate of Rs 6,34,398, the fiscal deficit will end up even higher than it is currently running. How much higher? Since I have to hazard a guess, it could be close to 3.8%, or even higher. This ignores the creative accounting, which will undoubtedly be deployed, to keep the numbers as close to the official target as possible.

Different people will come up with different guesstimates but all the external estimates of the fiscal deficit will be higher than the 3.4% Goyal claimed. Moody’s has already indicated it doesn’t believe the numbers, saying “it’s credit negative for the sovereign”

If the fiscal deficit is revised upwards, yields are likely to move up. Indeed, bond yields rose on Budget day. If the Foreign Portfolio Investors decide that they don’t like the numbers, the rupee could also move down.

Follow our full coverage of Budget 2019.