The Budget aims to bring India's GDP growth back to 9% levels while at the same time trying to reduce the fiscal deficit, the ratings agency said.
Ratings agency Standard & Poor's (S&P) said India's 2010-2011 Budget, announced on Friday, marks the country's first steps towards fiscal consolidation after two years of deteriorating finances. In a release, S&P said it believes that increased certainty that the government can restore its financial soundness over the next several years will be key to improving the sovereign credit ratings on India rated as 'BBB-" with negative outlook.
"For India, progress on fiscal consolidation is one of the most significant factors in our assessment of the sovereign credit rating. The Reserve Bank of India's handling of emerging inflationary pressure and the country's growth prospects over the next several years will also be important to stabilize the rating," said S&P's credit analyst Takahira Ogawa.
India's fiscal problems include large outstanding debt and a deficit that has widened over the past two years. The budget aims to bring India's growth level back to 9% growth and addresses wealth distribution issues for low-income groups, particularly in rural areas, at the same as trying to reduce fiscal deficits.
The union government plans to reduce the size of its fiscal deficits for FY11 to 5.5% from a revised estimate of 6.7% in FY10. On the revenue side, partly because of the planned introduction of the nation-wide goods and service tax (GST) in the near future, there is no significant change in tax. However, the budget does include increases in some indirect tax rates, which were reduced to boost domestic demand in previous budgets. On the expenditure front, the budget includes an increase in capital spending in areas such as infrastructure investments, and gradual increases in the social security sector.
"We believe the steps announced in today's budget speech could signal a turning point that reverses the recent deterioration in India's fiscal position," said Mr Ogawa adding that further steps to structurally improve India's fiscal position and flexibility would solidify this trend, and could contribute to a revision of India's sovereign outlook back to stable against the background of improving macroeconomic indicators.
Prior to the budget speech, the Indian government had changed its fertilizer policy to implement a nutrient-based pricing policy and will raise urea prices by 10% from April 2010. This should reduce the total size of fertilizer subsidies, which amounted to almost Rs1 trillion (Rs1 lakh crore), including the issue of fertilizer bonds, in fiscal 2008-2009, or 45% of total government subsidies. However, S&P said it believe further changes to the system of food and domestic fuel subsidies could improve the structure of expenditures and prevent future increases in the size of subsidies.
The ratings agency said in its view, India's fiscal consolidation will occur at a moderate pace. In a report tabled to parliament on 25 February 2009, the 13th Finance Commission recommended that the government take 'a calibrated exit strategy from the expansionary fiscal stance of 2008-2009 and 2009-2010'. The commission proposed a general government debt target of 68% of GDP in 2014-2015 from an estimated 79% in 2009-2010. It also proposed to bring down the general government fiscal deficit to 5.4% in fiscal 2014-2015 from an estimated 9.5% in fiscal 2009-2010. Based on this recommendation, the announced budget for 2010-2011 included a rolling target for the central government deficit, at 4.8% for 2011-2012 and 4.1% 2012-2013. In our view, one of the critical factors for India's fiscal consolidation will be the timing and the details regarding the implementation of the nation-wide GST system. A successful implementation of the GST could pave the way for a structural improvement in budget revenues.
In the same report, the commission indicated reforms of a new Fiscal Responsibility and Budget Management Act (FRBM), which will replace the current legislation that expires at the end of March 2010.
S&P said in its pinion, the new FRBM would be a positive step forward for India's fiscal consolidation if most of the key recommendations by the commission are adopted. These include the full disclosure of contingent liabilities and the inclusion of off-budget debt-raising activities such as government-issued oil bonds or fertilizer bonds. The commission also recommends some flexibility in the implementation of the FRBM in the event of an unforeseen economic shock. While in our view this is a realistic approach, there is the risk of slippage in the implementation of the new FRBM, if the requirements for such exceptional cases turn out to be overly lax in the final FRBM act.
NBFCs and the private sector can now enter the banking business if they meet RBI’s criteria. This is a major move for the financial sector
Private players and non-banking finance companies (NBFCs) have reason to cheer the Budget speech as the finance minister announced that the RBI is open to giving them banking licences if they meet the apex bank’s criteria.
“The RBI is considering new bank licences to promoters in the private sector and also NBFCs, if they meet the eligibility criteria of the RBI,” Pranab Mukherjee said while presenting the annual Budget for 2010-11 in the Lok Sabha.
NBFCs like Indiabulls, Reliance Capital, Religare, IL&FS, IDFC and Aditya Birla Financial Services are likely to apply for bank licences after the RBI norms are in place.
“The Aditya Birla Financial Services Group is already a large non-bank player occupying a significant position across all its verticals. We wholeheartedly welcome this initiative and will definitely apply for a licence. The Aditya Birla Group is confident that we will meet any eligibility criteria that might be set," said Ajay Srinivasan, chief executive (financial services), Aditya Birla Group.
“The finance minister has shared the government's desire to open up the banking sector to NBFCs and the private sector. This is a significant step towards further strengthening and broadening the banking sector and bringing it closer to the aam aadmi,” adds Mr Srinivasan
No new banks have been set up in the past eight years. In fact, no new Indian bank has been set up since the first flush of liberalisation in 1993 when half-a-dozen banking licences were given. This announcement clearly demonstrates the government’s plans for liberalisation of the financial sector.
India has 96 scheduled commercial banks (SCBs)—27 public sector banks 31 private banks and 38 foreign banks—having a combined network of over 53,000 branches. According to a report by ICRA, public sector banks hold over 75% of the total assets of the banking industry, with the private and foreign banks holding 18.2% and 6.5%, respectively.
Unlike banks, all NBFCs cannot accept demand deposits. Only NBFCs which hold a valid certificate of registration with authorisation to accept public deposits can do so. NBFCs that were earlier allowed to be converted into banks were Kotak Mahindra Finance and 20th Century Finance. While Kotak has diversified into various financial services, 20th Century became Centurion Bank; it was taken over by a bunch of private equity investors and eventually merged with HDFC Bank. Two of the other new licensees in the early 1990s—HDFC Bank and UTI Bank (renamed Axis Bank)—have become very successful private banks.
The announcement also cheered the markets. The Sensex gained 175.35 points while the Nifty gained 62.55 points. Religare (an NBFC) inched up 3% to Rs371 from Rs361, Indiabulls shed 1% to close at Rs98.90, and Aditya Birla Nuvo gained 4% to end at Rs842.
The Budget measures will support a short-term and a long-term rally, but the market’s medium-term prospects are clouded by global worries
After the Budget, market experts have declared that the rally today is a “technical breakout”. This makes no sense to most of us who do not know what is called technical analysis. But the plain fact is that something has hugely changed for the better. At 16,430, the Sensex has closed at its highest level over the past one month. The immediate reason for this is that huge worries about the fiscal deficit, rising borrowings, rise in excise and other taxes are gone. It is as if a huge stone has been removed from the chest of the market. It is for this reason the short term looks good. The rally will possibly take the Sensex up to 17000-17,200, after which the market will again go down.
It could well be that the market goes lower, thanks to global worries. There is talk of a double-dip recession in Europe. Continuing job losses in the US and talk of a bubble in China make the global situation pretty grim all over again. This will put pressure on the Indian markets in the medium term. However, the market cannot remain immune to a couple of features of the Budget. One, the amazingly low tax on salaried employees. Under the coming regime, right up to Rs8 lakh of taxable income, the tax is only 20%. This puts enormous amounts of money in the public.
This will boost both consumption and savings, ultimately keeping the growth going. The second is that the growth momentum of Indian businesses have been kept untouched. The Budget has been a fine balancing act between growth, cutting the fiscal deficit and increasing disposable incomes. All this will be reflected in the long term growth. Unless the external shocks cripple us again, the finance minister has just put the Indian bull on steroids.