India’s high budget deficits are partly due to a large population and low per capita income levels, which increase macro-economic imbalances and thus 'expose the economy to shocks', say Moody’s

Indian economy is exposed to 'shocks' due to high fiscal deficit and the country’s credit outlook will depend on the Narendra Modi government’s initiatives in the next month’s budget to contain expenditure and reduce exposure to global commodity prices, says Moody’s in a research note.

The ratings agency said, “More relevant to (determine) the sovereign credit outlook will be whether the budget includes measures that address the Government’s low revenue base, high current expenditures and exposure to commodity prices”.

India’s budget deficit is high and this increases macro-economic imbalances and thus 'expose the economy to shocks', Moody’s Investors Service said in the report titled, “Frequently asked questions on India’s fiscal position and the forthcoming budget”.

“In absence of measures to reduce the fiscal deficit, the future high growth rates many forecast for India may not be realised. The July Budget could indicate whether fiscal constraints on India’s sovereign credit profile will ease over the coming years,” it added.

The Union Budget is expected to be presented in the second week of July.

Whether the new government’s FY15 deficit estimate is above or below the previous regime’s estimate of 4.1% of GDP, it will not be the key determinant of India’s credit outlook, Moody’s said. The deficit in 2013-14 fiscal was 4.5%.

Moody’s assigns a ‘Baa3’ rating on India, with a stable outlook.

“India’s high budget deficits are partly due to a large population and low per capita income levels. Low income levels limit the government’s tax revenue base and at the same time drive socio-political pressure to increase government spending on subsidies and economic development,” it added.

However, Moody’s said that other countries with low per capita income have avoided deficits as large as India’s. This suggests that fiscal discipline can improve budget outcomes despite structural challenges.

The report added that wide budget deficits have kept India’s inflation high and contributed to a widening current account deficit between 2011 and 2013, which heightened exchange rate volatility and resulted in higher domestic interest rates.

These trends have exacerbated the slowdown in GDP growth since 2011, it added.

The report outlines the reasons behind India’s high fiscal deficits, provides a comparison between recent fiscal developments in India and in other similarly rated countries, explains how fiscal policy has affected growth and addresses the possible credit implications of the newly elected Government’s forthcoming budget.