InvestorQ : What are the risks you see in India running such a high fiscal deficit as we saw in the Union Budget announcement this year?
Arti Chavan made post

What are the risks you see in India running such a high fiscal deficit as we saw in the Union Budget announcement this year?

Rutuja Nigam answered.
2 years ago

The government has set fiscal deficit at 9.5% for FY21 and at 6.8% for FY22. Here are some likely downside risks of this kind of move.

· The primary concern is on the solvency and ratings front and rating agencies like Fitch have already warned that if India does not take care of the fiscal deficit, it could set the tone for downgrades in the near future.

· The immediate concern, and that is already visible to an extent, is on the interest payout front. If you look at FY21 over FY20, there has been a surge in interest payouts on loans. That will only escalate in FY22.

· The borrowings for the Indian economy between FY21 and FY22 will be combined amount of Rs.25,00,000 crore or about $330 billion. That is the additional debt that will have to be serviced by the government on a consistent basis.

· One of the ideas of the FRBM and also its achievements was that it managed to bring India’s interest outgo under control. Too much laxity on the fiscal deficit front can push the economy back in the rut, from which India had come out in last 15 years.

· The more important risk at a micro and business level is the bond yield risk. In the last few months, despite the low rates, the bonds yields continued to remain around 6% on the benchmark bonds. Even this can be quite deceptive, as we have seen in the past.

· Another likely effect of a higher fiscal deficit is that it crowds out private borrowers and forces the RBI also to borrow at higher yields. This pushes up the bond yields in the market. This can have a negative impact on bond prices and also for equity valuations.

· The bigger impact will be felt by the banks and the debt mutual funds that hold substantial amounts of debt in their portfolios. This could have larger repercussions for banks and debt funds that are holding on to bonds in their debt portfolios.

· The one thing you really cannot ignore is the ratings angle. Most rating agencies have issued veiled warnings on the fiscal deficit but they are likely to gloss it over for now due to the global stress. However, Chinese growth picks up and Indian growth does not pick up, then the rating agencies are likely to pose very probing questions.

To conclude, the real test for India will be how smartly they outperform and do better than the fiscal deficit indicated in the budget. Current estimates and even the 4.5% fiscal deficit by 2026 may be sailing too close to the wind. Having I prepared the financial markets for higher levels of fiscal deficit, smartness lies in bettering these targets in next few years.