India Budget FY17 - Will Be Steady and Staid

Budget 201617
India may meet fiscal deficit target for FY 2016, although marginally.
Indias annual budget is a tightrope walk for any finance minister, considering the underlying challenge of
drafting a policy document thats a steady mix of what is desirable and what is achievable.
The financial year 2015 16 was a trying period for a relatively insulated India.
Despite a weak currency due to the slowdown in global growth (that affected exports and capital
outflows) there was relief in the form of robust indirect tax collections. These were primarily from
opportunistic higher excise duties on petroleum products as well as new levies such as the Swachh Bharat
cess (announced in November 2015) in addition to the service tax rate hike announced in the previous
budget. The increase in indirect tax earnings helped the government tide over a shortfall in direct tax
collections due to slower growth especially in the export sector as well as meet its spending
requirements for physical infrastructure and social infrastructure programs.
The budget is expected to meet its fiscal deficit target by an improved margin in case of a cut in plan
expenditure on capital account.
2016-17 presents challenges such as meeting higher expenses on account of the seventh pay
commissions recommendations, the One Rank One Pension (OROP) scheme, and investment outlays,
which could be met through higher tax rates as well as the introduction of new taxes, duties, and cess.
The fiscal deficit target for FY17 could be relaxed from its earlier target of 3.5% of GDP, but not by a large
margin. Anything between 3.6% and 3.7% will give the government adequate room to meet its target
while keeping its commitment to greater fiscal discipline.

Government Unlikely to Breach the "Red Line" of Fiscal

Deficit
We expect the government to meet the fiscal deficit target of 3.9% of gross domestic product (GDP)
for 2015-16.

Contrary to media reports, the government may not risk breaching the fiscal deficit targets "red line",
despite temptations to dilute its stance amid a decelerating global economy and declining exports. Once
breached, India has (historically) taken several years to restore fiscal discipline. This is particularly evident
from the FY200914 period, when the country risked being downgraded to "junk" by global credit rating
agencies due to its high fiscal deficit. We believe the current finance minister, Arun Jaitley, would strive to
maintain this hard-won discipline.

Aranca Estimates 201516 Fiscal Deficit at 3.85% of GDP

Based on the actual figures for revenue and expenditure for AprilDecember 2015 (as per the Ministry of
Finances website) and the actual revenue and expenditure in the comparable period of the previous year
(AprilDecember 2014 as percentage of FY201415), we estimate the governments fiscal deficit to be
3.85% of Indias GDP beating its fiscal deficit target of 3.9%.
A better-than-budgeted fiscal deficit (even by a small amount) has been the norm in recent years, and we
expect a pleasant surprise from the government this year as well.

All Amount
(INR crore)

9MFY1
5
(% of
BRE)

9MFY16
(Actual)

9MFY1
5
(% of
BE)

201516
(Aranca
Estimates
)

201516
(BE)

Assumption
s

Revenue
Receipts

61.6%

803,808

70.4%

1,257,179

1,141,57
5

Revenue
receipts to
surpass BE
due to higher

indirect tax
collections.

Tax Revenue
(net)

60.1%

622,247

67.6%

1,057,179

919,842

Indirect tax
collections
increased
34% in April
2015
January
2016.

Non-tax Revenue

68.0%

181,561

81.9%

200,000

221,733

Non-debt Capital
Receipts

24.2%

22,004

27.4%

30,000

80,253

TOTAL
RECEIPTS

60.2%

825,812

67.6%

1,287,179

1,221,82
8

Non-plan
Expenditure

72.8%

968,019

73.8%

1,312,200

1,312,20
0

Non-plan
expenses to
be
maintained
at BE, as in
2015

Plan Expenditure

75.4%

345,978

74.4%

495,662

465,277

State
packages,
infrastructur
e programs
to push up
plan
expenses.

On Revenue
Account

76.9%

230,656

69.9%

330,020

330,020

On Capital
Account

69.6%

115,322

85.3%

165,642

135,257

TOTAL
EXPENDITUR
E

73.5%

1,313,99
7

73.9%

1,807,862

1,777,47
7

Fiscal Deficit

103.9%

488,185

92.6%

520,683

526,997

3.85

3.9

Fiscal Deficit
(%GDP)

Marginally
lower than
BE, as in
2015

Source: indiabudget.nic.in, Aranca Research,

BE Budget Estimates, BRE Budget Revised Estimates

Cess and Increased Excise Rates on Fuel to Boost Revenue

Direct tax revenue for the year is expected to fall short of budget estimates by INR 40,000 crore, as
forecast by Revenue Secretary Hasmukh Adhia. On the other hand, indirect tax revenues went up 33%
over April 2015January 2016. We expect indirect taxes to surpass budget estimates by INR 53,546 crore,
buoyed by higher tax rates (service tax increased to 14% from 12.36% in the previous budget), excise
taxes (increased on fuel), customs duty (on steel imports), and the Swachh Bharat cess (0.5%).
Capitalizing on the decline in global crude prices, the government has increased the excise duty on
petroleum products multiple times since late 2014, including three times in January 2016.
During April 2015January 2016, customs duty revenue from electrical machinery and other machineries
increased 34.4% and 27.8% respectively, indicating increased investment in the private sector. During this
period, the average growth rate in tax collection from the services sector was 27.2%, while that from
banking and financial services was 44.6%. The growth rate was 39.9% in work contract services and 41% in
goods transportation services. Consequently, we expect tax revenues (net to the central government) to
surpass budget estimates by INR 21,310 crore as a result of higher indirect taxes.
Non-tax revenues are estimated to be closer to the actual collection of INR 1.8 trillion recorded for April
December 2015, with dividends paid by PSUs and the RBI accounting for the majority of this revenue. The
other major components of non-tax receipts were interest receipts, spectrum charges, royalty, license fee,
sale of forms, and RTI application fees.

The government also expects to earn INR 100,651 crore in the form of dividends for FY 201516. Of this,
INR 36,174 crore is estimated to come from Central Public Sector Enterprises (CPSEs) and INR 64,477 crore
from banks, financial institutions, and the RBI. The central bank paid a dividend of INR 65,896 crore in FY
2016 so far, up 25% from the previous year.

Non-plan Expenditure
A major fixed expense that leaves little room for expense management.
Non-plan expenditure is a major component of expenditure and comprises salaries, pensions, defense
expenditure, and other similar fixed expense items with limited scope for any cuts. Almost 45% of the
budget is committed, with INR 4.56 lakh crore (25.7% of total expense) allocated for interest payments,
INR 0.89 lakh crore (5.0%) for pension payments, and INR 2.46 lakh crore (13%) for defense expenditure.
Given their fixed nature, these expenses cannot be lowered.

On the subsidy front, the government has benefited from falling crude and natural gas prices. The
ongoing downturn in these internationally traded commodities has eased the governments burden in
terms of lower compensation to oil marketing companies that provide fuels such as kerosene and
liquefied petroleum gas (LPG) at subsidized rates.
Furthermore, schemes such as Direct Benefit Transfer (DBT) have helped weed out inefficiencies in subsidy
distribution to a certain extent. Consequently, the petroleum subsidy expense is expected to significantly
drop on a yearly basis, thereby leading to a drop in overall subsidy expense for the year for the first time
in several years.
It would be difficult to trim the subsidy bill substantially however.
Budgeted at INR 2.44 lakh crore (13.7% of the total expenditure), the benefits of declining crude prices
would not push fertilizer and food subsidies lower as the government has failed to cut expenditure on the
same. As a result, fixed expenditure would constitute about 60% of the budget.

In 2015, the government announced packages for several states, including Jammu and Kashmir (INR
80,000 crore) and Bihar (INR 1.25 trillion), and financial packages doled out by ministers (INR 34,000 crore
for roads). Although this expenditure is spread over a longer period, a portion of the proposed
disbursements may have been accounted for in this fiscal year. These expenses have not been accounted
for in the 2015-16 budget, thereby giving rise to the possibility of non-plan expenditure breaching the
estimated threshold.

Cuts in Plan Expenditure

An ace up the Finance Ministrys sleeve.
If non-plan expenditure surpasses budget estimates, the finance ministry could exercise the option of
controlling plan expenditure in order to control its overall expenditure, thereby meeting its fiscal deficit
target. Indias finance minister Arun Jaitley could emulate his predecessor P. Chidambaram, who deployed
this method to control the fiscal deficit during FY 201314. Measures such as freezing fund disbursement
to ministries after December have been repeated over the past few years. These have resulted in gaps
between initial budget estimates for plan expenditure and actual spending under the category.

Expense Expectations for Budget 201617

High increase in expenditure on account of the seventh pay commission and OROP.
The government has outlined objectives such as reviving investment growth and decreasing farmers
poverty, among others, for Budget 2016-17.
Before we can even consider what expenditure the government allocates towards these, certain additional
expenses have already been identified in the form of payouts under the Seventh Pay Commission (SPC)
and the One Rank One Pension (OROP) scheme. For instance, budget 201617 would have to allocate
more than INR 1 lakh crore for the implementation of the seventh pay commissions recommendations
which makes up for nearly 1% of GDP thus putting strain on fiscal consolidation targets.
To ease the pressure, the government could adopt measures such as staggering the recommended hike in
pension or deferring the hike in house rent allowance (HRA) on account of a stagnant real estate market.
While the pay commission and OROP would constitute substantial components of next years increase in
expenditure, the need for increased outlays on the investment side is nonetheless important to push up
domestic demand. We expect increased expenditure for physical infrastructure projects such as railways,
roads, and ports due to their immediate effect on capital investments and long-term multiplier effect on
the economic growth.
The weak rupee has not been kind to the export sector, which has been declining for several months. The
government may announce direct intervention (such as interest rate subvention and special packages) or
impose import barriers (custom duty on steel imports) in response.
The much-anticipated food security scheme if implemented would exert pressure on the delicate
balance between declining revenues and rising expenses as well.

Tax Expectations for Budget 201617

Increase in rates imminent, some old taxes may be revived.
To shore up revenues and meet the increased expenses, the finance minister would need to increase tax
rates or introduce new taxes. Service tax, increased to 14% in the previous year, may be increased by
another 1% to 2%.
Considering the sharp fall in crude prices and low likelihood of an increase over the next year, the
government has the option of reintroducing customs duty on imported crude, petrol, and diesel, which
was removed in 2011, when crude prices had increased to over US$ 100 per barrel.
New cess to fund initiatives such as Start-up India or Digital India and other programs could be
introduced, similar to the Swachh Bharat cess levied last year. The percentage of Swachh Bharat cess
could be increased as well.
The government could increase import duty on gold, since gold imports have increased over the past
year, partly contributing to the trade deficit and weak rupee on account of forex outflows.
While the finance minister had announced reduction of corporate tax rates from 30% to 25% over next
few years, he may keep the rates unchanged for 2016-17. In case the headline corporate tax rate is
reduced, we expect the quantum of reduction to be small (~1%) and accompanied with withdrawal of
concessions in taxes, which will effectively ensure net increase in tax collections, even after a reduction in
rates.

Fiscal Deficit Target for 201617

More than 3.5% of GDP, but not by a large margin.
The fiscal consolidation roadmap outlined previously by the finance minister targeted fiscal deficit to
reach 3.5% of GDP in FY17 and 3% in FY18. These targets were predicated on an improving domestic
economy, without provisions for large expense increases on account of the pay commission, OROP, or
even the need for a higher investment outlay to compensate for weak private sector growth.
While part of the expenses will be met by higher tax rates, they would not completely help meet the fiscal
deficit target of 3.5% for FY17.
We expect the fiscal deficit target for FY17 to be relaxed, with the timeline to attain a 3% fiscal deficit
target (by FY18) extended by one more year. The target for FY17 is likely to be between 3.6% - 3.7%,
which gives the government some leeway on the path toward fiscal consolidation. Even if the timeline or
target were relaxed, it would still be commendable for India to commit itself to a fiscal consolidation
program despite waning global growth.
The finance ministers key objective this year will be to improve his budget at the margins, not overhaul it.

About Aranca:
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