Rate cuts looming as India struggles with fiscal consolidation

India will likely fall short of its fiscal targets and prompt rate cuts of up to 100bps in FY13, says RBS.

Historical data suggests that slippages will continue to plague the country’s fiscal consolidation efforts, but will probably not be as bad as the performance gap seen in FY12.

Here’s more from RBS:

Fiscal consolidation remains elusive – the FY13 (fiscal year ending March 2013) is yet again based on hope and under provision of expenditures than genuine discipline. For the year, the government is seeking to reduce its deficit to 5.1% of GDP from an upwardly revised 5.9% last year. This limited correction is contingent upon managing subsidies and meeting dis-investment targets. Considering routine slippages in the past and the absence of any concrete measures to meet these targets, there is scope for slippage.

Even without the above discussed likely slippage in the fiscal deficit, the extent of fiscal consolidation is weak. This is because similar to FY11; the government has considered the potential sale of mobile spectrum space in the budgeted receipts. Equivalent to 0.6% of GDP, this one-off receipts should have been treated as an off-budget item from a conventional fiscal accounting standpoint. Overall, it is now becoming clear that the political willingness and strength to rectify the dismal state of public finances. All we can say is that the scope for slippage is perhaps not as large as in FY12.

Where does it leave monetary policy? As we had discussed in a previous note, the RBI has signalled that future policy action will be towards lower policy rates. It however, also cautioned that the timing and magnitude of rate cuts will depend on the degree of fiscal correction and level of commodity prices. As the budget projections continue to carry the risk of slippage, a go slow approach could well be the outcome. We are currently expecting cumulative rate cuts of 100bps in FY13 but will be revisiting this forecast over the next week or so.