18 Feb 2020
The great responsibility assigned to the ‘Other Capital Receipts’ entry
For FY21, the budget has assigned a massive responsibility to entry number 6 of broader budget estimates. The entry more commonly known as ‘Other Capital Receipts’ represents proceeds from divestments from public enterprises and related income. This entry is included in the Capital Receipts because the denoted income is generated from the sale of assets. The context of the entry’s description is the backdrop of lower of tax collection and the Government’s consequent effort to liquidate its valuable assets, through privatization and stake sale.
While the quantum under this entry varied and plays a significant role in estimating the fiscal deficit for any given year, the size of the quantum carried is often times questionable. The Rs. 2.1 lac crore carried by the entry in budget FY21 is one such occasion, when the realizations from divestments seem unreasonable. In the previous year, divestments yielded Rs. 0.65 crore, just over 30% of the current estimate. Even in FY19, when the situation was somewhat sensible, the divestment yield was not more than Rs. 1.05 lac crore. As an end use, the quantum earned acts as a buffer important for deficit management.
The calculation of the Fiscal Deficit, which is estimated at 3.5% of GDP - incorporates ‘Other Capital Receipts’. The metric is ultimately calculated by adding ‘Other Capital Receipts’ with ‘Revenue Receipts’ and ‘Recovery of Loans’ (from Capital Receipts), subtracting the sum from ‘Total Expenditure’. Given the fact that the concerned entry of ‘Other Capital Receipts’ represents 0.9% of GDP, the former is playing an important role in deciphering the level at which this year’s Fiscal Deficit would likely hover. Speaking hypothetically, in case the divestments for the year remain at the previous year’s level of Rs. 0.65 lac crore, the current year’s Fiscal Deficit will easily breach the 4% threshold. Assuming that the accumulation falls short of the expectation by just Rs. 1 lac crore, the Deficit would still be over the 3.8% mark, if other conditions remain constant. The inviolability of the figure is therefore sacrosanct this year for the sake of the FRBM mandate.
Budget Variables (in INR Crore)
Keynesian rescue plan and market borrowings
The hoopla around entry number 6 is naturally connected to the Government’s efforts to reinvigorate the economy through all the resources available at its disposal. With a sagging economy, which is witnessing a demotivated private sector, mired by unsold inventories and underutilized capacities – India Inc. is unwilling to undertake capital raising and investment activity. In such a situation, the Government expenditure has come to the rescue marked by Public Final Consumption Expenditure (PFCE) consistently breaching the 10% level (as a proportion of GDP) from an aggregate demand perspective.
With this background, while revenue expenditure grows consistent with the nominal growth of the economy for the year, at 18%, capital expenditure is expected to grow much faster than we have seen recently. As a proportion of GDP, capital expenditure is expected to be 1.8% as compared to a three year average of 1.7%. If one includes ‘Grants in Aid for Capital Expenditure’ primarily for infrastructure creation (devolved to states), the combined capital expenditure entry is equivalent to 2.8% of GDP, as compared to the previous three year average of 2.6%.
The massive expenditure earmarked for asset creation is to be funded via debt that is an implicit obligation of the Government. Idea being that once a critical level is achieved, the private sector will take over. Until that moment however, the Government is on the driver’s seat. Again, one look at the Union Government’s capital receipts reveals the extent of obligations to finance massive projects particularly dealing with infrastructure development. While Gross Borrowings will be increasing by 4% (compared to previous year expansion of 18%), net issuances are expected to expand by 10% (previous year’s expansion at 18%). In this regard, we note that not much pressure is mounted over the centre’s fiscal position. In terms of quantum raised and outstanding, Net Debt Raised remains near the 2.4% (equal to the previous three year average) and Gross Borrowings at 3.5% (lower than the previous three year average) of the GDP. Here again, thanks to the ‘Other Capital Receipts’, the burden is contained on the fiscal balance and the deficit is consequently pegged at 3.5% - lower than FY20’s 3.8%.
Variables as a percent of GDP
The question of yields and where they might head
From a fixed income market perspective, the question of yields is very important. We estimate that Net Debt Raised will be close to Rs. 5.5 lac crore in FY21, representing 69% of the estimated Gross Borrowings for the year. If one looks at the previous three year average, it is noted that this ratio has rarely moved beyond 65%. What this means is that the Union Government will be retiring a little over Rs. 0.2 lac crore of debt in the next fiscal. However, via issuing an incremental Rs. 0.5 lac crore of fresh debt, the sovereign will be nullifying the effects.
Having said that, while the growth in the quantum of debt raised is somewhat lower than that of the previous year, one must remain cognizant of the fact that revenue receipts will collectively grow at just 3%. A figure which is augmented by a rather robust target growth of 9% in tax revenue in an unsure macro economy. Total Revenue Receipts, which are expected to grow by 13% are dependent on a strong show from the capital receipts, the estimate of which remains desultory at best at the moment. Not to mention the less than handsome returns expected from dividend pay-outs, putting pressure on the fiscal’s non-tax revenue. Therefore, there is a real possibility of incremental net debt issued during the course of the year to compensate for any shortfalls elsewhere – putting upward pressure on yields and the vulnerable Fiscal Deficit. Also, the fresh debt raised in FY21, will be adversely impacted by a high rate environment, given inflationary tendencies plaguing the market.
*Yield differential between 10 year India Government Bond and AAA Rated Corporate Bond
Furthermore, net private issuances of debt, which came down to just under an estimated Rs. 3.3 lac crore in FY20, as compared to the previous year’s Rs. 21.8 lac crore - are expected to rise. This is because Government induced impulses are sure to shake up the economy’s animal spirits, leading to capex. With higher corporate debt in the system, certain crowding out can be foreseen, especially via high quality blue chip issuances. The yield differential (AAA Corporate and 10 Year GSec), has been seen normalizing to within the 100 bps range towards the end of the current fiscal after breaching the 130 bps threshold a few quarters earlier on the back of certain high profile defaults.
While, FY21 might not enjoy the quantitative easing (in Developed Markets) induced liquidity flushing the system leading to high valuations and low yields – there still remains sufficient circulating money that can sustain the status quo. Pressure on rates however cannot be ruled out because of inflation fears and this could put pressure on the yield curve as a whole, despite RBI’s yield management programs (which should become more regular as we move through the year).
Overall, with an eye on yields, we will be vigilant pertaining to three factors going forward. First, the sanctity of the capital receipt account, second, inflationary tendencies, forming a dynamic with growth and finally on international liquidity, which should continue its magic in emerging markets like India given the prevalence of a global accommodative monetary policy.