Budget 2022: Fiscal Deficit Path Means Elevated Borrowings And Higher Bond Yields

Robust growth in tax collections and a higher than expected dividend from the central bank will likely allow the government to meet its fiscal deficit target of 6.8% of GDP for the current year.

But what next? How much fiscal consolidation can the government target next year? And what would this mean for government borrowings and interest rates?

According to Ananth Narayan, associate professor at SP Jain Institute of Management and Research, government finances have benefited from higher tax collections and stronger nominal GDP growth this year. "Tax revenue at the central level could be Rs 2-2.5 lakh crore higher than budgeted. That's 1% of GDP and it is excellent news," he said in a conversation with BloombergQuint.

Net tax collections, according to data from the Controller General of Accounts, stood at Rs 11.35 lakh crore between April-November 2021. This is 65% higher than the same period last year and 73.5% of the government's budget estimate.

This, according to Narayan, could continue next year.

Tax collections will also see a boost due to stronger nominal GDP growth. In the current year, nominal GDP is estimated to have grown at 17.6% compared to the 14.4% budgeted for by the government. In FY23, too, nominal GDP growth could be close to 14%, Narayan said.

Given this expected buoyancy in revenue receipts, the government could budget for consolidation of up to 0.8 percentage points, he said.

However, even with substantial fiscal consolidation, pressure of government borrowings is likely to remain high.

According to a report by Anubhuti Sahay, head of South Asia Economic Research at Standard Chartered, a 6% fiscal deficit could mean net borrowings by the central government of Rs 9.4 lakh crore. An additional Rs 40,000 crore may be needed to compensate states for a shortfall in GST compensation dues. Including redemption of Rs 3.05 lakh crore, the central government's gross borrowings for the next financial year may remain at close to Rs 12.85 lakh crore.

According to Narayan, inclusive of states, the net borrowings in FY23 could be close to Rs 16 lakh crore while gross borrowings could be close to Rs 22 lakh crore.

"Net borrowing of Rs 16 lakh crore is a problem. Generally, the banking system, insurance companies, pension funds can absorb about Rs 10-12 lakh crore on a centre + states basis. That will leave you a hole of about Rs 4 lakh crore," Narayan said.

Over the past two years, the Reserve Bank of India has stepped in to buy government bonds and also given banks inducements to increase their holdings of these securities. However, it may have limited scope to do so in the new financial year given concerns around excess liquidity.

This could mean that bond yields remain elevated. The 10-year benchmark yield in India is trading above 6.60%, 260 basis points spread over the overnight repo rate of 4%.

If it hadn't been for the RBI's interventions, yield could have been even higher at 7.5% or thereabout, Narayan said.

At present, though, concerns about government borrowings crowding out private sector funding requirements do not exist. Much of the demand from the private sector is for short term funding, for which there is ample liquidity, he said. "If you do see private capex come back and people looking to borrow 5-10 year money, then you could absolutely see a crowding out effect. I suspect that will be a good problem to have."

Watch the full conversation here: