India faces revenue shortfall challenge, but levers exist to bridge gap: Deutsche Bank

Deutsche Bank India’s Global Emerging Markets MD Srinivas Varadarajan believes India could face a revenue shortfall of nearly ₹50,000 crore this year, owing to changes in goods and services tax (GST) slabs and weaker-than-expected economic growth.He explained that slower nominal gross domestic product (GDP) growth may reduce tax receipts further by about ₹80,000 crore. Alongside a likely ₹15,000 crore shortfall from disinvestment, the total gap could reach nearly ₹1.45 lakh crore.Varadarajan noted that the government has levers to bridge most of this.
“An additional ₹40,000 crore from the Reserve Bank of India (RBI) dividend, about ₹30,000 crore from April’s excise duty hikes, and roughly ₹25,000 crore from the compensation cess can be used,” he said.Cutting capital expenditure by ₹20,000 crore would take the adjustment close to ₹1.15 lakh crore, leaving a residual gap of around ₹30,000 crore, which he suggested could be financed through treasury bills.These are edited excerpts of the interview.Q: Why such a paucity of buyers? Why are yields just going up and up, and bond prices stumbling?A: If you look at the proximate cause right now, and it’s a bit of a storm in a teacup, it is concerns around the fiscal bit which are a little bit blown out of proportion. If you look at some of the numbers the market is talking about, the shortfall because of re-jigging the goods and services tax (GST) slabs is about ₹50,000 crore. There’s a bigger shortfall, possibly coming in from the reduction in the nominal gross domestic product (GDP) growth from 10%, which was there in the budget, to around 9% given what’s happened to the deflator. That could lead to a net tax revenue shortfall of about ₹80,000 crore. In addition to that, the disinvestment shortfall could be around ₹15,000 crore. So, you’re looking at a net shortfall of about ₹1.45 lakh crore.To fill the shortfall, you’ve got a couple of levers already going for you. One is the increase in the RBI dividend of about ₹40,000 crore, the excise duty hikes that you did on petrol and diesel in April, which can bring you about ₹30,000 crore. The compensation cess you can try, and there is a surplus of about ₹50,000 crore. 50% goes to the centre, about ₹25,000 crore comes in from the compensation cess, and of course, you can reduce capex by ₹20,000 crore. So this all adds up to ₹1.15 lakh crore versus ₹1.45 lakh crore of shortfall. So, there’s a net shortfall of about ₹30,000 crore.And ₹30,000 crore could easily be met through financing from treasury bills. The budget had pencilled in net financing from T-bills at zero. So you can clearly finance this; it shouldn’t be much of a problem.Also Read | A surprisingly good Q1 GDP – but we need to get realI think the bigger issue, if you go back, the June policy was when, of course, the stance was changed back to neutral, and the guidance was that the bar for a rate cut is pretty high. But if you look at the August policy, my inference is that the bar for possibly a rate hike, of course, sometime early next financial year, is pretty low. Because if you look at the forecasts, you’re looking at a Q1 inflation forecast of about 4.90, you’re looking at a growth forecast of 6.60 for Q1 of next year. So effectively, what that tells you – if you smell the coffee, it tells you that the output gap is completely closed and you have a positive inflation drift from 1%, and that leaves you with plugging this into a simple rule, which tells you that the real rates are close to zero. If you need to plug in increased rates of half a percent, that tells you that the effective policy rates in those forecasts eventually should be 6%. So that’s basically a bit of concern. That’s what’s plaguing the market.Q: I have not heard anybody talking about a hike just yet. If the RBI has looked through 2% inflation, they logically ought to look through 4.9% inflation also. I don’t think people are speaking about a hike one year down the line or nine months down the line. The point is, right now, are there any tools, or is there any need? Is the RBI even wanting to talk up the yields?A: If you look at the price action since June, there’s a lot that’s been priced in by the bond market. Forget about the 10-year bond yield. We all know that from a low of 6.20, it’s gone up to 6.55 right now, 6.55. But if you look at the 15-year government bond, for example, that’s right now at 6.90, and when the easing cycle began in November, it was again 6.90. It went to a low of about 6.35, and it’s come back up again.You look at the 15-year SDLs (state development loans), for example, they are right now at 7.5%, which is higher than when the rate cut cycle began. It was 7.3% then. So a lot has happened. The market is also aligning itself with steeper yield curves globally.If you want to provide some palliative to the market today, you can, if I were to put on the hat of an institutional RBI, look at how best to solve the problem that we have right now in terms of high yields. If it is indeed a problem, at the outset, the RBI conducts monthly switch auctions for ₹20,000 crore. You can try and reduce the number of switches that come into the market to reduce the injection of duration, which the market needs to contend with.You could look, for example, to start by devolving some of the government bond auctions if you want to provide a signal. If that too doesn’t help, then maybe cancel some auctions now, but you can reintroduce them in the second half of the financial year if you require it from a fiscal perspective.Or alternatively, why not look at an Operation Twist? If you recollect, back in December of 2019 RBI had started Operation Twist. They did about ₹20,000 crore. In total, they did about ₹40,000 crore during COVID as well. So if you want to keep the bank reserve position neutral, then maybe you can try and come up with an Operation Twist too if you want to provide a yield signal.And, there’s one other thought, but again, it needs very careful consideration. And it’s not an easy call. If you want to provide a yield signal, maybe look at replacing some part of the CRR with open market purchases. So, you still provide liquidity to the system to offset some of the outflows because of maturing forwards, and at the same time, you’re providing a bit of a yield signal.Also Read | India’s Q1 GDP surges on local demand; but economists warn of tariff headwindsQ: Is the RBI worried at all that the yield is at 6.56? Maybe they are not. Maybe you bond dealers are, because banks and bond dealers are sitting on losses. But the RBI thinks 6.5% yield is fine. Do you think? Do you suspect that?A: Maybe not. If you look at the spot yield, it’s just moved by 30-35 basis points. Big deal – in the bigger scheme of things, it hardly matters. But you look at what’s happened fundamentally, your yield curve has steepened. Your spreads have widened. Look at the SDL and G-Sec spread, which at the lows was about 35 basis points. That’s right, now about 75 basis points.Q: You’re saying they should worry about growth, that things have gotten a bit out of hand?A: I don’t think we are there yet. There’s no cause to worry yet, but there’s also a lot happening in the background. Look at the forward market. For example, look at the five-year forward 30-year – that’s close to about 7.8%. Look at the five-year forward 15-year – that’s about 7.5%. Even a five-year forward 10-year is at 7%. So, a lot is happening in the bond market.I don’t think there’s cause for worry. And also, on the CRR bit, just to clarify, I don’t think it should be the first option. If you want to think a little out of the box, you could consider it, but a better option would be to implement an Operation Twist.And again, given what’s been happening in the external sector because of trade, one option to consider, if you look at it from a currency perspective, the 40-currency REER in July was about 100, and it’s probably lower now, even with a lower exchange rate and lower dollar index. And if you look at what happened in 2017 when the renminbi depreciated against the dollar to offset the tariff impact, one policy that could be considered and debated in policy-making circles is whether it makes sense to aid a depreciation of the rupee against some of our export competitors. lower tariffs – like China has got 30%, Korea 20%, 15% – you can try and do that. And maybe that would aid exports, and that can also be a loosening of policy.For more, watch the accompanying video

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