March 21, 2016

Prime Minister Narendra Modi’s government held to its fiscal consolidation goals and presented a pragmatic, if underwhelming, budget for FY 2016 on 29 February. The budget stuck to the earlier promise of bringing the budget deficit down to 3.5% of GDP in FY 2016, a move that has been touted as positive by market analysts, and it detailed a number of measures to revive investment, cut red tape and spur the rural economy. Overall, the budget bodes positively for India’s macroeconomic stability and growth going forward, although it is void of any blockbuster reforms. Expectations for the Modi government were high after they were elected on a platform of change and economic overhaul, yet since assuming office many crucial reforms have been stalled in Congress and implementation has been slow.



One of the budget’s main, and largely-expected, highlights was a comprehensive set of measures to support the agricultural sector and the rural economy. Poor monsoons have squeezed rural incomes in India in recent years and one of the main goals of the budget is to double farmers’ incomes by 2020. The budget outlines a number of measures to boost social safety nets, improve rural infrastructure and increase access to credit for farmers. This announcement comes as Modi faces a number of key elections this year and next, including in the agricultural state of West Bengal, and the move is likely in part designed to shore up support for his party. Other highlights include increased public infrastructure spending and a number of measures aimed at improving the ease of doing business.



The planned deficit reduction will be achieved largely by keeping spending in check. Total expenditure is projected to increase by 10.8%—just under the government’s assumption of nominal GDP growth of 11.0%. The government opted to partly postpone a civil service wage increase, a key measure to control expenditure. In addition, expenditure on subsidies is projected to decline modestly and capital spending is being kept in check. Regarding revenues, the budget details a rise in income tax for high-income earners, as well as a moderate increase in the service tax. While market analysts have some doubts over specific projections in the budget, the government’s targets appear achievable as a whole.



Market reaction to the budget has been broadly positive, if underwhelming. Bond yields fell after the announcement and the rupee strengthened. In addition, market analysts have speculated that the fiscal tightening contained in the budget could open the door for an easing in monetary policy going forward.



Although the budget is broadly market-friendly, the government still failed to deliver in a few areas. In particular, it failed to outline a comprehensive roadmap on how to reform India’s subsidy schemes, which account for approximately 1.7% of GDP. The subject is politically unpopular, which may explain its absence from the budget. In addition, market expectations of a cut in the corporate tax rate did not come to fruition.



FocusEconomics Consensus Forecast panelists’ foresee a fiscal deficit of 3.8% for FY 2016, which is unchanged from last month’s forecast. For 2016/2017, the panel expects a deficit of 3.5%.