Centre’s finances set to take a turn for the worse

With payments for bond maturities and accumulated fuel subsidies taking away all surpluses parked with the Reserve Bank of India (RBI), the government’s finances are set to take a turn for the worse.

The Centre faces a payout of Rs25,000 crore for bond maturities in the coming days, while the fuel subsidy bill on account of under-recoveries is rising to well over Rs65,000 crore.

The government has a surplus of Rs65,000 crore parked with the RBI and this will be used for redemption and subsidy payouts.
And more funds would be required towards the latter part of March to meet year-end needs of ministries to fulfill their plan targets.

This will put pressure on government finances as tax collections may falter given weak Index of Industrial Production (IIP) growth, while poor equity market sentiment will impede disinvestments.
Direct tax collections have grown by 17% year on year due to a rise in corporate taxes on account of good economic growth in the first half of last year.

GDP growth for the first half of 2010-11 exceeded 8.5% but the pace is unlikely to be the same given the weak trends in IIP, which came in at 2.7% for November against market expectations of 6.5%.

This trend may continue into the next few months on the back of high inflation and rising borrowing costs due to tight liquidity conditions.

Inflation as measured by the Wholesale Price Index came in at 8.43% for December and is expected to move higher given the primary article inflation, which is trending at over 17.5%.

Rising domestic inflation expectation coupled with prospects of further tightening of interest rates on account of tight liquidity and weak government finances have dampened sentiment in the equity markets.

The benchmark Sensex has come off by 10% from the highs seen in November and this is impeding further disinvestment plans of the government.

The government is still a few thousand crore short of its budgeted disinvestment target of `40,000 crore and further equity issuances looks unlikely given the current market conditions.

The government is also busy fighting parliamentary disruptions due to scams and corruption cases and normal governance is absent to take any policy decisions on disinvestments.

The budget for 2011-12 to be presented to the Parliament in February looks to be an interest-rate-negative affair.

The current parliamentary standoff coupled with the borrow-and-spend policy for political gains will ensure high borrowing figures for the next fiscal.

The government does not have any one-time revenue upsides in the form of 3G auctions next fiscal.

Persistent weakness in the equity markets, coupled with sticky inflation and rising interest rates will lower tax collection targets as well as disinvestment targets.

It’s difficult to see where support for government borrowing will come from especially since the banking system is strained for liquidity and is clamouring  for cash reserve ratio cuts. Interest rates will spike as the market senses the stress on government finances.

Bond auctions
The government auctioned Rs11,000 crore of gilts last week. These were the 7.17% 2015 for Rs4,000 crore, the 8.13% 2022 bond for Rs4,000 crore and the 8.30% 2040 for Rs3,000 crore. The cut-offs came in at 8.11%, 8.17% and 8.53%, respectively. The auction was fully subscribed.

RBI bond purchase
The RBI purchased Rs7,500 crore of bonds last week — the 7.46% 2017 for Rs1,552 crore at a yield of 8.02%, the 7.80% 2020 for Rs1,733 crore at a yield of 8.18%, and the 8.08% 2022 for Rs4,221 crore at a yield of 8.17%

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