FRBM report: Nub lies in implementation. Targets fixed by the FRBM report seem achievable for the central government. The escape clause with a cap on slippages is also commendable. We believe that the report's recommendation of setting up a Fiscal Council which will monitor the government's fiscal health is crucial for long term setting of fiscal rules. The states' fiscal health will be critical in ensuring the success of FRBM recommendations and reducing India's high consolidated fiscal deficit.
Key recommendations in brief
Key recommendations of the report: (1) general government debt/GDP of 60% by FY2023 with 40% for center and 20% for states', (2) fiscal deficit will be the key operational target with central GFD/GDP reducing to 2.5% by FY2023, and (3) revenue deficit/GDP reduced to 0.8% by FY2023 (based on assumption of 11.5% of nominal GDP growth). Further, escape clauses to fiscal deficit (within (+/-) 0.5% of GDP) are also laid down to counter any exogenous disruptions. The report recommends the setting up of a fiscal council which would ensure an independent assessment of various aspects of fiscal policy.
States' fiscal health: tough path to stick to for achieving debt target
The report does not explicitly recommend a path of consolidation (in terms of fiscal deficit) for state governments. However, it notes that if state governments' debt/GDP is to be maintained at current levels of 21%, aggregate states' GFD/GDP would have to reduce to 1.7% by FY2025. In case, it has to reduce to the recommended 20%, the states' GFD/GDP would have to reduce to 1.4%. Given the recent performance of the states, it is difficult to expect this pace of consolidation (Exhibit 4). If the recommendations are accepted, the 15th Finance Commission will have its task cut out to ensure states have adequate resources and implement a path to reduce their debt/GDP.
FRBM targets, if achieved, could ensure a long term regime of low and stable interest rates
Much of the success of FRBM recommendations would depend on the strength of the Fiscal Council along with the government's intent. Besides the Council, we believe that an efficient checks and balances system for the government with regards to any fiscal slippages would be essential in ensuring a sustainable and stable low GFD/GDP for India. In turn, the harmony of fiscal rules and inflation targeting frameworks would then be beneficial to ensure a low and stable interest rate regime. If we assume that the consolidated fiscal deficit/GDP reduces to around 4.5%, the gross dated securities borrowings could be around Rs14.2 tn by FY2023 (around Rs10.2 tn in FY2018E) which would be a positive for market rates.
Strengthening the case for a ratings upgrade
If India can reduce its consolidated fiscal deficit/GDP and debt/GDP to recommended targets, there could be a likely case for a ratings upgrade. However, Exhibit 5 shows there are also other metrics at play. Steady growth in per capita GDP, ease of doing business, lower corruption, sustained strength in external sector, etc would need to be monitored to gauge improvement in economic health. We note that the Economic Survey has made a strong case for a ratings upgrade based on some of the peers ratings and economic conditions. Gains from GST in the medium to long term, improvement in per capita income through sustained high growth, and steady fiscal improvement would make for a much stronger case for a ratings upgrade over the next 3-5 years.