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Fitch: India's Fiscal Improvement Firmly In Place, But Slower Than Expected

Fitch Ratings has commented, on the back of India's Union Budget announcement for 2008/2009, that the budget suggests the country's fiscal improvement remains firmly in place. The central government forecasts its revenue deficit would decline further to 1% of GDP in the coming fiscal year, from 1.4% in the previous year. At the same time, its fiscal deficit is forecast to drop to 2.5% of GDP, from 3.1% in 2007/2008.

The agency notes however that the pace of fiscal improvement is slower than expected. In fact, the government missed one of the targets set out in the Fiscal Responsibility and Budget Management Act (FRBMA), which targets a zero revenue deficit by 2008/2009. The government now says it needs an extra year to achieve its target. "The Indian government needs to implement additional measures if it is to meet the FRBMA target in FY09/10, and to continue catching up on the fiscal front with its rating peers," said Franklin Poon, Director in Fitch's Asia Sovereign ratings team.

The government's failure to achieve the revenue deficit target is partly due to the increase in education, health and social spending. For example, education and health expenditures are expected to increase by 10%-15%, respectively. The government is also giving debt waivers to farmers, amounting to INR600 billion (1.3% of GDP). At the same time, the tax exemption limit is to be raised to INR150,000. All these could be seen as populist measures ahead of the election year in 2009.

The government has not proposed any concrete measures in the budget to deal with some of the "fiscal stress points". On off-budget liabilities like food and oil bonds, while the government acknowledged the problem in the budget it stopped short of mentioning corrective accounting actions. Also, the government is not going to implement the nationwide Goods and Services Tax in the coming year, although the central sales tax will be cut further from 3% to 2%, and the CENVAT to 14% from 16%. No measures were announced for expanding the country's narrow tax base, while the possible impact of the Sixth Pay Commission was not discussed.

Fitch also notes that India's fiscal indicators are still lagging behind its peer rating group (sovereigns rated 'BBB-' (BBB minus), 'BBB' or 'BBB+'). The country has a higher general government deficit (5.5% of GDP vs the group median of 1.6% in 2007), a much heavier interest service burden (25% of revenue vs 7.2%), and a significantly higher general government debt (77% of GDP vs 29%). Despite the nominal high tax rates, India is a low-tax country and has a narrow tax base (revenues account for 21% of GDP, lower than the group median of 35%).

Overall, Fitch views the budget as slightly disappointing, on the back of failure to achieve its zero revenue deficit target in the coming year (which had already been widely expected), the introduction of populist measures, as well as lack of concrete measures to tackle the fiscal stress points. Nevertheless, Fitch would like to highlight that the country's fiscal improvement is still firmly in place. At the same time, its general government balance, interest service burden, and general government revenue (which are albeit still worse than its peer rating group) are slowly converging towards the medians. In fact, India's rating strengths include its strong growth story, high domestic savings rate and very strong external public debt position.

(This is press release of FICCI)

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