Given the structural nature of inflation in India arising from supply side constraints and India’s high fiscal deficit, given the political calculus in the run-up to State elections and the current state of the Indian economy, we expect the FY12 Union Budget to implement a selective fiscal stimulus withdrawal whilst focusing on appeasing select vote banks. This will mean a greater subsidy bill and a further allocation to rural India.

The 3 key challenges facing the Union Government

As the current coalition Government prepares its third Union Budget, three key challenges will mould the budget’s strategy for FY12: (1) Checking inflation and enhancing agricultural productivity; (2) Lifting supply-side constraints to economic growth; and (3) Executing the long overdue fiscal correction.

Our expectations from the budget

Given the above mentioned challenges that confront the ruling coalition, given the political calculus and the state of the Indian economy, the following is the articulation of what we expect the Union Budget FY12.

Fiscal deficit – poor quality of fiscal consolidation in FY12 to follow

The upward revision of nominal GDP numbers for FY11 (14% increase over budget estimates) along with the realization of windfall revenue gains on account of 3G auctions (Rs 0.7 tn more than budgeted) will result in the Central Government issuing a tighter revised estimate of the fiscal deficit (as a percentage of GDP) for FY11 – lower than the budgeted 5.5% of GDP.

The Medium Term Fiscal Policy Statement (MTFPS) projects a 4.8% of GDP fiscal deficit for FY12 and from a sentiment point of view, the Government of India (GoI) is expected to declare the same (or marginally higher number) for FY12 by compromising on the quality of fiscal consolidation.

Receipts side

The GoI will look to selectively roll back the fiscal stimulus administered in FY09 by increasing indirect tax rates for select articles. Given the abysmal headway on tax reform, the GoI is likely to implement a damage control strategy through the token implementation of the Direct Tax Code (DTC) whilst offering the promise of the Goods & Services Tax (GST) (yet again) next year. Disinvestment is likely to be a key lever that the GoI will use to make ends meet in FY12 in the absence of the 3G auction receipts support.

Expenditure side

Rural India and subsidies will be the two key expenditure thrust areas of the Union Government in FY12 given the forthcoming State Elections in 1HFY12. As suggested by our meetings in New Delhi last month, the Congress-led coalition at the Centre is likely to seek to boost its popularity ratings (on account of high domestic inflation and corruption charges) by playing the populist card as political strategists take centre stage whilst reformers take a back-seat (for now at least).

Investment Implications

Given this outline of the budget, refer to page 7 of this note for our sector leads’ expectations from the coming budget and the likely impact. As highlighted earlier, the FMCG sector appears most favourably positioned to gain from the coming Union Budget.

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