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The Union Budget for FY2019 needs to balance competing expenditure priorities and the demand for lower direct and indirect tax rates, while attempting to maintain fiscal discipline. We expect this budget to utilise fiscal space to enhance spending rather than reduce direct taxes. In our view, the Government of India (GoI) is likely to budget a fiscal deficit for FY2019 between 3.2-3.5% of GDP, which would be only modestly lower than the revised estimate (RE) for FY2018.

The prolonged transitional issues following the Goods and Services Tax (GST) signal that the GoI’s indirect tax revenues will undershoot the FY2018 budget estimates (BE), if one strips off the Integrated GST (IGST) collections that do not entirely belong to the Central Government. Although the GST Council would decide on any changes in GST rates, the tax growth assumed by the GoI would provide a hint as to whether further reductions in tax rates are forthcoming. The average price of the Indian basket of crude oil is likely to rise to US$65-70/bbl in FY2019 from US$56-59/bbl in FY2018. This would generate pressure on the government to reduce excise duties to temper inflation, while simultaneously pushing up the fuel subsidy by up to Rs. 88-93 billion relative to the BE for FY2018.

An assessment of the revenue buoyancy after GST and the extent, to which the recent reforms have widened the tax base, would critically influence the fiscal space for increasing spending or reducing the corporate tax rate that the Union Budget for FY2016 had promised. Realistically, a step-down in the corporate tax rate may be introduced only in conjunction with paring of exemptions, to maintain revenue neutrality.

We expect this budget to utilise fiscal space to enhance spending rather than reduce direct taxes. The FY2019 budget may increase the allocations for social infrastructure and social security spending, such as NREGA, food subsidy, insurance schemes and welfare pensions. We also expect enhanced outlays for rural and urban infrastructure, such as affordable housing, roads, railways and ports. Moreover, budgetary allocations for capital spending are likely to be supplemented by extra-budgetary sources of funds such as institutional finance and market borrowings of the CPSEs, as well as the NIIF.

News reports suggest that the Third Supplementary Demand for Grants indicated that Rs. 800 billion would be infused by the GoI into public sector banks (PSBs) through issuance of recapitalisation bonds in FY2018. We welcome both this front loading, and the transparency associated with the infusion being made directly by the GoI, even as additional details are eagerly awaited. Interest on the recapitalisation bonds may need to be provided in FY2019. Following the uptick in bond yields in Q3 FY2018, PSBs are faced with mark-to-market (MTM) losses, which would add to their operating losses and erode their capital ratios, thereby increasing the magnitude of capital infusion required from the GoI. Overall, PSBs must be adequately capitalised to be equipped to fund the uptick in investment growth that is expected to set in during H2 FY2019.

The Union Budget for FY2018 and the Fiscal Responsibility and Budget Management Act (FRBM) Review Committee report had indicated a fiscal deficit target of 3.0% of GDP for FY2019. This target is unlikely to be retained. Instead, we expect the GoI would budget a fiscal deficit for FY2019 between 3.2-3.5% of GDP, which would be only modestly lower than the RE for FY2018. Assuming nominal GDP growth of 11.4% in FY2019, this translates to a fiscal deficit range of Rs. 5.9-6.5 trillion. Every 10 bps of expansion in the GoI’s fiscal deficit to GDP ratio, would allow for extra spending of ~Rs. 185 billion, which is modest relative to the size of the GoI’s overall expenditure budget. If overall economic growth increases in FY2019, as is widely expected by the market, and inflationary concerns come back to the fore, the appropriateness of a stimulative budget will remain a subject of debate. Notably, deviation from fiscal discipline may introduce further volatility into yields of GoI securities (G-sec). The recent rise in bond yields represents the real cost of fiscal slippage, with higher interest rates getting locked in on instruments with a maturity as long as 38 years. This would worsen the interest payments to revenue receipts ratio for the GoI, which is structurally significantly higher than many emerging market peers.

UNION BUDGET 2018-19: EXPECTATIONS

FY2019 Union Budget to utilise fiscal space to enhance spending rather than reduce direct taxes

JANUARY 2018

Contacts: Anjan Ghosh +91 22 6179 6392 aghosh@icraindia.com Aditi Nayar +91 124 4545 385 aditin@icraindia.com

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FISCAL PERFORMANCE OF GOVERNMENT OF INDIA The GoI had forecast a fiscal deficit of Rs. 5.5 trillion in its BE for FY2018 (refer Table 1), higher than the provisional figure for the previous fiscal. During April-November 2017, the fiscal deficit of the GoI stood at Rs. 6.1 trillion, a considerable 33.6% higher than the same recorded in April-November 2016 (Rs. 4.6 trillion; refer Table 2), and equivalent to 112% of the BE. This was led by higher-than-budgeted expansion in expenditure, amid a contraction in non-tax revenues. With the pace of growth of capital outlay and net lending exceeding that of revenue spending, the quality of expenditure improved modestly to 12.5% in April-November 2017 from 11.1% in April-November 2016. Nevertheless, the share of the revenue deficit in the total fiscal deficit rose to 80.0% in April-November 2017 from 76.0% in April-November 2016. Net of refunds (gross of devolution to States), the GoI’s tax revenues expanded by 16.5% in April-November 2017 (refer Table 3), exceeding the 11.3% growth envisaged in the BE for FY2018 over the FY2017 Provisional Accounts (Prov.). However, this growth rate benefits from the inclusion of inflows of IGST amounting to Rs. 1.4 trillion, a part of which would eventually flow to the states, after adjusting for refunds to the tax payers. In particular, indirect taxes (customs duty, excise duty, service tax, Central GST or CGST, IGST and Union Territory Goods and Services Tax or UTGST) rose by ~12.2% in April-November 2017, higher than the 7.6% growth forecast in FY2018 BE. However, ICRA estimates that netting off 50% of the IGST collections in August-November FY2018, would result in a YoY contraction of 1.4% in the GoI’s indirect tax revenues relative to the year ago period. Moreover, the extended timelines for filing GST returns imply that the GoI would receive tax inflows for a large portion of indirect taxes for 11 months in FY2018. In terms of CGST, the total inflows stood at Rs. 854.1 billion up to November 2017 (refer Chart 1). A press release dated December 26, 2017 indicates that Rs. 234.4 billion was transferred to the GoI as CGST in December 2017 (up to December 25, 2017), only modestly higher than the monthly average for the previous four months. The full impact of the cut in GST rates on a number of items with effect from November 15, 2017, may dampen the monthly collections going forward. However, GST collections may record an uptick in Q4 FY2018, in a manner similar to the seasonal pickup that used to be displayed by excise duty and service tax. Furthermore, the introduction of the e-way bill in February 2018 may boost compliance. Additionally, lesser incidence of refunds etc. related to the transitional tax credit, may result in proportionately higher CGST inflows in the remainder of FY2018. Removing 50% of the IGST collected till November 2017, which is being shown as a part

Table 1: Fiscal Balances for GoI for FY2016, FY2017 and FY2018

Note: GDP estimates for FY2016 and FY2017 as per data released by the Central Statistics Office (CSO) on May 31, 2017. GDP estimates for FY2018 as per Advance Estimates released by CSO on January 5, 2018. $ Net of Refunds, Net of States’ share in Central Taxes Source: GoI Budget Documents; CSO; ICRA Research

Table 2: GoI’s Fiscal Balances in April-November 2017

FY2018 BE April–November 2017 Rs. billion Growth Rs. billion % of BE Growth Revenue Receipts 15,157.7 10.1% 8,048.6 53.1% 1.1% Tax Revenues$ 12,270.1 11.3% 6,993.9 57.0% 12.6% Non-Tax Revenues 2,887.6 5.3% 1,054.7 36.5% -39.7% Revenue Expenditure

18,375.1 9.1% 12,947.0 70.5% 13.1%

Revenue Balance -3,217.3 4.4% -4,898.4 152.2% 40.7% Miscellaneous Capital Receipts

725.0 51.8% 523.8 72.2% 122.6%

Capital Exp, Net Lending

2,973.0 8.3% 1,746.4 58.7% 31.0%

Fiscal Balance -5,465.3 2.1% -6,121.1 112.0% 33.6%

Source: GoI Budget Documents; Controller General of Accounts (CGA), Ministry of Finance, GoI; ICRA Research

FY2016 Actual FY2017 Prov. FY2018 BE Rs.

billion % GDP Rs.

billion % GDP Rs.

billion % GDP

Revenue Receipts 11,950.3 8.7% 13,762.8 9.1% 15,157.7 9.0% Tax Revenues$ 9,437.7 6.9% 11,020.6 7.3% 12,270.1 7.3% Revenue Expend. 15,377.6 11.2% 16,845.6 11.1% 18,375.1 11.0% Major Subsidies* 2,641.1 1.9% 2,604.9 1.7% 2,722.8 1.6% Revenue Balance -3,427.4 -2.5% -3,082.7 -2.0% -3,217.3 -1.9% Miscellaneous Capital Receipts^

421.3 0.3% 455.0 0.3% 725.0 0.4%

Capital Exp, Net Lending

2,321.9 1.7% 2,745.4 1.8% 2,973.0 1.8%

Fiscal Balance -5,327.9 -3.9% -5,350.7 -3.5% -5,465.3 -3.3%

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of the GoI’s revenues at present, its indirect tax revenues stood at Rs. 5.0 trillion in April-November FY2018. Basic customs duty and excise on fuels averaged Rs. 250.0 billion per month in September-November 2017, which we expect would continue in the remainder of this fiscal. Additionally, we are assuming that CGST inflows in December 2017 would be restricted to the aforementioned Rs. 234.4 billion. Scenario 1 (refer Table 4) assumes that total GST inflows will average Rs. 880.0 billion per month in Jan-March FY2018 (in line with the average for Jul-Dec 2017) and will be split equally between the centre and the states. Accordingly, the GoI would accrue around Rs. 1.3 trillion of CGST inflows in Q4 FY2018, leading to the total indirect tax collections amounting to Rs. 7.6 trillion, significantly lower than the BE of Rs. 9.3 trillion for FY2018. In our view, this scenario underestimates the likely collections by a wide margin. GST collections may rise in Q4 FY2018, similar to the seasonal pickup that used to be displayed by excise duty and service tax, and benefitting from the introduction of the e-way bill. Scenario 2 assumes that total indirect tax collections in Q4 FY2018 would be in line with the Rs. 2.8 trillion recorded in Q4 FY2017, which was equivalent to 33% of the full year collections for FY2017. Therefore, CGST inflows are estimated at Rs. 2.1 trillion during Q4 FY2018, with the balance led by basic customs duty and excise on fuels (Rs. 250.0 billion per month). In this scenario, the GoI’s total indirect tax collections would amount to Rs. 8.3 trillion, which again undershoots the GoI’s BE for FY2018. In our view, this scenario is also likely to underestimate actual collections by a considerable extent. Scenario 3 assumes that the indirect tax inflows in Q4 FY2018 would post a YoY growth of ~16% over Q4 FY2017. Retaining the inflows of basic customs duty and excise on fuels at Rs. 250.0 billion per month, CGST collections are estimated at Rs. 2.5 trillion in Q4 FY2018. In such a case, the total indirect taxes of the GoI would be Rs. 8.8 trillion, indicating a shortfall of Rs. 827 billion relative to FY2018 BE. Assuming that indirect tax inflows in December 2017 were limited to Rs. 484.4 billion, the growth in indirect tax collections would need to improve to ~32.4% in Q4 FY2018, to meet the budgeted target of Rs. 9.3 trillion. CGST collections would need to rise to around Rs. 1.0 trillion per month in Q4 FY2018 (Scenario 4), from Rs. 627.3 billion in April-November 2017 and Rs. 234.4 billion in December 2017, to avoid a shortfall relative to FY2018 BE, which seems optimistic. Overall, the extent to which the GoI’s indirect tax collections would undershoot the BE level remains difficult to ascertain. Direct tax collections rose by ~13.7% during April-November 2017, lower than the growth of 17.4% in FY2018 BE. Based on this data, the expansion in direct tax collections would

Table 3: Trends in Tax Collections (Net of Refunds, Gross of States’ share in Central Taxes)

FY2018 BE April –November 2017 Rs. billion Growth Rs. billion % of BE Growth Gross Tax Revenues 19,115.8 11.3% 10,873.0 56.9% 16.5% Corporation Tax 5,387.5 11.1% 2,498.3 46.4% 12.4% Income Tax 4,412.6 26.2% 2,151.8 48.8% 15.3% CGST NA NA 854.1 NA NA UT- GST NA NA 1.0 NA NA IGST NA NA 1,383.4 NA NA Customs Duty 2,450.0 8.4% 1,028.4 42.0% -30.7% Union Excise Duty 4,069.0 6.8% 1,651.7 40.6% -22.7% Service Tax 2,750.0 8.0% 791.3 28.8% -46.1% Compensation cess for GST

NA NA 309.1 NA NA

Source: GoI Budget Documents; CGA, Ministry of Finance, GoI; ICRA Research

Table 4: Trends and Expectation in Indirect Tax Collections for FY2018 (Net of Refunds, Gross of States’ share in Central Taxes)

Scenario 1 Scenario 2 Scenario 3 Scenario 4 Rs. billion Rs. billion Rs. billion Rs. billion

FY2018 BE for Indirect Taxes^ 9,269.0 9,269.0 9,269.0 9,269.0 Actual Indirect Tax Collections (Apr-Nov) removing 50% of IGST

5,018.2 5,018.2 5,018.2 5,018.2

Scenario 1 Scenario 2 Scenario 3 Scenario 4

Expected Excise, Customs, Service Tax Inflows (Dec-Mar)

1,000.0 1,000.0 1,000.0 1,000.0

CGST Inflows in Dec 2017 234.4 234.4 234.4 234.4 Expected CGST Inflows (Q4 FY2018)

1,320.0 2,094.4 2,549.4 3,016.5

Expected Indirect Tax Collections FY2018

7,572.6 8,346.9 8,802.0 9,269.0

Shortfall 2,056.5 1,282.1 827.0 0.0

^Includes collections for Excise duty, Customs, Service Tax Source: GoI Budget Documents; CGA, Ministry of Finance, GoI; ICRA Research

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need to improve to ~21% in the remainder of the fiscal year, to meet the budgeted target. In particular, the growth in personal income tax collections would need to improve to ~39% in the remainder of the fiscal year from 15.3% up to November 2017, to meet the budgeted target, which appeared somewhat difficult to achieve. However, on January 17, 2018, the GoI indicated vide a press release that the direct tax collections till January 15, 2018 stood at Rs. 6.9 trillion, 18.7% (18.2% for net corporation tax) higher than the year-ago level (refer Chart 2). Gross collections (before adjusting for refunds) rose by 13.5% to Rs. 8.1 trillion up to January 15, 2018 (11.4% for gross corporation tax). It is possible that the advance tax payments for corporate tax remitted in December 2017 were healthy, benefitting from a favourable base effect. Moreover, the press release indicates that refunds amounting to Rs. 1.2 trillion were issued during April 2017 to January 15, 2018, which is estimated by ICRA to be 9% or around Rs. 120.0 lower than the year-ago level. Therefore, it is unclear if the recent improvement in the growth of net direct tax collections is sustainable. ICRA expects the GoI’s direct tax collections to fall short of the level budgeted for FY2018 by Rs. 100-200 billion, on account of personal income tax, even as corporation tax may modestly exceed the budgeted level. The GoI’s non-tax revenues contracted by a significant 39.7% on a YoY basis to Rs. 1.1 trillion in April-November 2017, in contrast to the 5.3% growth envisaged in FY2018 BE. Non tax revenues would need to expand by a considerable 84.6% in the remainder of the fiscal year to meet the budgeted targets, which appears challenging. Dividends and profits of the GoI stood at Rs. 471.2 billion in April-November 2017, a low 33% of the FY2018 BE of Rs. 1.4 trillion. In particular, the surplus transferred by the RBI to the GoI declined to Rs. 306.6 billion in FY2018 from Rs. 658.8 billion in FY2017. Additional dividends and profits of Rs. 953.2 billion need to be garnered by the GoI in the last four months of this fiscal, to avoid a shortfall relative to the FY2018 BE. Recent news reports suggest that the RBI has agreed to transfer an additional Rs. 130.0 billion to the GoI. Nevertheless, it remains unclear whether additional dividends from non-financial and financial PSUs, would be adequate to meet the FY2018 BE. There is a risk of a shortfall of Rs. 150-250 billion relative to the dividends and profits that the GoI had budgeted for FY2018. The GoI had included Rs. 443.4 billion as non-tax receipts from other communication services in FY2018 BE, which may be difficult to meet, given the subdued financial health of the telecom industry. There is a low likelihood of fresh spectrum auctions being announced and completed in the ongoing quarter. In addition, the operators do not face major expiries till FY2022, which alleviates the urgency for auction. ICRA expects non-tax receipts from other communication services to fall short of the level budgeted for FY2018 by Rs. 110-120 billion.

Chart 1: Trends in Tax Collections (Net of Refunds, Gross of States’ share in Central Taxes, Rs. billion)

* Q3 FY2018 includes data for October-November 2017 Source: CGA, Ministry of Finance, GoI; ICRA Research

Chart 2: Trends in Growth of Gross Direct Tax Collections, Net Direct Tax Collections and Refunds based on press releases of the Ministry of Finance, GoI

Note: Data for April-Nov 2017 has been sourced from a press release of Ministry of Finance dated Dec 9, 2017, and differs from CGA data referenced in this note Source: Press Information Bureau (PIB), GoI; ICRA Research

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The GoI raised Rs. 523.8 billion through miscellaneous capital receipts in April-November 2017, equivalent to a substantial 72.2% of the BE for the full year (Rs. 725.0 billion). The acquisition of the GoI’s stake of 51% in Hindustan Petroleum Corporation Limited by Oil and Natural Gas Corporation would net the former around Rs. 370 billion. Moreover, there is a robust pipeline of potential disinvestment/divestment of PSEs such as Dredging Corporation of India, Rail Vikas Nigam Limited, Indian Medical Pharmaceuticals Corporation Limited etc. As a result, the total disinvestment proceeds would exceed the budgeted level by a considerable amount, helping to offset some of the feared shortfall in tax and non-tax revenue. The GoI’s revenue expenditure expanded by 13.1% during April-November 2017 (70.5% of FY2018 BE), higher than the budgeted growth of 9.1%. Based on the trend up to November 2017 and the BE for the year, there is scope for revenue expenditure to rise by a marginal 0.5% on a YoY basis in December 2017-March 2018. Moreover, capital outlay and net lending posted a substantial growth of 31.0% in April- November 2017, significantly higher than the 8.3% rise targeted in the BE for FY2018. Defence, road transport and highways, railways and urban development have led capital spending in April-November 2017. Capital outlay would have to contract by 15.4% on a YoY basis in the last four months of this fiscal, to avoid exceeding the BE. Furthermore, the GoI’s capital expenditure stood at 59.5% of FY2018 BE during April-November 2017. Since not more than 33% and 15% of expenditure of BE shall be permissible, respectively, in Q4 and March of the fiscal year, the extent of capital spending in December 2017 would determine whether a sizable portion of the allocation ends up being surrendered. The revenue and fiscal deficits of the GoI in April-November 2017 stood at 152.2% and 112.0% of the BE for FY2018 (refer Chart 3), respectively, inferior to the performance in April-November 2016 (113.0% and 85.6% of FY2017 Prov., respectively). This is despite the inclusion of IGST and GST compensation cess, a portion of which would eventually be shared with the states. In FY2017, the revenue and fiscal deficits had peaked in February 2017, before moderating in March 2017, driven by the seasonal uptick in tax receipts during March (refer Chart 4). We expect a similar trend to prevail in the current fiscal. Nevertheless, with the fiscal deficit up to November 2017 at 112% of the FY2018 BE and the expected shortfalls in some key revenue streams, we expect a fiscal slippage in FY2018. The magnitude of the latter would be governed by the extent to which GST collections record an uptick in Q4 FY2018 and whether expenditure can be curtailed within the budgeted level.

Chart 3: Revenue and Fiscal Deficits in FY2017 and FY2018 (Rs. billion)

Source: CGA, Ministry of Finance, GoI; ICRA Research

Chart 4: Estimated Monthly Receipts and Expenditure of the GoI during FY2017 and FY2018 (Rs. billion)

Source: CGA, Ministry of Finance, GoI; ICRA Research

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News reports suggest that through the Third Supplementary Demand for Grants, the GoI recently sought permission to incur an additional capital expenditure of Rs. 800.0 billion for recapitalisation of public sector banks through issue of government securities to the latter. Accordingly, this transaction would be cash neutral. However, the impact on the fiscal deficit would depend on whether the receipts generated by the issuance of securities are classified as debt or non-debt receipts. In December 2017, the GoI’s long term market borrowings for Q4 FY2018 were revised upward by Rs. 500.0 billion, whereas the receipt though net treasury bills in FY2018 was revised to Rs. 250.0 billion from the budgeted Rs. 20.0 billion. Subsequently, the GoI has indicated that additional borrowing of only Rs. 200.0 billion would be required through long term market borrowings. Accordingly, the net additional borrowing beyond the budgeted level is placed at Rs. 430.0 billion in FY2018, which is equivalent to 0.3% of GDP. Additionally, Rs. 737.2 billion had been raised through various small savings schemes in April-November 2017, relative to the FY2018 BE of Rs. 1.0 trillion. We expect inflows into small savings schemes to remain healthy in Q4 FY2018, which should help to garner funds in excess of the budgeted amount. Accordingly, the GoI would be able to incur a fiscal deficit in excess of the Rs. 5.5 trillion included in the FY2018 BE. Based on the assumption that nominal GDP for FY2018 would be Rs. 168.5 trillion, the budget for FY2018 had pegged the fiscal deficit of Rs. 5.5 trillion for the current year at 3.24% of GDP. However, the CSO’s Advance Estimate for nominal GDP for FY2018 (released on Jan 5, 2018) of Rs. 166.3 trillion, indicates that the fiscal deficit would be equivalent to 3.29% of GDP. Alternatively, the fiscal deficit in absolute terms would need to be pared below the budgeted level by Rs. 77.7 billion, to remain at 3.24% of the GDP as per the AE for FY2018. Key expectations for FY2018: The Union Budget for FY2018 as well as the FRBM Review Committee report (N.K. Singh Committee) had indicated a fiscal deficit target of 3.0% of GDP for FY2019. However, we foresee a low likelihood that the fiscal deficit in FY2019 would be capped at this level. In ICRA’s view, the GoI may budget for a fiscal deficit for FY2019 that is only modestly lower than the RE for FY2018, in a likely range of 3.2-3.5% of GDP. However, a deviation from the fiscal consolidation path would dent the credibility of the GoI’s commitment to reducing its fiscal deficit. Moreover, it may further harden bond yields, which have gone up by around 65 bps over the last eight months. This would bloat the Government’s interest payments, and prevent higher outlays toward other sectors in coming years. ICRA expects a pickup in growth of real GVA to ~7.0% in FY2019 from ~6.5% in FY2018, and of real GDP to ~7.1% from 6.7%, respectively. Assuming nominal GDP growth of 11.4% in FY2019 (relative to the Advance Estimate for FY2018), a fiscal deficit of 3.2% of GDP in FY2019 translates to Rs. 5.9 trillion, in absolute terms. We estimate that every 10 bps of expansion in the GoI’s fiscal deficit to GDP ratio would allow for extra spending of ~Rs. 185 billion. Given the uptick in the repayments falling due in the coming year, we expect the GoI to announce dated market borrowings of Rs. 6.5 trillion, up from the current estimate of Rs. 6.0 trillion for FY2018. The extent, to which the fiscal deficit in FY2018 and FY2019 would exceed the previously indicated targets, as well as the magnitude of G-sec issuance, would dominate the trend in Indian bond yields in the next few months. After the implementation of the GST, indirect tax rates on few items remain under the control of the GoI, as the GST Council would decide on changes in GST rates. Therefore, major tax changes that the GoI may introduce in the Union Budget for FY2019 would be limited to direct taxes. An assessment of the revenue buoyancy after GST and the extent to which the recent reforms have widened the tax base, would critically influence the fiscal space for increasing spending or reducing direct tax rates. Some tinkering is likely in the income threshold and deductions for personal income tax, which may provide a mild support to small-ticket consumption. A step-down in the corporate tax rate may be included along with paring of exemptions, to maintain revenue neutrality. In terms of non-tax revenues from the telecom sector, there has been no announcement so far of spectrum auctions to be held in FY2019. Nevertheless, the deferred payments related to earlier auctions and normal fees such as spectrum usage charges and licence fees, would accrue an estimated Rs. 440-460 billion in the coming fiscal. This is significantly higher than our estimate of the total inflows of Rs. 320-330 billion in FY2018. Dividends from CPSEs and PSU banks in FY2019 would take a cue from profitability in FY2018, which is likely to be subdued for the latter. Given the expectation that non-financial PSUs would step up dividends in FY2018, to contain a shortfall in the total revenues of the GoI relative to the FY2018 BE, the pace of growth of the former is likely to be feeble in FY2019.

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In line with the previous few years, we expect the RBI to transfer nearly its entire surplus to the GoI. The spike in the RBI’s expenditure in FY2017 related to the higher cost of printing currency after demonetisation, would be reversed in FY2018. Additionally, interest income from foreign securities would rise, commensurate with the increase in the foreign currency assets held by the RBI. However, the OMO sales of Rs. 900.0 billion conducted during FY2018, would reduce the interest earned by the RBI on holdings of Rupee securities. Moreover, with the systemic liquidity remaining in surplus mode during much of FY2018 (average of Rs. 1.8 trillion vs. Rs. 1.0 trillion in FY2017), the net interest on LAF operations would remain negative. The GoI may continue the recent practice of asking cash-rich PSUs to purchase its stake in other PSUs, rather than divesting through the market route. Moreover, the strategic divestment programme may be pursued aggressively in FY2019, particularly if the market conditions are appropriate. The GoI allocated Rs. 250.0 billion as fuel subsidy for FY2018 BE, lower than the RE for FY2017 (Rs. 275.3 billion). Moreover, the Medium Term Expenditure Framework (MTEF) statement released by the GoI has forecast a continued reduction in fuel subsidy from Rs. 250.0 billion in FY2018 to Rs. 180.0 billion and Rs. 100.0 billion, respectively, in FY2019 and FY2020. Against this, the revenue expenditure of the Ministry of Petroleum & Natural Gas stood at Rs. 286.3 billion in April-November 2017 (113.1% of the FY2018 BE of Rs. 253.1 billion). ICRA expects GURs for OMCs to increase from Rs. 197 billion in FY2017 to ~Rs. 220-250 billion in FY2018 (assuming average Indian basket crude price of US$56-59/bbl) and to ~Rs. 350-400 billion in FY2019 (at crude price of US$65-70/bbl). Therefore, ICRA expects the BE for FY2019 for fuel subsidies to rise by up to Rs. 88-93 billion relative to the BE for FY2018, and be significantly higher than the amount included in the MTEF for FY2019. The outlay for food subsidy was pegged at Rs. 1,453.4 billion in FY2018 BE, 7.5% higher than Rs. 1,351.7 billion included in FY2017 RE. As per the MTEF, the food subsidy is forecast to rise substantially to Rs. 1,750.0 billion and Rs. 2,000.0 billion, respectively, in FY2019 and FY2020, which would squeeze the resources available with the GoI for other purposes. If the issue price of rice, wheat and coarse grains under the National Food Security Act is retained at Rs. 3/kg, Rs. 2/kg and Rs. 1/kg, respectively, in FY2019, in line with FY2018, while minimum support prices are increased by 5-10% for rice, wheat, and various coarse cereals (in line with the trend for FY2018), the food subsidy bill is likely to rise in the coming fiscal. However, it is unlikely to exceed the level forecast in the MTEF. The allocation for fertiliser subsidy was retained at Rs. 700.0 billion in FY2018 BE, in line with the RE for FY2017. Moreover, the MTEF retained the fertilizer subsidy at Rs. 700.0 billion in FY2019 and FY2020, as well. While the subsidy backlog had eased to ~Rs. 320 billion at the end of FY2017, the same is expected to increase to ~Rs. 350-360 billion at the end of FY2018 owing to rising input prices primarily natural gas. While the subsidy backlog has declined significantly from the previous levels, it nonetheless remains significant and continues to impact the liquidity position of the industry. Additionally, the industry also awaits the payment of revised fixed costs to be paid out to the industry under Modified-NPS-III which has been pending since April 2014. ICRA expects the GoI to retain the subsidy allocation for the fertiliser sector at Rs. 700 billion for FY2019 in-line with the MTEF. Any additional allocation by GoI towards clearing of subsidy backlog in the light of implementation of the Direct Benefit Transfer (DBT) and payment of additional fixed costs will be a credit positive for the industry. There has been considerable vocalisation of farmer distress over the last few years, highlighting the importance of interventions to reduce the risks faced by the agricultural sector. The upcoming budget may increase the allocations for social infrastructure and social security spending, such as NREGA (rural job security), food subsidy (food security), insurance schemes and welfare pensions. Additionally, larger allocations for infrastructure related to cold chains etc. could be considered to boost the agricultural sector and the rural economy. GDP data from FY2013 to FY2018 (based on the advance estimates released by the CSO) indicates that private consumption has grown by 6.7% per year in this period, at par with the pace of overall economic expansion (6.8%). However, the average growth of gross fixed capital formation has been subdued at 3.9% in these years. In our view, stimulating investment demand should be prioritised over consumption demand, particularly since demographic changes will anyway drive the latter. We expect enhanced allocations in the Union Budget for FY2019 for infrastructure, such as affordable housing, roads, railways, ports, inland waterways and smart cities, which would help to jumpstart investment activity and economic growth. We anticipate budgetary outlays for capital spending to be enhanced substantially, supplemented by extra-budgetary sources of funds such as institutional finance and market

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borrowings of the CPSEs and the NIIF. Government spending on infrastructure would also trigger investment by the private sector. Nevertheless, the latter may remain subdued in the next 2-3 quarters, given moderate capacity utilisation, availability of brownfield distressed assets, high leverage levels of various corporates and the stressed balance sheets of PSBs. Importantly, the PSBs must be adequately capitalised to be able to fund the investment recovery that is expected to materialise after H2 FY2019. Policy interventions may be introduced to aid specific sectors, such as the rural sector, exporters or SMEs. For instance, easing of infrastructural and other bottlenecks for exporters, which dampen their competitiveness, as well as the procedural constraints being highlighted by SMEs after the GST, could be addressed. However, these need not be dovetailed with the Budget, which is essentially an exercise in setting revenues and expenditures for the year ahead. To sum up, the upcoming Union Budget is likely to focus on higher spending on infrastructure and social security to stimulate demand. Cutting taxes appears challenging in the current situation as revenue collections are yet to stabilise after the switch over to the GST. Moreover, policy interventions can be undertaken at any time by the Government, and need not be clubbed with the Union Budget.

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Sector -w ise Expectat ions

Fertilisers:

The Indian fertiliser sector is highly regulated with controls on several aspects pertaining to the business. The urea sector works on normative cost-plus-return framework, with controls on farm-gate price, distribution and gas allocation. The difference between retention price and farm-gate price net of dealer margin is paid as subsidy to the industry, which is variable in nature, depending on the energy price trends. The NPK segment works on fixed subsidy and variable farm-gate pricing principle. Because of the regulated nature, timely payment of subsidy is the key to the eventual returns achieved by the industry, with urea players impacted more than the NPK segment as more than 65% of the realisation comes by way of subsidy against around 30% for the NPK segment. In recent years, subsidy allocation to the industry has fallen short of requirements, resulting in recurring backlog of subsidy. As a result, subsidy gets exhausted within 7-8 months of the fiscal year, forcing the industry to resort to short-term borrowings, the interest costs of which are not borne by the GoI. With Direct Benefit Transfer (DBT) scheme ready to be rolled out on a pan-India basis, under which the GoI has committed to pay subsidy within seven days of confirmation of sales to the farmers, one-time clearance of backlog and adequate allocation of regular subsidy will be the key factors to the financial health of the industry. The urea industry also awaits the payment of revised fixed costs, which is long overdue. Many players in the segment have booked this as an income for the last three years. Any reversal of policy in this regard will lead to writedown of earnings and put significant pressure on profitability. Notwithstanding these concerns, ICRA expects the Budget 2018-19 to have several policy measures to give a stimulus to the agricultural sector such as on irrigation, crop insurance, e-NAM and agricultural credit, which will help the fertiliser players.

Healthcare:

Public-sector investment on healthcare accounts for less than 1.5% of GDP, which is one of the lowest globally, and the government intends to increase the expenditure to 2.5% of GDP by 2025. The outlay on the healthcare increased by a healthy ~28% in the Budget for the financial year 2017-18 and the allocation is likely to see similar increase in the forthcoming Budget as well.

In line with National Health Policy (NHP) 2017, the expenditure is likely to be directed towards setting up of new hospitals to increase the number of beds in the country, for transformation of existing district and town-level health centers to provide better healthcare facilities across geographies while using the existing infrastructure. The Budget is also likely to increase the allocation for addressing the increasing burden of non-communicable diseases (NCDs) such as diabetes, cardiovascular diseases, hypertension etc. and to increase the outlay for providing free drugs, diagnostics and emergency services across all public hospitals, in line with NHP 2017.

Public sector accounts for only ~30% of the total healthcare expenditure in the country compared to ~42-58% in Brazil, ~58% in China, ~52% in Russia, ~50% in South Africa, ~48% in USA and ~83% in the UK (Source: WHO). ICRA believes that investing in building and maintaining public health infrastructure should be given priority in the Budget as these facilities are lagging and a major portion of the population has to incur out-of-pocket expenditure on healthcare due to low penetration of health insurance. Besides setting up new hospitals, medical colleges and nursing academies are also required to be set up to address the shortage of beds and skilled medical professionals in the country.

Given the paucity of beds in the country, higher tax incentives for private-sector investments in modernising medical facilities and developing green field hospitals will be a welcome step. New infrastructure developed through incentives can also be utilised for catering to the growing medical tourism in the country, which is expected to continue to grow by ~20% over the next five years, generating export revenues and employment.

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Infrastructure /Construction:

ICRA expects continued thrust from the Government towards revival of investment cycle in the form of further increase in budgetary allocations towards infrastructure sector with focus on roads, railways and urban infrastructure. Dedicated allocation for specified large infrastructure projects announced such as Bullet trains, Bharat Mala, Sagar Mala, Smart Cities, inland waterways development etc will also help in expediting these projects. Further, budgetary allocation towards NHAI can be increased keeping in view the increased capital outlay on the national highway development. To revive private-sector interest in taking up new projects, independent regulator for specific infrastructure sub-sectors can be created which can focus on resolution of bottlenecks and further improve the regulatory environment. Further to promote private-sector investment in infrastructure, incentives like extension of tax holiday for infrastructure projects, relief on applicability of MAT during tax holiday, coverage of projects involving upgrading existing infrastructure under 80IA or 35-AD, and clarification on pending taxation issues with respect to InvITs can be provided. The infrastructure sector is also looking at further steps to improve long-term funding availability. In this regard, higher allocation towards National Investment and Infrastructure Fund (NIIF) is expected. Also, the deduction under Section 80CCF of the Income Tax for infrastructure bonds which was discontinued can be reintroduced for select infrastructure companies/finance companies.

Roads:

The total budgetary allocation (including PBFF, CRF and GBS) to fund the ambitious new highway development programme is estimated at Rs. 3,43,045 crore over FY2019-FY2022. Therefore, starting this Budget, the allocations to the Road Ministry are expected to increase substantially. In order to support the new programme, allocation to the MoRTH for FY2019 is expected to be in the range of Rs. 80,000-85,000 crore against Rs. 64,900 crore for FY2018. Further, NHAI market borrowings (IEBR) are estimated to be in the range of Rs. 60,000-65,000 crore to support the new programme.

Based on announcement in February, 2016 Budget, a new rating scale has been devised for infrastructure projects which is a comment on Expected Loss (EL) from the underlying credit against probability of default based ratings at present, which does not reflect some of the inherent strengths of infrastructure projects. An announcement on the timelines for adoption of the new rating scale for infrastructure projects is expected. The previous Budget also made an announcement on Mechanism to streamline institutional arrangements for resolution of disputes in infrastructure related construction contracts, PPP and public utility contracts. However, there has been no update on this yet. Thus, industry will be keenly watching for any updates on the progress on setting up of PPP Project Review Committee and the Infrastructure PPP Adjudication Tribunal for re-negotiating concessions if there is evidence of distress in projects (except aggressive assumptions/irrational bids).

Some measures are also expected to improve the long-term fund availability to the sector. A major part of the infrastructure financing is supported by the banking sector at present. Corporate and infrastructure sectors together account for less than 30% of bond issuances. Appetite for long term and papers rated below AA category is low. Deepening of the bond markets is required to support long-term infrastructure financing, especially given the twin challenges faced by commercial banks - asset-liability management and increasing share of stressed assets. Relaxation of rating threshold (lower investment grade) could encourage domestic insurance companies and pension funds to invest in bond issuances from the infrastructure sector.

Oil & Gas:

With crude prices rising, pressure is mounting on the GoI to reduce the excise duty on auto fuels to lower the burden on consumers and to keep a lid on inflation. Moreover, with the rise in product prices in global markets, gross under recoveries will escalate for the PSU OMCs. Under the extant subsidy-sharing policy, the GoI is committed to meet subsidy up to Rs. 12/litre of SKO (PDS) and Rs. 255/cylinder of LPG (Domestic). While the current framework caps the subsidy to be borne by the GoI, it will nonetheless call for additional subsidy allocation for FY2019 compared to FY2018 as the latter was done assuming a crude price of $55/bbl. If the Indian basket crude price were to be $70/bbl, the GoI’s subsidy requirement will rise to

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around Rs. 343 billion in FY2019 as per ICRA estimates compared to Rs. 224 billion in FY2018 (BE). Hence additional allocation of subsidy will be imperative for the industry’s profitability. That apart, relaxations in several taxation issues such as broadening the definition of “Mineral oils” for tax holiday of E&P players, extension of sunset clause for E&P blocks under Section 80 IB (9) and reduction in customs duty on LNG are awaited. Moreover, clarity is awaited on the applicability of service tax on “Royalty” and “Profit Petroleum” payments for E&P companies. ICRA also expects announcements on the consolidation process among the PSU Oil & Gas majors, which should acquire greater momentum in the ensuing fiscal after ONGC-HPCL deal is consummated.

Power:

ICRA expects higher budgetary allocation to meet funding requirements, mainly for distribution strengthening and rural electrification network to improve and ensure reliable power supply in the country. Further, the clarity is awaited on the import duty (or safeguard duty if any) for PV modules. ICRA further expects the Government to introduce measures to make available long-term debt funding at competitive pricing, given the large funding requirements, to meet the policy target in the renewable energy segment (175 GW cumulative by FY 2022). In this context, ICRA also expects an increased focus from the GoI on faster execution of grid-transmission network, strengthening projects to ensure grid stability, given the rising share of rural electrification in the overall energy consumption mix, going forward.

Real Estate:

Stakeholders of the real-estate sector will be waiting for measures that will boost demand over the near to medium term. In this respect, expansion of the income-tax deduction available to home buyers can incentivise first-time buyers and support demand growth. The deduction available on the principal repaid on loan taken for acquisition of a residential house property, which is capped at Rs. 1.50 lakh under Section 80C, can be increased to improve the purchasing power of the buyers. Also, the priority-sector lending status for home loans up to a specified limits, for example Rs. 60 lakh for metro cities and Rs. 45 lakh for non-metro, may further boost demand in the near to medium term.

Secondly, the Government’s efforts on affordable-housing segment can be further improved by augmenting the current schemes and relaxing the eligibility criteria. The existing provisions under Section 80-IBA permit 100% deduction in respect of the profits derived from developing and building certain housing projects subject to specified conditions, including maximum unit size of 30 square metres in the metro cities and 60 square metres elsewhere. Increase in the qualification carpet area to, say, 150 square metres will be beneficial and encompass a larger spectrum of projects. Further this will also align the benefit with the qualification criteria under MIG-I and MIG-II of credit-linked subsidy scheme (CLSS). Further, the budget allocations for the CLSS scheme for the next year can be further augmented in line with the strong response witnessed, especially in the EWS / LIG segment. It is estimated that in the current year, subsidy sanctioned and disbursed in the segment has been far higher than the initial Budget estimate of Rs. 400 crore for the year.

Lastly, the Government has also been pushing for REITs to be developed in India as an asset class. However, due to various reasons related to taxation and yield expectations, there has not been any listing in the country till date. Though major taxation-related hurdles had already been resolved in the previous years, if the Budget can streamline and relax some of the pending issues such as dividend-distribution tax applicability for subsidiaries which are not wholly owned, reduction of holding period for long-term capital gains applicability on REIT units, MAT on transfer of shares of SPV to REIT etc., it can support the development of REITs in the country.

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Textiles:

The textile sector is one of the major contributors to India’s export earnings, with a ~13% share. However, the sector has experienced pressure on exports across segments in the recent times. While apparel exports have grown at a subdued pace in the light of intense competition, yarn exports have also remained under pressure due to decline in demand from China as well as India’s losing market share in the Chinese yarn market. Adequate budgetary allocation for schemes such as refund of state levies and interest subvention benefits can help improve the competitiveness of Indian textile exporters in the international markets and improve India’s textile exports growth.

Also, within exports, India is still highly reliant on export of textile intermediaries, indicating potential for further value addition in the country and hence investment requirements in the downstream segments like apparel and home textiles. The budgetary allocation for the Technology Upgradation Fund Scheme (TUFS) was reduced by ~23% to Rs. 2,013 crore for FY2018 from Rs. 2,610 crore for FY2017, a level even lower than the one prior to FY2015. As the level of subsidies available under TUFS is one of the key drivers for investments in the textile sector, moderation in allocation constrains the pace of capacity addition. Accordingly, a higher allocation towards TUFS subsidy for FY2019 would prop up investments in the downstream segments, facilitating higher value addition in the country and an even higher contribution by the sector to the country’s GDP as well as forex earnings. As per ICRA estimates, apparel exports from India can go up by ~3-3.5 times, if raw materials and intermediaries which are exported at present, get processed further into apparels. This has the potential to double cotton-based apparel exports and increase total textile exports from the country by ~50% in value terms.

Further, given that the sector is largely dominated by the small-and-medium enterprises and faces constraints arising from infrastructure bottlenecks and dispersed value chain, continued funding allocation towards textile parks, financial assistance (in the form of equity/ grants) and access to conducive infrastructure can enhance the sectoral efficiencies. This in turn can help in enhancing the sector’s contribution to the country’s manufacturing production as well as GDP further.

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