Public investment to take a hit in FY18
Farm loan waivers not fiscal expansionary
In our study of 2017-18 budgets of 17 states, we had found that states' capex is budgeted to grow 17% and revenue spending at 12-year low of 9.6% in FY18. After including Punjab (PB), Uttar Pradesh (UP), and Uttarakhand (UK), we make four key conclusions.
* Farm loan waivers don’t imply fiscal expansion. Total spending by 20 states is budgeted to grow at 9.5% in FY18, the slowest pace in 13 years. Further, aggregate fiscal deficit of 20 states is budgeted at 2.7% of GSDP this year, similar to 2.6% of GSDP in FY17 (3.5% of GSDP including UDAY).
* Public investment is likely to take a serious hit in FY18. States' capex (including loans & advances) is budgeted to decline (~1%) for the first time in two decades, while revenue spending is budgeted to grow ~12%. Accordingly, while the share of rural sector in total spending is budgeted at the highest in two decades, spending on transport sector is budgeted to grow at 13-year low of 7.5%.
* Amid weak private investments, declining states' capex will restrict the revival in investment cycle, as the central government alone is unlikely to make a difference.
* With total spending of the general government (center + states) budgeted to grow ~8% in FY18 - less than half the growth seen in FY17 - we continue to believe that real GDP growth would ease from 7.1% in FY17 to ~6.8% in FY18 with downside risks, much lower than the market consensus of 7.4%.
In our note released in April 2017, which analyzed 2017- 18 budgets of 17 states, we had concluded that while total spending is budgeted to grow at the slowest pace in 12 years, the states – like the center – are focused on boosting capital spending and containing revenue spending. Continuation of better quality of fiscal spending gave us comfort regarding a potential recovery in investment cycle and limited our concerns about inflationary pressures in the economy. As we update our analysis to incorporate PB, UP and UK, which presented their budgets in June-July 2017, we find that some conclusions have changed.
We revisit the five themes based on our analysis of state budgets. While three remain intact, two have changed. Based on 20 states, we find that rural spending is budgeted to grow 20%+ for the second consecutive year, while their spending on transport sector is budgeted to grow at the slowest pace in 13 years. We also make four key conclusions based on our updated study of 2017-18 budgets for 20 states:
1. Farm loan waivers not fiscal expansionary
The UP budget was an eye-opener on how farm loan waivers impact state finances. As we discussed in our note on the UP budget, while the state government has budgeted for 14-year high growth of 25% in revenue spending, it has budgeted for the worst decline (of 30%) in capital spending in 13 years. Total spending by UP is budgeted to grow 11.7% in FY18, the slowest in 12 years.
On an aggregate basis, total spending of 20 states is budgeted to grow 9.5% in FY18 – the slowest growth in the last 13 years. Further, aggregate fiscal deficit of 20 states (Exhibit 1) is budgeted at 2.7% of GSDP in FY18, similar to 2.6% in FY17 (3.5% including UDAY). With no additional growth in total spending (budgeted at 10.8% as per our previous analysis of 17 states), and broadly unchanged fiscal deficit in FY18, it would be unfair to call farm loan waivers expansionary (Exhibit 2).
2. Public investments to be hurt badly in FY18
Farm loan waivers are not only non-expansionary but also hurt potential growth by shifting investment into consumption. Like in UP, the aggregate numbers for 20 states are showing a decline in capital spending (incl. loans & advances). After including PB, UP and UK, we find that revenue spending is budgeted to grow ~12%, better than 9.5% in our April report, but still the slowest in 12 years. Capital spending is budgeted to decline 0.9% in FY18, marking the first decline in two decades.
Because of the shift from capital spending to revenue spending, aggregate data show that states’ spending on the rural sector will grow >20% for the second consecutive year, while investment in transport sector will grow at the slowest pace in 13 years.
3. Limited revival in investment cycle in FY18
The first decline in states’ capital spending in 22 years along with a budgeted decline in investments by central PSEs and continued weakening of private investments imply a limited revival in the investment cycle in FY18. Since the central government accounts for ~6% of total investments in the economy, it is unlikely to make a material impact on overall investment cycle.
4. Continue to expect GDP growth at sub-7%
Over the past four years, the contribution of the government sector to real GDP growth has swollen from about 0.5pp to 3pp. This implies that the general government (center + states) accounted for more than 40% of real GDP growth in FY17 (Exhibit 3). With total spending growth of the general government decelerating to the lowest level in 13 years , it is unlikely to contribute as much to real GDP growth. Accordingly, we believe that with fiscal policy reaching limits, real GDP growth is likely to remain sub-7%.
Note: Maharashtra budget is still not adjusted for farm loan waiver. While our conclusions should remain valid, revenue spending growth could be higher and capital spending decline could be faster. There is unlikely to be any change in our expectations of limited revival in investment cycle and weaker real GDP growth in FY18.
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