Fiscal flip-flop on the anvil?
Historically, we have always observed Union budget sessions closely followed by major protests from one or more sections which are directly or indirectly affected by policies announced. Governments then decided partial or complete rollback of those decisions (which are factored in most of the times). It is to some extent unfair to blame governments (whether they anticipate or not) for the fallout of certain ambitious or surprise announcements during budget sessions. As the saying goes, not all can be made happy. There will be collateral damage as stated by the newly anointed Power secretary Mr. Subhash Garg, who considers Secondary markets not so important for the Real Economy. He more or less seems to reverberate an ideal bureaucrat as per Indian standards with no understanding of the construct of markets or the ramifications of what is spoken, given the rare opportunity to speak. Clearly, there is a strong reason behind why he has been moved from FMO to Power. The same interview that made me write this story also hints at a possible rollback of the much publicized and criticized point of this month-old budget.
After the Budget session on July 5, 2019, there has been a massive outflow of FPI money to the tune of $1.57 Bn (or 11,000Cr) and it is still unclear if the surcharge decision was taken keeping in mind the FPI fallout or it was merely a blind dart that missed the board. Going by the series of events after the budget, where the FM advised FPIs to move out of the trust structure in order to save tax, it seems to be the latter. It is also not right to blame the FM given the government’s construct where PMO wields majority power in key decisions. On the other side of the spectrum, the government is trying its best to put up a brave face amidst all the criticism it faces and is proudly showing off its firmness on decisions. It is not the surcharge or any negative proposal that freaks out FPIs but it’s the surprise factor that every budget carries with itself historically (be it LTCG or Surcharge). All FPIs ask for, is reasonable certainty. They always expect a statement from a prudent independently run FMO that the changes proposed in taxation will not be touched for a certain period. That again boils down to the way the State Government elections are spread out (we are still few hundred miles away from one nation-one election). The ruling governments are obligated to appease public (especially those habituated to Welfare schemes) that puts additional burden on the fiscal balance. In order to cover the gap, all the government can do is look upstairs towards the top of the pyramid. The obsession towards fiscal deficit which is an outdated conservative tool, stops the government from borrowing more or try an important move like borrowing offshore. It is far easier for the government to borrow in dollars without a hedge for atleast its expenditure in dollars. Given India’s large amount of Forex reserves, 10Y Offshore Bonds of upto even $30Bn shouldn’t really hurt. Part of the debt (if unhedged), can straight away refinance INR debt thus lowering the Sovereign yields closely followed by borrowing costs domestically, instead infusing the same into state owned companies or for that matter covering the INR deficit. I expected an initial move towards a hedged instrument, but government’s initial feelers indicate they are ready to go down the path of risk.
If government believes MoF borrowing dollars is an issue, it can let individual welfare oriented / developmental Government sponsored projects to borrow INR offshore (or Masala Bonds) capital at an SPV (Special Purpose Vehicle) level. For instance, the government can follow this system for its housing for all program (if self sponsored). It set up an SPV and provide Sovereign Guarantee for the same and let this SPV issue smaller denominated Masala bonds for 10–15 years to self finance itself on a secured basis. By doing this, the government can let the SPV borrow capital at near Sovereign cost. Moreover, since these projects are developmental in nature (welfare angle), the likes of IFC, ADB, AIIB etc. will subscribe as anchor investors driving towards concessional pricing. On the other hand, it’s not an ideal plan for MoF to debut with a Masala issuance at this stage, as Indian government may not be able to even hit a $10Bn mark and save much (as far as the cost of financing is concerned vis-a-vis an unhedged Foreign currency bond), given the knowledge and historical trends of INR readily available with investors. Hence, it would be best advised to do project specific Masala issuances rather than going for a cumulative budget deficit /general purpose issuance.
With all the worldly avenues within reach today, clubbed with return starved American, European and Japanese asset management companies, if the government wants to make any move to hurt the rich to cover its deficit, it should be a last ditch effort after all the others are exhausted. Government already almost killed the budding Hedge fund industry in India with a similar principal of the immensely talented Power Secretary.
Having said all this, we can only hope Government changes its mind on offshore issuances and abrogates the surcharge or excludes FPIs from its ambit.
