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Budget 2012 weakens India’s credit profile: Moody’s

A dependence on corporate tax revenue and vulnerability to commodity prices and exchange rates weakens the government’s credit profile, says credit rating agency Moody’s.

The analysis means that foreign lenders and institutional investors would be cautious while investing in Indian equities and bonds. Credit rating agencies assess risk profile of countries to help international investors.

In its weekly outlook published on Monday, the agency highlights fiscal 2012-13 budget’s lack of specific policies to address these weaknesses.

“The budget lacks new solutions to address sovereign fiscal constraints,” the agency said.

Here are highlights of Moody’s analysis of the budget 2012-13:

• It will take a combination of improved gross domestic product (GDP) growth and corporate profitability, lower global commodity prices as well as exchange rate stability to improve fiscal performance and meet the fiscal 2012-13 deficit target of 5.1 per cent of GDP. Although the central government was widely expected to miss its fiscal 2011-12 deficit target of 4.6 per cent of GDP, its revised estimate of 5.9 per cent of GDP for the year confirms significant fiscal slippage, a credit negative.

• Subsidy spending, which was 55 per cent higher than budgeted, widened the budget deficit substantially, with food, fertilizer and fuel subsidies 20 per cent, 34 per cent and 190 per cent higher than respectively budgeted. In addition, corporate tax rose a lower-than-expected 8 per cent versus the 19 per cent anticipated in the 2011-12 budget, which led to a shortfall in revenues. While the budget caps future subsidy spending at 1.7per cent of GDP (from an estimated 2.5per cent currently) it does not include specific measures to achieve this goal. Unless subsidy cuts and fuel price increases are introduced in the next few months, expenditure targets will likely be exceeded yet again in fiscal 2012-13.

• The budget proposal to expand the number of services that are taxed will yield new revenue sources, but a meaningful effect on overall revenue ratios will take several years since service taxes contribute only 5per cent of current tax revenues.

• Separately, the government also indicated in the budget its intention to set up a financial holding company whose purpose would be to raise funds and meet the equity capital requirements of public sector banks and financial institutions. The concept has the merit of allowing public sector banks to receive equity capital when they need it rather than only at the end of the financial year as is currently the case. We have been concerned about the timing of such equity injections, as there is always uncertainty as to how the committed funds will be disbursed among individual banks. However, it is unclear how this vehicle would be funded and we therefore remain sceptical about the ultimate implication of this initiative. There is a risk that this vehicle could be levered, possibly via bank loans, effectively resulting in round trip, fictional capital injections.

• Banks will get capital but remain depressed by the government’s worsening fiscal position. Two budget measures specifically related to the banking sector draw our attention. Both signal that the recapitalization of public-sector banks is a priority, a credit positive development in the current context of mounting pressure on banks’ asset quality and capital buffers. However, on balance, these measures can hardly offset the worsening fiscal balance of the government, which poses risks for banks. Public sector banks are largest creditors to the government.

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