We wouldn’t be surprised if raters – Fitch just sounded caution – downgrade India on fiscal risks. And we wouldn’t be astonished, if fiscal sustainability fears, like in the previous down cycle, prove wrong. We do not share concerns about a medium-term impact on the India story, as the present spike in the fiscal deficit is essentially cyclical . Risk: election of a completely irresponsible fiscal regime next week.
It is critical, in our view, to appreciate that the causality essentially runs from growth to the fiscal deficit, rather than the other way round. It is surely no one’s case that the benign 5.4% of GDP FY07-08 fiscal deficit led to the current growth collapse! Once growth revives FY11 on, we expect the fiscal position to improve with a rebound in tax revenue.
The very growth collapse contracting taxes, after all, is also shrinking credit demand. This leaves banks with surplus to fund the fisc, moderating the yield impact of high government borrowing and enabling softer lending rates to support growth.