Second-half fiscal squeeze
19 September 2017
The two largest emerging markets will need to be more austere in the second half of this year following record fiscal expenditure in recent quarters. Both China and India heavily front-loaded spending from their current fiscal year budgets which should result in a slowdown in government spending in the second half of the year. The impact on growth is fairly obvious; with a weaker fiscal impulse other growth drivers will need to pick up the slack or growth momentum will slow. The other possibility is continued spending at the current pace but at the risk of missing their deficit targets.
China's fiscal policy has continued to be accommodative this year. In addition to healthy exports and a robust property market, expansionary fiscal stimulus is one of the main reasons growth has rebounded so strongly. However, government spending is set to slow sharply over the rest of the year. China has significantly front-loaded fiscal spending this year. In fact it's the first time in the past 10 years that China recorded a deficit in the first quarter (see Chart 9). China usually maintains a surplus in the first half of the year to leave space in the second half if stimulus is needed to hit the growth target (the last two years have been an exception when the government began to record a deficit by the second quarter). China's year-to-date budget deficit totalled RMB1.02 trillion (tn) by August, leaving a deficit room of approximately RMB1.36tn for the remaining months this year. By comparison, the government had approximately RMB2.23tn of fiscal space at this time last year. This leaves significantly less room for stimulus through year end. If China's export outperformance fades and/or tighter credit conditions begin to slow the property sector, China has limited room to cushion the cyclical slowdown.
India is facing the same constraints. The central government's fiscal deficit had already touched 92% of the full-year budget estimate as of July, higher than the 58% average in the corresponding period of the last three years (India's fiscal year runs from April to March). Government spending was up 27% year-on-year (y/y) in April-March versus 18.8% in the same period of last year and compared to a six-year average of 16.7% y/y (see Chart 10). The y/y growth rate in April-March is particularly high when compared with the 6.6% full year expenditure target. This front-loading of expenditure (more so than weaker revenues) has pushed the fiscal deficit (as a % of budget estimate) higher than the trend seen in the last few years. What does this mean? First, the front-loaded spending can be supportive of growth over the current quarter. Growth weakened last quarter from a lagged spill over from demonetization, anaemic private investment, and good and services tax (GST) related de-stocking. The higher-than-trend spending last quarter may help arrest some of the slowdown and, at a minimum, support defence, public administration, and other services sectors sensitive to government spending. Second, although the government may continue front-loading expenditure during the July-Sep quarter to offset possible GST disruption; much like China, the government will have no fiscal space over the rest of the year to support growth lest it risk missing its deficit target of 3.2% of GDP. If private investment remains weak and consumption suffers from the weak employment record, growth may disappoint this fiscal year.