A Thoughtful Election Budget

No one was expecting a Budget that would put the economy on steroids. Considering this is the last Budget before the General Elections next year, the Finance Minister has done a fairly decent job of keeping the fiscal deficit in check, while meshing in measures to please rural India.

The biggest worry before the Budget was, if the fiscal deficit went overboard, the government would end up with a large borrowing programme, which, in turn, would lead to rising interest rates. That both expenditure and revenue assumptions have been fairly conservative provide a welcome relief. “By conservatively budgeting for revenue and expenditure, the government has probably neutralised some of the inflation and interest rate risks arising from higher commodity prices,” says Ridham Desai, head-India equity research and managing director, Morgan Stanley.

Albeit at a slower pace than earlier projected, the Budget commits to glide the path of lower fiscal deficit in the medium term. While the deficit target of 3.3% of GDP for FY19 is higher than expectation, the Budget also talks of limiting this to 3% by FY21, and central government debt to GDP to 40% over the medium term. “These intentions should calm the nerves of rating agencies and investors reasonably well,” says Nilesh Shah, managing director, Kotak Asset Management. 

While the main thrust of this Budget were initiatives to uplift the rural economy and improve the agricultural sector, it’s hard to assess how much of this will really result in spurring consumption and aid growth. The only thing that can really trigger consumption may be the government’s proposal to fix the minimum support price of all kharif crops at a minimum of 1.5x the cost of produce. “Higher food prices augur well for the rural economy,” adds Desai. 

The other trigger for growth could come from the hike in infrastructure spending. “Infra spending, including ex-budgetary spending, is expected to be up 21% at around $94 billion. This should be good for overall capex and quality of growth,” asserts Desai. Urban development will also see an increase in spending of 57%.

Besides, the higher level of protection as seen in higher customs duty may also help growth at the margin. “There is significant support for Make in India by way of increase in custom duties on various products ranging from electronics to tyres to auto parts, thus increasing protection or incentivising domestic manufacturing units. That should aid growth,” says Shah.

And finally, the cut in corporate tax rate for companies with revenue up to Rs.250 crore is probably meant as a reward for smaller companies that have shared a disproportionate brunt of the transition to GST. That said, the overall impact on corporate profits won’t be much. Desai says, “While the impact on aggregate profit of the corporate sector is quite insignificant (just over $1 billion), we feel this is guidance of where the corporate tax may be in a year or two from now. Prima facie this looks good for future profit of India’s corporate sector and it adds to our bullishness on medium-term profit growth.” For now though, there is slight drag on profit since the cess on tax has gone up from 3% to 4%, adds Desai. 

But these minor changes in tax rates look meaningless as they do not alter the growth scenario much. The reality is that the capex cycle is right at the bottom, with corporate profit as a percentage of GDP hovering at 3% compared with 7.5% in 2007, at the peak of the cycle, says Shah. “Today, private sector investment is on the back-foot and the government must step up to push through public sector investment. We are seeing that in roads, railways and also via public sector undertakings. But execution remains key,” adds Shah.

It’s not just execution – the government’s hands are also tied because of lower tax collections. However, what’s perplexing is that the government has fixed a rather unambitious divestment target for FY19. While the economic affairs secretary’s defence, ‘when you look at the figure against last year’s proceeds of Rs.100,000 crore, this year’s figure of Rs.80,000 crore looks unimpressive but in itself, it is not a small figure,’ may well be true, the real question is, why is a government that has boldly gone ahead with demonetisation and GST, dragging its feet on something that is not its business, as acknowledged by the Prime Minister himself.

Public sector companies have only perished in India mostly against the onslaught of private competitors, so continuing with these businesses only systematically erodes the realisable value for the government. On the contrary, getting rid of these assets when the market is buoyant will allow for better monetisation, something the Modi government can exploit to fund some of its audacious programmes such as the universal healthcare scheme that envisages a cover of Rs.500,000 per family, which has seen negligible allocation. Education spending again, at Rs.30,000 crore has been augmented but the need is probably a lot more. 

As for stock market investors, the introduction of long-term capital gains tax did not come as a surprise. And the case for withdrawing from equities, just because of the additional levy, looks really weak given the investment scene today, where return on fixed income barely covers inflation, and real estate the most preferred asset class among Indians, continues to be overpriced with abysmal rental yields of less than 2%. As of now, equities seem to be on a strong footing, but there could be some serious competition coming in soon. The Budget proposes a comprehensive Gold Policy to develop the metal as an asset class. This includes revamping the gold monetisation scheme to enable people to open a hassle-free Gold Deposit Account. Simultaneously gold import tariff has been cut to 5%. This could increase gold saving in the coming quarters. But then again, encouraging investment in an unproductive asset is a luxury India can ill afford.