Nirmala Sitharaman’s second Budget was a keenly anticipated event. After the whitewash that the first one was, there were hopes that the Finance Minister would not disappoint twice in a row. Well, she did.
We must remember that this Budget comes at a time when the economy is grappling with its worst slowdown, with growth at six-year low at 4.5% for the July-September quarter and unemployment at a 45-year high. Despite that the Indian equity market continued to scale new highs fuelled by global liquidity and low interest rates. FIIs invested more than 1.01 trillion (net) in Indian equities in 2019, making it their largest infusion since 2013 when they invested 1.13 trillion. Notably, more than half of it came from September when tax rate was cut for corporate India from 34% to 25%, which translated to 14-15% boost to post-tax corporate earnings. On the back of such a reform, the expectation was that the government would take bold steps in taxation, divestment and investments. But, Budget FY21 was dispiriting. The market went into a tailspin with the Sensex losing over 1,000 points to drop to 39,650 and Nifty losing about 320 points to reach 11,642.
Even the removal of the dividend distribution tax, or DDT, which was considered the one relief, will not help investors in the highest tax slab (40%). Dividends currently invite a tax of 20.35%, which is paid by the issuing companies. Dividends above 1 million invite an additional 10% tax, to be paid by the investors. Under the current Budget, all of this has been done away with and now, dividends will be taxed in the hands of the investors and those in the highest tax slab will end up paying more than they did previously. The government will lose revenue of 250 billion thanks to the DDT removal. “The market was expecting a more substantial statement on getting growth and investments back on track rather than the removal of DDT,” says Shankar Sharma, vice-chairman, First Global. Investors rarely invest in the equity market based on dividends and the Budget has been a bit of a non-event, feels Sunil Singhania, founder, Abakkus Asset Manager. “Investors were expecting a major push on infrastructure, which did not come through,” he adds.
Indian benchmarks have been trading at 12-month forward P/E multiple of nearly 20x, making us one of the most expensive among all emerging markets. One of the reasons that India still commands a premium is that it was one of the few markets that offered considerable growth. Even though Nifty earnings grew by just 6% annually over the past five years (2014-2019) the expectation was that earnings growth for the Nifty would be around 15-20% over the next two years (FY21-23) fuelled by lower corporate tax rates. “I don’t think fundamentals can be ignored and the money will go where the fundamentals are,” says Sharma, adding, “I think it will be a tough year, the economy has been slowing down considerably and will require a lot of money to turn around.”
The price of equity is not likely to correct either because of excess liquidity. Globally, interest rates will remain low with developed markets growing only at 1-2% and seeing practically no inflation despite their easy money policies. With interest rates staying low, equity prices are likely to stay inflated. In 2019, India saw the highest inflows across Asia of $14.7 billion. Taiwan and Indonesia saw foreign investors investing $6 billion and $3.5 billion, respectively in their markets. But the fortune of Indian markets will depend on the money flowing into emerging markets and global risk appetite.
FIIs have been overweight on India on hopes of a recovery in growth from reforms. In a Budget that was devoid of any substantial policy measures, the momentum in the market could well be broken. “I don’t think the Budget per se will impact FII inflows. I think there is disappointment since some of the expectations were not met. But much of the future inflows will depend on how the economic and earnings growth will pan out,” says Singhania. Indeed, how much money foreign investors will send in will also depend on interest rates in the US, currency movements and how the rather expensive Indian market compares in valuation to other emerging markets.
With the rather wobbly economy and no real pointers on where the growth is going to come from, Indian investors are in for a roller coaster ride in 2020.