Feb 1, 2018
Macro Takeaways on the Budget
A Rural Focused Yet Minimally-Populist Budget
We would rate this budget as generally along expected lines. The emphasis was expected to be on agriculture and rural and that, in fact, turned out to be the core focus of the budget.
One of the fears market participants had going into the budget was a populist budget laden with sops and freebies. The Government resisted the temptation to go down this route and should be lauded for that. Instead, the Government chose programs targeted at enabling farmer productivity, raising agriculture product prices and increasing farmer income.
Secondly, the government announced a slew of measures intended at delivering growth, improving rural quality of life via initiatives structured around electricity, education, health care, sanitation and infrastructure development
LTCG Tax Was Generally Expected, but Still a Negative on the Margin
The government chose to rationalize tax structures across asset classes. Equities enjoyed a tax advantage relative to fixed income and other asset classes. India now joins other world markets in instituting a 10% long term tax on equities, notably, the existing capital gains will be grandfathered and the newly instituted long term tax will be applied only on a going-forward basis starting 01-Feb-18. So, it is an advantage that was available to equity investors that is no longer in place.
Government Chose Fiscal Discipline, but the Math Still Looks Murky…and Bonds Call the Bluff
The Government should be commended on sticking to fiscal discipline and keeping the fiscal deficit at 3.3% in an election year. However, the math is based on some aggressive assumptions around GST tax collections. Hence, we saw the 10-year calling the bluff and as of this writing is at 7.58%.
Reduction in Corporate Tax Rates Extended to MSMEs with Rs. 250 Cr Turnover Is a Positive
Corporate tax for companies with turnover, now up to Rs. 250 Cr. (vs. Rs. 50 Cr. earlier) cut to 25%. This should enable greater investment and jobs creation and is a net positive from our investment perspective.
At a macro level, there is a dampening of sentiment from the introduction of a long-term tax; however, this is likely to be transitory and we don’t think it will dissuade investors from participating in the markets.
The news on reduction of corporate tax rates for MSMEs is a net positive for the markets. That will spur a rise in profitability and increasing investment and savings that will find its way back into the economy.
From a sectoral perspective, Private sector banks benefit from the incrementally more stringent capital requirements which will put pressure on PSU banks.
Sectors to Benefit
With the rise in allocation to infrastructure, infrastructure buildout industries, steel, cement, agriculture and fertilizer, as well as housing finance companies, affordable real estate and auto ancillaries look positioned to benefit.
Agriculture received prominence in the budget with the focus remaining on improving exports and doubling of farm income by 2022. Housing and Infrastructure continue to be the key focus area for the Finance Ministry with the Bharatmala gaining traction and the government targeting 9,000 Km of national highway by FY19 and smart cities development remaining strong.
In the Financials space, SEBI’s mandate for larger corporates to meet 25% of their finance needs from bond market should bridge demand-supply gap in financing and encourage corporate bond market expansion.
The National Health Policy and the Ayushman Bharat scheme allocating Rs. 5 lakh per year per family for 10 Cr. families for hospitalization and health care is a positive for the sector.
The Finance Minister re-iterated that the nation was on track for GDP growth of over 8% in the future.
Probably the most important news of the event is that the 10-year has hit a 22-month high at 7.58%. While some of the move could be explained by the slightly higher fiscal deficit target, we doubt it. More likely, the bond market is reflecting some unease around the revenue and spending targets and the proposal of increasing the minimum support price (MSP) of all crops to at least 1.5x that of the production cost likely stoking inflation.
With yields rising, our recommendation for conservative investors remains short term bonds. With an improving economy, corporate credit funds are also appropriate for moderate risk investors. We would however, note that we are currently in a stage of the economic recovery where rising rates and rising inflation, accompanied by rising equity prices, is generally a weak environment for bonds. In an environment such as this, a conservative view on bonds is the appropriate positioning. As we move forward, increasing duration exposure will make sense; however, that’s not where we are today and we would want confirmation on an approaching peak in rates prior to changing our view.