The number one rule of financial markets is that you don’t fight the trend. It follows that having any form of high expectations from this year’s union budget to be presented on February 1st is wishful thinking at best. I cannot recall the last time the Indian markets rallied hard on any key policy announcements made by the now two and a half year old government. For a government that was supposed to be the answer to the lack of any clear development agenda and policy paralysis, market participants are still waiting for this government to hold good on these promises.
As with all budgets, it will be presented amid some tailwinds–improving tax buoyancy, declining CPI and falling domestic interest rates and some headwinds–slowing GDP growth due to demonetization, rising commodity prices and an uncertain global environment. Given the current spillover effects of demonetization, the ‘tight rope’ walk for FM to boost public spending while keeping the fiscal deficit within limits has become even more complicated. It is highly probable (and desirable!) that the fiscal loosening option will be explored by the government to (a) step up spending on infrastructure and social programmes; and (b) provide direct tax incentives to individuals for boosting consumption. The government ought to take a second look at the fiscal consolidation roadmap – and the median forecast is for the FY18 fiscal deficit target to be revised to 3.4%.
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The key focus has to be on infrastructure with more budgetary allocation for rail, roads, ports and airports projects. Reduction/removal of minimum alternate tax on infra firms will be a huge boost for attracting more investment in this space. Provision of Consolidated Group Tax Return Filing for infrastructure groups will reduce costs and enhance ease of doing business significantly. Another market expectation is the logistics industry getting the status of infrastructure which will provide higher tax benefits.
On the banking front, PSB recapitalization announcements will be eagerly awaited. Higher provision towards recapitalization of PSU banks will also augur well for reclaiming double digit credit growth in banking system. Previous year’s budgeted infusion was Rs200bn of which approx. Rs170bn was infused. Last year’s budget included some key announcements that promoted low cost housing and offered cheaper home loans to individuals who opted for amounts of up to Rs.3.5 mn during the FY17 fiscal. These benefits should be extended for the 2017-18 and there should also be additional tax breaks for those involved in the construction of such affordable housing. This would be a great boost for the housing loans segment.
Consumption should get a boost in the form tax incentives for individuals Government could work with a combination of measures such as increase tax exemption limits, tax deduction limits under 80C and deduction of interest on home loans to increase disposable income and boost consumption. Further, as tax buoyancy is likely to improve in FY18, any announcement relating to hike in STT and/or changes to capital gains tax regime would be a blunder, and would definitely damage the stability of the equity market. On the GST front, clarity on GST rates is unlikely but GST related policies and rollout timeline should be announced.
The Finance Minister must also address the slowing rural economy in a more serious manner. It is easy to talk about the idea of digital India in weekly radio shows and election rallies. But the fact remains the PM has turned to the UPAs “entitlement” programs to respond to post-demonetization shocks to the rural economy. While Modi will certainly love to have the opportunity to take another dig at MGREGA in the future, data shows by early January 2017, the Centre had released Rs. 55,076 crore for MGREGA – the highest allocation so far since the program was launched. Replacing the leaky and inefficient welfare delivery system with the deceptively elegant cash transfer model seems like a distant dream and probably an idea whose time has not come. The target in 2014 was for direct benefit transfer (DBT) to cover 536 schemes across 65 ministries and departments. By December 2016, only 84 schemes across 17 departments and ministries were using DBT. Moreover, the pace of money transfers through DBT has slowed down.
Budgets have not historically set medium term market trends in Indian equities and the focus will soon move to the UP elections even if Jaitley delivers a lackluster speech. However, time is running out for Modi and his team to be perceived as drivers of economic and social reform. This budget presents an opportunity, perhaps the last one before 2019, to do so.
(The author of this article Vatsal Srivastava is a senior market strategist. All views are personal)