However, the Union Budget does precious little to change sentiment about the corporate earnings environment
Despite accounting for higher government salaries (7th Pay Commission) and not increasing taxes sharply, FM Jaitley stuck to the 3.5% fiscal deficit target (as a proportion of FY17 GDP). The net government borrowing target of Rs 4.25t was significantly below expectations. BNPP chief economist Richard Iley opines, and we agree, that RBI could reward this with a rate cut in the near term.
Rural and infrastructure spending remain key focus areas
The increase in capex outlay (plan + non-plan) in the budget was a trifling 3.9%. However, if one takes a holistic view of infrastructure spending —including provisions of the railway budget and some joint centre-state programmes (e.g. PMGSY road projects)—the total increase in key areas of infrastructure spending is projected to be in excess of 23%. Together with projected rural spending growth of 10%, this underscores the government’s twin targets of rural demand support and investment acceleration.
Some of the tax proposals will likely disappoint the market
Principal disappointments were the imposition of a Dividend Distribution Tax (DDT) of 10% for dividend income of Rs 1 m and above, and increased Securities Transaction Tax (STT) on sale of stock options to 0.05% from 0.017%.
Assumptions are credible on the whole, but some aggressive elements remain
Assumption of 11% nominal GDP growth in FY17 and an 11.7% increase in tax revenue appear credible to us. However, the assumption of Rs 500 bn non-tax revenue from telecom spectrum auctions and Rs 565 bn from divestments appear aggressive and could upset the fiscal arithmetic towards end-FY17e.
Beneficiaries: wholesale-funded FIs, real estate, downstream oil, cement
A low government borrowing programme leads to the possibility of a rate cut, which is obviously positive for wholesale-funded institutions. Second-tier mortgage companies (e.g. LICHF) and cement manufacturers could benefit from a boost to low-cost housing. Non imposition of DDT on REITs benefits a select few property companies (DLF, Prestige). Rural-focused companies (e.g. M&M) benefit from higher rural spending.
Losers: telecom, auto, upstream oil and jewellery sectors
Service tax on spectrum will make telecom spectrum trading expensive. Luxury tax on vehicles priced above R1m impacts M&M and Maruti negatively. Ad valorem cess (20%) on domestic crude oil was much higher than the market expected—impacting the upstream oil sector negatively.
India’s underperformance may continue in the near term; H216e appears better
India has underperformed AxJ in 2016 YTD, correcting from its super-premium valuations, and the budget does precious little to change sentiment about the corporate earnings environment. Investment acceleration and rural demand recovery might come through, but possibly no earlier than 2H16, in our view. The longer-term stability of India remains intact, however, due to benign commodity prices and continuing fiscal discipline, potentially leading to further monetary easing.
Fiscal discipline is encouraging; growth focus somewhat low-key
The FY17 budget had raised hopes of growth-supportive measures and rural stimulus, possibly even at the cost of fiscal discipline. In the end, FM Jaitley stuck to the promised fiscal deficit target and provided the necessary rural stimulus, but the hopes of acceleration in capital expenditure were somewhat dashed, with a trifling 3.9% budgeted increase in total capex. Including the railway budget and central enterprises, the total capex outlay wasn’t so disappointing (23% increase over FY16 RE), but implementation of railway capex disappointed severely in FY16— and the FY17 capex target will have to be monitored closely against actual progress.
In the final analysis, what the FM didn’t do became more important than what he did. An increase in service tax and re-imposition of long-term capital gains tax on equity investments were widely anticipated. The budget delivered neither. On the other hand, it disappointed the market with a 10% tax on dividends (in excess of R1m) in the hands of the recipient.
(i) The government reiterated its fiscal consolidation path with a fiscal deficit of 3.9% of GDP in FY16, 3.5% in FY17 and 3% in each of FY18 and FY19. Sticking to the earlier communicated target of 3.5% in FY17 is likely to go down well with the RBI. In particular, sticking to this fiscal discipline in a year of higher government salary payments (7th Pay Commission and OROP) is creditable, despite some aggressive assumptions.
(ii) A lower revenue deficit in FY16 and further reduction of 20bp in FY17 are commendable.
(iii) Increased expenditure in the rural (10%) and infrastructure & energy sectors (35%) is encouraging. Enhanced rural expenditure comprises allocation to NREGA (12% higher), agriculture and irrigation (110% higher).
(iv) Incentives in low-cost housing came in the form of income tax deductions for additional interest of R50,000 pa on loans<Rs 3.5m for first time home-buyers, and MAT for profits on constructing smaller units. Tax deductions on house rent were increased to Rs 60,000 from Rs 24,000, where HRA is not provided by the employer.
(v) Allocation for recapitalisation of PSU banks (Rs 250 bn in FY17) was a disappointment. The market was expecting at least Rs 300 bn-350 bn. Given the worrisome asset quality of PSU banks and their large capital requirement, Rs 250 bn could prove inadequate.
(vi) Tax of 10% in the hands of dividend recipients above R1m. It’s not yet clear whether holding companies receiving dividends from subsidiary companies would be subject to this tax. But on the whole this is a retrograde double taxation measure, and likely to be taken negatively by the market.
(vii) Newly imposed Infrastructure Cess (1-4%) and 0.5% Krishi Kalyan Cess (Farmers’ Welfare Cess) on all taxable services disappointed somewhat, but are clearly better outcomes than the widely anticipated 1.5% hike in service tax.
(viii) A 10-15% increase in tobacco excise duty was a disappointment.
(ix) General Anti Avoidance Rules (GAAR) will be implemented from 1 April 2017—in line with the previous announcement in 2015. On the whole, we think questions about the ‘investment boosting’ capability of the budget will linger. But, sticking to the fiscal deficit target in a year of sharp expenditure increases is creditable.
Largely credible assumptions, but some doubts remain
Sticking to a 3.5% fiscal deficit target while accounting for higher salary expenses and at the same time not hiking taxes significantly necessitated some awkward trade-offs and some aggressive assumptions, though most of the revenue assumptions seem to us reasonably credible.
Likely market impact: correction near term
India is the second worst performing market (after China) in 2016 YTD. This is somewhat surprising, given the relative resilience of the Indian economy to the prominent economic headwinds of today–Chinese slowdown and RMB volatility, commodity price collapse and the risks to global banks’ balance sheets. However, India’s valuation premium explains in part the recent underperformance. In early 2015, India’s premium to AxJ was egregious. Now it appears relatively benign, but still significantly higher than the long-term average. On top of that, India has suffered one of its worst ever episodes of earnings downgrades over past one to two quarters.