Budget 2018: Policy comfort is the key to lower rates

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Published: February 2, 2018 6:55:44 AM

We believe that the Budget 2018 supports our standing call of playing consumption over investment.

Budget 2018 policyOn the whole, it was broadly in line with ours as well as market’s expectations in terms of its focus on stepping up rural spend in the run-up to the 2019 general elections, some income-tax relief and the re-introduction of long-term capital gains tax.

We believe that the Budget 2018 supports our standing call of playing consumption over investment. On the whole, it was broadly in line with ours as well as market’s expectations in terms of its focus on stepping up rural spend in the run-up to the 2019 general elections, some income-tax relief and the re-introduction of long-term capital gains tax. That said, we think that the sell off in the G-sec market is overdone. Yes, we also do expect finance minister Arun Jaitley to breach his fiscal deficit target of 3.3% of GDP (3.2% BAMLe) by 20 bps to 3.5%, this fiscal. This, however, should get funded by a further drawdown of the Centre’s surplus with the RBI.

In fact, we see the G-sec market switching to excess demand. Although the market is spooked by the hike in minimum support prices (MSP), the actual inflationary impact is likely to be far more moderate, as ruling market prices are higher in many cases. At the same time, policymakers will have to calm sentiment, as it is very unlikely that investors will venture out to buy bonds when they are perceived to be a falling knife.

We support the FM’s rural focus to improve on “ease of living”, given rising strains. After all, growth in farm income is really weak: about 4% in Rabi 2017, a drop of 5% in Kharif 2017 and a likely 3% in Rabi 2018 with sowing marginally lower. It is for this reason we welcome the step up in allocations for rural roads, housing, the announcement of Operation Green to raise tomato, onion and potato production.

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We also welcome the launch of the flagship National Health Protection Scheme to cover over 10-crore poor and vulnerable families, providing a coverage up to Rs 5 lakh per family per year for secondary- and tertiary-care hospitalisation.

We welcome the 21% step up in estimated budgetary and extra-budgetary expenditure on infrastructure to kick-start the capex cycle. At the same time, we do not see a turnaround in investment until banks cut lending rates by another 25-50 bps to spur consumer demand that will put idle factories to work. Corporates will look to invest afresh after capacity is exhausted. It is for this reason we expect the RBI to cut rates again to signal lending rate cuts to banks in the “slack” April-September industrial season.

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We expect the FM to breach his fiscal deficit target of 3.3% of GDP by 20 bps to 3.5% in FY19 in the run-up to the 2019 polls. This will largely be driven by lower-than-budgeted telecom proceeds, disinvestment (given rich-equity valuations) as well as GST collections, in our view. Given that growth is running 100 bps below potential, we do not mind some fiscal slippage, especially as the overall government fiscal deficit is broadly in line with its long-run average of 7.3%. After all, we are far from a situation of crowding out, as the upturn in growth for the next few quarters will be largely driven by base effects.

Nonetheless, we are relieved to find that the ministry has decided to draw down its surplus cash balances with the RBI to fund capital expenditure at a time of fiscal consolidation. We think that inflation risks are overdone. Although the market is spooked by the hike in MSP prices, the actual inflationary impact is likely to be far more moderate as ruling market prices are higher in many cases. We do not
see much inflationary impact of higher customs duty on inflation. Still, we push the next RBI rate cut to August from April, as the MPC will want to wait for good rains, given the added uncertainty about agflation.

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After all, inflation will climb to 5.4% in the June quarter, albeit purely on base effects. If we look beyond, fundamentals–excess capacity, tight money supply, a possible La Nina–actually point to a benign inflation outlook. We continue to believe that macro risks in the G-sec market are overdone. Our calculations suggest that the G-sec market will see excess demand in FY19. Net borrowing at Rs 4,790 billion is in line with our estimates. We estimate that the RBI will inject about $37 billion next year to fund 6% real growth (in old series). Our BoP forecasts place RBI FX intervention at about $13 billion. As a result, we expect the RBI to buy $24 billion of gilts through open market operations and buybacks (Rs 719 billion budgeted). This will exceed our estimated market gap in FY19, as was the case in FY16.
At the same time, the RBI/MoF have to come out with confidence building measures (CBMs) to calm market sentiment. Is it really necessary, for example, to borrow more from the market this fiscal even while adding to surplus balances at the RBI?

 

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