Budget 2020: Fails to deliver on elevated expectations

The context:

For many years now, weeks heading into the Budget Day gives me adrenaline rush and excitement on what could be the key announcements, both for professional and personal reasons. This year too was no different, and given the sharp macro slowdown (FY20E real GDP of 5%) that called for a greater need of growth revival through fiscal measures, investors expectations had risen. Although, everyone was well-aware that the scope for stimulus was limited given the fiscal situation (just 3% YTD tax collections, & corp tax cuts already announced), nevertheless, high hopes had built-in for: a) lowering personal income tax rates, b) increase in rural/agri spending which is being hit substantially, c) some market-friendly measure (like abolishing LTCG/ DDT/ STT/ privatization, etc.) to boost sentiments, d) higher infra/capex spending, and d) some path for NBFC/banking stress resolution.

The event:

Are Fiscal deficit number credible? 
The headline fiscal deficit is now targeted at 3.8% for FY20RE (+50 bp vs earlier targets), & 3.5% for FY21E, both bang in-line with the consensus expectations. While the headline numbers suggests macro stability, quite often than not the devil lies in the details, based on projections assumed by the govt., and off-balance sheet financing. While the nominal GDP growth assumed at 10% (after 7.5% in FY20E), and projected tax revenue of Rs 16.3 trn (increase of 9% for FY 21BE) is realistic, the catch is it still assumes high FY20E tax base (+14% growth is assumed, 2x of GDP growth vs general 1.2x buyancy) on assumption of collections from the dispute settlement scheme. Further, on the revenue-side, disinvestment targets of Rs 2.1 trn appears optimistic (3x of FY20RE, forming 10% of govt. total income), and telecom spectrum/AGR revenues of Rs 1.3 trn (2x of FY20) may be tough to achieve (as the industry already has high debt).  On the expenditure-side, it will grow at 13% and the focus on rural India has stayed - albeit MNREGA allocation is down and higher agri spending is likely for PMKY (Rs 6k/ yr as transfer to farmers). Further, while fiscal deficit came at Rs 8 trn, the more keenly tracked number by investors is govt.’s bond borrowing program, which at Rs 5.4 trn for FY21E is again broadly as expected, and the remaining deficit is largely funded by the increase in national small savings fund (NSSF, Rs 2.4 trn, 2x jump already in FY20RE, and expected to remain flat next year).

Although the fiscal math remains challenging in my view, but then every year there are always some nitty-gritties like above that makes the assumptions look aggressive. However, with govt. having more data points than investors, we can presume that they have done their homework while setting these targets, and from bird’s eye perspective I see there is no out rightly very aggressive assumption (will await more details from brokers tomorrow). Further, govt. revealed off-budget financing details (again need to understand this better), at a time when some doubts were being raise on the relevance of the official deficit number, which should possibly help to bring transparency. 

Will personal tax new regime boost consumption? 
The budget introduced a new optional tax slab structure (that could save taxes up to 75k for income up to Rs 15L) if the assesses let go of deductions/ exemptions (HRA, LTA, 80C, 80D, Int. on housing loan, etc). This in govt’s view should help to simplify taxation for lower-end income-earners (say 3-10L), and thereby give assesses a “choice” if they want to save for the future or use these tax savings for consumption. While the salaried-class individuals are unlikely to shift (barring few who are currently not able to utilize their exemptions), what is more worrying is that the new system no longer encourages longer-term investments (ELSS, insurance, home loans EMIs), and gives option to those, who are generally ill-equipped to take correct decision. Also, this comes at a time when household savings rate is already falling, when India needs risk-capital to fund its growth, and when govt needs funds through NSSF to meet deficit targets. The more annoying part is FM’s statement in post-budget media conversation, where she believes new regime to be eventual path of taxation in few years (they are testing waters now), which implies to me that taxes will go up (rather than widely expected cuts) for the higher middle class in the subsequent years.

Dividend distribution tax abolished: Apparently, we were among the last few nations to remove this tax, which now allows dividends to be taxed in hands of recipients (at their respective tax rates) rather than at corporate-levels at 20%. This should benefit FIIs and MNCs who are located in low tax countries, apart from small retail investor. Thus, a small sentiment booster for the markets. However, promoters with large stakes will be negatively impacted (as their dividends will now be taxed at their rates, say 42%), and therefore such companies will now do more buybacks (taxed at 20%) rather than dividends, and might also announce one-off special dividend this year, to take out cash. Also, DDT removal could be seen with corp-tax cuts already announced, as it incentivizes companies to undertake capex spending rather than paying out dividends. Further, MFs until now use to levy dividends for equity funds at 11.5% and debt funds at 29%. For investors in high tax bracket, it now makes sense to switch to ‘growth-option’ MF rather than ‘dividend-option’, and do SWPs. 

                                     

Doing LIC IPO might actually open Pandora’s box:  Govt’s ambitious disinvestment target relies on LIC IPO, IDBI sale, BPCL, Concor, SCI, Air India, among others. The largest proceed is expected to come from LIC IPO, which will not be an easy task, as it requires legislation change, favorable market conditions given its large size, and will face stiff opposition from political parties & unions for selling the perceived ‘jewel’ of the nation. With Rs 27 trn in AuM and market leadership (66% share) in a high-growth potential sector, it could command valuation of 8-10 trn, and thus investor’s demand could be very high. However, contrary to popular belief, I have had my doubts for long on LIC’s governance, their unknown investment management team, and often joke about them being the biggest Ponzi scheme in India. I say this because LIC has been bailing out successive government’s unexciting disinvestment programs in the past, has been a lender of last resort for PSU banks capitalization, and few reports suggest its equity fund performance is very poor in the recent years. Yet, it continues to reward policy holders/ agents through attractive returns, albeit with limited transparency & through govt support. As it undergoes IPO, we could possibly see more skeletons coming out here.

Infra boost: To attract foreign investment in infrastructure, govt has announced sovereign wealth funds will get 100% exemption on income, FPI limit in corporate debt market is increased to 15% (prior: 9%), and there is also some proposition to have some gilt series being traded without any FPI limit, that will allow Indian govt bonds to be included in global bond indices. The govt has not compromised on capital expenditure (18% in FY21BE), albeit expenditure spending growth is low in Defense and Railways, but solid on roads and smart cities. 

Conclusion: No stimulus, lacks out-of-the-box thinking

While many believe that Budget is unlikely to be the only place to announce big steps, and quite often govt. has announced reforms outside the Budget day, nevertheless, I still look up to the event as it likely lays out the path on which govt. is heading. The broad message this time seem to be: a) the higher middle-class (income >15L) and rich will continue to be taxed more on all its income avenues, so as to meet govt. obligations towards farmers/agri which is a large section of population, b) focus remain on supply-side measures (corp tax cut, DTT, govt. spending, PPP infra, etc) rather than the demand-side (consumption boost), and therefore GDP growth is poised for possible medium-term recovery rather than on short-term revival, c) fiscal prudence and macro stability is given due importance, and d) more willingness towards foreign flows for infra-building. The biggest disappointment to me is the new tax regime, as it complicates the structure rather than the stated objective of simplification (at least until the compulsory full transition comes into effect), and the lack of urgency in govt.’s action - if we do not pull the growth trigger now, then when is the question on my mind.

On markets, the bond market should heave a sigh of relief (they were closed for trading yesterday) as fiscal deficit and FY21 bond supply has no negative surprise, and we should see some rally in bonds, in the near-term. Though this could fizzle out, if progress towards budgeted numbers for disinvestment is slow. On the equity side, Nifty corrected 300 points on Budget day, and is down 6-7% from its recent highs at 11,650. The budget has lost opportunity to give any boost to revive economy, and lacks any reformist/ radical announcement, and therefore broker’s GDP growth estimates might be pushed further ahead. And with so many expectations building up until the budget day, I will not be surprise to see another 3-5% downside from here for Nifty to hit 11,000 immediately next week, on ceteris paribas basis (coronavirus developments, global markets performance, geopolitical developments, etc). The only savior could be lower bond yields, which should support banking sector,  lack of any big negatives for FIIs (unlike the previous July-19 budget), and possibly any indication from FM/ secretaries that more steps are coming. 

Key sector winners: None in my view, but market might reward IT and Staples on risk-aversion, high dividend payouts (on DDT removal), and perceived boost to lower-end consumption (new tax regime).

Key sector losers: Real estate/Autos/ Infra (vs rising expectations), Insurance/ AMC on no tax exemptions (though it corrected already 10% today, and could be interesting to evaluate the actual impact), cigarettes (on excise duty hike).