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The Union Budget is round the corner, Will this budget heal the demonetization pain?

The Finance Minister (FM) ArunJaitley will present NDA’s fourth budget under the current term on February 1, 2017. We believe that the government is likely to relax its FY2018E fiscal deficit target of 3% by 30-50 bps. This is likely to increase its spending ability by `50,000cr-`80,000cr in FY2018E. While this could move the focus away from fiscal discipline path, the possible gains of ~`1lakh crore by taxing the black money deposits would support the government’s spending in FY2018E. We are positive on the interest rate, as banks are expected to witness lower cost of funds by retaining the low cost deposits received through demonetization. Overall we expect 1) increase the tax slab limits to boost consumption, 2) Infrastructure spending to revive capex cycle, and 3) rural schemes to remove distress from rural economy.

Demonetization has created short term pain for the economy

The sudden liquidity crunch after the note ban has seen consumption sectors such as auto, real estate, building materials, consumer durables, etc., take a severe beating. The rural economy has also been adversely affected, as cash crisis led to a slowdown in the small scale businesses resulting in job losses. However, the economy is expecting remedial action through the budget.

One-off gain to maintain fiscal discipline

Over the last three years, government has achieved significant progress towards achieving Fiscal Responsibility and Budget Management (FRBM) Act target of 3%. The government is likely to step up rural infrastructure spending, which may partially pressurize its financials; however the one-off gain of ~`1 lakh crore by taxing the black money deposits supports these spends without pressurizing the financials. The collection of lower one-off taxes, however, may pose risk to FY2018E fiscal deficit.

Budget likely to take corrective measures

We believe that the government is likely to take corrective measures which would offer remedy to the demonetisation wounds. In our opinion, increase in individual income tax slab limits and reduction in corporate tax rate is expected to be the highlight of the budget in order to revive the consumption cycle. The PM’s address on December 30, 2016 announced various corrective measures to fix the rural economy, such as affordable housing, interest subvention, credit support for small businesses, etc. We expect more measures in the upcoming budget to remove distress from rural economy.

Before we try to gaze at what it might have in store, there are 4 points to be noted at the outset:

1) Deviating from the tradition of presenting the Union Budget on the last day of February, this year the Budget will be presented on the 1st day of February. This is primarily from the point of view of getting the Budget announcements implemented from the 'beginning' of the new fiscal instead of its implementation after a few months into the new fiscal.

2) Almost a century old practice of presenting a separate Railway Budget is getting done away with from this Budget onwards, as the Railway Budget presentation is getting merged with the Union Budget.

3) The Budget date is just a few days ahead of the elections in 5 states, which includes the politically crucial state of Uttar Pradesh. This holds significance considering the fact that the Union Budget (including the Railway Budget) is an event wherein various social and welfare schemes get announced, tax and fiscal incentives are given out, the influence of which on the voter community is debatable.

4) The Budget will be presented in the backdrop of the government's recent demonetization drive, which has had an impact of varying degrees across sectors and has perceptibly affected both – consumer and business sentiments.

Of the above, while points 1 & 2 are just facts-to-be-noted, point 3, though important, the decision w.r.t. the Budget presentation date is as yet pending with the Election Commission. However, whether the eventual date will have a significant bearing on the final contours of the Budget is difficult to guess, we believe it is point 4 that is of relevance this time around.

Reeling under the challenges posed by the government's demonetization drive, businesses and consumers at large have seemingly built high expectations from the Budget. These largely revolve around getting reliefs aimed at higher disposable income in the hands of the population and/or improving affordability, which in turn will aid in improving consumer sentiments and support business and economic growth.

Higher tax exemption limits, lower duties on products, higher tax incentives to encourage home buying, incentivize savings, etc. are among the usual desired expectations, which will help in meeting the objective of improving consumer and business sentiments to a certain extent. Apart from these, in wake of the short-term impact witnessed on the rural and the informal segments of the economy, the government is expected to enhance its focus here.

Notably, while the government has already expressed its intention to double farmers' income by the year 2022 and this Budget could spell few measures aimed at this, the MSME segment, which has also been adversely impacted on account of it representing a good part of the informal economy with cash being the primary exchange for transactions, is also expecting few relief measures to flow its way.

Focus on government's pet projects like Make in India, Digital India and Swachh Bharat are expected to continue to receive considerable attention considering the potential objectives that can be achieved through these. While the Make in India and Swachh Bharat campaigns can be a great source for job creation considering the investments that they could attract, strengthening of the Digital India campaign will support the government's initiative of transforming the Indian economy to a less-cash economy.

Efforts at job creation and lifting the rural economy, which has been particularly impacted post-demonetization, is likely to be amongst the key agendas, which could be addressed through greater focus on agriculture and micro small and medium enterprises (MSME) sectors. Increased emphasis on the latter will aid in the revival of investment cycle, which will boost credit demand in the system.

On the taxation front, the expectations of a largesse are high by consumers and the business community alike in wake of the pain inflicted by the recent demonetization drive and are looking up to the government to bring things back to normalcy in the economy. However, considering the fact that the government's financial gains in the near-term have been restricted from the demonetization drive, its capability to deliver an out-of-theordinary budget also gets curtailed.

Nonetheless, to alleviate the challenges recently cropped up in the economy, and also with an eye on the upcoming state elections, tweaking in personal income-tax slabs could be announced. Further, with the Finance Minister having indicated in his earlier Budget the reduction in corporate tax rate, the current Budget is an opportune time to initiate this move. The Service Tax, however, may be hiked to move towards greater alignment with the GST rates, which is expected to be implemented in 1HFY18.

On the Fiscal path front, while the government has targeted a fiscal deficit of 3% of GDP, considering that it will have to be the front-runner in pump-priming the economy in wake of lack of private investments, a 25-50 bps increase may be considered by the government.

In conclusion, we expect the Budget to keep its focus relatively higher on the rural economy and the various social and welfare measures related to healthcare, education, agriculture, etc. along with investments in infrastructure / housing. This is primarily in wake of the challenges thrown up by the demonetization drive and the upcoming state elections. But with the limited benefits yielded by the former to the government in the near-term, it is unlikely that the government has much scope to deliver a 'populist' budget. Nonetheless, in terms of sectors, we expect Infrastructure (Roads / Power / Cement), Housing (Banks / NBFCs), Agriculture (Agro-chemicals / Irrigation / Fertilisers / Tractors) and Rural (Consumer Durables / FMCG) to benefit from the budget announcements.

Lower interest rates + tax cuts = Consumption boost

We believe that government’s aim is to leave consumers with more disposable income and fuel the consumption demand. Therefore, increase in tax slabs and lowering corporate tax rate will play an important trigger, as interest rates have come off in a big way. With banks retaining low cost deposits, their cost of funds is expected to remain low for a long period, indicating that interest rates will also remain low going ahead. The low interest rate and low taxes would accelerate revival in consumption demand.

Budget conviction picks

With the focus on tax reduction we expect consumption sector is likely to be a direct beneficiary from this budget. We expect FMCG, consumer durables, automobile sectors to benefit going ahead. We prefer companies like ITC, P&G, Asian Granito, Mirza International, etc. in this space. We also expect the credit cycle to revive with lower interest rates and government’s impetus on housing sector and companies like Axis Bank, LIC Housing and DHFL to remain our best play. We like L&T, Powergrid and KEI industries in the infrastructure space.