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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
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
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