High expectations of populist measures to mitigate impact of demonetization; challenging global backdrop makes path even more difficult.
This time market is approaching the union Budget with very high expectations as this is the first budget after demonetization. The market perceives the budget as an opportunity to fix the derailment caused to the growth trajectory. Demonetization has been projected as some kind of equalization measure for society leading to narrowing down of gap between rich & poor. Hence there is an expectation that personal taxes will be reduced significantly, some relief packages specifically targeted at poor along with couple of populist schemes are expected to be announced. Most of the sections of society are waiting for this budget with lots of expectations. The higher the expectation the more difficult it is to meet them. Therefore we caution the investors about a high probability of disappointment post the event.
What do we expect broadly from this budget?
In order to provide stimulus to derailed economy post the demonetization we expect the government to come out with some kind of stimulus package for the economy especially targeted towards MSME/SMEs. In the GDP equation GDP= C+I+G+ (Ex‐Im) where C==consumer spend, I=Investment , G=Government spending, Ex=Exports &Im=imports, the only parameter that can be tinkered or played with is G i.e. government expenditure as all other components are either not under government control or are highly disturbed by demonetization for e.g. Consumption has taken a severe beating amidst cash crunch, Investments or CAPEX cannot come in when capacity utilization is ~70% & general environment is uncertain. Exports are not likely to see any major spurt because of all round protectionist talk going on & our imports are mostly inelastic. Thus, by default it is government expenditure that can do something to provide impetus to economy.
Where can government spend or increase spends?
1) We expect infrastructure which includes roads, ports, railways, waterways, water treatment projects etc, may get higher allocation than previous years. Since the brunt of demonetization has been borne maximum by rural population we expect some schemes dedicated to rural folks to be announced or allocation to existing schemes may be enhanced. We expect irrigation, housing (rural as well as affordable), healthcare to be focus areas in the budget.
2) Other ways to stimulate sagging economy would be to provide more money at the hands of public (disposable income) by way of cutting personal taxes and/or reducing indirect taxes like excise duty. We expect relaxation of incremental Rs 50 thousand in threshold for taxable income for individuals. In our opinion there is low probability of increasing exemption limits under Sec 80C & interest paid on housing loan. We do not expect too many changes in indirect taxes as GST is in the offing.
3) Government can announce some innovative schemes like cash for clinker (scrappage of old vehicles) etc. to provide fillip to commercial vehicle/automobile sector which in turn can invigorate growth in related auto ancillary sectors too.
4) Since small manufacturing units are more impacted by demonetization, we expect government to find ways to provide more credit to these entrepreneurs. Government can use in some way huge cash available with banks (even after normal withdrawals are allowed).
How can the incremental or extra expenditure funded?
We believe government tax collection expectation for next year will be driven by the impact of demonetization especially on manufacturing sector which in turn will decide the buoyancy in tax collections. We expect FY18 tax collection to get severely impacted as corporates will have to bear double whammy from GST & demonetization. In view of revenue generation/enhancement constraints there is an expectation that government may go for some relaxation on FRBM targets, implying that FY18 fiscal deficit maybe higher than earlier stated target of 3% of GDP. However we wish to highlight that any deviation from earlier given target on fiscal deficit may be taken as negative by economists, global investors & credit rating agencies. Also this step will signal government’s acceptance that demonetization has hurt the economy which (in our opinion) the government may not want to acknowledge. In that case moot point is where the money will come from to fund the stimulus or relief packages?
We believe the government can create some room for itself by over estimating nominal growth of GDP in FY18 (recently released AE‐Advanced estimates by CSO on full year FY17 GDP growth are an indication of that). One off income from the two tax disclosure schemes shall also lead to optically high growth in tax collected numbers. Both these numbers will be used as base for projections for FY18E.
What markets do not want to see in Budget?
No change in capital gains tax
Post the Prime Minister’s remark that not enough taxes are being paid by stock market participants, markets are jittery over reintroduction of Capital Gains tax. Although FM has clarified in this regard & hinted that nothing of that is coming, yet the market remains worried. While Capital Gains tax may not come back as it would create negative press/headlines we believe some rationalization of certain other rules, which will effectively mean more taxes on activities in capital markets in some form or the other, may be undertaken. We will be watchful of tax changes especially in regard to FII investments because it is critical for that money to stay in India. Our view is in CY17, investing community may prefer Developed markets over Emerging markets, which in any case is going to put pressure on flows into India. On top of that if any adverse tax changes are made then we expect large amount of outflows from India.
Too many populist schemes
We believe markets may not like announcement of too many populist measures. Market would like to see economics given precedence over populism. However in view of important state elections (UP, Punjab, Uttrakhand etc) & aftermath of demonetization there is a lot of buzz being created on this budget’s provision to be more oriented towards poor, rural areas etc. In times of low economic growth any irrational increase in expense on such populist schemes may further spook the markets.
We do not expect too many populist schemes as past track record of this government has shown that its foremost agenda is economic growth.
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