Equity Income Perspectives on Union Budget FY 17
Written on Tuesday, March 8, 2016
By Source: IDFC Mutual Fund
MARCH 2016 The Union Budget prioritizes fiscal prudence over aggressive growth targets. Expenditure growth is moderate with ample evidence of prioritizing and directing funds for the more pressing needs of the hour i.e. rural sector, 7th pay commission (not full implementation), banking sector recapitalization, and some critical infrastructure spends. In our view the budget was not so much about revenue buoyancy (no big bang tax reforms) or a growth impulse (no big bang capex plans); it was about prudent expenditure management and stressing the need for improvement in the operating / administrating environment. We believe rightly so, as we have legacy unproductive / underutilized capital employed which needs to start operating and generating returns before we can embark on a new capex cycle. For now capex / fiscal impulse is small and it remains the domain of the government till corporate India corrects itself.
Corporate sector growth and profitability – what has the budget done to stimulate aggregate demand drivers across consumer / private or public
Consumer sector demand
The rural stress was acknowledged and a slew of developmental, social and security schemes were announced. The target is to move away from food security to income security and doubling rural incomes by 2022. Rural development grants stand at 87,000 Crs. vs. 79,000, an increase of around 11% from the previous fiscal. We have seen rural sector demand deteriorating in the last 2 years however the above effort will help higher consumer spending in the rural segment and companies aligned to rural sector should fare better in this context. Faster adoption of some of the initiatives like crop insurance, irrigation should bring down the cyclicality in the sector both for the farmer and companies alike.
The consumption stimulus for urban consumer has been moderate with 7 Central Pay Commission recommendations being implemented in stages. Urban discretionary demand on the contrary would be impacted because of various tax hikes leading to higher consumer inflation in discretionary products. Pass through of these taxes can dent demand in an already weak growth environment. Some key changes proposed in the budget are:
Imposition of infrastructure cess of 1% / 2.5% and 4% on small petrol, small diesel and large cars/SUVs respectively.
1% additional luxury tax on vehicles above retail price of 10 lakhs.
Excise duty of 1% (without input tax credit) or 12.5% (with input tax credit) to be levied on articles of jewelry which will lead to additional 1% cost in the system.
Excise duty on branded readymade garments and made up articles of textiles of retail sale price of Rs.1,000 or more increased from Nil to 2% (without input tax credit) and 6%/12.5% to 12.5% (with input tax credit).
Also there seems to be some discrepancy of the budgeted vs recommended amount in the 7th pay commission which could dent the much anticipated consumer discretionary demand.
Private / public capex
Contrary to market expectations, there weren't any major incentives doled out to kick-start the capex cycle. Rather, the focus was on incremental improvements and reducing bottlenecks facing the corporate India.
Defense spending, which has been a key area of focus of the government, also saw a muted budget allocation with budget growth being restricted to 6% only.
Private corporate sector is ailing from bloated balance sheets - a result of underutilized and unproductive capacities. The government suitably addressed this by providing a legal framework for dispute resolution and renegotiations in PPP projects to ensure faster resolution and viability. Removal of DDT for INVITs encourages INVIT projects and opens avenue for alternate funding in the future. While private sector has to make do with reforms and structural improvements, new spending and capex at this stage is clearly the domain of the government with increased allocation to roads, railways, renewables and irrigation.
The allocation of road projects in 2016-2017 has been the highest ever. Budgetary allocation for roads is higher by Rs.150bn (compared to FY16 B.E.) to 550 bn. This will be apart from Rs.150bn bonds to be issued by NHAI. Including the Rs.270bn allocation for Pradhan Mantri Gram Sadak Yojana (PMGSY) the total allocation for the roads sector stands at record Rs.970bn versus around Rs.850bn for 2015-2016.
Another key proposal of the budget has been increase in clean environment cess by Rs.200 per ton. This will impact cost structure of already stressed power and metal companies.
Banking and Financial services
Lack of capital with public sector bank has been a key area of concern in the sector. The government announced a capital infusion figure of Rs.250bn for FY17 – significantly lower than the requirement of these banks. With just Rs.250bn given and limited ability of PSU banks to raise money from external sources, 'growth capital' is clearly a worry.
The ARC (Asset Reconstruction) industry today faces a massive challenge of capital shortage due to which it is unable to buy more and large assets/NPLs from banks. By increasing sponsor ownership from 50% to 100%, allowing non-institutional investor participation in security receipts, allowing 100% FDI in ARCs, the government has given a boost to this sector and thereby helped banks indirectly.
Dividend Distribution Tax – Resident Indians will need to pay 10% tax on dividend if the dividend amount exceeds 10 lakhs. This could impact dividend policy of the corporate sector in India. STT was left unchanged except for option where it increased from 0.017% to 0.50%. Uncertainty around GAAR was put to rest with government clarifying that implementation will be from April 1, 2017.
The budget on an overall basis, fell short of the growth rhetoric but definitely addressed and acknowledged the stress points prevalent in the Indian economy. The underpinning of the current budget is socialistic with higher revenue expenditure targeted primarily at Indian rural consumer. While higher allocation to the rural development schemes augurs well for rural consumer, marginally high service tax, infrastructure cess and other duty hikes will dent consumer demand in the more discretionary categories. Private sector was suitably handled by targeting structural problems in the sector such as early resolution of financial problems and alternate avenues of capital financing. Government of India continued with its spending in roads and railways. India is a work in progress story. The good part is all entities are consolidating (banks / corporate / consumer / government) and focusing on sustainable growth and profitability and not relentless pursuit of growth at any cost. The emergent India, in our view will be strong and resilient and will have sustainable growth for a long time to come.