India’s stock market investors loved the budget, simply because the finance minister didn’t do the one thing they feared the most—tax capital gains on equities. In the process, they shrugged off the fact that the expected cut in tax rates for companies was limited to small firms with a turnover of less than Rs50 crore.
But at the end of the day, it’s important to note that the budget is a mere sideshow. What’s far more important is to see how far the new US president takes his protectionist measures. The markets are astonishingly calm about the uncertainties of Donald Trump’s policies, and Wednesday’s rally suggests complacency is on the rise.
Does the budget do enough to strengthen the country’s defences against the expected turmoil? Not quite; although there are some steps worth noting. The government has budgeted for a fiscal deficit of 3.2% of gross domestic product (GDP) in fiscal 2018, lower than Street expectations. But this is largely because it plans to contain expenditure at more or less this year’s levels.
The budget speech stated that the budgeted expenditure on infrastructure has been increased by 25%, and market experts cheered this, especially since private spending on infrastructure is poor. But note that expenditure on infrastructure will rise only 10.7% when compared with the actual spend this year. The 25% rise being spoken about is against this year’s budgeted amount, which is irrelevant.
Also, in the current fiscal, with oil prices being much lower on an average, excise duties on petroleum products were raised, and it resulted in a windfall for the government. It remains to be seen if excise receipts from the sale of petroleum products will be the same this year; much depends on how oil prices move.
Also note that net receipts in small savings schemes are estimated to have soared to Rs9,0376 crore this fiscal year, from Rs52,465 crore in FY16. And an even higher amount of Rs1,00,157 crore has been budgeted for FY18. Small savings are in vogue when interest rates on fixed deposits are falling, and collections may well be high, although it’s not clear if the highs of this year may be revisited. Even so, the interest burden for the government is higher in small savings schemes, and the rise in its share of government financing is hardly welcome.
Bond market investors had their share of questions about the fiscal maths as well. When the finance minister first announced that net borrowing for the year will be Rs3.48 trillion, yields fell. But later in the day they rose when investors realized that the gross borrowing figure was the same as last year’s at Rs5.8 trillion.
The finance minister did well, however, to allay concerns of foreign portfolio investors regarding a circular that had caused a fair amount of confusion in December. But, on the other hand, the government has decided to tax long-term gains on equities which were acquired after 1 October 2004 without paying securities transaction tax. This can hit investors of unlisted companies and cause needless friction for some classes of investors.
The decision to contain the fiscal deficit at 3.2% and not opt for a large fiscal stimulus is laudable, and will be appreciated, especially by overseas investors. Note that the headline Nikkei India Manufacturing Purchasing Managers’ Index was up from 49.6 to 50.4 in January, and in this backdrop, a large fiscal stimulus would have been imprudent. If government borrowing can indeed be contained at less than Rs3.5 trillion, yields can be expected to fall over time and lead to lower interest rates.
“We grow more confident of our call that the Union budget will support lower lending rates. We expect RBI to cut policy rates by 25 basis points with the finance minister pursuing fiscal consolidation. On balance, we expect banks to cut average lending rates by 5-75 basis points by September,” analysts at Bank of America Merrill Lynch said in a note to clients.
The budget also included sops for some sectors such as banks, housing and rural infrastructure. This in turn can help sectors that depend on rural consumption such as consumer goods and cement.
But all told, there wasn’t anything dramatic in the budget for markets to be overly excited about. As pointed earlier, the focus will now shift back to global developments.