Macro-policies’ impact on debt and equity investments
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If the Union Budget of 2017 and the latest monetary policy, of February, are any indication, investors should continue to invest in financial assets, both equity and debt. The Budget was a good follow-up to the previous three Budgets, and it encourages a strong macro-environment, which is reassuring for financial assets.
The Budget laid emphasis on controlling the current account deficit, keeping a low fiscal deficit and restraining inflation. These are key ingredients for economic development, which in turn creates a perfect environment for the growth of financial assets.
Impact of the budget
The Budget’s corporate, excise and other revenue numbers tally up; and are reasonable and achievable. Individual tax collection projections may seem high, but this has been done after reasonable deliberations and number crunching, hence it will be fair to assume that the government will collect the 25% increase in direct taxes.
There are no changes to indirect taxes, which signals the government’s strong intention to implement the Goods and Services Tax. There may be hiccups in the implementation process, but I believe those will be overcome too.
The Budget has adhered to the path of fiscal prudence. The need of the hour is to direct more resources towards infrastructure spending and that has been done. Fiscal deficit has been pegged at 3.2%, as was expected for the financial year 2017-18, which leaves room for infrastructure spending.
Budgetary allocations to sectors like agriculture, rural development, roads and railways, will have a multiplier effect on economic growth. Overall, provisions of over Rs3.96 lakh crore have been made for creating and upgrading infrastructure. Railways, too, get their allocations of Rs1.31 lakh crore, which keeps the wheels of the economy chugging well.
Income tax was reduced in the lowest tax bracket and this will increase savings in the hands of people. Some of those savings will further flow into financial assets, thus creating a virtuous cycle of economic development.
On the flip side, physical assets are seeing a rationalization in tax structure. For example, the Budget capped tax benefits for interest paid on real estate properties, which reduces the incentive to invest in real estate.
The demand for real estate is expected to remain low because of the changes in tax structure, which in turn will keep the credit growth subdued.
Gold has not delivered returns over the past 3 years. Usually, the dollar’s strength against the Indian rupee drives its returns.
However, with India’s current account deficit under control, which is one of the factors contributing to the rupee-dollar disparity, the rupee will likely remain well-behaved going forward. This does not make gold an attractive asset class, and hence more investors will look at financial assets.
Therefore, equity markets continue to look good and should attract more investors. Equity valuations may have expanded in the past few months, but with the thrust of the Budget towards creation of economic assets that will assist development, the expansion of the market’s price-earnings ratios will continue on the higher side.
Overall, the Budget has given a fillip to many sectors, but it is infrastructure that holds a lot of promise. Budgetary allocations to this sector will drive the sector in the coming months and years. This sector remained under-invested in the past because of issues such as projects not taking off, over-leveraging and high interest rates.
However, now the sector seems to be on the cusp of new growth as much of the negatives are behind it. The sector is in a sweet spot of low valuations and attractive opportunities, which are key triggers for it to do well.
Another theme with inexpensive valuations is technology, although the reasons for low performance here are overseas factors. The low valuations present an opportunity for decent risk-adjusted returns.
Effect of the monetary policy
Debt, too, has turned attractive. The monetary policy turned market sentiments bearish with respect to fixed income, as the monetary policy has taken a tough stance on inflation.
The debt market, before the policy, seemed to be getting into an overheated situation, which is typical of late cycles. But now the policy has pushed the debt market to the mid-cycle, which is similar to a moderate growth phase, making fixed income a relatively safer asset class.
The policymakers have stopped short of using stimulation measures such as lowering inflation, expanding fiscal deficit and depreciating the currency.
The monetary policy also tightened the monetary conditions. The currency is relatively stable and appreciating, which means that exports can remain tight. The fiscal deficit will be lower than last year with a mere 6% increase in expenditures.
The Reserve Bank of India’s change in stance from ‘accommodative’ to ‘neutral’ has seen a rise in yields, which has made fixed income attractive again.
Had the policymakers decided to stimulate the economy by increasing fiscal deficit or by reducing the interest rates, it would potentially mean close to an end of this rate-cut cycle.
Hence, the current scenario in the debt market is likely to be a pleasant experience for debt investors. The short- and medium-duration funds are attractive and can offer better risk-adjusted returns.
Nimesh Shah is managing director and chief executive officer, ICICI Prudential Asset Management Co. Ltd.