4 min read.Updated: 07 Mar 2016, 09:27 PM ISTNilesh Shah
One aspect of fiscal discipline is that the government's net borrowing programme is lower than last year's by `15,000 crore, giving more funds for private sector investment
The Budget came in the backdrop of weak global environment, pressure of non-performing assets (NPAs) in the Indian banking system and lower nominal gross domestic product (GDP) growth. Finance minister Arun Jaitley honoured his commitment to fiscal discipline and debt market gave a 20-basis point salute and equity markets gave a 1,500-point salute to the Budget. (One basis point is one-hundredth of a percentage point.)
The commitment to fiscal discipline brings multiple benefits. The Reserve Bank of India (RBI) can now cut interest rates further. Inflationary expectations will remain muted, which will allow lower rates to persist for a longer period of time. Global rating agencies can also upgrade India’s rating if we negotiate well with them.
One aspect of fiscal discipline is that the government’s net borrowing programme is lower than last year’s by 15,000 crore, giving more funds for private sector investment. Foreign institutional investors (FIIs) in both debt and equity markets, having been assured, have turned from being sellers to buyers, and are likely to be this way in calendar year 2016. Between 2003 and 2008, the Sensex multiplied seven times as valuations got re-rated on the back of reduction in fiscal deficit. This cycle can be replayed, albeit on a smaller scale, which would provide support while corporate earnings recover.
The rally in the debt market, despite tight liquidity, has given a mark-to-market gain of 40,000 crore to the banking system. This is much more than the 25,000 crore recapitalisation provided in the Budget. An enabling environment will help banks tackle the issues of NPAs far better than receiving capital from the government.
The Budget has also underestimated the tax revenue growth that may happen due to a pick-up in the economy, higher collection in the income disclosure scheme or if the fast track dispute settlement mechanism takes off. Non-tax receipts’ estimate, however, looks challenging, especially the ones related to spectrum receipts and divestment. We have never achieved divestment targets in the past, including during a bull market.
To be able to achieve its divestment targets, the government must explore the strategic divestment route. The Budget has provided for asset sales by public sector units, which could be a game changer. Many foreign companies are not interested in setting up projects in India but would be keen on buying existing or running projects. In these times of negative interest rates in most parts of the world, the government can easily raise more than its divestment target by selling a few running power or road assets.
To adhere to fiscal discipline, the Budget has also proposed some steps to improve productivity of government spending. If executed well, such steps can make a materially positive impact on growth.
One such step is the proposed statutory backing to use Aadhaar card. While it’s not mandatory to have Aadhaar to avail government benefits, including subsidies, with statutory backing for it, direct cash transfer regime can be introduced for subsidy payment. This can help India get rid of many of its legacy issues.
The finance minister also spoke of an electronic platform for centralising procurement. A transparent mechanism like this can lower the cost of procurement by a big margin.
There was also a proposal to have a transaction tax on cash transactions above certain values, which will help integrate the parallel economy.
Apart from fiscal discipline, there was also a big push to increase government investment in road and rail infrastructure by allocating around 2.18 trillion in this direction. If entrepreneurs can be supported with ease of doing business, better liquidity and lower interest rates, private investment can revive and work along with the government’s thrust on road and railway sectors.
The rural sector is another area that is under stress due to two successive below-average monsoons. The Budget has rightly allocated a significant amount of money for completion of last-mile funding of 23 major irrigation works and shifting focus on water conservancy through the Mahatma Gandhi National Rural Employment Guarantee Act (MGNREGA). The rural economy can give a boost to the overall economy as monsoon this year is expected to be good courtesy La Niña. This will in turn generate a self-fuelling growth momentum and create an income multiplier effect, not only in the rural sector but also for the mainline economy.
With declining interest rates, possible passage of key reform bills such as bankruptcy code (and also Goods and Services Tax), and a strong infrastructure push, one can expect good times ahead.
So, which asset classes are likely to benefit from this? Both debt and equity will do better in 2016 than they did in 2015. Investors are recommended to consider duration funds like gilt and bond funds on the back of potential rate cuts as well as credit accrual funds, despite the recent downgrades in the debt segment. Large-cap and multi-cap funds in the equity segment should do well in 2016. While stock picking will continue to give an edge, non-leveraged construction sector, consumer durables, select consumer staples, automobiles, non-banking financial companies (NBFCs) and private sector banks should do well. Rural economy related sectors will provide a superior outperformance based on a good monsoon.
While a lump sum investment is fine for debt funds, systematic investments may work better for equity funds.
In Mahabharata, it is mentioned that sometimes one good thing of a person covers 99 bad things. This Budget has many good things but the one on fiscal prudence has the capacity to cover all the pains of the global as well the domestic economy. This will then usher in achhe din for investors in debt as well as equity markets.