The Union Budget managed to be a big disappointment and a big relief at the same time.

The government chose to stay in its safe zone and announced no big bang expenditure items in the budget. But that also meant there is no serious digression from the path of fiscal consolidation, and that came as a relief.

Most of the allocations were kept at the same level as announced in the interim budget in February. Rural markets got operational enhancements as the scope of existing schemes was increased and some initiatives were added to the existing flagship schemes.

The relaxed movement of fear gauge NSE India Volatility Index (India VIX) ahead of the Union Budget indicated that expectations weren't very high to start with. After minor spikes during the Budget speech, India VIX ended the day's session down 3.75% at extremely low levels of 13.

The blow to equity markets lies in the announcement of two things. The government increased the threshold of public shareholding in companies to 35% from the current 25%. Essentially, this would mean promoters will have to offload stake, which will bring in a deluge of stocks in the market. It is natural that this supply will worsen the price dynamics and dilute valuations. "For larger companies themselves, around 3 trillion to 4 trillion of equity will have to be sold in the market. But if a time-frame of three years is given, this much supply of stock is manageable, it will be absorbed," said Ratnesh Kumar, MD & CEO, BOB Capital Markets Ltd. Another sentiment dampener came in the form of higher taxes on the super rich, through an enhanced surcharge. Investors with fat pockets would now find their disposable income to invest reduced.

Then there was the withdrawal of a tax exemption on buyback of shares for listed companies. While this was largely a loophole fixed, nevertheless investors of companies that wish to buy back their shares will now have to contend with lesser realisations.

To be fair, the budget announced several reforms that are salutary in the medium to long term. Aware of the constraints in the domestic economy, the budget has resorted to attracting foreign capital by relaxing foreign direct investment policy and even willing to borrow from foreign shores to fund its own deficit. Incentives to increase the production and use of electric vehicles and freeing up land owned by public firms for housing were other such measures.

Also, the 70,000 crore capital infusion for public sector banks is expected to prod lenders to disburse credit more freely to an economy in need for it. The government is willing to take on the first loss in the securitized loan pools of non-bank finance companies whenever these are bought by the banks it owns. That means non-bank lenders will get the much needed money to put their finances in order and also lend.

But there is no short-term boost that would kindle the animal spirits of the economy so that investment grows. This means that growth would largely remain modest in the current year, rural demand would depend on the monsoon and the burden of healing the economy now falls on monetary policy.

To be fair, Sitharaman can hardly fling cash to the economy with both hands tied by fiscal frugality. Therefore, markets are willing to take the absence of a stimulus in stride given the commitment to fiscal discipline. The budget lowered the fiscal deficit target to 3.3% of gross domestic product (GDP) from 3.4% stated just four months back in the interim budget.

This is the biggest relief from the budget. Bond yields dropped over 10 basis points intraday, cheering the lowered fiscal deficit and the indication that the government is willing to borrow from foreign shores given the constraints in the domestic market. Given the dollar inflows this could bring, the rupee too gained. “The fact that the government will now be seeking external funds for sovereign needs reflects a fundamental shift in the budgeting process and in the budgeting philosophy in our view," said Abheek Barua, chief economist at HDFC Bank.

While there was initial excitement about the proposal on sovereign dollar bonds, this was later viewed with more scepticism. To be sure, borrowing offshore would mean the government will end up taking the exchange rate risk on its balance sheet. Given that this additional source of funds would incentivize loosening fiscal deficit, the risk of being exposed to currency fluctuations seems like a big price to pay. Also, this would mean that bond investors will have the option to buy abroad, essentially taking away some liquidity and depth from the domestic bond market.

To be sure, not many are buying the lowered fiscal deficit number, given that off-balance sheet borrowing has been high and is not addressed. The reliance on national small savings schemes is immense as is on divestment and dividends from public enterprises. The government’s assumptions on revenues are not that kosher either. “The budget numbers highlight the government’s intent in fiscal consolidation. Downside risks to GST and direct taxes are still there, though there is adequate scope for the government to reduce expenditure on certain items to stick to the fiscal consolidation path," said Suvodeep Rakshit, senior economist at Kotak Securities. The fact that bonds gave up most of their intraday gains shows this distrust on fiscal deficit.

The divestment target has been raised to 1.05 trillion from 90,000 crore in the interim budget, which should be met given some of the relaxation the government has proposed in defining its total ownership. The dividend from public sector enterprises including Reserve Bank of India is expected to be 11% higher than last year.

With the budget keeping to its limitations on giving the economy an impetus, the burden now falls on the monetary policy. Policy watchers now expect the RBI to cut the repo rate by 50 basis points as inflation is expected to remain within the central bank’s comfort zone. “Since the government has adhered to fiscal discipline, it gives enough headroom for the RBI to ease policy rates by 50 bps or more in the remaining FY20," said Manish Gunwani, CIO – Equity Investments, Reliance Nippon Life Asset Management Ltd.

The government’s efforts to give room for the private sector to borrow from the market by keeping its own deficit under check should be appreciated. Only time will tell whether playing safe would ensure the much needed sustained economic growth or whether loosening its purses would have been better.



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