Thursday, 2 February 2017

Union Finance Budget Financial Year 2018 Review

With the Indian economy developing, we have moved from a tilt towards a command and control economy to a more market determined economy. Consequently, it is only natural for Union Finance Budget’s to increasingly loose prominence and impact. In developing a competitive and free market based economy, government has had to make policy announcements throughout the financial year, to flexibly and effectively respond to challenges that arise. In that sense the budget as a document signifies policy direction.

In terms of policy direction, the current budget provides continuity and steps away from a tax and spend economic approach that is known to fail world-wide. The simple reason why tax and spend doesn’t work is that government is a fairly inefficient allocator of resources, when compared to free market forces.

From a macro perspective
  • The budget is based on an assumed nominal GDP growth of 11.75%. Total expenditure for FY18 is expected at 12.74% of GDP versus 13.36% of GDP as per FY17 estimates.
  • Tax revenues are expected to grow 12.23% based on a steep increase of ~25% in income tax collections. The assumption is questionable considering the budget has no provisions for expanding the tax base and that this increase comes on a base of a 22.7% increase expected in FY17. In addition corporate tax collections are expected to grow only 9.07% while excise duty collections are expected to grow only 5.04%.Customs collection growth is expected at 12.9% year on year, a tough ask in a slow growing and protectionist world environment.
  • Divestment target involves capital receipts of 72,500 crs versus assumption of 45,500 crs in FY17.Most of this is expected to be done through ETF’s. Divestment of government owned insurance companies seems necessary to meet the targeted amount.
  • On the expenditure side, revenue expenditure is expected to grow only 5.9% year on year, while capital expenditure is expected is expected to grow only 10.7% year on year. These proposals mean a fall in share of both expenditures as a percentage of nominal GDP. This is especially significant as world-wide governments are pushing capital expenditure to revive economic growth, while the budget envisages a falling effective spending on the capital account (after adjusting for nominal growth). 

In specific proposals the budget has taken positive steps in the direction of declared policy approach of the government.                                                              
  • In rural areas, the focus continues for more effective spending, through greater focus on creating capital assets like ponds, roads etc. The efforts though seem inadequate when one considers  expected agriculture growth of only 4% in FY17 on top of  a low base of FY16 and FY15( both being years of inadequate monsoons coupled with some natural disasters). The MNREGA scheme allocation itself is flattish year on year.
  • The total expenditure on infrastructure is envisaged to grow by 9.1% over FY17 budget proposals, a clear de growth as a percentage of nominal GDP. However the proposal for streamlining of dispute resolution in infrastructure related contracts is a step in the right direction to expedite completion of contracts and build up.
  • For the financial sector, the budget focus on encouraging digital transaction is a step in the right direction.
  • Direct tax proposals though were mystifying as pointed earlier with the budget taxing, existing large tax payers more while doing nothing to tax the rich in exempt categories like agriculture to increase the tax base.
  • Lowering of property classification of long term to 2 years is a step in the right direction, but is unlikely to cause a rush at builder’s offices, in a clearly weak demand environment. Even the assumed demand for affordable housing is questionable with much of the government stock in the category finding no takers.
  • Capital allocation for recapitalising banks seemed clearly inadequate, in face of increasing NPA’s of the banking system.
  • The non-imposition of any long term tax on equity investments or cash / banking transactions as was rumoured pre budget, clearly helped market sentiment post budget.
  • The proposals to clean political funding is a step in the right direction with the budget reducing allowable cash donations to Rs2000 per person, while enabling a method  of larger donations through electoral bonds. Compulsory filing of returns by political parties also helps in creation of transparency.
  • The update on the Goods and Service Tax efforts in the budget also points to a consistent policy direction.

In conclusion, the union finance budget was good as it didn’t propose drastic changes in government policy direction, thus generating trust in the stability and transparency of such policy.

Impact on your portfolio

Forex: The economic survey before the budget pointed out that the rupee was overvalued by 8% to 10% against some Asian counterparts, indicating to a possible depreciation in the near term.This has implications in terms of higher inflation (in turn impacting interest rates) and forex exposure of corporates (in form of revenues or debt).

The equity markets celebrated post budget as they were relieved at not being at the receiving end of any adverse tax proposals, after the prime minister had earlier hinted that they should contribute more to national development. However the celebration seems premature considering that the markets had already rallied from lower levels expecting lowering of corporate tax and other such favourable proposals, which didn’t materialise (for the listed space). In addition the market has completely ignored the adverse world-wide economic milieu in which companies are operating. Heavily leveraged balance sheets and margin pressures due to surplus capacity are other unresolved problems the markets are ignoring.

With corporate tax rates in  the USA being proposed to be brought down to  20% or below as promised by the new republican administration and expected rupee depreciation ,it will not be surprising to see FII’s( who own ~40% of floating stock) selling into the Indian markets to avoid mark down of their investments.

Zara Investment Advisory looks forward to capitalise on opportunities that are created by the above possible events causing market volatility.

Here’s wishing you and your family, prosperity and health in the year ahead  

In your service

Dinesh da Costa, CFA                                                                                 2nd February 2017
Principal Officer & Investment adviser
Zara Investment Advisory
Phone:(0832)2268252,Mobile: 9822280576

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