Portfolios will divesify post Budget: Sukumar

The Union Budget was largely positive and a balancing act between political, social & economic factors. It has to be viewed in the context that in recent years most policy announcements have been made outside of the budget and that it is being increasingly used to announce revenue raising measures. As expected, the economic statements on GDP growth, reduced deficits & improved tax-to-GDP ratios were positive and reiterate the fact that the Indian economy is moving into a higher growth trajectory. However, one needs to keep in mind that oil companies bore the majority of the brunt of the high global oil prices and if one factors the same, the deficit numbers would be higher. 

While being silent on some of the key issues such as labour reforms, the Union Budget does move ahead on tax reforms. The proposed introduction of GST augurs well, as the worldwide experience has been that such a regime would broaden the tax base and also makes revenues less sensitive to economic cycles. This would also help the government in meeting its increased spending needs and its Fiscal Responsibility and Budget Management (FRBM) targets for the next year. 

Overall, the increased economic growth has lead to additional revenues for the government, helping it to raise funds for the various projects initiated last year. The government continues to focus on various social sector & infrastructure development programmes, which is a positive for the economy as a whole, as it would help in the benefits of economic growth percolating to all segments of the society. This in turn could help in bridging the socio-economic divide and boosting economic activity across the country.As always, implementation of policies and the various infrastructure projects will remain key to the eventual economic progress.

Equity markets

The markets have responded favorably to the Union Budget, with the BSE Sensex gaining over 0.86%, while the Nifty added 0.24% during the day. The Oil & Gas sector has been under pressure as there have been no specific announcements to alleviate the situation of downstream companies. The marginal increase in Securities Transaction Tax is unlikely to have an impact. The simplification of the overseas investment norms for mutual funds could lead to diversification of portfolios across currencies.

There have been no major changes on the direct tax front, which is a positive and indicates stability. Most of the concerns regarding the Fringe Benefit Tax have been addressed. The rationalization of the indirect tax structure brings duties towards the ASEAN levels, which is a positive. Taking into consideration these changes, the Union Budget could be seen as a positive for sectors such as autos (excise duty cut on small cars from 24% to 16%), cement & engineering (increased infrastructure spending and the focus on various projects) while being negative for oil & gas and petrochemicals (no clarity on funding the under-recoveries).

Corporate India has become more competitive with Return on Equity (ROE) amongst the highest in emerging markets and is expected to benefit from the increased domestic and overseas demand. The combination of gradual removal of structural barriers and sustained improvement in the economic environment is likely to lead to a significant amount of value being unlocked. In this regard, we believe that the infrastructure spending by the government will be a medium to long-term positive. Top Indian companies are increasingly benchmarking themselves against the best in the world and this should help them achieve higher standards in efficiency. Assuming a GDP growth of around 7 to 8%, we expect earnings growth to be in the range of 12 to 15% over the next 3-5 years. 

Debt Markets

The markets initially reacted positively to the announcements in the Union Budget initially, but given the tight liquidity, sentiment continues to cautious due to lack of any immediate positive triggers. The government's borrowing was broadly in line with expectations.  The yield on actively traded security, 8.07% 2017 moved up by 3 bps to 7.38%. 

Broadly, the Union Budget has made announcements that have implications for both systemic as well as secondary market liquidity. The latter should be helped by the decision to increase the FII investment limits in gilts and corporate bonds to $2 billion ($1.75 billion) & $1.5 billion ($0.5 billion) respectively. This should help in deepening the secondary market. With central & state governments sitting on cash, increased spending towards the various social and infrastructure projects may lead to improved systemic liquidity. On the other hand, the government's decision to convert the special securities issued to PSU banks into gilts would reduce the immediate demand.

The key positive for the debt markets has been the deficit numbers and the fact that after last year's pause to FRBM targets, the government is back on track towards reigning in deficit. Also sustained fiscal prudence could also lead lower than budgeted borrowings in FY 07, which would help the debt markets. Also extending the NDS-OM to mutual funds will help in improving the liquidity for the players. However, from a long term perspective we believe that the government has to address the requirement of a robust credit derivatives market which will help in improving price discovery and hedging of the credit risk.

Overall, the budget has been a non-event for the debt markets as liquidity conditions and concerns over interest rate direction have taken precedence. The economy is yet to experience the complete pass-through effect of the international crude oil prices and the possibility of demand-pull inflation given the indications of pickup in aggregate demand. On the other hand, credit offtake is expected to sustain a high growth rate. In such a scenario, we expect markets to trade in a range until liquidity improves and the direction of policy rates would depend on inflation levels and the yields would move in relation with news flows and fundamentals. Given the recent increase in yields, accrual income component of returns will go up.

The author is Sukumar Rajah, CIO - Equity, Franklin Templeton Mutual Fund.

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