This was one of the toughest backdrops in recent years for a Finance Minister to present the Budget.
With a severe growth slowdown arguably requiring a strong fiscal response on one hand and with sluggish revenue collections constraining government's fiscal on the other, the challenge was evident.
Consequently, the Finance Minister ended up using the FRBM deviation of 50bps on fiscal deficit for both the current and the next year. Overall, the government appears to have chosen to consolidate on the reforms of the past few years.
The Budget continued with the thrust on infrastructure, agri and rural economy, social welfare, improvement in ease of living, simplification on taxes and leveraging technology for better governance. Import substitution was another thrust area. It was also heartening to see the focus on sustainability through measures on environment and climate change. Similarly, the continued focus on cooperative federalism is positive.
The government has sought to keep capital expenditure growth high to support the economy. While the total expenditure is budgeted to grow at 12.7 percent in FY21, capex is budgeted to increase by 18 percent, higher than the 13 percent growth in the FY20.
The revenue receipts are slated to grow by 9 percent in FY21. Gross tax revenues are expected to grow by 12 percent in FY21, higher than the 4 percent growth in the previous year, on expectations of higher buoyancy and better compliance.
The divestment target at Rs 2.1 trillion while ambitious will need support from strategic sales including the proposed LIC of India IPO. The latter is indeed a bold move as is the intent on IDBI stake sale. More could have been done for the real estate sector beyond increasing the window of tax exemptions by a year given its employment generation potential and the multiplier impact it has on the economy.
At a time when RBI has stayed accommodative by cutting rates and keeping liquidity ample, the ground level feedback points to continued liquidity tightness.
While NBFCs and PSU banks having significantly slowed on lending and private banks staying very selective has played a role, the tightness in real estate market has been a major driver through reduced money circulation.
Addressing issues in the real estate sector are vital to address this macro and micro level disconnect and in turn help revive loan growth. Hopefully, the government will pay attention to the needs of the sector going forward.
As expected, the government's thrust on the infrastructure sector continued. While the Rs 100 trillion outlay is a good start, we need to find sustainable ways of funding infra in the country. Both private sector capex and the public-private-partnership model on infra has faced challenges.
In this context, full tax exemption to Sovereign Wealth Funds for investments in Infrastructure and other notified sectors along with a single investment clearance window were significant positives.
Overall, the focus on expenditure must shift from outlay to outcome. There is a huge scope for rationalization on subsidies. Oil is a classic example. As recent as in FY13, petroleum subsidy outlay was ~Rs. 1 trillion which has been rationalized to nearly one third. On the other hand, the excise collection on fuel has increased to ~ Rs. 2.1 trillion.
At the same time, LPG penetration has improved substantially and at a much lower cost. Similarly, we need to rationalize other subsidies most notably food and fertilizer which stand at a massive Rs 2.6 trillion already.
With schemes like PM-KISAN already operative, providing direct benefit to farmers and the poorest may be a smarter alternative to these subsidies.
The new regime on personal taxes with a choice of lower rates but without exemptions, while aimed at boosting consumption has negative implications for savings.
Over time as resources become available, tax rates must be reduced further as history suggests that Laffer curve should work and ensure better collections. Companies have been exempted from paying Dividend Distribution Tax, while dividends will be taxed at an individual level.
Most importantly, the tax regime needs predictability. Renewed commitment on strategic divestments and asset monetization is welcome. Finally, to rev up revenues, we must get growth and tax buoyancy back. Tax-to-GDP ratio hasn’t improved in last 10-years, hence, government expenditure as percent of GDP has fallen from 16 percent in FY10 to 13 percent now.
This points to the need for an immediate growth revival to bring back tax buoyancy and hence muster enough resources to continue with the distribution agenda around social causes.
Similarly, we have now reached a tricky situation where the gap between interest rates and nominal economic growth has shrunk substantially.
This means that the growth in output is barely enough to meet the cost of servicing debt. This, if allowed to persist, will undo the efforts of last several years on deleveraging and stall the improvement in debt ratios.
Bottom line is that growth needs to be revived at any cost. With an intent to deepen the corporate bond market, the FPI limit has been raised to 15 percent from 9 percent currently.
Given the new normal in the banking system, promoting alternative sources of funding such as the bond market, securitization market and alternative funds market is vital. The RBI, even as it may not have space on rates, must play its part too through bold and creative steps to bring down spreads. Bond yields should stay rangebound with a slight upward bias.
Even as rising inflation and higher government borrowing are concerning, we expect the RBI to stay accommodative given the output gap. The accommodation may not take the shape of direct rate cuts but could be on the lines of the recent Operation Twist.
Overall, while inflation and the fiscal-savings dynamic should keep a floor on yields, RBI’s monetary accommodation and global environment should provide a ceiling. On equities, in the absence of market-friendly measures in the budget and given the cautious global environment owing to the spread of Coronavirus, markets could stay volatile in the near-term.
However, eventually, markets should move back to focusing on corporate earnings. In our view, significant easing in financial conditions, both locally and globally, improving prospects for the rural economy given an increase in food prices and better acreage, and the various measures taken by the government so far should bring about an improvement in both economic activity and corporate earnings going forward.
The equity market rally became broad-based in January. Small caps significantly outperformed large caps with the Nifty Small Cap 100 rising 6.7 percent for the month versus a 1.7 percent fall in the Nifty. Similarly, Nifty Mid Cap 100 rose 5.3 percent outperforming the Nifty by 7 percent.
This is in line with our view of the past few months- the extreme polarization that the market had witnessed in favour of selective large caps should continue to reverse as a revival in economic activity and corporate profits materializes going ahead.
Overall, the union budget is an important event that everyone keenly watches. However, one must not lose sight of the fact that total expenditure by states is nearly 40 percent higher than the Centre. Moreover, on capital expenditure, states are nearly twice the Centre. Businesses must do their bit as well.
Eventually, all stakeholders need to rise to the occasion in making sure we reach our potential as a country. A decade ago, following a period of strong growth, most global pundits had predicted 10 percent real GDP growth for India on a sustainable basis.
And at 4-5 percent growth now, problems appear aplenty but given our favourable demographics and with the significant reforms of the past few years such as GST, Insolvency code, and the thrust on formalization and digitalization of the economy, we have a solid framework to build on.
We are the last bastion of high growth for the world in foreseeable future and must not lose sight of this aspiration.
The government should continue supporting by reducing friction whether it is through administrative and judicial reforms or using technology for better governance and last-mile delivery, or simplification on taxes. The focus must be on execution, execution and execution, and the $5 trillion goal shall transform from an aspiration into reality.(The author is Chief Investment Officer– SBI Funds Management Private Limited)