Will we see REITs finally take off in FY18?

Suhas HarinarayananThis is the first time in Independent India that the Railway and the Union Budgets are being rolled into one. It has been long overdue as the Railway Budget has lost its eminence over the years and other than a cursory glance at the freight rates where no further tweaking is anticipated or a likely announcement of the railway regulator, all eyes are fixed primarily on the Union Budget.This year's Union Budget exercise has been made doubly difficult by a) the disruption caused by demonetization on both growth and in assessing the tax-to-GDP ratios and b) likely disruption on growth and tax collections that could be caused by the implementation of GST during early part of FY18. As a result, setting targets for various important metrics are compounded by the difficulties in calculating the GDP itself. Even the CSO (Central Statistics Office) has admitted difficulty in estimating the impact of demonetization on the GDP, leave alone the teams of analysts attempting the same. Based on the current trends that we are seeing in the December 2016 quarterly results, it does appear that the impact was probably overestimated in a few sectors, correctly estimated in a few and under-estimated in only a very few.Getting back to the Budget itself, assuming we have a reasonable estimate of GDP, over the years investors have keenly looked at the Budget for a few data points that are crucial to their decision-making, be it the equities, fixed income or the currency markets. The most significant data point, typically, is the fiscal deficit. While the FY17 target of 3.54 percent could be met with some finesse because of the excise duty bounty at hand and the late contributions from the Central Public Sector Enterprise (CPSE) Exchange Traded Funds (ETFs), setting the target for FY18 is even more important. We believe that the government has to print a number, lower than the FY17 target, in order to satisfy the wider audience including the rating agencies. Along with this measure, we expect the government to present a roadmap to adhere to 3 percent target by 2019, as per the Fiscal Responsibility and Budget Management Act (FRBM).Embedded into this number would be a few assumptions regarding impact of demonetisation, the expected revenues under Income Disclosure Scheme -2 (IDS-2) and the GDP growth estimates. Receipts from IDS-2 will be determined not only by the percentage of unaccounted income of the total deposited cash post demonetisation but also more importantly by the penalty rate on this income. Given the overriding need to print numbers that are palatable for the wider audience, we reckon that the ability of the government to spend its way to growth could be low unless there are surprises on income collections as the spending tends to be more fixed in nature. As a result, we expect spending to be directed towards only select, focused segments such as rural sector and roads. The government has already announced various measures on December 31, 2016 that primarily benefit rural India and we should have more numbers on those.And in order to meet the macro numbers, the principal objectives of the government would be to enhance revenue, revive investment and persist with the reforms on subsidy, this time possibly by extending the Direct Benefit Transfer (DBT) on fertilisers. Let us take up investments first.One of the areas that the government can target to revive investment would be the real estate sector. Real estate investment trusts (REITs) can help recycle almost USD 50 billion (2.5 percent of GDP) and given the low yields across asset classes, a final clarification of the tax pass through for dividends received by the REIT controlled holding companies from the special purpose vehicles (SPVs) holding the assets can lead to launching the country’s first REIT in FY18. Power sector is another sector that is critical for investment revival but continues to go through its share of stress. Hence, extension of the 80IA tax benefits that expires on 31 March 2017 is important for the sector including for renewables which is the only segment within power generation that witnessed investments. Extension of accelerated depreciation for wind assets is also important as that is set to expire in FY17.From a revenue collection standpoint, while there are talks about an overall reduction in corporate tax rates and some personal tax reforms, a roadmap for the same can be something that the government should work towards including setting the final time-table and clarifying on the rate structure under GST. Of the three favoured items for revenue augmentation – excise duty on fuel, service tax, and excise duty on cigarettes --we expect the last two could tend higher. While the GST Council has not clarified on the rate at which GST would be levied on services, given the dual standard rate structure (12 percent and 18 percent), there is a higher probability of services being subjected to a tax rate of 18 percent.There are many more "wish-lists" that individuals and corporates would like to pass onto the government as the government gets an opportunity to play Santa. But there no is doubting the fact that this is one of the toughest years to be making a budget given that the first task in the preparation itself is so difficult to get an answer to - What is the GDP in FY18? Maybe the government could seriously think of moving the financial year for FY18 from the date that GST becomes applicable!(Author is Suhas Harinarayanan, Head-Institutional Equities Research, JM Financial Institutional Securities)