Govt likely to propose wider fiscal deficit target for FY19; 5 sectors for wealth creation

There are a couple of things that the government would strive to achieve. One is on the subsidy side, they have stated goal of bringing subsidy to zero as a percentage of GDP. That is something that would possibly continue going forward as well.

Despite the volatility that we have seen in oil prices, the clear trend would be to bring down the subsidy burden. That is one positive from a Budget perspective.

Secondly, in terms of revenue collections. While it is still too early to comment about how GST is panning out some initial numbers fail to provide the true picture, but overall if you look at tax collections, they are so far so good.

Once we get a little bit more clarity in terms of GST collections and as the number of people filing returns going up, possibly there will be some degree of stability coming on the revenue side as well.

Overall, the Budget will be something that will continue to strive towards fiscal consolidation. However, the path that they had outlined in terms of having a fiscal deficit at 3 percent of GDP for FY19, that may see some little bit of deviation.

Q) Will that be on the higher side?

A) It might be slightly on the higher side, but it would not be a significant deviation from the 3 percent target. The overall message would still be fiscal consolidation. There might be a little bit of a deviation here and there depending upon how GST collections pan out over the next few months and the focus on subsidy reforms will continue.

And on the expenditure side, there will be a push towards public capex and so capital expenditure and hopefully roads will be a significant area of focus for them, rural infrastructure, rural spend.

If there is a clear trend shift in terms of how the expenditure split is moving away from revenue towards the capital, even if there is a slight deviation on the fiscal deficit front away from the 3 percent, it would be a positive overall from an economic perspective.

Q) What would you have done if you were the Finance Minister?

A) Overall, the government has done a fairly good job so far. Like I said, there may be a little bit of a deviation here and there. The government needs to focus more on the expenditure – which in other words means that whatever you are doing is productive in nature.

The government should keep a very tight control on the revenue side and ensure that the expenditure focus now shifts towards the capital expenditure.

Overall, if you look at the revenue side, so far we are tracking fairly okay and disinvestment receipts also have been tracking well and possibly will meet the Budget numbers.

If we look at the fiscal perspective, a minor slippage here and there is possibly acceptable in this current scenario. Also remember, we have gone through two large events i.e. demonetisation and GST, both of which have significantly taken or at least taken a toll in terms of how the GDP growth trajectory was progressing.

In this scenario, having a slightly expansionary fiscal policy need not necessarily be a bad thing for an economy such as ours. Clearly, the focus of the government should be on the continuation of reforms irrespective of the election calendar.

The focus should also be on to clean up the banking system and bring about a resolution to the banking system stress as fast as possible. The recapitalisation scheme clearly is a good thing.

Providing budgetary support to PSU banks would have been difficult and whatever little bit of budgetary support is being provided has been done.

On the tax front, the focus should be on increasing tax compliance rather than do something on rates. Rates clearly, we are fine in terms of how rates are.

Q) In terms of corporate tax or GST?

A) GST. Essentially, the focus should be on increasing the tax-to-GDP ratio and that can come about only through improvement in compliance, not so much by tinkering with rates or making rates higher.

That does not really serve the purpose and is counterproductive in nature. I think you need to do things along the line to ensure that more and more people come into the tax net and therefore, the tax compliance improves

The government has to take the role of spurring investment growth and bringing GDP back towards that 7-7.5 percent kind of trajectory.

And, a minor shortfall in terms of fiscal deficit is something that one should not be really worried about at this point in time given how we are on the overall economy and the construct of the economy.

Q) Linking to this question, when do you see private capex coming back?

A) We are still a little time away from private capex coming back in a big way. There are two parts to this story. One is, of course, the demand and the other is the ability of the banking system to fund such capex.

So to answer the second part first, the banking system is still reeling under a significant amount of stress on their balance sheet while incremental stress is not as high as what it was a year or two back but the quantum of stress is very large.

The appetite of the banks to lend is still fairly reduced. On the demand side, corporates are also facing leveraged balance sheet which reduces their ability or the appetite to put up fresh projects or fresh new capex.

Therefore, the revival on the private sector side is still some time away. The onus is on the government to bring back investment growth. If you look at data on GDP for the last three years we saw that investments and public capex are clearly dragging growth. Therefore, for investment growth to come back, the government needs to spend.

Q) We saw a 29 percent year-to-date return in 2017, so how is 2018 looking?

A) If you look at from an equity market perspective, structurally we continue to remain positive on the markets. It is very difficult to pencil in a number at this point in time.

There are three things that the market would look at in the year 2018.

One is corporate earnings revival. The last quarter was something that was a pleasant surprise. After a fairly long period of time, you saw a double-digit earnings growth at the index level and the biggest positive for me.

The pace of earnings downgrade has also now started to slow down and if you look at the companies which have reported largely in line with the expectations, very few which really disappointed.

Remember, this is coming off a quarter which was fairly turbulent because of GST implementation. If you look at the earnings growth trajectory, clearly Q2 sets the base for earnings growth to improve from here on.

Second, the Street would also look at the reform agenda. The government has clearly shown that irrespective of political compulsions, they will push ahead with the reform process and there is no stopping there.

Be it in terms of GST implementation, be it in terms of ensuring that subsidy burden gets reduced, all of that is being taken care of and the reform agenda is being pushed forward.

From a macro construct, we are in a situation where GDP growth is possibly bottoming and from hereon, on a quarterly basis, you will start seeing improvement in GDP growth.

The economy will bottom out and show signs of revival and that coupled with corporate earnings improving should be driving the market going forward.

However, one has to be mindful of valuations. Valuations so far, have seen multiple rerating without earnings growth catching up. Now, we will be a situation where there will not be a significant multiple re-rating of the market,

But, it will be more of earnings growth driving the market from here on. So you will have a situation where the return on equity (ROE) expansion will start to improve for the market and therefore, the difference between ROE and cost of equity widening will support valuations rather than just the multiple rerating happening for the market.

Q) So do you see the flows also ebbing a bit?

A) Flows, so far have been strong, especially domestic flows. I think that the move into equity markets and away from physical assets is a fairly structural move that is taking place.

Today, if you look at what has moved into the equity markets even though we see significant numbers in terms of a growth perspective, but if you look at absolute quantum, it is still fairly small. And so, it is just like the tip of the iceberg.

Q) What are the sectors to watch out for in the coming year, 2018?

A) In the year 2018, markets will still be driven by consumption and consumption is going to be the key driver. Investment growth at the margin will pick up the pace, but overall growth will be driven by consumption.

So, given this construct, we believe that the sectors within the consumption space are likely to hog the limelight. Investors should watch out for sectors such as automobiles, retail private sector banks, the entire consumption pack, both FMCG and consumer durables. This is the large construct on the consumption side where we are fairly positive on.

On the infra space, the growth will be driven by public capex or public spend. There are two areas where govt is putting money -- one would be affordable housing and the second would be roads.

Both of these imply that the sector that benefits significantly from this spend would be cement would be a big beneficiary. This is one sector where there is not too much capacity addition happening.

Finally, another sector where we are positive on is oil and gas as a space. There is the considerable focus of the government on reducing the subsidy burden. In terms of valuation, this is a sector which is still trading at attractive valuations vis-à-vis global peers.

And finally, rural sector is another theme which investors can bet on. We are seeing wage growth coming back on the rural side. The government spends in terms of key programmes that they are running in the rural space will possibly get a boost in the forthcoming budget.

The focus of money is coming back in the rural economy and that generating demand is something that one needs to be watchful of and that could be a key theme for consumption as a whole.