It's that time of the year again! It's budget day, and that means every industry leader in the country will come and tell you how a lower GST slab for their industry is just what's needed to drive the economy up, and every market participant will tell you that lowering of DDT or LTCG (or both!) would make everything merry. In today's post, we try to look at the current state of the Indian economy, look at sectors that have been under stress, look at the ways the budget look address long term v short term issues, and end by looking at the fiscal bandwidth we have and the market reaction to potential moves.
We have covered a topic people generally have the most interest in, Income taxes, in a separate post this week. Do check that out as well: Why a tax cut might not be the best idea
The state of the Indian economy:
We look at this in three broad parts, growth and how it has been doing, the amount of fiscal room the government has, and how inflation and rates have been moving.
Growth: We enter the budget session with a subdued economy. Multiple sectors have been hit leading to, the most prominent of which has been auto and auto ancillary. The growth rate in GDP in the current fiscal year hit a low of 5.0%, with the economic survey expecting a recovery in the year to come with growth expected to be around 6-6.5%. While the improved rates will be a sign of relief, they are still not high enough to provide growth and employment to our burgeoning population.
Fiscal room: The corporate tax cute announced earlier in the year, combined with the lower direct and indirect tax collections introduce stress on the fiscal deficit number(the difference between what the government earns and spends). The government has been keen on maintaining fiscal discipline and has succeeded in maintaining it too soon. We believe this stance will continue, although we'll explore potential catalysts to change that in the following sections.
Inflation & Rates: The silver lining in these dark times has been that our inflation has remained steady and within range. While this did seem to change in the December number when the retail inflation crossed 7%, it was largely driven by a temporary spike in vegetable prices, and should cool down significantly in Jan and Feb. On the rates front, the RBI has consistently dropped rates this year, but transmission has been lacking as banks are reluctant to pass it on to their customers. The recent operation twist could help mitigate that to a certain extent, but it would be fair to expect the central bank to have a hold on rates for the next few months as they wait for inflation to stabilize and some help to come in from the fiscal side.
So that's where we stand today in terms of the economy, going through pain, but what many believe will be a bottom for the economy with some recovery in sight. Next we look at the various sectors that have been under stress and could see some moves from the government.
Sectors under stress:
While the broader slowdown has had impact across the board and affected both the growth and the margins of firms, in today's post we look at a few sectors in which the stress has been compounded by other factors. We see what has happened in the space till now, and try to look at the policies that could help the sector emerge out of the space.
Auto: The sector has been plagued with a variety of issues leading to either people deferring purchase (BS regulations) or reducing it (axle load). With a lot of people directly and indirectly dependent on the space through its support of steel, paints, and auto parts industries, a recovery in auto is critical to preserve and grow jobs in the country. We have covered the regulatory issues in Auto in some detail here: Link the current issues plaguing the sector in a post here: Link and the impact of scrappage policy on Commercial vehicle sales here: Link
The next few years will be interesting for the space, as the industry incumbents have to deal with not only a variety of regulatory changes, but also increase threat of new competitors, both in form of Chinese and Korean car companies as well as potential new entrants in the EV space. How the government balances environmental imperatives, competitive markets, and the protection and growth of domestic industry will remain to be seen.
Power: We have covered the happenings in Indian power here: Link with a focus on India solar here: Link. The power sector continues to face the traditional problems of discom payment, as well as new problems arising out of the handling of renewable power.
As India moves towards becoming a global superpower, having a strong power sector will be critical. Balancing the environmental drive via increased renewable, as well as ensuring our coal and gas-fired plants have steady, reliable, and cheap fuel supply will become critical. With respect to divestments in the space, the government seems to be executing them via sales to other government-owned firms, which could affect the leverage of these firms and impact their performance through a down cycle adversely.
Real Estate: Although this hasn't received as much media attention as it should, we have a strange combination of a supply glut and extremely high prices in the RE markets in India. While prices and rental yields seem a lot more reasonable on the commercial RE side of things, the extremely low rental yields in most Metros/Tier 1 cities combined with stagnating demand on the back of reduced lending capacity of the stressed Housing finance corporations, and surplus inventory indicates that there could be more pain in the system. As real estate in these select cities continues to sky-rocket new migrants find homes in illegal colonies, and have to be provided free/subsidized homes when these colonies go for redevelopment, increasing the prices in an already inflated system.
BFSI: Which brings us to the last, and perhaps most pivotal sector in our current environment, the banking and financial services space. The NBFC space has seen one of its worst shakeups in recent times, with many names going under, and other players under significant stress. This not only has ramifications for the folks employed in that sector, but wider implications as auto loans, homes loans etc also come under stress thereby affecting many more people indirectly. On the banking side, while things have begun to show a slight improvement, the issue of banks like Yes Bank remain, and recent NPA numbers of some of the larger more trusted private players in the space have also begun to slow slippages. Depending on the length of the current slowdown, these NPA numbers could go up further, thereby shaking the assumptions of a recovery that the market was banking on.
Long term vision vs Short term relief & Fiscal bandwidth
As we have stated earlier in the post, the fiscal room for relief from the government seems limited at the moment, and the government has been historically not too willing to compromise on fiscal discipline. Being in the first of a five year term, they have even less reason to do so, although the series of negative reactions in the state elections combined with the relatively limited bandwidth the RBI has in spurring growth may convince them to reconsider.
With the limited bandwidth available the government now faces the dual tasks of bringing in stuctural changes that international agencies will view favourably, and will help the country long term, and short term relief to the economy, that the markets are likely to view favourably. With the host of structural steps taken by the govenment in the last few years, and the limited space this time, we believe the focus will be more on short term relief measures targetted at increasing rural income and welfare. This make take many forms - employment generation via government schemes, minimum support price hikes, credit policies for SMBs etc. While the market also seems to be expecting income tax cuts, as discussed in our earlier posts, while there might be a slab rejig, a tax cut seems unlikely. The views on DDT and LTCG remain similar - there may be a readjustment in who pays them, i.e for the DDT the government can make it taxable directly in the hands of the investor instead at the firm level but that will most likely be at a higher rate, trying the make the move revenue neutral for the government. There will be a time in the future when these rates will come down, but that time is not now. Long term focus on infrastructure growth is expected to continue.
Potential Market reaction
The market in all its bullish joy seems to be expecting a lot from this year's budget. The corporate tax cut seems to have convinced speculators that other similar moves could be on the horizon. However as discussed these would probably not be high on the government's priority list and will in all likelihood be excluded from the budget. In the absence of a strong divestment program, the government's spend will also be quite moderate. With expectations this high, the budget will most likely fall short, and the markets may remain flat or see downward movement over the next few sessions as investor align their expectations with reality.
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