Decoding Modi – 2.0 Budget 2019

This budget, presented in the backdrop of a slowing economy, liquidity issues of both banks & NBFCs, agrarian crisis, limited fiscal space, and global headwinds in the form of trade-tariff wars, has two main takeaways – a) Government focus lies on sustainable long-term investment-driven growth rather than short-term push to consumption through fiscal stimulus or tax cut. b) Government’s resolve to adhere to a prudent fiscal roadmap.

The government’s strategy is to keep the interest rate lower by allowing foreign currency-denominated sovereign debt, which in turn would drive growth through investment.

Major Themes – Equity Market Perspective

1) Boost to Infrastructure Investments: The government has shown substantial reliance on off-budget resources and public-private partnerships (PPPs) to enhance infrastructure investment.

2) Adhere to a prudent Fiscal Roadmap: The budget has stuck to the stated fiscal consolidation path of achieving a deficit target of 3% by FY21. However, achieving FD target of 3.3% (FY20) is contingent upon tax buoyancy assumptions, disinvestment targets & nominal growth assumption of 12%

3) Recapitalization of PSU banks to support credit growth: Recapitalisation of PSU banks by Rs.700 bn is likely to provide some growth capital. However, the key would be infusion to stronger banks to fund growth.

4) Relief to NBFCs: A one-time government guarantee for the purchase of high-rated pooled assets of financially sound NBFCs up to Rs.1.0 tn indicates that the government seeks to address NBFC concerns.

5) More incremental equity issuance: The proposal to bring down promoter holding from 75% to 65% coupled with the government willing to go below 51% for select CPSEs could lead to an increase in India’s weight in global indices.

Sectoral Impact:

1) Automobile (+ve): Incentivizing EVs (suggested GST reduction from 12% to 5%; deduction up to Rs.1.5 lakhs for interest paid on loan taken to purchase an EV). However, increased cost of diesel and petrol, as wells as marginal relief announced to revive the ailing sector are negative for the Auto sector.

2) Banks & NBFC (+ve): Much needed impetus has been provided – Recapitalization of PSU banks (Rs.700 bn); FIIs & FPIs investment to be allowed in debt securities issued by NBFCs; Credit Guarantee for high rated NBFCs and change in HFCs regulator to RBI.

3) Infrastructure (+ve): Higher allocation to Road, Railways and Urban Infrastructure is positive for the sector. The government plans to invest Rs.100 lakh crore in the infrastructure sector over the next five years. FPIs will be permitted to subscribe to listed debt securities issued by REITs and InvITs

4) Real Estate (+ve): Additional deduction of Rs.1.5 lakhs for interest paid on loan sanctioned during FY20; a tax holiday for affordable housing & several reform measures to promote rental housing. However, some dampening impact would arise from higher income taxes for individuals earning > Rs. 20 Mn.

5) Consumer Goods (-ve): No initiative in the budget to boost consumption. AC import duty hiked from 10% to 20%; negative for soap input cost (0% to 7.5%); import duty hiked by 2.5% on gold; proposal for a reduction in promoter holding from 75% to 65% would impact several players in FMCG & Retail players.

6) Information Technology (-ve): Reduction in promoter holding and a proposal to levy 20% tax on share buybacks may have a negative impact on cash-rich IT Sector. Earlier, listed IT companies doing buybacks did not have to pay any tax and therefore they preferred buyback over dividends to distribute cash back to shareholders.

Equity Market Outlook

Indian markets are trading at 19.2x FY20E and 16.3x FY21E (consensus earnings; source: KIE) which are reasonable, especially given the low-interest rates.

Earnings have been muted during the last 5 years (3.2% CAGR during FY14-19) on the back of poor performance of Corporate banks, Metals and Capital Goods sectors, etc. However, the outlook for these sectors is rapidly improving and these sectors are likely to witness a sharp improvement in profitability. As earnings growth improves (consensus estimates at 22.7% CAGR during FY19-21E), the P/E’s should look more reasonable and move lower.

In view of the expected recovery in earnings as well as our comfort derived from reasonable India’s Market Cap/GDP ratio, we recommend increasing allocation to equities, especially in multi-cap/large-cap funds in a phased manner. Investors with higher risk appetite and slightly longer horizon should also look at mid-cap/small-cap or thematic funds.