Union Budget FY21: Fails to meet high expectations

Union Budget 2020-21 was announced in the backdrop of a tough economic environment, with high expectations to revive the economy by stimulating investment and boosting consumption. However, it fell short of prevailing high expectations, as the government continued to prefer fiscal consolidation and held growth recovery at bay.

The government has continued to focus on infrastructure, agriculture and rural economy, social welfare, simplification on taxes and leveraging technology for better governance. Although the budget disappointed on key market expectations like reduction in LTCG rates or some sort of growth stimulus, fiscal prudence was maintained by refraining from increasing borrowing limits for FY20 and marginally higher borrowings during FY21, in line with the market expectations.

Thrust on the Farm & Agri, infrastructure segments continued

The Government announced various schemes like increased insurance farm coverage, ensuring faster movement of perishable goods by proposing PPP model under Kisan Rail etc. remained committed to doubling farm income by 2022. We believe a strong focus on agriculture, irrigation and rural consumption bodes well in the long-run.

The government’s thrust on infrastructure sector also continued. In December, the government had launched Rs.102 tn worth of infrastructure projects, under the national infrastructure pipeline (NIP), to develop social and economic infrastructure in the next five years. As we need to find some sustainable ways of funding infrastructure in the country, 100% tax exemption to Sovereign Wealth Funds for investments in Infrastructure and other notified sectors along with a single investment clearance window is likely to get big boost.

Fiscal Consolidation Path Maintained

The government has adopted a limited fiscal slippage against the demands for a big stimulus, in order to balance growth concerns without affecting the market and debt obligations. The budget pegged the Fiscal Deficit to GDP ratio at 3.5% for FY21 and 3.8% for FY20, in line with the street expectations, Gross market borrowing for next year at Rs.7.81 tn is in line with the market expectations while no extra borrowing for the current year is a big positive surprise for the market.

The budget arithmetic seems credible – gross tax revenues are assumed to grow at 12% with the assumption of 10% nominal GDP growth (reasonable!!). Tax rationalization for income along with tax cuts for corporates will be offset by growth recovery benefitting collections of GST and customs. Nonetheless, challenges on the non-tax revenue and disinvestment front could continue and could pose a risk to receipts. The real test lies in the Rs.2.1 tn worth of divestments (LIC, Air India, Concor, BPCL, etc), where any delay can blow a hole in the Budget arithmetic.

How the changes in Taxation are likely to impact us?

FM has introduced an optional simplified tax structure based on income tiers with lower rates for individuals but without any exemptions. Given the multitude of exemptions available to a salaried person, net benefit to the individual would depend on his utilization of existing deductions. It is being claimed that this new direct tax framework is useless as it is not likely to benefit the end taxpayers.

It may sound foolish at the outset but it has the potential to boost consumption as many people skip consumption just for investing to save taxes. There is another breed of a taxpayer who might be ready to pay high taxes but may not like to get funds blocked for deductions. This might sound like lunatic but real-life story has a different story to tell. So, we believe a lower tax option for Rs.5-15 Lakhs salary bracket is likely to boost consumption.

Companies have been exempted from paying Dividend Distribution Tax, while dividends will be taxed in the hands of investors at marginal tax rates. It is likely to adversely impact individuals with high taxable income; for high net worth individuals, the dividend will now attract 30% tax, excluding surcharge and cess.

With the abolishment of DDT, dividends on equity mutual funds will be taxed at the slab rate of an individual taxpayer. Now, investors looking for regular income from their equity investments should look at systematic withdrawal plans from a tax efficiency perspective. Growth option plans will continue to offer the best long term investment option for investors looking to participate in the equity story as the incidence of taxation, comes about only once at the point of sale.

Equity Market Outlook

Although the Budget did not deliver on the key market asks for equity markets like relaxing LTCG or removing STT or big growth stimulus, we continue to remain constructive on equities and recommend accumulating equities in a staggered manner through SIP/STP.

Nifty 50 forward PE ratio stands at 17.5x which is near 10-year average and hence would provide some support after a round of recent correction. The discount of mid-caps/small-caps to large caps has narrowed by 5-10% over the last one month. However, we are still positive on Small-cap/Mid-cap post recent underperformance (Since Jan 2018) and reasonable valuations. Multicap space can be looked at from a long term perspective.

Debt Market Outlook

The debt market is likely to react positively on the back of fiscal discipline – no additional borrowing this year, and manageable borrowing next year. The deepening of the bond market by increasing the FPI limit from 9% to 15% along with the complete opening of certain specified categories of government securities for non-resident investors may also lift sentiments in corporate bond space with improved market efficiency and rate transmission.

The underlying global environment is unequivocally bullish bonds. A muted late-cycle global growth dynamic may be further impacted by the Coronavirus outbreak. If the central banks take into account this new growth headwind, it may increase local market risk appetite for bonds. We continue to remain highly positive on accrual space/spread assets and should be the main theme for 2020.