Growth slowed to 4.5 percent (GDP basis) in the quarter-ended September 2019 versus 5.0 percent in quarter-ended June 2019, reaching a 26-quarter low. The challenges to the economy have stemmed from both domestic (risk aversion in the financial sector and corporate sectors and weak private capex cycle) and external fronts (uncertainty caused by US-China trade tensions). Weak growth has shifted policymakers' focus to reviving the growth trend. Indeed, monetary policy has remained accommodative as the Reserve Bank of India (RBI) lowered the policy rate by 135 basis points in 2019 and has kept interbank liquidity in surplus territory. Simultaneously, fiscal policy turned supportive, as the government has taken steps in the past 8-9 months to address the slowdown, e.g., reducing corporate tax rates, setting up a special fund for the real estate sector, and extending partial credit guarantee scheme to NBFCs and HFCs.
Though growth is improving, it is still slow-paced. While in the near-term, it is likely to remain in the slow lane, one can expect a gradual recovery in 2020 on a low base effect due to traction from past policy actions, and expectation of a global recovery from FY20. However, risks remain skewed to the downside from slower response to policy actions, longer-than-expected stabilisation in demand conditions, renewed signs of credit stress affecting the flow of resources, and weaker global growth.
The government accounts (for April to November 2019) indicate that the deficit reached 115 percent of the budgeted target, largely because of disappointment on the receipts side, even as expenditure has been largely as per the budget estimate. On a 12-M trailing basis, the fiscal deficit was tracking at 3.7 percent of GDP, much higher than the government’s target of 3.3 percent of GDP for F20. April-November revenue receipts were tracking at 50.1 percent of budget estimate, lower than 55.6 percent last year.
The shortfall in revenues is stemming from losses due to the corporate tax cut, the slowing economy, slow tracking divestment and shortfall in indirect tax collections. Within tax revenues, direct taxes growth decelerated to 2.7 percent year-on-year y-o-y in FY20 versus 16.5 percent in FY19 as of November, mainly due to a drop in corporate tax receipts. Growth in non-tax revenue receipts as of November saw a sharp increase of 67.8 percent in FY20 versus 31.4 percent in FY19, largely due to the RBI dividend. April-November expenditure was tracking at 65.3 percent of the Budget estimate, lower than 69.8 percent last year. Fiscal deficit is expected at about 3.7 percent of GDP in FY20 versus target of 3.3 percent of GDP, with slippage from tax revenues and divestment, though some expenditure compression will limit the slippage.
At a margin, GST collections improved for the past two months remaining above the Rs 1 trillion-mark. Total budgeted divestments stand at Rs 1,050 billion, whereas the total actual divestment as of November is tracking at 17.2 percent of the budget estimate, increasing pressure on the fiscal. The Total Budgeted Expenditure for FY20 is Rs 27.869 trillion, i.e., 13.2 percent of GDP. Total actual expenditure, as a percentage of budget expenditure is tracking at 65.3 percent.
News flow suggests that expenditure in the March quarter may be restricted to 25 percent of the Budget expenditure as against an earlier limit of 33 percent. This implies that the Union Government may cut the annual budgetary expenditure for FY20 by Rs 2.2 lakh crore which would be roughly 7.8 percent of the Budget estimate as tax revenues remain significantly lower than the required rate. There is a possibility of an interim dividend from the RBI, and uncertainty still prevails regarding the telecom-related revenues which could accrue to the government post-the court ruling.
The recent decision by the government to lower corporate tax rates and unveil the national infrastructure pipeline of $1.4 trillion over the next five years indicates that policymakers will likely favour promoting CapEx-driven growth. The Finance Ministry lowered the corporate tax rate from 30 percent to 22 percent with the effective tax rate lowered from 34.9 percent to 25.2 percent (including surcharge). The government also announced a special 17 percent rate for new companies incorporated on or after 1 Oct 2019 and starting new manufacturing facilities before March 2023. This was done to improve business sentiment, support corporate sector balance sheet position, improve competitiveness and help attract foreign capital.
The Budget would continue to focus on roads, rail, irrigation and urban infrastructure with a mix of on-budget (budgetary support) and off-budget (market borrowing) funding. History suggests that the Union Budget's influence on short-term market performance is declining, but expectations (as measured by pre-Budget performance) are still important in determining what the market does after the budget.
The past 28 Budgets' data show that when the market is up before the Budget, there is about an 83 percent probability of the market falling 30 days after the Budget announcement and a 75 percent probability of the market falling 15 days post-Budget. Looking at the past seven NDA budgets (including the interim Budget of February 2019), the market has been down in the 30 days prior to the Budget on an absolute basis in four cases. It has been down on three of these four occasions 30 days after the Budget.
On a relative basis, India has underperformed in six of the seven cases 30 days prior to the Budget announcement and in five out of seven cases 30 days post-Budget announcement. This year, India is tracking higher on an absolute basis and is at par on a relative basis so far in January. Market participants will have to deal with a fair amount of volatility on Budget day, even though this volatility has been declining over the past 28 budgets.
From the Budget and stock market perspectives, one should watch for the following:
a) Government spending on infrastructure, housing, water and farmer cash transfers to drive overall growth
b) Credible fiscal deficit target, given its impact on macro stability
c) Rationalisation of direct taxes—Cut in personal tax, removal of long-term capital gains tax for all classes of investors, removal of dividend distribution tax, and extension of low corporate tax rate for new investments in the services sector
d) Scale of privatisation: This would demonstrate the government's desire to undertake structural change as well as reduce supply in the market
e) Interest rates: Linking small saving rates to repo rates should help bank deposit growth in the long run.
(The writer is Chief Investment Officer-Kotak Mahindra Life Insurance Company)
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Updated Date: Jan 27, 2020 12:01:05 IST