BusinessEditorial & Opinion

Union Budget 2020:Lacks Punch; No Fiscal Stimulus, Says Motilal Oswal Research

Union Budget 2020:Lacks Punch; No Fiscal Stimulus, Says Motilal Oswal Research 1

Bengaluru, NFAPost News Service: The Union Budget 2020-21 was presented on 1st Feb’20 amidst a very challenging economic environment. Although it was not acknowledged explicitly, the budget appears to have realized the fiscal limits. Not surprisingly then, it did not enough excite the market, where expectations were running very high.

Headline numbers suggest that the government has relaxed its fiscal deficit target for FY20 and FY21 by 0.5 percentage point (pp) of GDP each to 3.8% and 3.5% of GDP, respectively – broadly in line with expectations. However, while the government has reduced its FY20 receipt target by INR1.5t, the actual shortfall could be as large as INR3t, posing challenges to the fiscal math for FY20/21. Most surprisingly, the government has reduced the devolution rate of taxes to states at 30.5% in FY20RE, as against 35-36% in previous years (and 33% in FY20BE).
–        In terms of major announcements, the government has tried to rationalize personal income taxation on the lines of the corporate income tax changes announced in Sep’19. Personal income taxpayers now have an option to either continue with the current regime or choose the new lower tax regime (for taxpayers with annual income below INR15lakh) provided they give up on all major exemptions. Total cost of these exemptions to the government was INR1.16t in FY20 and the estimated revenue forgone on the new personal income tax rates is INR400b. Second, the government has proposed to remove the dividend distribution tax (DDT), which will lead to estimated annual revenue forgone of Rs 25,000 crore.
–        As far as spending details are concerned, they are also not very encouraging. Key highlights:
1.      Although the central government has targeted growth of 15% YoY in capital spending in FY20 and 18% in FY21, capex growth is almost negligible next year after including the planned investment spending by public sector enterprises (CPSEs).
2.      Like in the past three years, the government has shifted a large part of its food subsidy to Food Corporation of India (FCI), which implies persistent reliance on off-budget borrowings.
3.      Rural spending by the central government has increased ~22% YoY in Apr-Dec’19, and the government has reduced it in FY20, implying 30% growth. However, in contrast to expectations, rural spending is expected to grow at a modest 7.7% next year.
–        Overall, as expected, while the government has relaxed its fiscal deficit target by 0.5pp of GDP in FY20, the market borrowings remain broadly unchanged at INR4.7t and the additional deficit is actually funded by the national small savings fund (NSSF) and a reduction in buybacks. Further, although the fiscal math faces challenges, the fact that FY21 bond supply is in line with expectations may support the bonds market.
–        From the economy perspective, in sharp contrast to expectations, there were no major boosts to consumption (as we had hoped). Another concern is that investments by the government and CPSEs are budgeted to remain stagnant in FY21. With the fiscal policy accepting its limits and the inefficacy of monetary easing, a meaningful economic revival may not pan out next year.

Market strategy
The Indian government presented its FY21 budget in a challenging context of slowing demand, weak investment cycle, six consecutive quarters of deceleration in GDP growth and rising inflation. Expectations were running high as regards short-term demand boost, big-bang announcements for growth revival, and some sector-specific measures for Real Estate/NBFC.

While the finance minister has taken limited fiscal slippage of 50bp for both FY20 and FY21, she has refrained from going for any big fiscal stimulus package to revive near-term demand. Instead, she has opted to balance growth concerns without sacrificing fiscal prudence, providing a sigh of relief to the bond markets. The abolition of the dividend distribution tax (DDT) is a positive step, but long-term capital gains tax on equities continues.

Given the lack of any material fiscal push, consumption and demand recovery in the economy will be gradual, in our view. There was no major increase in allocation to rural-oriented schemes (MGNREGA) with total rural spending expected to increase at a modest 8% in FY21. Rationalization of personal income tax rates will provide marginal demand stimulus at the lower end of the consumption bracket but may not move the needle, in our view.

Absence of any major announcement for the stressed Real Estate sector was disappointing as it can potentially act as a force multiplier for the economy given its multiple linkages with other sectors.

Overall from an equity market perspective, we believe the budget has been a non-event and belied the lofty expectations. Incrementally, it puts the hopes of a sharp corporate earnings recovery at risk. Equity markets reacted with a 2.5% correction in Nifty on 1st Feb’20. We believe once the fine-print is absorbed, the market’s focus should revert to fundamentals, viz. corporate earnings growth, global cues around the spread of Corona Virus and its potential impact on global growth.

Given the absence of sharp growth revival, we expect the market to stay narrow – select sectors with better earnings visibility will continue enjoying valuation premium over the broader markets.

Top ideas: Large-caps: ICICI Bank, SBI, HUL, Bharti Airtel, Maruti, Infosys, HCL Tech, RIL, Ultratech and L&T
Mid-caps: Crompton Consumer, Ashok Leyland, Indian Hotels, Federal Bank, JK Cement, Tata Global, ABFRL, Alkem

Headline numbers on expected lines

Fiscal deficit relaxed to 3.8% in FY20 and 3.5% of GDP for FY21Considering the very challenging economic environment, the government has decided to relax its fiscal deficit targets by 0.5pp of GDP for both this and next year. From the budgeted target of 3.3% of GDP for FY20, the deficit is now relaxed to 3.8% this year and pegged at 3.5% of GDP for FY21. These numbers are broadly in line with market and our expectations.

Union Budget 2020:Lacks Punch; No Fiscal Stimulus, Says Motilal Oswal Research 2

Interestingly, although the government has relaxed the FY20 deficit target by 0.5pp of GDP, there is no announcement of additional market borrowings this year. Additional deficit is expected to be financed by higher NSSF and a reduction in buybacks.

Further, the gross market borrowings (GMBs) and net market borrowings (NMBs) are pegged at INR7.8t and INR5.4t, respectively, for FY21 – in line with expectations. Moreover, the primary deficit (fiscal deficit excludinginterest payments), which narrowed from 0.7% of GDP in FY16 to 0.3% in FY18/19, is estimated to have risen to 0.7% of GDP again in FY20 before narrowing to 0.4% in FY21.

Union Budget 2020:Lacks Punch; No Fiscal Stimulus, Says Motilal Oswal Research 3

Union Budget 2020-21 1 February 2020 5 Key Budget Highlights –

Direct TaxDDT abolished; dividend to be taxed in the hands of recipientThe finance bill has abolished the dividend distribution tax (DDT) and proposedto tax the dividend in the hands of shareholders/unit holders based on theirapplicable income tax slab rate.Holding companies have been granted a deduction (under section 80M) for thedividend income received from their subsidiaries to remove the tax-cascadingeffect.The maximum deduction of expenses (interest, commission and otherincidental expense) incurred for earning such dividend income has been cappedat 20% under the proposed Section 57 of the Income Tax Act.Companies are required to deduct TDS at 10% if dividend paid to unitholder/individual exceeds INR5k under Section 194 of the Income Tax Act.In FY18, India’s government collected DDT of INR412b from domesticcompanies. According to our analysis, ~88% of the aforementioned amount waspaid by listed entities and the balance by unlisted companies.Of the DDT paid by listed players, private companies contributed 63%, followedby PSUs (~28%) and MNCs (~9%).

Union Budget 2020:Lacks Punch; No Fiscal Stimulus, Says Motilal Oswal Research 4

Receipt estimates appear ambitious

Although gross receipts of the government have increased 4% YoY in Apr-Dec’19, the government has budgeted strong 15.5% growth in total receipts in FY20 and another 16.3% growth for FY21 (Exhibit 9). As a percentage of GDP, it is expected to increase sharply from 8.8% in FY19 to 9.4% this year and 10% next year. Within total receipts, the government has budgeted 9% YoY growth in net taxes and massive 43% growth in non-tax receipts (including non-debt capital receipts). As far as the break-up of receipts is concerned, the reliance on non-tax revenue and non-debt capital receipts has increased in the recent past. Consequently, taxes are expected to account for 73% of total receipts next year, the lowest in a decade (Exhibit 10).

Why receipt estimates appear ambitious?There are various reasons for our skepticism on the receipt estimates of the central government. Exhibit 11 compares the budgeted numbers with our expectations (based on actual data available up to Dec’19).

1.As against actual growth of 5% in personal income taxes (PIT) in the first ninemonths of FY20 (Apr-Dec’19), the government expects very strong growth of21% this year, followed by 14% next year.

2.Similarly, while customs duty collection has declined 12.3% YoY in Apr-Dec’19,the government expects it to grow 6% this year and by stronger 10% next year.

3.Union excise duties are also expected to grow 7.5% YoY this year, while theyhave declined 2% in Apr-Dec’19.4.Overall, we believe that there could be a shortfall of Rs 4 trillion in gross taxes thisyear (vis-à-vis FY20BE), while the government has revised it down by Rs 3 trillion. What is even more surprisingly is that the center has assumed strong growth of14% in net taxes because of devolution rate of only 30.5% of gross taxes thisyear, as against 35-36% in the past four years.

Assuming devolution rate of35.5%, net tax growth will be only 6% in FY20.

5.Overall, tax receipts growth appears highly optimistic for FY20, which raise sun certainty about the FY21 tax estimates.10.6 9.0 9.3 9.4 9.2 9.1 9.4 9.1 8.8 9.4 10.0 35.9 (4.3) 16.7 14.89.1 9.1 14.4 8.1 7.1 15.5 16.3 FY11FY12FY13FY14FY15FY16FY17FY18FY19FY20REFY21BEActual receipts (% of GDP)Actual receipts (% YoY)69 80 81 77 78 75 77 80 79 78 73 27 15 15 19 17 20 19 12 15 18 17 4.3 4.7 4.5 4.0 4.5 5.0 4.5 7.7 6.2 4.2 10.1 FY11FY12FY13FY14FY15FY16FY17FY18FY19FY20REFY21BENet taxNon-tax receipts Non-debt capital

The government has budgeted strong 16% growth in total receipts in FY20 and another 16% growth for FY21The center has assumed strong growth of 14% in net taxes because of devolution rate of only 30.5% of gross taxes this year, as against 35-36% in the past fouryears. Assuming devolution rate of 35.5%, net tax growth will be only 6% in FY20

6.Although non-tax receipts for FY20 are believable, they are also very highlyambitious for the next year. The government hopes to list the Life Corporationof India (LI C) due to which it has set a divestment target of Rs 2.1trillion for FY21 –up from Rs 650 billion this year. While it is possible, it brings with it a high degree ofuncertainty.

7.Further, the government has budgeted to receive INR1.33t from the telecomsector, up from Rs 590 billion this year. Considering the grave situation of the telecom sector, such massive payment next year appears unlikely.

No major boost to economic growth

Overall, in line with our expectations, while the government has relaxed its fiscal deficit target by 0.5pp of GDP in FY20, the market borrowings remain broadly unchanged at INR4.7t and the additional deficit is actually funded by the national small savings fund (NSSF) and a reduction in buybacks. Further, although the fiscal math faces challenges, the fact that the bond supply is in line with expectations may support the bond market.

On the contrary, while the government has announced a reduction in the personal income tax rates, it is estimated to lead to a maximum boost of INR400b. Although it is very difficult for us to do any micro-level analysis, it seems unlikely that the trade-off between lower tax rates and exemptions will prompt a large section of the taxpayers to choose the former. The net effect, thus, could be much lower. Further, instead of simplification, an increase in the number of tax slabs and the option to switch to the new lower tax regime add to the uncertainty. From the bond market perspective, the higher the impact, the worse it is for captive demand of sovereign bonds.

Although the fiscal math faces challenges, the fact that the bond supply is in line with expectations may support the bond market.

The flip side of keeping a tab on fiscal deficit and market borrowings was that – in sharp contrast to market expectations – there were no major boosts to consumption (as we had hoped). Another concern is investments by the government and CPSEs are budgeted to remain stagnant in FY21. With the fiscal policy accepting its limits and the inefficacy of monetary easing, a meaningful economic revival may not pan out next year.

Additionally, the hike in custom duties in a number of daily household essential commodities (such as footwear, furniture, wall fans, kitchenware, refrigerators, air-conditioners, mobile phones, stationary items, toys etc.) could potentially lead to a spike in core inflation during the year. Therefore, the monetary authority’s mandate to keep inflation close to 4% is going to be challenging, especially when headline inflation has crossed the upper target of 6% – primarily because of a spike in food inflation – and is likely to remain elevated for most of CY20. We thus continue believing that further monetary easing in any form is unlikely.

Another concern is that investments by the government and CPSEs are budgeted to remain stagnant in FY21.

Research Team

Gautam Duggad ([email protected])Nikhil Gupta ([email protected])

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