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India Strategy: Union Budget FY19 preview - Pragmatism to continue…

FY19 Union Budget will be presented in the backdrop of: a) a recovering economy from dual disruption (demonetization and GST), and, b) strong commodity prices. The incumbent government will try and maximise its reach (populace) while keeping fiscal progress on track (hence populism will take a back seat), in our view. We expect three key themes to emerge from the FY19 Budget: a) continued focus on infrastructure spend, led by roads, highways, defence, regional connectivity (as private capex is still weak), b) increased rural allocation by way of MNREGA, rural housing, crop insurance, irrigation and rural roads (given weakness in the agricultural and rural economies), and c) overall rationalization in taxation, as nominal growth (hence tax collection) and tax base expand. Key budget beneficiaries within our top picks are: Bharat Electronics, Ashok Leyland, Ashoka Buildcon, Spicejet, Kajaria Ceramics and Greenply Industries (Other IDFC budget beneficiaries in Exhibit 1).

We estimate 11.1% nominal GDP in FY19E: Our budget calculations are based on our estimated nominal GDP growth of 11.1% in FY19E (7.1% real GDP growth and 4% inflation). However, we are mindful of the upside risk to our GDP and tax collection estimates.

Revenue stability to return in FY19E, post slippage in FY18: A landmark change in India’s tax regime resulted in all three factors - growth, output and tax collections – being hit, given existing complexities in the structure and implementation woes. Two major factors caused the hit: a) weakness in economic activity, and b) weakness in compliance. Consequently, we estimate 8% growth in centre’s tax revenues in FY18E (versus 11% yoy growth earlier). We expect a mild slippage in personal income tax as well. Interestingly, disinvestment receipts should overshoot government’s FY18 target (once ONGC and HPCL deal goes through) at Rs905bn versus FY18BE of Rs725bn and provide the much needed support to the fiscal space.

For FY19, we expect a better compliance led by: a) e-way bill, b) invoice matching, c) kick off in reverse charge mechanism and d) reduction in overall tax rates (recent roll back in GST tax rates). We expect these factors to be backed by an overall pick up in economic activities, resulting in tax collection stabilising at around Rs13.4 trn (13% yoy growth) in FY19; RBI dividends too should normalise in FY19E. We have not factored in telecom spectrum revenues for FY19, given: a) stretched balance sheets of key telecom players, and b) the recent consolidation in the industry, which has eliminated the need for new bandwidth.

Government capex growth estimated at 9% in FY19E: Government expenditure has grown by 15% yoy (FY18BE growth 8.5%yoy) in FYTD18 (until Nov 2017), indicating front loading of expenditure led by: a) active capital expenditure by the government to provide a boost to the economy (while private capex has been weak), and b) advancement of budget presentation in FY18. Given the uncertainty around revenue (and thus restricted fiscal space), we expect capex expenditure to be curtailed until the end of this year with capex growth of around 3% yoy for FY18. We expect the government to meet its budgeted target of 9% yoy growth in revenue expenditure to Rs18.4trn in FY18.

The government will likely continue to pursue schemes/reforms that have already been announced and provide detail on funding and execution on the same (recapitalisation of PSU banks, Bharartmala, Sagarmala, regional connectivity, affordable housing etc), in our view. Consequently, we expect infrastructure and rural growth to be key focus areas in this budget.

Fiscal consolidation to slow down by a year: We expect fiscal consolidation to slow down by a year and expect FY18 fiscal deficit to GDP (GFD/GDP) ratio to settle at 3.5% in light of lower revenue collection (led by GST) and weaker GDP base. We estimate GFD/GDP ratio to settle at 3.2% in FY19.

10-year bond yields estimated at 7.3%-7.6%: Assuming 77% of our expected 3.2% GFD/GDP ratio in FY19 is funded through debt, we arrive at a gross borrowing target of Rs6.2trn and a net borrowing target of Rs4.5trn. With firming commodity price and a likely fiscal slippage, we expect bond yields to stick to the higher end of our estimate of 7.3%-7.6%.