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Union Budget FY20: Gambit for sustained growth recovery

The first full budget of the NDA 2 government is encumbered with pervasive growth slowdown, reflected in a) weak consumption, b) low profitability of corporates, c) lull in private capex, d) agrarian distress, e) peak levels of unemployment, and f) ongoing crisis in the NBFC sector. Also, the support of global trade is missing, because of the ongoing trade conflicts. Hence, the fiscal approach embedded in the budget encapsulates four-pronged strategy 1) boost the demand side through robust expenditure growth, 2) catalyse credit support by strengthening capital of PSU banks, 3) ring-fencing the damage in the NBFC sector by lending sovereign guarantee to strong NBFCs in the sector, 4) providing protection to specific industries against global competition in the context of intensifying global trade conflicts, that is impairing India’s growth. This is a measured gambit, with the hope that this strategy would trigger sustained growth recovery.

Consumption impulses from higher revenue spending: Importantly, total expenditure growth is estimated at 20.5% in FY20BE to Rs20.8trn (over actual estimates), comprising 88% on revenue spending, budgeted to grow at 22%. Capital spending is budgeted to grow lesser at 12%. Total allocation for rural and agriculture sectors, including rural schemes, various subsidies and allocation is a total of Rs6.5trn or 23% of total spending, with massive 43% yoy growth, with significant contributions coming from PM Kisan Yojna. With 20.5% growth in total spending far exceeding nominal GDP growth of 12% in FY20BE, the budget is significantly demand stimulative.

Optimistic on revenue target: Strong spending budget is premised on fairly optimist projections for tax revenue collections; gross collections are estimated to post 18.3% yoy growth and net collections, after transfers to states stand at Rs16.5trn (BE), a growth of 25%. The underlying assumption is that better compliance and higher tax rates for higher income segments (above Rs300m) would deliver 23% growth in income tax collections. Similarly, higher excise duty on petroleum products, amid recent decline in crude prices, will aid 30% growth in excise collections and hike in duties on certain import items will result in 32% jump in custom duty collections. In our view, gross tax collections are overestimated by at least Rs1.3trn, and hence, can impose constraint on spending capability. We believe this shortfall will be made good by higher extraction of dividends from RBI, disinvestments, curtailment in capital outlay and allowing some slippage on the fiscal deficit front. The government may also resort to borrowing in foreign currency to prevent pressure on domestic market borrowing because of fiscal slippage.

Fiscal deficit target of 3.3% of GDP is optimistic: Government’s fiscal deficit target of Rs7.0trn for FY20BE converts into 3.3% fiscal deficit/GDP, which we believe looks conservative, compared with 3.4% in FY19, but is also partly contributed by scaling up the GDP growth projection. Given our assessment of optimistic revenue targets and ambitious spending budget, deficit targets of the budget look fairly optimistic.

Considerable reliance on one offs: The dependence on non-tax revenue and disinvestments would together contribute Rs4.2trn through higher disinvestment target of Rs1.05trn and dividend payout of Rs900bn by RBI. Importantly, there has been significant ramp-up in recapitalisation of PSU banks at Rs700bn, which is funded by issuance of GoI recapitalisation bonds, thereby adding to the debt without reflecting in fiscal deficit. Importantly, while the recommendation of the Bimal Jalan committee is yet to be tabled, budget appears to have already assumed a transfer of RBI’s reserve of Rs900bn. In our view, in case of slippage of tax collections, the transfer of resources from the RBI could be larger.

Budget to boost consumption demand: Overall, the macro context of the budget appears to be stimulating consumption demand. The strong boost to spending for the farm sector and other rural sector heads, improvement in lending banks, stabilisation in NBFC sector along with monetary easing by the RBI in combination represent a stimulus package.

What is the risk to the gambit? The fiscal strategy is based on the expectation that following the 12-month impact of the stimulus, there could emerge a reasonable chance of revival of private capex cycle, such that structural issues like employment and income generation sustain the upcycle. The key risk to the gambit are: a) persistence of NBFC crisis, b) volatility in global financial conditions, c) surge in crude prices, d) worsening of global trade conflicts.

Market outlook: While the reflationary stance of the budget could provide a boost to corporate earnings, especially in consumption, agri-rural sector, banking, and housing. However, given the stretched valuations (Nifty at 11,811, trailing 12-month PE of 29x), there is reasonable likelihood of market remaining range-bound.

IDFC India Portfolio: We maintain our positive view on consumption-oriented sectors, which have seen a soft patch over past two quarters; Consumer goods and autos in particular. Sustenance of demand visibility and potential weakening in INR/USD will likely overweigh margin concerns in the ITES space. Banking is Equal Weight while NBFC space is Under Weight - UW. Slight OW on Metals. Other UW sectors are - Telecom, Media, Power Utilities and Oil & Gas. We also continue to remain cautious on Mid & Small-Cap stocks.

Sectoral/Thematic Impact of the budget

• Building materials (pipes): Sector to benefit from rising focus on piped water supply. Positive for Astral Polytechnic and Supreme Industries
• PSU banks: PSU banks to receive capital infusion worth Rs700bn against Rs400bn expected. Positive for weak state-owned banks
• NBFCs: RBI’s backstop liquidity facility of Rs1.3trn and government guarantee of 10% first loss for buying  pools of NBFCs. Positive for retail NBFCs, but not beneficial for weak NBFCs like DHFL
• HFCs: RBI to take over as regulator, which may not bode well for HFCs with developer loans
• PSUs in general: Increased disinvestment through CPSE ETFs will lead to increased supply of shares, resulting in downward price pressure on PSU stocks; Coal India, NMDC, NTPC, Power Grid, etc, are few examples
• Companies with revenue Tax rate for companies with revenue less than Rs4bn brought down to 25%; Players with revenue less than Rs4bn -  IEX

·   Utilities: Range of suggestions on improving structural strength of the sector; In general, all utility companies to benefit; IEX, Torrent power, GMR Infra are key examples