Vijay Kumar Gaba

 Deposit Rates Grow Faster than Lending Rates in December 2022 (CARE Ratings)

 It’s almost a week since the union budget for FY24 was presented in the parliament. The budget documents have been analysed by a variety of experts. Most of these experts have focused their opinion on the budget as per their professional affiliations and/or ideological orientation.

If I may sum up the consensus opinions, it would be as follows:

·         Development economists have criticized the budget for inadequate allocation to the social sector, especially education, health, rural welfare, MNREGA etc.

·         Market economists and strategists have commended the budget for higher allocation towards capital expenditure and commitment to fiscal discipline despite political expediency.

·         Accounting and tax professionals have spoken about the changes proposed in the tax laws to ease compliance and plug tax evasion loopholes.

·         The changes in personal taxation have not evoked much discussion or debate, given the tiny size of taxpayer that would be impacted by the changes.

From the investors’ viewpoint, however, there are some budget proposals that may potentially have deeper and wider impact than what would appear prima facie. Investors therefore need to examine these proposals in some more detail. I would for example like to, inter alia, analyse the following in some more detail:

Impact on working capital

The budget proposes to force businesses to make prompt payments to MSME. It is proposed that if a business fails to make payments to MSME vendors within the time specified in the MSMED Act (45 days or less), the expense in respect of such payment will be allowed only on actual payment basis, and not on accrual basis.

It would be worth examining Automobile OEMs, FMCG companies, textile companies etc. who have major sourcing from MSME vendors. This provision could have a material impact on their working capital financing requirement; as the credit period of MSME dues reduces to less than 45 days.

Insurers’ demand for gilt

Life insurance companies are one of the major buyers of government securities. The budget proposes to withdraw tax concessions in respect of insurance policies where the annual premium is in excess of rupees five lacs per annum per insured person. The instant market reaction to this proposal has been quite negative for life insurance companies.

If the market reaction was valid and life insurance companies are most likely to see a sharp fall in new insurance premium; it would be worthwhile to examine the impact of lower incremental insurance companies’ demand for government securities. Given (i) most banks are facing deterioration in the credit to deposit ratio due to faster rising credit demand; and (ii) the changes in rules of TDS on interest for the foreign portfolio investors are likely to further adversely impact the foreign demand for the Indian gilt; lower insurance demand could pressurize the bond yield higher.

Investors need to analyse this factor carefully to find out if any changes in asset allocation are required.

Savings vs Tax savings

In the past couple of years, the finance minister has given clear indications that the government wants to move towards a new tax regime with minimum tax exemptions and deductions. The latest budget reaffirms this stance.

Savings linked to tax saving schemes has been particularly popular amongst the salaried tax payers. It would not be exaggeration to say that a section of tax payers has been forced to curb consumption and save. Most of these savings have been in savings schemes like EPF, PPF, NPS or life insurance. Lately, contribution to equity linked savings schemes has also attracted greater interest. Besides savings, tax concessions have encouraged investment in residential properties also.

The genesis of tax concession to encourage savings lies in the socialist regimes of yesteryears where (i) focus of governments was on curbing consumption; (ii) fiscal deficit financing was only from the domestic sources; and (iii) social security was negligible for non-government employees. The governments offered higher rates of interest and favourable tax treatment even on interest to encourage savings. This has put the banking system at relative disadvantage and prevented rates from falling materially in good times.

Most of these conditions are now changing fast. There is no need to curb consumption. Foreign borrowing is permitted for fiscal deficit financing. Changes in pension rules for government and PSE employees and introduction of a variety of social security schemes have changed the needs of savers of various categories of investors.

It is therefore appropriate that interest rate regimes are made more market oriented; and saver are encouraged to explore more attractive investment options.

An anomaly however is over reliance of the government on the small saving schemes for deficit financing. Over 40% of the deficit is now financed through high cost small savings. Considering the fiscal constraints of the central and state government, small saving schemes run the risk of turning into a Ponzi scheme where the old obligations could be discharged only from the fresh inflows. If we build even 2% probability of new flows being insufficient to fulfil redemption/maturity demand, we could have a disaster of epic proportions.

Game of Tom and Jerry continues

It has been a consistent endeavour of every finance minister in the past couple of decades to plug the loopholes that were being used for tax avoidance by the wealthy taxpayers. However, the tax experts and money managers have been able to find alternative methods. Thus, the game of Tom and Jerry continues between the tax authorities and taxpayers.

Staying with the tradition, the finance minister has sought to plug some more avenues that were frequently used by taxpayers to lower their tax liability. Rationalization of tax on income from market linked debentures (MLDs); large insurance policies; reinvestment of long term capital in buying house property, meaningful TCS on foreign travel and investments; etc. are some major proposals in the latest budget to curb tax avoidance.

Investors may note that with every budget the avenues for tax avoidance are narrowing. Thus, it is pertinent that they avoid “tax avoidance” as one of the investment objectives. The chances of them ending up more tax in their endeavour to save taxes are rising with each budget.

 Largely as expected; capex sustainability core focus (Phillips capital)

Budget fared well across categories – prudent fiscal position, steep rise in capex allocations, continued focus on sustainability, Atmanirbhar Bharat, and social upliftment.

Capex budgetary allocations have risen sharply in FY24 (up 37% vs. 23% in FY23); including IEBR, growth stands at 32%/10% in FY24/23. Incremental capex allocation in FY24 is highest for railways, roads, infra spending by states, and energy; defence and housing are muted; additional allocation of Rs 550bn has been made towards OMCs and BSNL capital infusion.

Sharp drop in food and fertiliser subsidy (Rs 1.6tn) is in the expected lines. MNREGA allocations have also see a sharp decline to Rs 600bn vs. Rs 894bn in FY23RE.

Fiscal deficit for FY24/23 is in line with our expectation – at 5.9%/6.4% of GDP; gross/net borrowing expectedly remains elevated at Rs 15.4tn/11.8tn, marginally higher vs. FY23. We expect this to keep yields elevated in the near future until clarity emerges on RBI rate reduction path (likely by Q3-Q4 FY24). State fiscal deficit limit has been set at 3.5% (including 0.5% for power sector reforms). Tax/GDP ratio at 11.1% bakes in all optimism, we expect marginal slippage considering likely economic softness in FY24. Revenue  expenditure/disinvestment targets are realistic, marginal slippage also expected under non-tax revenue.

Strategy

Buoyant public and private capex keeps us positive on the investment sectors (capital goods, railways, cement, logistics; defence is a tad soft – as expected) more than the discretionary segments. We are also positive on the agriculture space, government’s focus on raising domestic production, and eventually encouraging exports – is a long-term positive for rural income. Near-term, we are not positive on rural demand, FY24 allocations not encouraging.

Union Budget FY24: A Fixed Income and Macro Perspective (IDFC Mutual Fund)

Central government gross borrowing through dated securities is estimated at Rs. 15.4 lakh crore in FY24, well within market expectations, after Rs. 14.2 lakh crore in FY23 which was also devoid of any surprise. States’ borrowing could pick up in FY24 in line with potentially mildly-higher fiscal deficit, higher SDL redemptions and a possible shift from the pattern in FY22 and FY23 of a consistent undershoot the borrowing calendar. This implies consolidated (centre + states) gross borrowing, moving up each year after moderating from the peak in FY21, could now rise beyond FY21 and well above pre-pandemic borrowing (Figure 4). Even net consolidated borrowing as a share of GDP will be 1.1ppt higher than FY20 (pre-pandemic). Total outstanding government liabilities remain high at 82% of GDP at end of Q2 2022, after rising to 89% of GDP in FY21 and FY22 from 75% in FY20.

However, the central government is now in a position such that if nominal growth is in the 10-11% range and expenditure does not rise sharply in FY25 and FY26, it could well be on the fiscal glide path and get to below-4.5% fiscal deficit in FY26.

Strategy

While gross borrowing announced today has positively surprised versus market expectation, the standalone number is nevertheless a significant one. We expect the yield curve to steepen further somewhat, especially over the latter part of the year when market may have better line of sight on whatever modest rate cuts to expect if at all down the line; assuming a soft-landing scenario for the developed world.

The environment for fixed income is decidedly getting more constructive given better macro stability, terminal policy rates in sight, and the consequent fall in global bond market volatility. This argues for somewhat higher duration in active funds than before. At any rate one has to compensate for the ‘roll down’ effect on portfolio duration that happens when one is passively holding the same set of bonds. For these reasons, and keeping consistent with our underlying view, we have expanded our consideration set to 3 - 6 year maturity bonds; a marginal tweak from 3 - 5 year maturities before.

Pragmatic budget with focus on Growth and Macroeconomic Stability (Canara Robeco)

Budget has managed to create investment acceleration without damaging other expenditures. This was a modestly positive for equity markets. Consistent key positive for economy has been that Govt has been trying to focus on productive spending within constraints of resources over last 8 years.

Strategy

Budget is modestly positive for Industrials, Banks and both FMCG and non-FMCG discretionary consumption. Equity market will move back to two key factors from tomorrow, the earnings (season) and cost of capital (interest rate outlook globally). We think that both these factors are neutral to negative for us from near term perspective and thus market will continue to consolidate till we get visibility on earnings upgrades or substantial decline in interest rates (Inflation globally/locally) to change multiples. India trades at premium to other Ems and thankfully that is correcting with the consolidation over last 1 year. Indian equity market trades at 19xFY24 earnings – with earnings CAGR of 13-14% over FY23-25E – in a fair valuation zone from near term perspective.

Marching ahead on sustainable growth path (JM Financials)

The main focus area of Budget FY24 was on capex, with a substantially higher allocation of INR 10tn (33% YoY) while adhering to the fiscal consolidation path. The fiscal deficit target is set at 5.9% of GDP for FY24, but the way forward to FY26 would be steep.

Capex target for FY23 missed slightly (INR 7.3tn vs INR 7.5tn FY23BE) as states could not undertake the capital expenditure. The revenue growth assumptions (10.5% YoY) look optically conservative since it is on a higher base of FY23. However; over the FY23BE figures, the revenue growth rate comes to 22% which is quite stretched.

Strategy

We have a constructive view on the markets and we believe that the high allocation towards capex and schemes like PM Awas yojana are likely to benefit real estate ancillaries like cement and building materials while companies in the industrial space are the clear beneficiaries of the governments capex push.

Capex boom all the way (Yes Securities)

Continuing from the previous years, this Budget is a futuristic blueprint that seeks to harness the full potential of the economy through universal development and to touch the lowest income pyramid with inclusive policies. Impetus for job creation and macro stability remains the economic objective of the Budget making exercise. To improve the future productive capacity of the economy, effective capital expenditure has been increased to 4.5% of GDP or INR 13.7 tn, with outlay for railways and roads respectively up by 50.0% and 25.0% respectively over the FY23RE.

We see the budget maths as being rational with the nominal GDP growth assumed at 10.5% and laud the government for being able to stick to a consolidation plan at 5.9% GFD/GDP in FY24BE from 6.4% in FY23RE.

Strategy

The yield curve has flattened out significantly as the RBI has sharply increased the short-term rates. We see some scope for the yield curve steepening once again while holding the short-end of the curve. Tighter liquidity, larger general government issuances along with probable increase in the corporate bond issuances could be the factors behind steepening of the G-sec curve.

As in most years, we see the central government front-loading its borrowings into H1 FY24, thereby creating a possibility for the 10-year G-sec yields to rise to around 7.60-7.75% in that period.

Critical would be the demand from the insurance companies to clear the market supplies. We note that the incremental buying of the insurance companies in H1FY23 is lower than in H2FY22. The demand for guaranteed returns insurance policies could also die out as banks have raised their deposit rates now and tax arbitrage at higher end of term premia is done away with in this Budget.

Balanced Budget With Capex Led Growth (Kotak Mahindra AMC)

❖7% Growth expectation for FY23 looks Conservative

❖Focus on 3G

•      Growth - Fiscal consolidation & Infrastructure spending

•      Governance - Improving Tax Compliance

•      Green - Energy independence through green energy

❖Higher spending on Infrastructure than expectations to help Capex and Growth

❖Consumption to get a boost - Tax cuts

❖Multiplier effect on growth by pulling in private investment

❖Achievable divestment target of ₹ 610Bn

Strategy

❖Equity/Hybrid:

•      Indian Markets trading at a premium to other Ems

•      It’s a Buy on Dips Market

•      Allocate via Hybrid Funds such as Balanced Advantage & Multi-Asset Funds

•      Conservative investors can consider Equity Savings and Conservative Hybrid Funds

•      Exposure to Equity Funds preferred via SIP route

❖Fixed Income:

•      Market Linked Debentures will be taxed as Short Term Capital Gains at applicable rates. This will bring it at par with Debt Mutual Funds

•      Yield curve has flattened in the last 1 year, 3-7 years segment of the curve looks attractive

•      Short/ Medium Duration & Dynamic Bond Funds can be considered

•      Some allocation to Long Duration Funds can be considered in case the long-term yields harden further

Consistent, Credible and Prudent (IIFL Asset Management)

In line with the past few budgets, the government maintained its focus on capital expenditure to improve long term growth potential. While the headline capex growth seems higher (37% growth YoY), the adjusted budget spends are still higher by 25% YoY post internal adjustments, which is commendable. Further, a larger proportion of the capex has been provisioned for the central government (against spends by states and PSUs), which should result in better execution.

The FM maintained the trend of projecting realistic and achievable estimates, leaving the potential for an upside surprise if there is a pickup in economic activity. Tax revenues are projected to grow at 10.4% (vs 12.3% in FY23). Divestments targets also seem achievable at INR 610 bn (vs INR 600 bn in FY23). Improvement in global activity and peaking of interest rates could lead to upward revisions and lower deficits compared to projections.

Strategy

We maintain our focus on creating a balanced portfolio with a mix of companies which are likely to – experience structural growth or benefit from the economic turnarounds. In terms of sectors, we see interesting opportunities in Private Sector Financials, Consumer Discretionary, Industrials and Materials to participate in the domestic economic recovery.

We continue to maintain an overweight exposure to the secular segment (31% portfolio vs 21% for benchmark) and remain underweight in value traps (20% vs 31%) across most of our portfolios. Our portfolios are also overweight cyclicals (22% vs 16%) vs defensives (25% vs 32%), we expect this trend to continue in the near term.

Growth support; fiscal consolidation (DBS)

The central government’s FY24 Budget was growth supportive whilst sticking with a

modest glide path for consolidation. The underlying math was reasonable as it factored

in the upcoming moderation in nominal GDP growth, and lower tax buoyancy, whilst prioritising long-gestation capex spending.

Accompanying sectoral announcements were a mix of tweaks to the personal income tax brackets (to provide support to the salaried class), changes in custom duties to support local manufacturing, and targeting green transition goals, which was balanced by higher allocation towards MSME credit guarantee schemes, skill upgradation and other inclusive welfare goals. The medium-term path of further fiscal rationalisation remains in place as the government reinforced its target of lowering the deficit to -4.5% of GDP by FY26.

Strategy

The high contribution of small saving scheme might be at risk as banks continue to offer competing deposit returns. Looking ahead, market conditions might be less conducive in FY24 on account of a narrower liquidity balance, squeeze on banks as credit growth continues to outpace deposit generation hurting incremental demand for bonds as well as limited progress on global bond index inclusion plans. This increases the likelihood that the central bank might show its hand via open market operations in the course of the year to contain unexpected volatility.

 Prologue: If you find these observations completely trivial, that is precisely the idea. The budget speech and most of the promises made thereunder sound trivial, lacking specifics.

As expected, the budget speech of the finance minister, while presenting the last full budget of the union government before the next general election, sounded like an election manifesto. The finance minister counted the achievements made in the past nine years (since 2014) of her party’s government; and made many promises for the future, totally lacking on specifics.

Perhaps for the first time in the history of independent India, the finance minister used “We will” and “will be” to make all the budget proposals. The general convention has been to say “I propose to” or “is proposed”. Besides, the nomenclatures of an overwhelming number of central sector schemes now use “PM” as prefix. It is obvious that the central government is too conscious to ensure that the electorate must know that the benefit provided to them is coming from the central government.

The obsession with complex names of schemes, apparently reworked from a pre-defined acronym, also continues. As has been the practice in the past few years, many schemes have been renamed and/or clubbed to give an impression of new schemes.

The capital allocations made in the budget are mostly incongruent to the promises made, making the promise less credible. Adjusting the promises with the funds allocation, the budget is a mundane account presentation. It provides marginal relief to middle class taxpayers; proposes to plug some loopholes that are used by high networth individuals to evade taxes; continues the task of simplification of tax administration, and proposes to ease compliance for entrepreneurs.

The best part of the budget speech was the recognition of changing socio-economic paradigm in terms of adoption of technology and digitalization of routine life. The finance minister not only used technical jargon in her speech, but also made several proposals that potentially could enhance adoption of technology in the normal course of business, e.g., education, business transactions, data storage and exchange, and public services. The idea is to improve Ease of Doing Business by increasing the speed and efficiency.

Key themes

1.    Inclusive Development

2.    Reaching the Last Mile

3.    Infrastructure and Investment

4.    Unleashing the Potential

5.    Green Growth

6.    Youth Power

7.    Financial Sector

Positive take away

Farm sector

·         Proposal to build an open source digital platform for farmers to improve communication, access and support for agri based enterprise.

·         Establishment of an agriculture accelerator fund to transform agriculture practices, increase productivity and profitability. Farm credit target increased to Rs20trn.

·         Plan to set up massive decentralised storage capacity for marginal and small farmers.

Education & Skill development

·         Plan to materially improve teachers’ training.

·         National digital library for students.

·         Further enhancement of 740 Tribal residential schools.

·         Digitization ancient inscriptions.

·         PM Skill Development 4.0 to be launched; and include coding, AI, robotics, mechatronics, IOT, 3D printing, drones, and soft skills.

Capital expenditure

·         33% increase in total capital expenditure outlay to Rs10trn.

·         100 critical transport infrastructure projects, for last and first mile connectivity for ports, coal, steel, fertilizer, and food grains sectors.

Ease of doing business

·         Simplification of KYC

·         Expansion of Digilocker scope

·         PAN to be common business identifier across agencies.

·         Unified filling process. No need to submit same information to multiple agencies.

MSME support

·         Provision to ensure prompt payment to MSME vendors.

Climate change

·         Rs350bn outlay for energy transition.

·         Green credit program to be unveiled.

Small savings

·         2yr Mahila Samman Savings Certificate bearing 7.5% p.a interest

·         Senior Citizen Savings Scheme limit doubled to Rs30lacs.

·         Limit of monthly income account increased to Rs9lacs for single account and Rs15lacs for joint account.

Negatives

·         No improvement projected in Tax to GDP. Tax revenue to grow exactly in line with nominal GDP growth of 10.5%.

·         Interest payment to rise by 14.8% to Rs10.8trn.

·         No provision for disinvestment proceeds.

·         Sharp cut in capital allocation for school and higher education.

·         Sharp cut in allocation for MNREGA, Food subsidy and assistance.

·         Negative real growth in allocation for smart city, PM Awas Yojna, national Livelihood mission, etc.

·         Abysmal Rs42.4cr (-17%) allocation for capex in agriculture and farmer welfare.

·         Poor 1.7% hike in revenue expenditure for agriculture and farmer welfare.

·         Poor capital expenditure outlay for skill development (Rs99.2cr); Science & technology (Rs88.3 cr); forest and climate change (Rs145cr) food and PDS (Rs150.3cr).

·         Doors opened for opaque off shore derivative instruments (P Notes) through IFSC (GIFT city).

·         Discouraging foreign travel and investments through higher TCS (20%)

Key direct tax proposals

Corporate Tax

·         Increase in limit for presumptive tax – MSME from Rs2cr to Rs3cr; Professionals from Rs50lacs to Rs75 lacs.

·         Payment to MSME to be allowed as expense on actual payment basis, subject to the time limits under section 15 of MSMED Act.

·         New cooperative that commence manufacturing activity before 31 March 2024 may avail lower tax rate of 15% as available to new manufacturing companies.

·         Now the new start up units established before 31 March 2024 could avail tax benefits.

·         Cost of all self-developed/earned intangible assets to be treated as NIL for capital gains purposes.

Personal taxation

·         New tax regime introduced in FY21 to be the default tax regime for all individual assesses.

·         Deduction u/s 54 and 54F in respect of capital invested in a residential house to be capped at Rs10cr.

·         If the aggregate premium on insurance policies issued on one life exceeds Rs5lac in any previous year during the term of the policy, the proceeds from such policies would be taxable as other income. Deduction will allowed for premium paid, if such deduction has not been claimed earlier. This does not apply to ULIP, Keyman insurance and proceeds received post death of the insured.

·         All income from online gaming to be subject to TDS.

·         Conversion of physical gold into electronic gold receipts not be treated as transfer for capital gain purposes.

·         Income tax slabs under new personal income tax scheme reduced to five from seven earlier.

·         Minimum exemption limit increased to rs3 lacs from rs2.5lacs earlier.

·         Standard deduction to be available under new tax scheme also.

·         Effective maximum marginal tax rate reduced from 42.74% to 39% by capping all surcharges at 25%.

·         Limit for exemption in respect of leave encashment increased from rs3lacs to rs25lacs.

·         Income from investment in Market Linked Debentures to be taxed as Short Term Capital Gain on debt securities.

·         Overseas tour package and remittance under LRS (for purposes other than education) in excess of Rs7lacs to attract 20% Tax Collection at Source.

·         The debt repayment component of distribution made by REIT and InVIT to its unit holders to be fully taxable in the hands of unit holders as income.

 

Fiscal Trends

Trends in government expenditure