Do it yourself: Fiscal Deficit

Showing posts with label Fiscal Deficit. Show all posts

Wednesday, March 12, 2025

Trade war cannot quick-fix

In the year 1689, British monarch William of Orange put steep tariffs on French wine. He wanted to encourage the British to drink their own booze - make and drink. It was not a great idea because without wine, Britain turned to the hard stuff - gin. So, for the next 50 years, England was in the grip of the so-called gin craze. And newspapers wrote about the surge in crime and death and unemployment.

In the 18th century, Britain put trade restrictions and taxes on tea being shipped to the colonies. This eventually led to the Boston Tea Party, an iconic event in the American war for independence.

In the 1800s, the Brits were importing a lot of tea from China, and they didn't like the trade deficit, so they started to export opium to China, which caused an opium epidemic in China. China put a tariff on opium and then banned it altogether. This led to the very bloody Sino-British Opium Wars. The Qing lost the war. This defeat is popularly believed to be the first step in the direction of establishing modern day China.

Restrictions on the trade of cotton textile, indigo, salt etc. by the British empire on India inspired many key events in India's war of independence.

Soon after its unification in 1871, Italy turned to protectionism to foster its “infant” industries. It terminated its trade agreement with France in 1886; raised tariffs as high as 60 percent to protect its industries from French competition. The French government responded by passing the highly protectionist Méline Tariff of 1892, which famously signaled the death knell of the country’s flirtation with free trade. This eventually pushed Italy closer to Germany and Austria-Hungary in the years leading up to the First World War.

A famous example of protectionism gone awry is 1930’s Smoot-Hawley Tariff Act—which along with similar protectionist measures enacted around the globe—helped torpedo world trade, killing two third of the global trade, and exacerbate the Great Depression leading to WWII.

In the post WWII era, US trade restrictions on Cuba, Iran, Iraq, Russia, North Korea, Syria etc. have had a significant impact on global strategic balance.

Wider economic sanctions on India in the wake of 1998 nuclear tests, helped India develop indigenous technologies and evolve as a major power in space technology.

There is a strong view that America’s “trade war”, with Japan in the 1980s, was one of the best things that ever happened to American industry and consumers, because American businesspeople rose to the challenge of the time. The "quality movement" spread across the country. Businesspeople, previously outraged by the Japanese “stealing” trade secrets, decided to join the club and took to “benchmarking” on an industrial scale, often with Japanese companies as their targets. The benefits of all that attention to quality were large and durable for US businesses and consumers. In the end, the “war” did not prove to be destructive.

The short points are:

· Trade wars perhaps as old as the cross-border trade itself.

· Trade wars have often culminated in larger geopolitical conflicts and resulted in changes in the global maps.

· Trade wars have been mostly caused by (i) distress in the domestic economy of the aggressor, promising protection and assurance to the local businesses; and/or (ii) eroding credibility of the extant political leadership, resulting in such leadership raising the rhetoric of aggressive-nationalism and external threats to the national integrity to protect its position.

· There is evidence of trade wars causing structural shifts and paradigm changes in the global economy. However, there is little to suggest that but for trade wars, the world would have been a better place.

In my view, the latest specter of a wider trade war has been unleashed by the US administration to find a quick-fix solution to economic malaise, the US economy is suffering from nearly two decades of fiscal and monetary profligacies.

The US public debt has increased from US$3.41 trillion in the year 2000 (~35% of GDP) to US$29 trillion (~105% of GDP) currently. In this period, the fiscal deficit has risen from a US$236 billion surplus in the 2000 to a deficit of ~US$1.8 trillion currently. This is obviously not sustainable and needs to be corrected.

The moot point is “Whether trade war is a good solution for correcting historical mistakes?”

Tuesday, December 3, 2024

Growth slowdown may be structural

India’s real GDP grew by 5.4% yoy during 2QFY25 (July-Sep); the slowest growth rate recorded since 3QFY23. The Reserve Bank of India had forecasted a growth of 7%, just a month ago, while the market consensus was less sanguine at ~6.5%.

For the argument’s sake, some of the slowdown in 2QFY25 could be attributed to a high base (2QFY24 GDP grew at 8.1%). However, it is tough to deny that the Indian economy has been growing below potential in most of the post global financial crisis (GFC-2009) period. In fact, it will not be totally perverse to argue that in the past one decade or so, the potential growth curve itself has moved lower.

For record, the Indian economy has grown at an average rate of 5.8% during the past decade (FY15-FY24). Even normalizing for the Covid-19 lockdown impact, the Indian economy has grown at an average rate of 6.0%, much below the estimated potential growth rate of over 8%. The real GDP had grown at an average rate of 7.8% during the preceding decade (FY05-FY14).

The slowdown in 2QFY25 has been led by the industrial sector, especially, manufacturing and core sector (e.g., mining and electricity) – a sector that has been the highest priority area for the incumbent government in the past decade. Agriculture (3.5% growth) sector did well on the back of a bountiful monsoon; and services also grew at a decent 7.1% led by public administration. On demand side, investments contracted for the fourth consecutive quarter, belying the promise of a massive jump in allocation for capex in the union budgets for FY24 and FY25. Private consumption grew 6% yoy on a low base of 2.6%, but declined qoq, despite the higher DBT.

The fiscal data for April-October 2024 period shows that contrary to its commitment in the union budget, the government has sacrificed capital expenditure in favor of direct cash transfer (DBT) to households. Ahead of key state elections, the government transferred an advance installment of tax devolution to states to meet revenue expense obligations. The central government capex (including on defense) was much lower than the budget targets. The disbursement of the promised capex loans to the states was also lower. Revenue expenditure on education, drinking water and sanitation were restrained to increase DBT allocation.

The popular narrative after the announcement of 2QFY25 GDP data appears to be that high effective rate of taxes and higher interest rates are hurting the growth and fiscal and monetary stimulus may lead to a course correction. I sincerely beg to differ from this hypothesis.

I have often highlighted that the obstacles to the acceleration in India’s growth rate are structural and not cyclical. Inability to adequately exploit our most valuable resources – the human capital and the largest pool of arable land in the world – is the principal reason for below potential growth. Consistent misallocation of capital, adhocism in policy making, lack of a conceptual growth framework, a distorted federal political structure, blatant pursuit of crony socialism, and lack of a long-term socio-economic growth plan.

In this context, it might be pertinent to note the OECD has projected a gradual deceleration in the potential growth rate of the Indian economy in the next four decades, as the marginal productivity of capital declines and contribution from technological progresses diminishes. (Table 1). The potential rate declines, even if in a blue-sky scenario, where India is able to take fuller advantage of its demography and is able to achieve a much higher rate of capital accumulation and employment (Table 2). (see full report here)

Thursday, November 7, 2024

My two cents for improving fiscal balance

After the conclusion of the recent Haryana Assembly elections, a lot of people, including some of the senior most political analysts & observers, wondered why the Congress party lost the election, contrary to the popular perception. The ruling party was witnessing serious anti-incumbency issues. The Congress party, being the principal opposition party, had raised all the pertinent issues concerning the common people. Congress leader Rahul Gandhi carried an effective campaign. Almost every poll projected a clear lead for the Congress Party.

At a gathering last evening someone asked me “how do you explain the repeated poor performance of the Congress Party, despite the rising popularity of its main leader?” My answer was simple, “Congress leaders are telling people what problems (inflation, unemployment, nepotism etc.) they are facing, as if people are not aware of their problems. Congress leaders, however, do not offer a solution for any of the peoples’ problems. That is why they lose elections.”

Yesterday, I ended my note highlighting a potential problem for investors (see here). Some readers suggested, “it would have been better if I offered some solutions also, lest it is a meaningless exercise”.

So, here are my two cents for augmenting the government fiscal balance. Of course, as usual, some of the readers may find these utopian. Notwithstanding, in my view these are practicable, effective, and worth sharing for generating a wider discussion.

Go back to villages

Since independence the government has focused on development of industrial and urban infrastructure in the country. It has actively participated in the endeavor through a large number of public sector enterprises; besides offering a myriad of tax and other concessions to the private entrepreneurs. Now, the country has a reasonably strong industrial base. Many of our industries are globally competitive. We have a strong set of entrepreneurs and risk takers. It is therefore high time when the government should reset its priorities and turn its primary focus on agriculture. To meet this end, the government may consider:

Exiting all industrial and banking activities and actively undertaking agricultural activities. It should develop barren lands; develop water bodies and irrigation facilities; develop and use technology for enhancing productivity; give employment to landless farmers; take risk with new technologies & crops; partner with marginal farmers in consolidating their land and do farming on that land - just the way it undertook industrial activities immediately after independence.

Undertake, on mission basis, the task to re-skill the underemployed farmers and farm labor. The farmers and their family members may be trained as dairy workers, domestic help, nurses, tourist guides, artisans, etc. Expecting the construction sector to absorb all surplus farm labor is a bad idea.

Develop at least 5 very large special agri export zones in rocky and desert areas of central and western India and undertake export of farm produce as a commercial activity. These zones may be developed in public, private or joint sectors. Besides, it may acquire farm assets, especially rice farms, overseas to reduce water intensity of Indian agriculture.

Encourage various states to make bilateral or multilateral agreements for procurement, processing and trading of farm produce and movement of labor within states.

Nationalize all rivers. Develop a national water grid. Set up a national water regulator, who shall work out a water sharing formula for all states and union territories every three year and maintain adequate provisions for managing droughts. The idea should be to ensure that not a drop of river water flows into sea from India. Develop a water distribution grid on the models of roads and power grids on a mission basis.

The aim should be to grow agriculture and allied sectors to become at least 40% of the economy. This only can assure sustainable employment for Indian youth, and orderly urbanization of India to promote services, (especially tourism) and rapid industrialization.

It has taken more than seven decades for Indian industries to reach a stage where the government may consider fully exiting the industrial activities. It may take 2-3 decades for Indian agriculture to reach a stage where the government will be able to exit farming activities completely. I am definitely not suggesting nationalization of the agriculture sector. I am just saying that the government should undertake the activity on a commercial basis to provide the sector with much needed escape velocity in terms of capital, technology, and risk-taking capability.

Pragmatic business regulation

The government must substantially liberalize rules and regulations governing businesses in India. It should make the regulatory pragmatic, allowing a great deal of freedom to businesses.

For example, an autonomous sustainability commission may be set up. The commission may comprise representatives of the scientific community, civil society, and judiciary. Instead of prescribing a rigid dogmatic environment clearance regime, each business must be permitted to submit a customized sustainability plan to the commission. The plan must specify how the enterprise proposes to address the sustainability concerns arising from its business. The commission may accordingly award environment clearance.

A pragmatic, business-oriented regulatory framework would stimulate growth, encourage larger CSR activities, generate more employment and hence ease pressure on fiscal.

Thursday, May 23, 2024

What if? - Part 4

The ongoing celebrations of the Festival of Democracy shall end on 4^th June 2024, with the announcement of election results for the 18^th Lok Sabha. In the past two months, the market narrative in India has pivoted around the election outcome. Even though 4QFY24 earnings did impact the performance of specific stocks materially; speculation about the election results has mostly dominated the sentiments.

Once the elections are over and the contours of the new government are clear in the first fortnight of June, the focus will shift to the presentation of a full budget for the current financial year. To keep the tradition, only an interim budget (vote on account) for FY25 was presented in February 2024 to run the government till a new government is formed for the next five years. A final budget is expected to be presented by the new government in the last week of July 2024.

Some media commentators and market experts have attempted to sketch the final budget based on the election speeches and media reporting of the party’s manifestos. Fears have been expressed that in the event of a non-BJP government assuming power at the center, the pace and direction of economic growth and development may slow down as resources are diverted to fulfill the populist agenda of opposition parties. In a non-BJP regime, the budget allocation for capital expenditure and infrastructure development may diminish materially.

I find that this narrative suffers excessively from an intrinsic fear of change. I could not find anything in the manifestos of opposition parties, mainly Congress, that would suggest any change in the focus on infrastructure development and faster economic growth. Most social welfare schemes promised in the manifesto aim to reduce poverty and achieve equitable growth. Almost all these schemes are in vogue in many states and at the central level. A set of similar schemes is also promised in the BJP manifesto also.

Technically speaking, market participants should rejoice the Congress manifesto, as it promises a much larger amount of cash in the hands of consumers. This could help put the missing piece of Indian growth, viz., consumption, in place. Provisions like statutory guarantee for MSP can also boost the farm input sector. Consumers and Chemicals are two major underperforming sectors of the market.

Besides, if a non-BJP government assumes power at the center, the market participants may again begin to speculate about tax exemption for the LTCG and dividends, etc. On the other hand, several BJP leaders and think tank members have spoken about the need for estate duty (inheritance tax) in the recent past. This has been a fear factor in pre-budget analysis since 2017. The finance ministers have defended LTCG taxation and dividend tax. In the past 10 years, effective personal taxation rates have remained high and the proposed Direct Tax Code is expected to remove more exemptions.

Insofar as fiscal profligacy is concerned, there is no evidence that the UPA government (2004-2014) indulged in fiscal indiscipline during their regime. Center’s fiscal deficit did jump from 2.54% in FY06 to 6.46% in FY09 due to the stimulus necessitated by the global financial crisis. However, it was gradually brought down to below 4% by FY15. This was despite welfare schemes like MNREGA, fuel subsidies, etc. Similarly, during the NDA regime, the center’s fiscal deficit jumped to 9.17% in FY20 and has been on the mend since then. This is despite the implementation of Food Security, cash payout to farmers, and many other welfare schemes.

There is no empirical evidence to support the fears of fiscal indiscipline by a non-BJP government.

I find that most schemes and programs promised by NDA and opposition INDIA groups would be implemented, if at all, gradually and mostly by merging and optimizing existing schemes at the state and center levels. The fiscal burden will come only incrementally with the equivalent or higher rise in nominal GDP. The fear of likely fiscal slippages may therefore be unfounded.

Logically, the analysts should be looking forward to a stock market rally in the short term if a non-BJP government is formed at the center. Though, it may not actually happen. We may see a knee-jerk reaction down and then a recovery, after the full budget is presented in July.

In case of a BJP victory, we may see a euphoric move up and then a corrective move down as the budget may not enthuse the market participants and earnings fail to justify some lofty valuations.

In either case, after July 2024, the markets shall be guided by the earnings, macro conditions, and global developments, rather than the outcome of elections.

So to answer What if? – I would say Nothing, just chill.

Also read

What if? - Part 1

What if? - Part 2

What if? - Part 3

Tuesday, February 6, 2024

View from my standpoint

ले दे के अपने पास फ़क़त इक नज़र तो है, क्यूँ देखें ज़िंदगी को किसी की नज़र से हम —साहिर लुधियानवी

Last Thursday, the finance minister presented an interim budget for the fiscal year 2024-25. The budget presentation had two part – (i) rhetorical and (ii) substantive.

The first part included a speech about the performance of the governments led by Prime Minister Narendra Modi for the past 10 years and promises for the next 23 years. The finance minister spoke about how in 2014 their government inherited an economy that was in shambles; and how they have pulled it out from a total mess and put it on the fast track to achieve the status of a developed nation by the year 2047; when we would celebrate 100 years of our independence from the colonial British rule. The finance minister also promised to implement a slew of development schemes over the next five years. She however refrained from listing any specifics or financial details.

The second part included (i) the accounts of the government for FY24; (ii) fiscal proposals for FY25, and (iii) a vote on account to meet the government’s expenses till a new government is formed and a full budget is approved by the parliament. This is the part that needs to be discussed and analyzed.

Fiscal prudence – achievement vs desirability

The finance minister presented that the fiscal deficit target for FY24 has been revised downward to 5.8% (Budget estimates (BE) 5.9%) and budgeted a fiscal deficit for FY25BE at 5.1% of GDP. She emphasized that the government is well on course to achieve the FRBMA target of a 4.5% fiscal deficit by FY26. The sharp improvement in the fiscal deficit has been received well by most. A tight balance is particularly commendable given the impending general elections. In my view, we need to ponder deeply over the following five points:

1. At this stage of economic development, whether this degree of fiscal tightening is desirable? FY24RE shows that to meet the fiscal targets, the government has cut capex spending also. Is it appropriate to save on capital expenditure to meet fiscal targets? FY25BE growth in capex spend on key sectors is very moderate.

2. FY25BE further confirms the trend of the past three years that the government is systematically cutting its consumption expenditure, subsidies, and social sector spending while allocating more for manufacturing and export incentives. Should investors assume that our economy is taking a left turn toward the Chinese model of growth (primarily manufacturing and infrastructure capacity building) from a largely consumption and social sector capacity building led growth?

3. The budget does not explain why Rs one trillion, 50-year interest-free loan to states shall not be considered part of the fiscal deficit. For all practical purposes, it’s a drain on the center’s finances that will likely never be returned.

4. Interest expense now constitutes 25% of the total government spending. There is no indication that this proportion will come down any time soon. On the contrary, with fiscal deficit staying at 4% of GDP or above for at least three more years, and greater reliance on high-cost small savings funding of deficit, it is likely that the proportion of interest in total expenditure may rise further. Under these circumstances, the sovereign rating of India may not see any upgrade anytime soon.

5. With the current valuations of PSEs, disinvestment looks increasingly improbable. The government has not presented an alternative plan for fundraising so far.

…

Wednesday, January 31, 2024

To be or not to be!

“Sir, I rise to present the Budget of the Central Government for the year 1962-63. The main purpose of this Budget is to place before Parliament an account of the finances of the Central Government for the current year and to obtain from the House a vote on account to meet the expenditure of the Government until the new Parliament considers the Budget again.” (Shri Morarji R. Desai, Minister of Finance, introducing the interim budget for the year 1962-63)

Tomorrow, the union finance minister will present an interim budget for the fiscal year 2024-25. An interim budget is necessitated due to the impending general elections, which ought to be completed by the end of May 2024. The union budget for the current fiscal year 2023-24 authorized the expenses of the union government till 31 March 2024. The incumbent government has the mandate to be in power only till the general elections are completed and a new government is sworn in. It is a convention of parliamentary ethics that the incumbent governments make policies and programs only for the period they are mandated by the electorates to be in power.

Therefore, conventionally, governments have avoided making any policy announcements in the budgets, if general elections are to be held within 2-3 months of the due date for the budget. The finance minister usually seeks a vote on account to get parliamentary sanction for the government expenses to be incurred between the beginning of the new fiscal year (1 April) and the presentation & approval of the normal budget by the newly elected parliament. Though ‘Vote-on-Account’ has been referred to as an “interim budget” by many finance ministers, it may not be the correct description of this exercise.

I considered this introduction necessary to put the discussions and narratives being run in media and markets, in right context. Even industry associations and professionals are making suggestions to the government and fueling speculations about tax reliefs, industry-specific incentives, tax-rate restructurings, etc. The whole narrative appears to be based on assumptions that the incumbent government does not care about the established conventions of parliamentary ethics and it may make populist announcements ahead of the general elections.

These assumptions are based on the breach of convention by Shri Piyush Goyal, the extant finance minister, in the interim budget of 2019. The government announced ₹6,000 direct cash transfer to farmers having up to 2 hectares of land. under Pradhan Mantri Kisan Samman Nidhi; ₹3,000 per month pension after 60 years of age to unorganized sector labor under Pradhan Mantri Shram Yogi Mandhan; hike in the standard deduction for salaried people, and some relief in TDS. These schemes entailed an additional fiscal burden of approximately rupees one trillion.

I would like to consider the 2019 interim budget as an exception rather than a norm. I am therefore not expecting any breach of parliamentary ethics in the 2024 interim budget. I shall watch the interim budget only for two data points –

(i) Fiscal deficit for FY24, considering it was the first complete normal year post-Covid and Ukraine war-led disruptions.

(ii) Nominal GDP projection for FY25, since this is used as a denominator for calculating fiscal deficit as a percentage of GDP; Tax to GDP ratio; corporate profit to GDP ratio, etc.

Friday, August 4, 2023

Some notable research snippets of the week

India rates: Liquidity update (Nomura Securities)

Liquidity update: Over the past few months, liquidity in the interbank market has been relatively range bound, largely tracking the normal inter month seasonal patterns. However, overall system liquidity, including the government’s cash balance, has increased because of the larger-than-expected RBI dividend and the liquidity infusion from the INR2,000 note’s withdrawal.

As of 26 July, interbank liquidity was approximately INR1.24trn, while overall system liquidity was INR3.6trn on 14 July. As a percentage of NDTL, interbank liquidity is approximately 0.7%, while overall system liquidity is 2%. Despite the increase we have seen MIBOR spike above the MDF rate on various occasions.

What has been affecting INR liquidity? Currency in circulation (CIC) has been decreasing since the RBI announced that the INR2,000 note would be withdrawn . Since the announcement, CIC has declined by INR1.36trn up to 14 July. This is in line with our assumption that there would be a INR1.5trn injection of liquidity into the system by September. Going forward, we would expect a reversal of this, as Q3 FY23 approaches, as CIC usually picks up around election season.

On the FX side, the RBI bought approximately INR1.25trn worth of US dollars in the first two months of FY24. This has led to a large injection of liquidity, while weekly data show the numbers have been more muted in June and July. We continue to monitor the forward book, as we have seen a reduction in the outstanding long USD position.

On the government’s cash balance, we currently estimate this was around INR1.6trn on 14 July. The recent boost has come from the larger-than-expected RBI dividend (INR874bn). The government has repaid the Way and Means Advances (WMA) drawdown taken at the end of FY23. Bond supply will remain high over the coming months with no maturities; however, there will be a net maturity of INR1.5trn in T-bills. Overall, for now we expect a somewhat stable government cash balance over the coming period.

In terms of RBI actions on the liquidity front, OMO sales stopped in the early part of this year and the RBI has remained absent in the market since. However, under the LAF facility, the RBI has continued to intervene via the VRRR and VRR route. In June and early July the RBI intervened asymmetrically, by taking out liquidity on the VRRR once the MIBOR/call rate dropped below the policy rate, while remaining hesitant to inject when MIBOR/call rate spiked.

Liquidity projections From our projections, we continue to see FX interventions as the largest driver for FY24, and if the RBI continues to buy US dollars aggressively for its reserves, we can see a liquidity infusion of over INR2.5trn from this channel. While on the flip side, if INR comes back under pressure owing to global growth concerns or rising commodity prices this may flip back negative. As noted above, we expect outflows from CIC to resume over the coming months and pick up owing to the elections. On OMOs, we still expect the natural drains on liquidity to warrant the RBI conducting OMOs in Q3 FY24; however, as our economists have pushed back on the timing of for the RBI’s rate cuts to February 2024, we think the RBI is unlikely to start OMOs significantly before the RBI’s first rate cut. Subsequently, we have pushed back our timing on the start of OMOs to Q4 FY24, but still expect INR500bn of OMOs this year. For Q3, we would expect the RBI to be more proactive with tools under the LAF, predominantly through the VRR route.

Center’s fiscal in check in 1QFY24 (Kotak Securities)

The Center’s fiscal deficit remained under control in 1QFY24 at 25% of FY2024E. Though corporate tax collections remain weak, receipts were buoyed by CGST and personal income tax. Expenditure remained well-supported by capital expenditure in railways and roadways, even as revenue expenditure is being tightly controlled. For now, we maintain our GFD/GDP estimate at 5.9%, in line with FY2024E.

GST collections remain in range: GST collections for June (collected in July) were 10.8% higher yoy at Rs1,651 bn (May: Rs1,615 bn), with CGST at Rs298 bn (Rs310 bn), SGST at Rs376 bn (Rs383 bn), IGST at Rs859 bn (Rs803 bn) and compensation cess at Rs118 bn from Rs119 bn in May. After the distribution of IGST, June CGST and SGST revenues (before refunds) were at Rs696 bn and Rs708 bn, respectively (Exhibit 2). CGST + IGST collections are currently at a monthly run-rate of Rs663 bn in 1QFY24, with the required run-rate at Rs683 bn. For now, we expect CGST collections to be close to the FY2024E target.

Receipts in 1QFY24 buoyed by RBI dividends, income tax and CGST: Gross tax revenue in 1QFY24 was 20% of FY2024E (3.3% higher than 1QFY23) and net tax revenue was 18.6% of FY2024E (14% lower than 1QFY23). Total receipts were at 22% of FY2024E (0.5% higher than 1QFY23), led by non-tax revenues (mostly due to RBI dividends) at 51% of FY2024B. On the tax front, CGST+IGST collections were at 25% of FY2024E (11.4% higher than 1QFY23) and personal income tax was at 22% of FY2024E. The drag in revenues was from corporate tax collection in 1QFY24, at only 15% of FY2024E ((-)14% growth over 1QFY23) and excise duty collections at 15% of FY2024E ((-)15% growth over 1QFY23). Direct tax was at 18.3% of FY2024E ((-)1.9% growth) and indirect tax was at 22% of FY2024E, (9% growth).

Railways and roads support capex; revenue expenditure kept in check: Expenditure in 1QFY24 was at 23% of FY2024E. This was propped up by capital expenditure at 28% of FY2024E (59% higher than 1QFY23), which continued to be supported by (1) roads at 39% of FY2024E (23% higher than 1QFY23) and (2) railways at 33% of FY2024E (70% higher than 1QFY23). Loans to states for capex rose sharply in June, pushing the 1QFY24 spend to 23% of FY2024E.

Revenue expenditure in 1QFY24 at 22% of FY2024E was in line with last year’s levels, 0.1% lower than 1QFY23.

Maintain our FY2024 GFD/GDP estimate at 5.9%: We see a limited slippage risk in FY2024’s fiscal estimates. Though the higher-than-budgeted RBI surplus transfer provides a significant buffer, it could be offset by a divestment shortfall (market risk), downside risks to tax receipts (trend in 1Q shows some weakness in corporate tax collections) and/or risk of higher spending, given the busy election cycle. For now, we see limited risks of fiscal slippage in FY2024 and maintain our GFD/GDP estimate at 5.9%.

India’s Core Sector Index Rises to 5-Month high (Centrum Broking)

Eight core industries, with 40.27% weightage in the index of industrial production (IIP) recorded a growth of 8.2% in June. Previous months eight core index was revised up from 4.3% to 5%. The cumulative growth across these eight industries during the April to June period in the current fiscal stood at 5.8% compared to 13.9% in the previous fiscal. The recent figures for core infrastructure thereby indicates healthy growth in the economy. However, demand side continues to remain weak on the global side, but the government expenditures helped to keep the core industries afloat. As per government’s front-loading of capex, have helped the cement and steel production to perform well this quarter. We continue to expect strong growth in the production of cement and steel sector in the upcoming months. India’s Fiscal deficit for the first quarter of FY23 stood at Rs. 4.51 lakh crore against the full year target of 17.87 lakh crore.

Eight core industries shows healthy growth

· Production of crude oil continued to see a contraction for 13th consecutive month. Crude oil production contracted by 0.6% in June’23. The cumulative index contracted by 2.0% during the first quarter. On monthly basis the index contracted by -3.05% compared to a growth of 4.93%.

· Refinery products recorded growth of 4.6% compared to a growth of 2.8% in the previous month. Whereas Natural Gas grew for the month and recorded 3.6% compared to a contraction of 0.3% in May’23. The oil basket in general has been disappointing for the past few months as demand has been low which can be seen as the prices have been low.

· Coal production registered a high single digit print of 9.8% in June compared with growth of 7.2% in May. To the contrary, on monthly basis coal production saw a contraction of -3.1% compared to a growth of 3.97%. The cumulative index increased by 2% during April to June period. The rate of growth has picked up after slowing down for the last three months, indicating revival in demand.

· Steel production grew by 21.9% in June compared to 10.9% in the previous month on YoY basis. On a monthly basis as well, the steel production performed well, as it recorded a growth of 1.15%, compared to 0.79% Its cumulative index increased by 15.9 per cent during the quarter April to June.

· Fertilizer production rose by 3.4% in June compared to 9.7% in Mau, on YoY basis. Whereas, on a month on month basis the fertilizer production contracted by 5.35% compared to 16.43% increase in the month of May. Its cumulative index increased by 11.3 per cent during the quarter April to June.

· Cement production witnessed a growth in May by 9.4% compared to an increase of 15.3% in May, on YoY basis. The growth in cement production was led by the current capex push by the government. Moreover, on monthly basis it expanded by 1.68% compared to a contraction of 0.31% recorded in the previous month. The cumulative index increased by 12.2 per cent during the quarter April to June. We continue to believe that this sector will see major growth due to robust increase in construction activity in upcoming months.

· Electricity production recorded encouraging numbers as it recorded 3.3%. The May numbers were revised up from -0.3% to 0.8%. On monthly basis, it recorded a positive growth of 0.89% compared to 4.84% in the previous month. The cumulative index increased by 1.0 per cent during the quarter April to June.

India Auto: Slow growth for PVs and 2Ws in July 2023

Our dealer surveys for July-23 indicate: 1) passenger vehicle (PV) demand has been tepid, especially for the small car segment, with discounts inching up further, and waiting periods lowering (Fig. 8 ) (Fig. 7 ) ; 2) Medium and heavy commercial vehicles (MHCVs) wholesale volumes were up, but given seasonal weakness, discounts have also inched up; 3) two-wheeler (2Ws) demand recovery remains slow, especially given a delayed festive season.

Overall, we maintain our view that consumption will see a re-balancing of growth in FY24F, where the mass segment such as 2Ws can witness a demand pick-up, albeit from a low base, while PV demand is likely to slow down.

Monsoon activity has picked up well (7% above normal as of 27 July [link ]), and bodes well for rural demand as well, in our view.

For Jul-23, we estimate PV industry wholesale volume at ~353k units, up 3% y-y. However, retail sales would be slightly lower, leading to ~15k inventory build-up, on our estimate. We maintain our PV industry growth estimate at ~6% y-y for FY24F.

In 2Ws, we expect wholesales to be up 1% y-y in Jul-23F. Retails are likely up 8% y-y, implying limited inventory build-up, given a delayed festive season in 2023. We expect MHCV wholesale volume to rise 11% y-y.

For tractors, we expect volumes to be up 10% y-y in Jul-23F.

EV registration data for July-23: 2W EV retail sales have increased marginally from 3.5% in Jun-23 to 4.3% in July. Ola Electric, TVS Motor and Ather Energy continue to dominate the segment. We note that the FAME-II scheme is unlikely to be extended beyond Mar-24 which can lead to slower adoption rates.

Our Commodity Cost Index has stabilized (Fig. 13 , Fig. 14 ) while OEMs have taken price hikes. Hence, OEMS will have gross margin tailwinds in FY24F, partly offset by higher A&P and discounts.

IT Services: Q1 fails to live up to modest expectations (AXIS Capital)

Q1FY24 results reflect weaker-than-expected performance vs modest expectations across Tier 1 techs, while Tier 2 techs saw mixed performance – Coforge, PSYS, and KPIT fared better, while LTIM and MPHL continued to struggle. Margins were ‘flat to up’ YoY although down QoQ, due to seasonal factors aided by easing of supply side and tight cost control (including delayed wage hikes in some cases). Hiring remains in check.

Q1FY24 weaker than expected

Tier 1 techs saw a weak start to FY24, with companies missing modest growth expectations, except Infosys. Tier 2 techs also had mixed fortunes like the prior quarters – Coforge and PSYS fared better, while LTIM and MPHL struggled relatively. Within the ER&D coverage, KPIT continued to sustain steam, while LTTS and Tata Elxsi struggled relatively. Growth moderation spread to Europe sequentially, while North America continued to be weak. Amongst verticals, companies continued to see near-term challenges in financial services, hi-tech, and communications.

Margins held up YoY; seasonality pulled down margins QoQ EBIT margins for Tier 1 techs (except for TechM) were up YoY, driven by easing supply side pressures and tight cost optimization (in some cases, delayed wage hikes as well). Margins were down sequentially on account of seasonal factors, including increments, visa costs etc. Companies continued to see tightness in sub-contracting and utilization, as hiring stayed tempered, with Tier 1 techs seeing headcount decline for a third quarter in a row.

Guidance cut Infosys’s FY24 outlook on both growth and margins was below par, after the disappointing exit for FY23. Wipro’s Q1FY24 revenue guidance confirms fears of the company’s historical troubles resurfacing, as industry demand tailwinds have ebbed. HCLT’s guidance was along expected lines, while Coforge’s revenue guidance is reassuring, given street’s concerns around higher BFS exposure for the firm. KPIT retained its growth guidance (while math indicates it should have been upgraded), and it will review its guidance in Q3FY24 (we expect an upgrade). Despite the Q1 miss, LTTS retained its overall growth guidance of 20%+ YoY cc – guidance ask rate for the next three quarters at 4.1% CQGR.

Continue to advocate a tactical approach In line with our sector reports (on Tier 1 techs and Tier 2 techs), we continue to suggest a selective approach within the sector, based on a combination of earnings and valuation comfort, unlike the quasi-uniform rebound seen for Indian IT services firms through FY20-H1FY23, as growth is likely to remain polarized in the current macro backdrop.

Friday, January 27, 2023

Brokerages preview of Budget 2023

Stabilization is the key (Yes Bank)

This Budget would have the daunting task of progressing towards consolidation after the covid related fiscal push. On the other hand, an eye needs to be kept on the economic growth in an atmosphere of slowing global growth and tightening domestic financial conditions. On a strategic level, the broad reforms process should continue with outlays earmarked for rural development, boosting manufacturing, employment generation, and capacity building through infrastructure. Despite this being the last Budget before general elections, we do not anticipate much in terms of tax dole outs for the masses.

For FY24E we anticipate the Budget deficit to increase to INR 17.8 tn, GFD/GDP to print at 5.9% (after attaining the 6.4% target for FY23BE). Net and gross borrowings are likely to increase in FY24E to INR 11.7 tn and 15.4 tn respectively. Despite RBI pausing after another 25bps hike in February 2023, we see a scope for yields to rise in H1FY24 towards 7.60-7.75% as centre targets to front-load borrowings in H1.

The fiscal balancing act (Emkay Equity Research)

The upcoming Union Budget will require policymakers to ensure the fiscal impulse is maximized to improve potential growth, while signaling adherence to medium-term fiscal sustainability. This will require continued financial sector reforms, better resource allocation, and funding by aggressive asset sales via functional infrastructure monetization, disinvestment, and strategic sales, among others.

We project FY24E GFD/GDP at 5.8% after 6.4% in FY23E, implying net and gross borrowing at whopping Rs12trn and Rs15.1trn, respectively, adjusted for Covid-GST comp. loans. The scope for a blatant populist budget looks bleak amid moderating tax revenue, high committed revex, and market loans.

On the revenue side, lower tax buoyancy could be partly countered by higher RBI dividend and still healthy assumption of divestment proceeds. We watch for possible changes to capital gains tax structure and new personal tax regime, extension of concessional 15% tax rate for new manufacturing units, and higher import tariffs on PLI-related products.

Expenditure focus is likely to be on rural, welfare, infrastructure, PLIs, and energy transition. Capex spend will remain significantly higher than pre-pandemic (2.9% of GDP), especially amid larger fiscal multiplier on employment and growth and still-lacking private capex.

Steady as she goes (Axis Capital)

FY24 budget on 1 February 2023 is likely to be a mundane reading showing good fiscal progress in FY23 (6.1% of GDP fiscal deficit vs. 6.4% budget) and plans to further lower the deficit in FY24 (5.7% of GDP) by rationalizing subsidies. The central government is likely to conserve resources, targeting low double-digit growth in allocation to capex, rural development, social services so that outcomes don’t suffer due to cost inflation.

Central government’s fiscal deficit is likely to fall further to 5.7% and will be on track to achieve 4.5% of GDP by FY26. The 0.4% of GDP fiscal consolidation is supported by INR 1.5 trillion drop in food and fertilizer subsidies due to merging of food subsidy under PMGKAY with NFSA and correction in global fertilizer prices. This outcome along with modest tax buoyancy (12% YoY growth) should give the government space to target low double digit spending growth in rural development and capex.

Key expectations in the budget

· Tinkering with personal income tax slab to provide relief on real disposable income.

· Expand scope of Production Linked Incentive (PLI) schemes and green hydrogen.

· Bump-up allocation for rural development and social welfare to ensure outcomes don’t suffer due to cost inflation.

· Target double digit capex with increase in capital allocation to new DFI and special long-term loan to states for capex.

· Increase scope of asset monetization pipeline.

Capex focus to stay but rural thrust also likely (Nirmal Bang Institutional Equities)

· We expect fiscal consolidation to be gradual and are building in a fiscal deficit of 6.2% of GDP in FY24 vs. 6.4% of GDP in FY23.

· While we do not entirely rule out the government factoring in a slightly lower fiscal deficit of 5.9-6% of GDP for FY24, we believe that under-estimation of revenue expenditure or aggressive revenue estimates may not be palatable for markets.

· However, we also note that in recent years, the government has erred on the side of caution with its revenue estimates. We are factoring in tax revenue growth of 11.5% for FY24, just a tad higher than our nominal GDP growth of 10.5%.

· We expect the focus on government capex to stay and factor in 15% growth in FY24. We believe that Railways and Roads will be the largest beneficiaries of incremental government capex.

· Overall, we factor in revenue expenditure growth of ~7.5% in FY24 over the revised estimates for FY23. Ahead of Lok Sabha elections in CY24 and given the recent rural distress, we expect higher allocation to rural schemes with focus on rural infrastructure development. This will partially offset lower fertiliser subsidies and some moderation in food subsidies.

· We expect higher payouts under various government schemes to ease the burden of inflation for the ‘Bottom of the Pyramid’ strata. This may include higher payouts under the PM Kisan Yojana announced in the budget or during the course of FY24.

· We expect the budget to remain focused on improving India’s competitiveness as a manufacturing hub and reducing logistics costs. Incentives for industry are likely to be oriented towards encouraging investments in clean and green technologies.

· We are penciling in net borrowing of ~Rs12.1tn and gross borrowing of Rs16.5tn in FY24, which along with the inflation focus of RBI will keep bond yields range-bound at ~7.3% in the near term.

Trade-off between capex and consolidation (BoB Caps)

The government has reiterated its commitment to India’s fiscal glide path which targets a 4.5% fiscal deficit by FY26. We thus expect a lower figure in the FY24 budget estimate (BE) vs. the 6.4% deficit in FY23BE. Additionally, for India to become a US$ 5tn+ economy from the current ~US$ 3tn, continued momentum in the investment cycle is vital. Therefore, we believe the capex support seen in the past two budgets will continue. The FY23BE of Rs 7.5tn capex is likely to be met and should see a bump up of 10-15% to Rs 8.5tn-9tn in FY24BE, with outlays in the usual sectors of roads, highways, defence and railways. We believe the production-linked incentive (PLI) scheme could be extended to newer sectors, while affordable housing would also stay in focus.

· Fiscal normalisation post Covid expected to remain a core theme of the FY24 budget; fiscal glide path likely to be maintained.

· Budget could stay geared towards improving living standards of the poor while continuing to build necessary infrastructure.

· In line with past trends, we do not expect the budget to spark a significant move in the stock market.

A tightrope walk between fiscal and elections (Philips capital)

FY24 Union Budget is likely to be a tightrope walk, considering its fiscal guidance, and the 2024 union elections. We estimate fiscal deficit for FY24 at 5.8-6.0% and FY23 at 6.2%. Muted nominal GDP growth (due to global slowdown and low deflator) will constrain tax revenue and government spending, compared to the strong pace in the last couple of years. Thus, the government’s innovation will be tested – to deliver an effective budget, encompassing capex, rural, social, policy incentives, subsidies, and tax/growth buoyancy. In case the government adopts an easy approach to the fiscal path, across-the-board expansion can be expected and delivered.

In the upcoming budget, we anticipate continued focus on PLI incentives (for new sectors), Atmanirbhar Bharat (to enhance manufacturing, exports, while managing imports), sustainability (supply/demand push towards renewable energy and alternative technologies), and infrastructure expansion (defence, railways, ports, logistics, and roads). The government wants to encourage the adoption of the new income-tax regime, thus incentivization is likely. Fiscal support to rural India will continue (adjusting for food and fertiliser subsidy); we will be watching for any meaningful stimulus (low probability considering fiscal constraints).

Fiscal deficit for FY22 should be lower than budgeted at 6.2% vs. 6.4% BE, helped by higher nominal GDP growth, tax buoyancy, and expenditure management; non-tax revenue will fall short due to low RBI dividend and disinvestment. Higher food/fertiliser/petroleum subsidy will result in revenue expenditure surpassing BE. Capex targets will be largely met. For FY23, we expect muted revenue expenditure (4-5%) growth, and decent capex growth at 7-8%. Lower-than-FY23 subsidies will generate scope for other rural and social expenditure. Our tax growth estimate is muted (5-6%) due to high base and low inflation and growth momentum. We are not very upbeat on non-tax revenue either. FY24 fiscal deficit at 5.8% offers limited scope of spending enhancement, while 6% fiscal deficit can aid expansion, catering to varied sections in an election year.

Wednesday, January 4, 2023

Food for thought

The Government of India has rolled out an integrated food security scheme effective from 1 January 2023. The new scheme shall remain effective till 31 December 2023. The scheme is estimated to cost the central government rupees two trillion. Under the scheme, the government would provide 5kg food grains per person to Priority Households (PHH) beneficiaries and 35 kg per household to Antyodaya Anna Yojana (AAY) beneficiaries, free of cost.

The scheme has apparently subsumed two extant food subsidy schemes of the central government, viz.,

(a) Food Subsidy to Food Corporation of India (FCI) for discharge of obligations under The National Food Security Act, 2013 (NFSA). Under this scheme Under the scheme, 5 kg food grains per person is provided to Priority Households (PHH) beneficiaries and 35 kg per household to Antyodaya Anna Yojana (AAY) beneficiaries at a subsidized rate of Rs 3 per kg for rice, Rs 2 per kg for wheat, and Rs 1 per kg for coarse grain.

(b) Food subsidy for decentralized procurement states, dealing with procurement, allocation and delivery of food grains to the states under NFSA, popularly known as the Pradhan Mantri Garib Kalyan Anna Yojana (PMGKAY) started for 9 months in April 2020 to mitigate the effect of Covid pandemic on poor and extended twice thereafter. Under this scheme beneficiaries registered under the NFSA were provided an additional 5 kg of foodgrain per month for free.

This implies that by implementing the new integrated food security scheme:

(i) The central government would save about Rs1.5 trillion on food subsidies in the calendar year 2023.

(ii) The beneficiaries registered under NFSA would get free ration for one year; though the quantity of ration available will be less.

(iii) The state governments who were claiming credit for free ration actually funded by the central government will not be able to do so.

The new scheme is thus a fiscally prudent and politically smart move by the central government. It has however evoked a variety of criticism. For example, the political opponents are criticizing the government that the very fact that over 81 crore still need subsidized or free food indicates the failure of the government's economic policies. The economic and financial market experts have criticized the government for failing in controlling subsidies. Their criticism is that the government is increasing subsidies which it will find politically inexpedient to unwind; and hence burden the future governments.

In my view, the criticism may not be fair, or, inter alia, the following reasons.

· The National Food Security Act was enacted in 2013 by the UPA government, in recognition of the fact that the fundamental right to life enshrined in Article 21 of the Constitution includes the right to live dignity that essentially includes the right to food and other basic necessities. This in fact is a globally accepted good practice for welfare states.

· The fact that 75% of the rural population and 50% of the urban population is entitled under NFSA to subsidized food does not necessarily imply that as many households cannot afford to buy food for their sustenance. This could just be a mechanism to compensate for poor minimum wage structure; faulty agriculture pricing mechanism; disproportionate indirect tax structure; and inadequate social infrastructure, especially health and education. Besides, this should be seen as a direct and effective wealth redistribution mechanism.

· Number of people availing subsidized food cannot be a good measure of poverty.

· The incumbent government has shown resolve in managing subsidies by not increasing fuel subsidy, despite political pressures, increasing fertilizer prices and imposing GST on common food items. Despite being a challenging year, the government is most likely to meet its budgeted fiscal deficit targets. Consequently, the Indian bond markets have shown remarkable stability, defying turmoil in the global bond markets.

· The restructuring of food subsidy schemes could be the first step in the direction of further rationalization of food subsidy from 2024 onwards.

Overall, in my view, NFSA, like MNREGA, is a transformative legislation. This ensures a dignified life for over 800 million people; and thus provides stability and resilience to the economy. The government’s commitment to obligations under NFSA must be commended, not criticized.