Union Budget FY2019; Overt reflationary bias risks fiscal slippage

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Overt reflationary bias risks fiscal slippage ■ Government has taken its ‘Ease of Doing Business’ goal further by stressing on the ‘Ease of Living’ for the common man pivoted on the objective of creating employment, promoting rural prosperity, reviving MSME sector, protecting domestic industries from competition from imports and improving common man’s healthcare. ■ Union Budget yet again appears reflationary (but supported by a modest revenue spending growth of 10.2%) while being optimistic expected tax buoyancy. We believe, this year being the run-up to the general elections, might impel higher fiscal spending. Potential fiscal slippages in FY19 Union Budget; possibility of matching 3.5% fiscal deficit of FY18 Overall, the fiscal deficit target of Rs6.2tn or 3.3% of GDP for FY19 is premised on understated expenditure budget and higher tax revenue collection. In our view, achievement of 11.5% Nominal GDP growth and Real GDP growth of 7-7.5% will require greater fiscal support. Subsidy amount could be higher on account of higher minimum support prices (MSPs), rising commodity prices and the previous years’ rolled over fertilizer subsidy. Likewise, there is potential for higher allocation for MNREGA and the newly launched universal health coverage scheme. Capital allocation can be compromised with higher burden of revenue spending, as was the case in FY18. Key policy takeaways: ■ Tax measures: o Corporate tax - Incentivizing MSMEs, Food Processing and Employment Generation. o Individual income tax - Introduction of LTCG tax of 10% on gains in excess of Rs1 lakh on equity market investments is an attempt to retract the diversion of capital into the secondary markers (including Mutual Funds) back into the real economy. o Custom duties- There is an increase in duties by 10-50 percentage points for several consumer products, which reflects an aggressive attempt to protect the domestic industries or incentivize import substitution. ■ Farm sector: The thrust on the farm sector is reflected in the re-emphasis on doubling of the farm income and the commitment to ensure higher Minimum Support Prices (MSP). ■ Thrust on infra sector: Overall capital outlay of Rs3tn is a rise of 11% over FY18BE, but it is still modest 12% of the total budgetary spending of Rs24.4tn. Of this, Rs1.57tn is allocated for all infrastructure sector, which has grown by 21% over FY18RE. The thrust is more on sectors such as Roads and Railways. ■ Universal healthcare: The ambitious near universal healthcare coverage scheme is another mega entitlement announced in the Budget. While we await details of the policy specifics, there is an intent to create an ecosystem for a country-wide healthcare in the long term ■ Market outlook: While the reflationary stance of the Budget could provide boost to corporate earnings, especially in areas of consumption, agri-rural sector, healthcare, retail lenders and infrastructure sector (roads & railways), the headwinds of rising inflation and hardening interest rates will need to be tackled. Steep hardening of G-sec yields (10-year at 7.8%) can prove to be a dampener for lofty stock valuations. Additionally, the introduction of long-term capital gains tax is aimed at diverting systemic liquidity from financial trading activities back into the economic activities. Tightening liquidity can increase the vulnerability for the lofty valuations of the Mid & Small Cap stocks. We maintain our preference for liquid Large Caps while being selective on the Mid Cap side. Winners and losers: ■ From a portfolio allocation standpoint, our OW stance on rural, agri and consumption space have found considerable support in the Budget. Hence, the key winners from the Budget are in the space of Agro Chemicals & Fertilisers (Coromandel International, Deepak Fertilizers & Chambal Fertilizers), Automobiles (M&M, Hero Moto & Ashok Leyland), FMCG and Consumer Durables sector (GCPL, HUL, Bajaj Electricals, Havells & Symphony). Stronger thrust on Roads and Railways should also provide good opportunities (Sadbhav Engineering, PNC Infra, ITD Cementation, KEC International, Kalpataru Power & Skipper). ■ Attempts to protect the domestic industries by increasing customs duties are likely to aid several Mid & Small Cap companies (Orient Refractories, Sterlite Tech, Varun Beverages & Sheela Foams). ■ Universal medical coverage scheme is likely to generate structural opportunities in the Hospital space (Narayana Hrudayalaya, Apollo Hospitals, Fortis & HCG - all unrated). ■ The reflationary slant of the Budget is positive for the Banking sector, as it will lead to higher credit growth. We maintain that the Private Banks (ICICI Bank, HDFC Bank, IndusInd bank & Federal Bank ). Hardening of the G-sec yields will be a drag for PSB and NBFC space.