The new government rides on a long wish list of policies/reforms, with limited resources. FY15 Budget will reveal the government’s priorities and thus will be looked upon by the market as a policy document, even more than prior years. Important policy announcements to be watched out for include (i) GST rollout (ii) insurance/pension regulations (iii) housing/urbanisation focus (iv) potential deregulation or cut in subsidies of urea/diesel, etc (v) direction of factor market reforms like land and labour (vi) bank recapitalisation and (vii) SOE (state-owned enterprises) reforms/ disinvestment.
The government’s stance on the growth-inflation dynamic remains the most critical near-term policy to watch for investors, in our view. We continue to believe that changed political economy implies that inflation moderation imperative will overshadow near-term headline growth desires. This will also aid a more robust medium-term growth outlook, in our view.
We project a fiscal deficit of 4.1% of GDP in FY15 and 3.6% in FY16 vs. the 4.5% recorded in FY14. We expect this budget to set the stage for a future pick-up in growth, rather than drive acceleration in real GDP this year. In all it should be a good budget for the equity and bond markets.
Disinvestments, tax amnesty can surprise markets?
FY15 should be a year of modestly recovering real GDP growth, which because of operational gearing should be good for profits and hence corporate tax revenues. Fiscal arithmetic for the government remains challenging nevertheless, also given the legacy of rolled over expenses and arguably some preponed revenues. Can the government surprise markets by being more aggressive in its disinvestment programme or by launching a tax amnesty scheme, to buttress revenues? Disinvestment of SOEs will be material in terms of the amount raised only if it implies privatisation – which looks unlikely given the Gujarat experience. Regular proceeds from stake sales will anyway be budgeted in.
A tax amnesty scheme may face legal difficulty given moratoriums by the Supreme Court. Moreover, it might compromise the punitive line the BJP has taken on black money and thus use up scarce political capital. Fingers crossed, nevertheless.
The government can yet take an aggressive stance towards cutting subsidies but simultaneously increase spending on capex. The fiscal arithmetic even for our forecast fiscal deficit estimates is not comfortable. Where will the revenues come from for supporting a more aggressive capex programme, if at all? Press reports have mentioned (i) higher disinvestment proceeds and (ii) additional tax revenues through a tax amnesty scheme.
SOE divestment may be used as a way of encouraging participation by retail investors in the equity market. If asset sales are carried out at reasonable valuations and these provide good returns to retail investors, it can arguably create a virtuous cycle in attracting more capital from them. This would also ensure more productive deployment of savings in financial assets, arguably.
As said, a tax amnesty scheme may face legal difficulty, but can arguably be overcome by the government’s majority in the Lok Sabha/Joint Session. However, it is more likely that such a step will be taken in consultation with the Supreme Court, rather than independently.
Sectoral impact – Positive for cyclicals; consumption recovery hopes premature
We expect a road map for SOE bank recapitalisation to alleviate concerns about their growth. We expect the thrust on infrastructure spending to increase in the budget. We expect progressive steps to increase oil & gas production and lower fuel subsidies, and the budget may provide some direction. We expect diesel to gradually get de-regulated through monthly hikes, and gas prices to be revised, but the government’s ability to immediately raise LPG and kerosene prices amid rising gas prices is likely to be limited, given the inflationary challenges. Inflation moderation and fiscal consolidation imperative imply a muted outlook for consumption (including discretionary) recovery in the near term, except selectively where pent-up demand is evident.
Remain bullish. Buy Financials, SOEs (oil & gas, banks), power/infra/industrials
We remain bullish on Indian equities. We believe investors will be willing to give a premium for the growth hope and look beyond FY15 earnings estimates. Based on our topdown expectation of 15% earnings growth in FY16 & 15x PE (price-to-earnings multiple), our Nifty target for end- 2014 is 8000. There could be upside to the target based on how policy-making evolves.