Saurabh Mukherjea: Positive for financial assets, not for banks

Whilst the Budget has not hit any self-goals or given reason for any interest group to be particularly distressed, the Budget was a good holding operation at best. 

The Indian economy is currently undergoing an extraordinary amount of flux. GDP growth in FY18 is likely to be a challenge and the banking system is dealing with unprecedented levels of asset quality stress. Besides, boosting capex spends and setting aside 0.07 per cent of GDP for recapitalising banks, the central government did not do much to address these two fundamental issues.

GDP growth in India is decisively slowing as evinced by the dramatic slowdown in bank credit growth as well as auto sales volume growth in 3QFY17. Whilst GDP growth is likely to recover in FY18 from the lows it will hit in 2HFY17, GDP growth in FY18 will be lower than what it would have been if the government was not forcing the economy to formalise at such a rapid pace. The increased focus on tax compliance is likely to mean that the non-tax paying informal sector in India will shrink at a rapid pace. This, in turn, will entail a degree of demand destruction as the informal sector accounts for more than 40 per cent of India’s GDP and provides employment to more than 75 per cent of the labour force.

Separately, the Indian banking system which is the backbone of the economy is reeling under asset quality stress. Banks are already struggling with a corporate asset quality cycle that is yet to bottom out. Furthermore, higher NPAs in the SME/retail segment would worsen the situation. Loss of income due to demonetisation, pressure on cash flows owing to higher tax compliance and a decline in the value of real estate-based collateral will raise asset quality risks. 

Though PSU banks have much lower exposure to retail/real-estate-linked lending than private sector banks, their quality of lending is suspect. These segments have grown at a much faster pace for PSU banks in recent years and high reliance on the segment implies a greater in-built risk in PSU banks’ retail/real-estate-linked lending.  Even if the government’s hands were tied with respect to funding recapitalisation, the announcement of a bad bank or banking sector reforms could have helped resolve the situation at hand.

The biggest let-down for the financial sector was no additional allocation to recapitalise PSU Banks with the allocation of Rs 10,000 crore being in-line with the amount set aside as per Indradhanush two years ago. Hence, the banking system continues to remain thinly capitalised and not in a position to support any credit-led economic recovery. 

However, there was a thrust on increasing digital transactions which are positive for the banking sector in long-term in terms of better cost efficiencies.  Moreover, lowering the holding period required to get capital gains tax relief from real estate from three years to two years and expanding the bucket of financial instruments where proceeds from sale of real estate could be reinvested (without attracting tax) could mean that there could me more flow of savings towards financial assets which is positive for banks, insurance companies, asset managers and stockbrokers.

Thus the Union Budget FY18 opted for the path of least resistance. The Budget did not do anything special to boost India’s growth prospects or to improve the state of India’s banking sector. At the same time, it steered clear of announcing retrograde anti-capital market measures and anti-rich measures and it did not drop the ball on fiscal discipline in a big way despite being two years away from a General Election. In these uncertain times these small positives are worth celebrating.
 

The writer is CEO, institutional equities, Ambit Capital