Budget 2018: Cheers for 'Bharat', some LTCG tax overhang for markets

A bird’s view shows the Finance Minister has taken a bit from the resourceful and given it to the ones who need it, mainly rural India and the economically weaker section. And rightly so, given their distress and the need to raise their quality of life. Across all agencies, the allocation to rural India is pegged at Rs 14.34 trillion. Farmers also get respite with minimum support price (MSP) for Kharif crop proposed at 1.5 times cost of production (currently 1.15 – 1.25 times cost). These measures along with focus on education where allocation is up from Rs 2.5 billion for 2017-18 to Rs 307.5 billion, should help Bharat where over half of India resides. These should, as the Budget document claims, create employment of 3.21 billion person days, 0.32 million kilometres of rural roads, 5.1 million new rural houses, 18.8 million toilets, and 17.5 million new household electric connections besides boosting agricultural growth. So, companies with high rural exposure in the two-wheeler, staples, consumer durables, etc sectors, stand to gain.

Similarly, allocation to infrastructure has been hiked to Rs 6 trillion from Rs 4.94 trillion for 2017-18, wherein outlay for housing and urban affairs is up 57 per cent to Rs 600 billion, railways is up 21 per cent to Rs 1.46 trillion, and roads and highways by 10 per cent to Rs 1.21 trillion. The succour to smaller corporates through lower corporate tax of 25 per cent will also mean more money in their hands. 

Summing up, these should translate to higher demand for labour, services, steel, cement, finance, consumption items, etc, and thereby corporate earnings.
 

But, there is a flip side too. Even after assuming government’s tax receipts at face value, experts point to the potential risks to inflation and interest rates. For instance, higher-than-usual increase in MSP at a time when oil prices are already pinching will mean elevated inflation, prompting the Reserve Bank of India to stay hawkish.

Already, the slip in fiscal deficit for 2017-18 by 30 basis points – though partly due to transitional impact of goods and services tax, and pushing ahead of FRBM target of 3 per cent fiscal deficit to 2021, hasn’t gone well with bond markets. Bond yields on the 10-year government securities, which have been rising, were up 21 basis points post Budget announcements. And this is still hoping oil prices don’t surprise negatively. Higher oil prices can weigh on rupee, and potentially impact foreign fund flows into Indian markets.

Higher bond yields have already pushed up cost of funds for corporates and consumers. With metals and oil prices ruling firm, these can hurt India Inc’s earnings. So, unless demand picks up and drives earnings along expectations, the overhang for equities could increase.

Worse, the Budget has imposed a tax of 10 per cent on long-term capital gains on equities and related instruments, thereby reducing its attractiveness. With bond yields close to 8 per cent, experts believe certain debt categories can safely deliver around 9 per cent. So, there are chances of domestic fund flows into equities slowing if headwinds rise, thereby spiking the rally in stock markets.

All-in-all, while it is still a growth-spurring Budget, a lot now depends on execution—including fast-tracking infrastructure investments and staying the fiscal path.

Given the rich equity valuations, headwinds (oil prices, inflation) and expected increase in equity supply, it will be tough to make money now in equities, says a CEO of a leading brokerage. Thus, it is advisable that investors focus on safety, stocks with strong earnings visibility, and tone down return expectations.

In its first take on Budget, Bank of America Merrill Lynch says, “As expected sectors exposed to rural India should benefit, but there isn’t much to excite an already inflated market. We stay cautious – Sensex (target) of 32,000 by December 2018-end.”