India Budget 2020-21 – Conservative and Incremental

• Given the context of an economic slowdown, expectations were high for strong growth measures to revive the economy. The budget was predominantly ‘incremental’ in nature sticking to a fiscally conservative stance. However, it fell short on immediate measures to revive the economy.

• The shift in the burden of DDT to investors, a diluted personal tax cut, LIC IPO and incentives to attract foreign capital are some highlights

• No major policies were announced to address the stress in real estate and NBFC segment

• The fiscal deficit target for FY 21 at 3.5% of GDP was in line with expectations

• The fiscal math however to a large extent depends on the aggressive disinvestment targets being met

• With the budget out of the way, the focus should be back on domestic earnings recovery

• We recommend patient long term investors to stick to their long term asset allocation and not get swayed by the near term volatility

Key Highlights

1. FY21 Fiscal deficit estimated at 3.5%; Escape clause invoked in FY20

The government revised the current year fiscal deficit target to 3.8% (from an earlier 3.3%). Lower than anticipated GST collections and a reduction in corporate tax rates have hurt the government’s tax collection. The finance minister used the ‘escape clause’ under the FRBM Act (which allows leeway to relax the fiscal deficit target by up to 0.5%). 

The fiscal deficit target for the year 2020-21 has been pegged at 3.5% in line with market expectations. The nominal GDP growth for the year 2020-21 is estimated at 10%.

2. Ambitious Disinvestment target – LIC IPO remains the key

The disinvestment target for 2020-21 has been set at ₹2.1 lakh crore. This looks ambitious. The 2019-20 disinvestment target which was originally set at around ₹1 lakh crore was later revised sharply downwards to ₹65,000 crores. The government plans to sell a part of its holding in LIC via an IPO and its stake in IDBI Bank. But, these measures can help bridge the revenue shortfall only if we have a buoyant market.

3. Corporate Tax proposals bring cheer 

• Lower corporate tax rate of 15% (introduced in Sep 2019 for new manufacturing companies) has been extended to newly incorporated power generation companies that start production by 31st March 2023.
• Up till now, start-ups with a turnover of up to ₹25 crores were allowed a deduction of 100% of their profits for 3 consecutive years out of 7. The budget has raised the turnover limit to 100 crores and the period of eligibility for the claim of deduction from 7 to 10 years.
• Cooperative societies are currently taxed at a rate of 30% with surcharge and cess. They will now be taxed at 22% plus 10% surcharge and 4% cess with no exemption/deductions.
• Easing Compliance – Businesses with turnover of less than 5 crores (earlier 1 crore) don’t have to get their books of accounts audited by an accountant. This eases their compliance burden. But, the higher limit will only apply to those with less than 5% of their business transactions in cash.

4. Attracting foreign Investors

• FPI limit in corporate bonds has been raised from 9% to 15%. 
• Sovereign Wealth Funds will be granted 100% tax exemption on interest, dividend and capital gains in respect of investments made in infrastructure and other notified sectors before 31st March 2024 and with a minimum lock-in period of 3 years.

What is in it for you?

1.Lower Income tax rates for individuals forgoing exemptions and deductions

The new income tax rates and slabs will be applicable to those who forego exemptions and deductions. The deductions include Standard deduction, Section 80C, Section 80D, LTA, HRA, interest on housing loan on the self-occupied property among others. 

However, the new rates will be optional and individuals have the choice of opting for the new regime (lower tax rates and no deductions) or continuing with the earlier regime (higher tax rates and deductions)

Individuals will have to check if they will have a greater benefit under the new tax rates and decide on which option to choose. 

2. More Safety to Bank Depositors – Bank Deposit insurance hiked to ₹5 lakhs

Insurance cover on bank deposits has been raised from ₹1 lakh to ₹5 lakh, in case of bank failures. If you have deposits in multiple banks, the insurance coverage limit applies separately to the deposits in each bank.

3.Dividend Distribution Tax – Burden transferred to investors

Stocks:

Dividend Distribution Tax (DDT) has been shifted from companies to individuals. Currently, companies have to pay DDT of around 20.56% (including cess and surcharge) on their aggregate dividends. These will now be taxed in the hands of the recipient as per his/her personal income tax slab which is not good news for those under higher slab rates.

This will, however, make the equity market more attractive for foreign investors as they will be subject to the lower dividend tax rate applicable to them under various tax treaties.

Mutual Funds:

Dividends paid by mutual funds too will now be taxed in the hands of the investor at his applicable income tax slab rate. Currently, funds deduct DDT of 11.648% on equity schemes and 29.12% on debt schemes. 

Dividends over ₹5,000 a year will be subject to 10% TDS in case of Indian investors. Dividends received by NRIs will be subject to 20% TDS irrespective of the dividend amount.

4.Tax benefits on affordable housing loan interest extended by another year

The tax deduction up to ₹3.5 lakhs for interest paid on home loans taken for the purchase of affordable housing announced in the last budget has been extended by another year and can be availed till 31-Mar-2021. 

5.High earners to shell out more in Employer’s contribution to EPF 

In a change from the past, employer contributions to a recognized provident fund, superannuation fund and NPS beyond ₹7.5 lakhs a year in total will be subject to tax. Earlier there was no monetary limit.

6.Segregated Portfolio of Debt Mutual Fund to tax you less

In case of a segregated portfolio, the period of holding and proportionate cost of the main portfolio will be available for the segregated portfolio. 

7. Residency Test – NRIs not taxed in any country will pay tax in India

An Indian citizen will be deemed to be a resident of India and will become taxable in India on his income generated in India if he is not liable to a tax resident of any other country. Government has also further clarified that income earned outside India shall not be taxed in India unless it is derived from an Indian business or profession.

To be categorized as an NRI, an Indian now has to stay abroad for 240 days, as against 182 previously. An Indian national who wants to claim the non-resident status can’t stay in India for more than 120 days or more in a year.

8.Introduction of Debt ETF

Post the success of the Edelweiss Bharat Bond ETF, the government will launch another ETF to raise money.

Equity Market Perspective: Expectation mismatch

Given the high expectations for strong reforms to address the current economic slowdown, the markets were disappointed by the lack of major announcements. There was no decision on lowering LTCG (Long Term Capital Gains Tax) in equities. 

While directionally this budget has indicated its intent to propel long term growth, it leaves much to be desired in terms of structural measures that could aid faster consumption and investment growth in the economy.

However, we continue to remain positive on equities from a 5-7 year point of view. This is primarily led by expectations on

1. Expected pick up in Earnings growth – led by a recovery in profitability of corporate banks.
2. Reasonable Valuations – except for PE ratio, all other valuation indicators such as Price to Book ratio, MCAP to GDP, Earnings Yield vs 10Y GSec indicate reasonable valuations (except for select pockets).
3. Improving Sentiments – led by Lower Corporate Tax rates, Increasing resolutions under IBC, strategic sale route for divestment, range-bound oil prices, low-interest rates and reforms momentum.

With the ‘non-event’ budget out of the way, the markets in the near term will eventually start to focus on global factors, updates on coronavirus and signs of recovery in a slowing domestic economy. 

We continue to recommend patient long term investors to stick to their long term asset allocation and not get swayed by the near term volatility.

If you are underweight equities, you can take advantage of the near term declines if any to bring back your equity allocation close to your long term intended allocation.

Debt Market Perspective: Near Term Positive

The restraint of the government from announcing any major populist measure is a key positive for the debt markets. Both the fiscal deficit target at 3.5% of GDP and Gross Borrowing at ₹7.8 lakh crores for FY21 were in line with the bond market expectation.

The measure to increase FPI limit in corporate bonds from 9% to 15% of the outstanding stock of corporate bonds is a good move to improve the liquidity in bond markets. Opening up of certain specified categories of government securities for NRI investors is also a step in this direction.

Further, other factors such as moderation of global growth, softening global commodity prices, easing stance of major global central banks, slowing domestic growth, weak credit growth and high real yields in India also point towards lower yields. 

On the negative side, excess SLR (Statutory Liquidity Ratio) investments within the banking system and high food inflation remain the key risks to monitor.

Given the above context, we expect interest rates to remain “lower for longer” and the bond yields to trade within a narrow range.

We continue with our recommendation to stick to debt funds with high-quality credit and with short duration (less than 3 years). 

Credit risk funds can be avoided given the current weak economic growth environment and the poor liquidity (read as difficulty to buy and sell) for lower-rated securities.