The ‘Rebuilding India’ Budget

A pragmatic, bold and growth oriented budget with a focus on capital spending to revive the economy without resorting to higher taxes.

Quick Summary

A budget focused on investment-led growth with higher spending on infrastructure and healthcare. 

While the fiscal deficit is higher than expected at 9.5%/6.8% for FY21/FY22 but it is done for the right reasons – reviving the growth of the economy with a high quality of spending mix (infra led) vs choosing the populism route. 

Contrary to market expectations the budget thankfully has no negatives in the form of additional COVID-cess on high earners, no unfavourable income tax announcements and no negative news flows on foreign investment.

The other big structural shift was the focus on privatization, asset monetization, and long-term funding for infrastructure investment. 

In addition, there are measures to make the financial sector more robust – including a new development financial institution (DFI), a bad bank (via asset reconstruction company), higher FDI limit for the insurance sector, and liquidity for depositors in banks under duress.

Overall the budget sends a strong signal about the government’s intent to revive the economy with bold structural measures.

Key Highlights

1. Fiscal deficit higher than expected 9.5%/6.8% for FY21/FY22 – but for the right reasons – more growth oriented than populist
   
2. Growth push with increased capital spending (up by 35%) 
   1. Focus on capital expenditure and infrastructure investments 
   2. Increase funding for Infra projects via Asset Monetisation
   3. Proposal to set up a Development Finance Institution to aid infrastructure financing
      
3. No increase in tax for individual taxpayers, corporates and equity investors despite fiscal pressure comes as a relief
   
4. The Government’s reforms drive continue
   1. Disinvestment Push
   2. Privatization of 2 Public Sector Banks
   3. Proposal for a Bad Bank via an ARC/AMC 
   4. Foreign Direct Investment (FDI) limit in insurance increased from 49% to 74%
      
5. Transparency measures to reduce off-balance sheet financing and include it in the budget 

What’s in the details?

1. Fiscal deficit higher than expected 9.5%/6.8% for FY21/FY22 – but for the right reasons – more growth oriented than populist

• FY21 Fiscal deficit at 9.5% of GDP and FY22 Fiscal deficit at 6.8% – higher than expectations – but for the right reasons
• The budget has gone with a higher-than-expected fiscal deficit to spur growth through higher than expected capital spending
• Healthcare allocation has more than doubled for FY22 to strengthen existing infrastructure targeting wellness, nutrition and sanitation.
• Significant push for investment driven growth – emphasis on road, rail, defence, communication and housing in that very order
• The fiscal consolidation path is also slower – aims to improve central government deficit to below 4.5% of GDP by FY26 – this clearly indicates the intent of government to continue the reform momentum and investment led spending over the next few years
• The government’s bet is on growth to drive higher revenues and help in gradual fiscal consolidation over the years
• The nominal GDP growth for FY22 is pegged at 14.4% – this is conservative and in fact even marginally lower than the 15.4% projected in the Economic Survey

2. Growth push with increased capital spending

2.1 Focus on capital expenditure and infrastructure investments

At INR 5.5 lakh crores, the government spending on capital expenditure is 35% higher that the budget estimates of the previous year, though slightly lesser (26% higher) in relation to the revised estimates for 2020-21.  

The other interesting aspect of government expenditure is a remarkable shift in the balance between revenue expenditure and capital expenditure. The overall share of capital expenditure in government spending has increased to 15.9% for FY22 compared to 13% in FY21. 

Further, the capital spending is expected to increase to 2.5% of GDP in FY22 (vs. 2.3% of GDP in FY21RE). If achieved, that would be the highest since F2006.

A significant part of this is to be financed by the monetisation of public assets.

2.2 Increase funding for Infra projects via Asset Monetisation 

In a bid to monetize public infrastructure assets, the “National Monetisation Pipeline” will be set up to assist the monetization of potential brownfield infrastructure assets. A dashboard to track the progress of this pipeline will also be created. 

Key projects to be considered for monetization include:

• Roads operated by NHAI, power transmission assets operated by the Power Grid Corporation through their InVITs
• Oil and gas pipelines of GAIL, IOCL and HPCL
• Monetisation of Dedicated Freight Corridor assets by railways for operations and maintenance
• Monetisation of airports for operations and management

Further, Infrastructure Debt Funds will be launched to raise funds by issuing tax efficient “zero coupon bonds”.  Investments made in Real Estate Investment Trusts (REITs) and Infrastructure Investment Trusts (InVITs) have been made more attractive to both domestic and foreign investors, while deepening their capital raising avenues.

2.3 Proposal to set up a Development Finance Institution to aid infrastructure financing:

The Finance Minister has allocated INR 20,000 crs in the budget to set up a Development Financial Institution with the objective of facilitating long-term infrastructure financing. The DFI is expected to lend a corpus of INR 5 lakh crore over the next three years. This is a step in the right direction, as only long-term lending institutions can finance the building of infrastructure.

3. No increase in tax for individual taxpayers, corporates and equity investors

There were concerns that there might be additional taxes for equity investors (LTCG, STT etc)

and increase in taxes for the rich with a higher surcharge or a Covid-19 cess. However, putting all the fears to rest, there were no notable tax increases for individuals, equity investors and corporates. 

4. The Government’s reforms drive continue

4.1 Disinvestment Push

• Disinvestment target of Rs. 1.75 lakh crores for FY22. 
• The ongoing divestments  were affected by the onset of the pandemic and are expected to be completed in F2022 – this includes companies such as BPCL, Air India, Shipping Corporation of India, Container Corporation of India, IDBI Bank, BEML, Neelachal Ispat Nigam, Pawan Hans etc
• Furthermore, a Special Purpose Vehicle to assist in the monetization of non-core assets such as surplus land (either by way of direct sale or concession or by similar means) is to be set up.

4.2 Privatization of 2 Public Sector Banks and 1 General Insurer 

• 2 PSU Banks and 1 General Insurance Company to be privatized. 
• Dilution of stake in LIC via IPO

4.3 Proposal for a Bad Bank via an ARC/AMC 

An asset reconstruction company to mop up the stressed loans of the public sector banks – popularly known as ‘Bad bank’. This entity will be dedicated to managing and disposing off the bad loans in the public sector banks.

4.4 Foreign Direct Investment (FDI) limit in insurance increased from 49% to 74%

The government’s proposal to increase the foreign direct investment limit in insurance from 49% to 74% is likely to accelerate growth and spur competition in the sector raising hopes of a flux of foreign capital into private Indian insurers. Further, as the Centre is looking to sell its stake in general insurance firms, a higher foreign investment limit could fetch better valuations.

5. Transparency measures to remove off-balance sheet financing and include it in the budget 

To show a lower borrowing number to meet the fiscal deficit target, the governments starting a few years back had started off the practise of off balance sheet borrowing – a smart accounting gimmick.

Now before you switch off, the mechanism is simple. Food Corporation of India (FCI), procures food grains from farmers at higher prices (minimum support prices) and distributes it across ration shops for lower prices. The government is supposed to pay the shortfall as a part of food subsidy. However, the government made FCI borrow instead of the government borrowing and paying FCI. This was leading to an understated fiscal deficit projection. But this year, the government has finally decided to take the bite, and has taken all those loans on its own balance sheet leading to the correct fiscal deficit number of 9.5% of GDP in FY21.

This is a great move signalling higher transparency and makes the budget estimates more believable and closer to reality.

What’s in it for you?

1.No changes to equity or debt mutual fund related taxation

2. Personal income tax – largely left untouched

There are no major changes to the income tax structure. However, there were few related tweaks.

• Buyers of affordable houses get Extension of time to avail additional tax benefits
  • Additional deduction of Rs. 1.5 lakhs will be  available for loans taken until the end of FY 22 for the purchase of affordable housing. To ensure adequate supply, tax holiday for developers of affordable housing projects has also been extended till 31st March, 2022.
    
• Tax Exemption On ULIP Proceeds Capped
  • For  Unit Linked Insurance Plans (ULIPs) taken on or after Feb. 1, the maturity proceeds of policies with an annual premium of more than Rs 2.5 lakh will be taxable on par with equity-linked mutual fund schemes. Individuals holding multiple ULIPs with an aggregate premium in excess of Rs 2.5 lakh will have to pay tax on the proceeds.
    
• Interest on EPF over ₹2.5 lakh a year to be taxed
  • Interest earned on Employees’ Provident Fund (EPF), Voluntary Provident Fund (VPF) or exempted PF trusts, where the annual employee contribution is above ₹2.5 lakh, will now be taxable.. The interest income was entirely tax-free so far.
    

3. Taxation process to become tax-payer friendly

• Exemption from filing tax for elderly 
  • Senior Citizens aged 75 years and above who only have pension and interest income are exempted from filing income tax returns if the tax liability has been deducted by the paying bank.
    
• Pre-filled Tax forms 
  • Details of capital gains, dividend income and interest income will be prefilled in your tax form
    
• Easier Tax Compliance & Resolution of disputes
  • Tax audit threshold to be increased to Rs. 10 crores from Rs. 5 crores for individuals with less than 5% cash transactions.
  • The time limit to re-open past IT Assessment will be reduced from 6 years to 3 years. Only in cases, where there is an evidence of income discrepancy of at least Rs. 50 lakhs, re-opening can be made upto 10 years & that too with the highest level of approval.
  • Dispute Resolution Committee will be constituted for faceless resolution of grievances of the individuals with taxable income upto Rs. 50 lakhs and disputed income up to Rs.10 lakhs.
  • The appeals process to the Income Tax Appellate Tribunal to become faceless – Only electronic communication will be done.
    
• Relief for NRIs facing double taxation issue on retirement accounts
  • Double taxation refers to a situation in which NRIs are taxed on the same income twice, both in India and the country of residence. While NRIs are not taxed on global income in India, they are taxed on income earned or accrued within India. The government will set up rules to eliminate the hardship of double taxation

4. Changes to duty levied on certain goods and introduction of Agri Cess

The government has also proposed changes to the customs duty of certain raw materials / goods being revised.

• Things expected to get cheaper – Gold, Silver, precious metals such as Platinum & Palladium, Steel products, Nylon products etc

• Things expected to get costlier – Mobile Phones, Refrigerators, Air Conditioners, Leather goods, certain auto parts etc

Agriculture Infrastructure and Development Cess has been introduced on certain goods. To ensure the imposition of cess does not lead to additional burden in most of these items on the consumer, the basic customs duty (BCD) and excise duty rates have been lowered. 

5. Depositors in stressed banks to get faster access to their money

When banks get into trouble (remember PMC Bank, Yes Bank etc), most customers lose access to their deposits. To address some of these concerns, the government will soon introduce changes that will allow depositors to immediately access up to ₹5 lakhs in the event a bank fails.

Equity View: Growth Focus and Government’s intent to continue with Reforms – Positive for Equity markets

Before going into the budget, we had a neutral view on equities i.e to continue with your original long term asset allocation. In our view, it was not the time either to be underweight or overweight on equities.

We had also explained our equity view framework in detail here.

The broad rationale was:

Earnings Growth Recovery over the next 5 years…

We remain positive on earnings growth recovery over the next 5 years and expect a strong earnings growth environment over the next 5 years.

This is led by Initial signs of Economic Recovery, No visible second wave of virus despite an active (and crowded) festival season, Low earnings base, Cost Control measures, Low interest rates, Consolidation of Market Share by organised players, Govt Reforms (Lower corporate tax, Labour Reforms, PLI Schemes etc), Banking System Stress – not as bad as feared & Early signs of pick up in real estate sector. 

Valuations: HIGH Valuations – but yet to reach ‘VERY HIGH’ valuations…

While we would have ideally liked overweight equities given the above view, the valuations however were on the higher side discounting for most of the positives. Our internal valuation models were indicating HIGH valuations but were yet to reach the “VERY HIGH” valuation band.  Given the context of low interest rates and high liquidity both globally and in India, we were ok with valuations being slightly on the higher side.

Our plan was to continue with a  neutral stance to equities and to go underweight only if valuations breached into the “Very High” valuation band as per our internal valuation model.

In light of the above context, the budget has added further support to our earnings growth recovery thesis. 

The budget stands out for its

• Growth focus – with major push for Infrastructure and Capex
• No changes in personal and corporate taxes 
• Transparent, Realistic numbers
• Continuing reform measures – Disinvestments, Privatization of 2 Public Sector Bank, Asset Monetization, Proposal for a Bad Bank via an ARC/AMC, Hike in FDI limits for Insurance sector etc

Overall the budget sends a strong signal about the government’s intent to revive the economy with bold structural measures. This is positive for earnings growth and in turn equity markets. The markets have responded positively and went up by 7-8%. 

Our recommendation for patient long term investors continues to remain the same: 

Stick to your long term asset allocation and continue to have an eye on equity valuations. 

Key Risks:

1. Virus Spread 
2. US Inflation going up and leading to pause in Central Bank stimulus 
3. US Treasury Yields reaching 2%
4. Sharp increase in crude oil prices (leading to inflationary pressures)

Fixed Income View: Brace for some volatility in longer duration funds  Higher Government Borrowings needs to be supported by RBI   

Both Fiscal Deficit for FY22 at 6.8% of GDP and Net Market Borrowing (Gsec +T bills) at INR 9.7 lakh crores for FY22 came in much higher than what the bond markets were expecting (roughly around INR 8.5 lakh crs). Further, the INR 80,000 crores extra borrowing for this year came out of the blue.

From a bond market perspective, the above events have led to concerns of an increase in long term yields. 

However given the context of the current pandemic and economic slowdown, RBI’s intent clearly is to keep the interest rates low till the economy recovers.

Our base case is that as seen in recent times, RBI will continue to play a major role in managing the government borrowing programme through its various tools. RBI will want to keep the yields in a narrow range and try to avoid any sharp increase in yields or else it may end up counteracting the government’s  push to revive the economy.

So while the market concerns remain on the higher government borrowing and the yields on the longer end have inched up slightly post the budget, RBI’s ability to manage the borrowings will finally determine yields at the longer end. 

Overall, the yields at the longer end are expected to be volatile with the possibility of a gradual increase in yields.

In our view the rate cut cycle is over and investors must slowly prepare for a gradual reversal in interest rates albeit at a much slower pace till the economic recovery is in place.

We remain negative on longer duration funds and prefer to play the fixed income space via shorter duration high quality funds. 

Our view is that – Short Term Interest Rates will continue to remain at lower levels in a narrow range led by

1. RBI’s Accommodative Monetary Stance
2. High Liquidity in the system
3. Low Global Interest Rates
4. Inflation currently within RBI’s comfort zone
5. Muted Credit Growth
6. Economic Recovery still at a nascent stage
7. Robust Foreign Reserves and comfortable Current Account Deficit 

Summing it up…

1. We expect short term interest rates to remain “lower for longer” and the bond yields to trade within a narrow range.
2. We continue with our recommendation to stick to debt funds with high-quality credit and with shorter duration (less than 3 years)
3. Debt funds with longer duration (Gilt/Long Duration funds) may be subject to some near term volatility – RBI’s ability to manage the large government borrowing remains the key. We continue with our negative stance on long duration products.
4. Credit risk funds can be avoided given the inherent liquidity risks (read as difficulty to sell lower rated papers in case of high redemptions).

Key Risks:
RBI’s ability to manage the government borrowings without causing an increase in interest rates and inflation (in the context of rising commodity prices and improving economy) remain the key risks to monitor.