Budget ticks the right boxes, sets the agenda for new term

By Bharat Iyer

The union budget for FY2019-20E ticks the right boxes. The focus is on maintaining macro stability, attracting more foreign capital into the country via both equity and debt markets and reviving growth gradually.

Growth assumptions are wellanchored, with nominal GDP forecast to grow by 11 per cent. Tax revenues are forecast to grow at about 18 per cent, only a tad aggressive. In this backdrop, policy makers continue to attempt fiscal consolidation, with the fiscal deficit targeted at 3.3 per cent of GDP against 3.4 per cent earlier and market expectations closer to 3.6 per cent.



Meaningful initiatives have been announced to attract foreign investment, very necessary given a meaningful decline in the domestic savings rate over the last decade. These include: a) an intent to ease foreign direct investment limits in select sectors such as insurance, media and aviation; (b) easing the ‘know your customer’ (KYC) norms for foreign portfolio investors (FPI);

(c) government potentially borrowing more in the overseas financial markets, given the current low levels of sovereign external borrowings (less than 5 per cent of GDP), freeing up local capital for the private sector and (d) FPIs being allowed to invest in listed debt securities issued by ReITs and InvITs.

The currency and bond markets reacted positively to the budget. The INR strengthened by about 0.15 per cent and yields on the benchmark 10-year bond declined a meaningful 6 bps.

Equity market reaction on the day was a tad underwhelming though, with the Nifty declining by about 1 per cent, though the Bank Nifty remained flat. But investors would do well to consider that the broad market had already rallied a meaningful 18 per cent over the last 8 months, partially in response to policy positives emanating from the decisive mandate in the national elections in May and the stimulus provided in the interim budget in February.

The key concern on the day pertained to potential increase in supply for the equity markets following announcements that

(a) the government would ask the capital markets regulator to consider increasing the free float requirement for listed equities from 25 per cent to 35 per cent and (b) including the investments of government-controlled entities in considering appropriate government ownership levels (51 per cent) in public sector undertakings. The panic reaction could however be unwarranted as the regulator has yet to opine on the proposal and the time frame for implementation. Also investors would do well to note that a low free float factor currently constrains India’s weight in the global benchmark equity indices, which the proposed move would potentially address.

On balance, the focus on macro stability is key for sustaining current rich valuations for Indian equities at about 18x one year forward earnings. Corporate earnings are recovering, led by lower credit costs for financials and should aid market performance. Adjusted for one-off gains and losses, earnings for benchmark indices increased 15 per cent over FY19 and a similar growth rate is expected over FY20E. Earnings growth should continue to lead markets higher and we target a Nifty level of 12500 by the year end.

Banks, materials including cement and steel and segments benefitting from government investments in priority infrastructure segments such as transportation and affordable housing should likely lead market performance.

Disruptions in global financial markets remain the key risk to the equity markets, given the dependence on foreign capital to boost growth, particularly the investment cycle.

(The author is MD & global equities research head, JP Morgan India)