Budget 2018: old habits die hard

The present NDA government has been trying to deglamorize the Union Budget since the beginning of its term. It has been trying to keep most of the major policy initiatives outside the budget speech. But as they say, “Old habits die hard” — so, today was no different. However, the Union Budget is always looked at with great expectations on various issues.

The finance minister was clearly struggling between political compulsions and fiscal prudence to maintain a finance balance. Though the pressure of nine forthcoming assembly elections and then the General Elections over the next 14 months forced him to sacrifice fiscal prudence and focus on the rural, agricultural economy, which actually has been struggling for some time.

At the same time it’s also true that the Indian agricultural sector does need a lot of bold structural reforms to become sustainable and for which only a few budget announcements like guaranteeing the Minimum Support Price (MSP) for all kharif crops at 1.5 times the cost incurred by the farmers are not sufficient.

The positive  part of the budget was that the government continued with its capex. The government capex is budgeted to grow in FY19 at 10 per cent comparable to the FY18 figure of -4 per cent. In absolute terms, the government capex will amount to Rs3 lakh crores as compared to Rs2.7 lakh crore in FY18 revised estimates.

The financial markets seem to be quite disappointed with the budget; the bond market was disappointed with the fact that the fiscal deficit is much higher than market estimates.

Though the fiscal deficit as a percentage of GDP is expected to be 3.3 per cent for the next year, which is lower than 3.5 per cent for this year, the absolute amount of bond to be issued by the government will be higher than the last year.

The government’s bias towards elongating the maturity profile of government debt means that this increased amount of bonds will most likely be long dated. In the current environment global yields are rising and RBI is concerned about inflation. The bond market is not ready to handed supply side pressures. The bond yields have already risen over 100bps in last 6months and may continue to remain elevated.

The Equity market which has been the morning star of India’s great growth story got a bit of hiccup in form of reintroduction of long term capital gains tax (CGT) at the rate of 10 per cent, without any change to the Securities Transaction Tax (STT). This may impact some of the trading activity in the markets but from the long term investor’s point of view equity remains an attractive asset class. This belief becomes sanguine if you look at it in the light of recent quarterly results announced by various listed corporates.

Finally to be fair to the Government, in the present economic circumstances and the election pressures, the Finance Minister has delivered a budget which promises to support the economic recovery, and at the same time does not push the economy on the path of fiscal imprudence as we have seen in the pre-election budgets of the past. I also strongly believe that the Indian Juggernaut will continue to roll forwards and this budget will soon be forgotten by the financial markets.

Will long term capital gain tax derail the great Indian equity story?
Long Term Capital Gain Tax (LTCG) is not new to the Indian market, but last time when it was removed from equity related gains, the Securities Transaction Tax (STT) was introduced with the objective of better tax compliance.

So, to be fair, the government should have changed the STT structure along with the introduction of LTCG. But apparently, the equity market has become a victim to its own success.

However, this doesn’t mean that with the introduction of LTCG, Indian equity has suddenly become unattractive for a long term investor. Indian equity market has generated a CAGR of over 15 per cent in the last 20 years, which is higher than any other asset class even if we adjust it from tax. 

There is no reason to believe that Indian equity market will not be able to maintain a healthy CAGR going forward. Specially, when global economic growth is coming back and the Indian Economy itself is pegged to grow over 7 per cent with reasonable amount of inflation.

The ongoing results season so far has been more encouraging than the previous few quarters, and earnings growth seems to be returning to the equity markets. These along with the structural reforms taken by the government so far should allow markets to remain positive.

Despite LTCG, the individual investor participation into the equity market through mutual fund will not die out anytime soon. The reason is absence of any other investment avenue, which is expected to do as well and also because it is as liquid as this asset class. Though we are focusing on the local issues we should also not forget that the Indian Equity market also had a lot of momentum coming from positivity in the global market and we don’t expect that to be fading soon.

I think this motivated the finance ministry to try and raise some additional revenue by imposing LTCG on the equity-related gains. Finally, we all should also acknowledge that the long-term investment decisions have to be based on the returns profile of the asset class over the period of time and not solely on the tax arbitrage.