After rallying for eight consecutive weeks, India’s stock markets finally took a breather following the announcement of the Union Budget, with investors getting spooked by Finance Minister Arun Jaitley’s proposal to introduce long-term capital gains tax. The government tried to maintain a balancing act between growth and populism but tilted towards the latter.
The fiscal deviation in this year’s budget was on expected lines with deficit estimated to be 3.5 percent of GDP. For the week, the benchmark indices fell 3 percent each with the Nifty falling below the support level of 10,800. Mid-cap and small-cap indices underperformed to fall around 7 percent each. The rupee closed at 64.055 against the dollar, down 51 paise for the week.
On the global front, the Federal Reserve kept interest rates unchanged but stoked expectations for a more aggressive pace on tightening after it adopted a slightly more hawkish outlook on inflation. This led to a 666-point fall in the Dow and a global markets rout, which was another reason for the weakness in India.
Coming back to the budget, it looks like it was set with the next Lok Sabha election in mind. With half of India’s population employed in agriculture and allied sectors, the focus on ‘Bharat’ was expected. The thrust was on farmers, senior citizens and the underprivileged through various schemes and increased allocation of money. Social infrastructure has also been prioritised.
Deviating from its fiscal consolidation path, the government will let fiscal deficit for FY18 slip to 3.5 percent of GDP. For FY19, the target is 3.3 percent. The budget estimates 11.5 percent nominal GDP growth rate. Assuming an extremely conservative 7 percent real GDP growth rate, this translates into an inflation of around 4.5 percent. Both look difficult if the expenditure in health and other populist schemes go overboard and inflation rises due to higher oil prices and minimum support prices (MSP) for crops.
To achieve the target of doubling farmer income by 2022, the budget fixes MSP at 1.5 times the cost production for both rabi and kharif crops. It also proposed increasing farm credit target to 11 trillion rupees, which is expected to stoke consumer inflation and prompt the RBI to turn more hawkish.
The budget also proposes to launch a flagship National Health Protection Scheme to cover more than 100 million poor families for secondary and tertiary care. If implemented efficiently, this could be the world’s largest government-funded healthcare programme.
The most important announcement from the capital markets perspective was the proposal to introduce long term capital gains tax on capital gains exceeding 100,000 rupees at the rate of 10 percent without allowing the benefit of any indexation. It is expected to mobilise revenue to the tune of 200 billion rupees. The dividend distribution tax on equity-oriented mutual funds may net another 75 billion rupees.
A reduced corporate tax rate of 25 percent for companies that have reported turnover of up to 2,500 million rupees will benefit almost the entire MSME sector, which accounts for almost 99 percent of companies filing their tax returns. This means the government will have to forego revenues amounting to 70 billion rupees.
For the coming week, the RBI’s Monetary Policy Committee meeting will be closely watched. The central bank expects CPI inflation to rise to 4.3-4.7 percent in H2FY18, and this will curtail any elbow room for more rate cuts.
On the corporate earnings front, Bosch, Tata Motors, Hero MotoCorp, Lupin, Cipla, Eicher Motors, BPCL, HPCL, M&M, ONGC, SBI and Tata Steel are some important companies which will report their numbers. On the macro data front, India’s services sector PMI for January 2018 will be out on Monday.
Markets are entering the long-awaited correction phase, and we will need to see whether there is support at lower levels or panic sets in for new investors. A further stock market fall could provide an opportunity for selective buying.
Ambareesh Baliga has about 25 years of experience in the stock market and has worked with Karvy and Kotak groups in the past. He is a regular market commentator on various business channels. He is a commerce graduate from Calcutta University and a qualified cost accountant.