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February 2017

India Union Budget 2017: Rural Impetus with Fiscal Prudence

Overview

India’s Finance Minister Arun Jaitley presented the Union Budget on February 1st, 2017. This sought to outline the direction and pace of the government’s economic policies for the coming year. The key areas of focus were:

  • Reviving the rural economy, through agricultural capex and employment schemes
  • Providing a boost to infrastructure, emphasizing transportation and affordable housing
  • Rationalizing taxation, through the roll-out of the Goods and Services Tax (GST) bill and relief for small tax payers
  • Maintaining fiscal balance, by adhering to 3.2% fiscal deficit target with an explicit debt-to-GDP target

We believe the government has announced a pragmatic budget, which can provide catalysts for growth to help offset the temporary slowdown following demonetization, while also adhering to the long term fiscal consolidation roadmap that has been previously laid out.

Key Themes

Push for revival of the rural economy
Agriculture represents 17% of India’s GDP, but accounts for more than half of all jobs. This year’s budget has focused on providing stimulus to this segment of the economy, with government driven rural and agricultural capex set to increase by 24%. In particular, the government has sought to address key issues in the agricultural sector, including the expansion of irrigation coverage, crop insurance, soil health cards and rural electrification. The budget includes the highest-ever allocation (Rs 480bn or approximately $7bn) to the flagship rural employment guarantee scheme (MNREGA) as well as measures for skills training. These should further help in reviving rural consumption and stimulate demand for products such as tractors, two-wheelers and fast-moving consumer goods in rural areas, which were disproportionately impacted by the poor monsoons of 2014 and 2015 and demonetization in November.

Continued Focus on Infrastructure
Government driven capex for infrastructure development has increased significantly with a further Rs 3.9 trillion (approximately $60bn) allocated to infrastructure spending, including over Rs 2 trillion (approximately $35bn) that is specifically earmarked for improving transportation links. Amendments to existing laws surrounding public-private partnership involvement in airport and metro rail projects and tax benefits for investment in affordable housing should support further investment. Overall, we see the investment in infrastructure as a critical part of India’s ability to improve the ease of doing business and believe it can have meaningful positive benefits for the economy.

Rationalization of Taxes
Highlighting the government’s commitment to providing a simpler tax regime, several reforms to rationalize India’s tax system were introduced. Firstly, the corporate tax rate for MSMEs1 , which account for 96% of Indian companies, has been reduced to 25% from 30%. While the government had announced its intention to do this by 2020 in last year’s budget, bringing this forwards should help provide some positive stimulus. While we did not see a reduction in corporate tax rates for large enterprises, we had expected the government to still push this towards to their stated target of 2020. In the context of a unified goods and services tax (GST), the Finance Minister reiterated the intention to roll this out in FY2017-18, doing away with a plethora of taxes imposed by the central and state governments.

The government continued its emphasis on attempting to curb corruption and the black economy, while also seeking to increase use electronic payment methods, by banning cash transactions above Rs 300,000 (approximately $4,500). Going in to the budget, there were some fears among market participants around the imposition of a long term capital gains tax on the sale of equities, which had hitherto been exempt; the market reacted positively to the status quo being maintained. Additionally, the government clarified that Foreign Portfolio Investors will be exempt from indirect transfer provisions, putting to rest investor concerns from earlier this year.

Other Measures
Against the backdrop of a sharp increase in non-performing and stressed assets, the FM announced recapitalization of public sector banks to the tune of Rs 100bn (approximately $1.4bn) in FY18. Further, allowable provision for Non-Performing Asset of Banks increased from 7.5% to 8.5%. While we still harbor some concerns around non-performing loans, in particular in the state-owned banking sector, we see this as a positive extension of the policies introduced by former Central Bank Governor Rajan and continued under his successor Dr. Urjit Patel. The budget also made a bold push towards transparency in political funding, including the imposition of a limit of Rs 2,000 (approximately $30) on cash donations to political parties. Finally, the revenue and expenditure growth assumptions appear reasonable; hence, we believe the 3.2% fiscal deficit target is credible and achievable.

Outlook

Overall, we view this year’s budget as positive. It has focused on the revitalization of agriculture and rural development, acceleration and modernization of India’s infrastructure and expansion of online and digital platforms in every area of the administration and the economy. We remain constructive on the outlook for Indian equities and believe the budget can provide catalyst for growth and earnings improvements. We continue to focus on bottom-up, stock selection based investing and find a considerable number of opportunities, especially in the domestically oriented industrial, consumer, financials and building materials sectors, which should benefit from increased operating leverage as growth continues to pick up. Given the market is trading at ~16.8x P/E, which is in line with the historical average, we continue to believe it is an attractive entry point into one of the fastest growing major economies in the world.

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The broad team of over 100 investment professionals brings a global reach and perspective to the investment process across nine offices worldwide. 

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