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India Equity Strategy
FY12 Union Budget Review - Long on Promise
• FY12 Union Budget. The Budget for FY2012E announced today was
long on promise, but a bit short on numbers. No major changes in
taxation were expected and none were announced. The Finance
Minister outlined meaningful policy initiatives pertaining to fiscal
consolidation and financial sector reforms. The funding environment
for infrastructure projects was also liberalized.
• Lower fiscal deficit targeted, but underlying assumptions appear
optimistic. The targeted fiscal deficit of 4.6% is lower than market
expectations. But our Economists opine that subsidies appear to be
under provided for and tax buoyancy budgeted appears high at this
stage of the economic cycle. This concern weighed on financial
markets, causing them to pare early gains. However, while we think
investors will likely remain skeptical of the ability to achieve the
deficit target, the issue is unlikely to come to the fore until 2HFY12E.
Over the interim, the Government has substantial policy room to cope
with this risk once the state elections are concluded next quarter.
• 2011 markets outlook. Into the next quarter, the markets will likely
focus on the substantial policy agenda and progress herein. We remain
positive on Indian equities over 2011 but maintain that sustainable
returns will be back ended, as the policy initiatives fructify and high
inflation and tight liquidity roll over into the second half.
• Sector stance. Over the last quarter, our portfolio stance has been
biased toward global sectors – IT services, Energy and Metals and
regulated utilities. Going forward, we are looking to turn more
constructive on Financials and the Investment Cycle – particularly
private sector banks and industrials in the early part of the cycle.
Budget FY2012 - In line with expectations
The Finance Ministers Budget Speech for FY2012E was largely in line with our
expectations (please refer to “FY12(E) Union Budget Preview,” dated Feb 28, 2011).
1) There were no major changes in taxation. Individual tax payers gained
Rs2, 000 / annum due to the exemption limit for income tax being raised
from Rs160,000 to Rs180,000. The surcharge on corporate tax was reduced
from 7.5% to 5%, which should reduce the peak effective corporate tax rate
by about 60 bps. Contrary to expectations, however, the Finance Minister
did not raise excise duties (a 200 bps point increase was expected).
2) A substantial policy agenda was announced.
a) The Direct Tax Code (DTC) and Goods and Services Tax (GST)
are expected to be implemented next fiscal quarter. Separately, the
Finance Minister is targeting direct cash transfer of cooking fuel
subsidies to target households by next year. These measures when
implemented should help consolidate the fiscal position.
b) Insurance, pension and banking sector reforms are to be considered
over the near term (for details, please refer to the section on
Banks).
c) Funding norms for infrastructure projects have been liberalized (for
details please refer to the section on Infrastructure and Capital
Goods). Separately, the Land Acquisition (Amendment) Bill ad
Mines and Minerals (Development and Regulation) Bill have also
been tabled for consideration in the Budget session of Parliament.
Passage will mean a substantial leg up for the investment cycle.
3) The fiscal deficit for FY12E is targeted at 4.6% (better than earlier official
guidance of 4.8%). Correspondingly the Governments borrowing program is
pegged at Rs3.43 trillion, about Rs400 bn lower than earlier expectations.
But the assumptions behind the calculation appear a bit optimistic.
Subsidies appear to be under provided for and tax buoyancy at 1.3x nominal
GDP growth appears relatively high to us at this stage of the economic
cycle. Achieving the divestment target of Rs400 bn assumes that global
liquidity and risk aversion remain benign. Widening the tax net to include
more goods and services is, however, a positive. Expenditure estimates also
appear better anchored, both in terms of the quantum and the split between
Revenue and Capital Expenditure.
Market direction and portfolio stance
The financial markets were initially enthused by the policy initiatives announced and
the lower deficit and Government borrowing targeted. At one stage, equities were up
3%, bond yields declined 7-8 bps, and the rupee appreciated by about 0.2%. But
these gains were subsequently pared as skepticism emerged on some of the
assumptions in the Budget, particularly pertaining to the deficit.
We expect the skepticism to persist over the near term. But it is worth highlighting
that the risks associated with the deficit are unlikely to materialize meaningfully
before the second half, if at all. We do not expect any meaningful reduction to our
earnings estimates on account of the Budget provisions announced today. Currently,
we estimate earnings growth of 17% for the broad market for FY12. Also, the
Government does have better policy leg room to cope with some of these risks,
particularly subsidy reduction, once the state elections are concluded (May 2011).
We believe that into March-April investor attention will gradually shift to the policy
initiatives announced and the Government’s success in getting Parliamentary
approval for the Bills tabled. To reiterate, the Government has tabled nearly 32 Bills
in the current session of Parliament. We think debate and passage of these will
clarify Government policy on a number of grey areas and boost business confidence.
Our views on the equity markets for 2011 remain largely unchanged subsequent to
the Budget (for details, please refer to India Strategy: Year Ahead 2011 – Bumpy
Ride to Continue, dated January 7, 2011). We remain positive on the equity markets
for the year ahead, but believe sustainable returns will be back ended as the policy
initiatives announced fructify and as high inflation and tight liquidity roll over into
the year.
Over the last quarter, our portfolio stance has been biased toward global sectors – IT
services, Energy and Metals and regulated utilities. Going forward, we are looking to
turn more constructive on Financials and the Investment Cycle – particularly private
sector banks and industrials in the early part of the cycle.
Following, we present in the following pages a detailed assessment of the Budget by
our Economics and Sector teams
FY12 budget surprises positively but beware
of the fine print
Jahangir AzizAC, (91-22) 6157-3385, jahangir.x.aziz@jpmorgan.com,
J.P. Morgan India Private Limited
Sajjid Z Chinoy AC, (91-22) 6157-3386, sajjid.z.chinoy@jpmorgan.com,
J.P. Morgan India Private Limited
• FY12 fiscal deficit targeted at 4.6% of GDP, lower than the expected
4.8%
• Net borrowing announced to be Rs3.4 trillion, almost Rs400 billion
lower than expected
• Equity market heaved a sigh of relief on escaping feared increases in
taxes; bond yields rallied on the lower borrowing; and the INR
remained stable
• Net of asset sales, however, achieving this fiscal deficit target in FY12
would entail an effective fiscal consolidation of an unprecedented 1.7%
of GDP in one year
• With no substantive tax increases or expenditure cuts, the fiscal outturn
for FY12 could be significantly higher
• But these risks will begin to materialize only in 2HFY12, in the interim
we continue to expect the yield curve to flatten
• FY11 fiscal deficit expected to print at 5.1 % of GDP (budget target
5.5%) on account of 3G asset sales and higher nominal GDP
FY12 budget beats market expectations…
The Finance Minister pegged the FY12 fiscal deficit at 4.6% of GDP (consensus:
4.8% of GDP) and a corresponding market borrowing of Rs. 3.4 trillion, almost
Rs.400 billion lower than what the market had forecast, causing markets to rally
sharply. On the news, the equity market rose more than 3 percent in response, yields
fell by 7-8 basis points, and the rupee appreciated by about 0.2 percent. However,
much of these gains were pared back in the rest of the day.
The market cheered the fact that the government was able to deliver a lower-thananticipated
fiscal deficit without resorting to more broad-based increases in excise
duty, as was feared. On the contrary, the basic exemption for personal income taxes
was lifted from Rs. 1, 60,000 to Rs 1, 80,000 (including higher exemptions for senior
citizens) and the current surcharge for domestic companies was reduced from 7.5
percent to 5 percent. Further, total expenditure was only budgeted. In addition, gross
expenditure was only budgeted to grow a little over 3% over last year compared to a
10 percent increase the previous year. At first pass, therefore, it appeared that the
finance minister had avoided raising taxes by as much as he may have wanted and
instead resorted to curtailing expenditure growth to reduce the fiscal deficit.
…but beware of the fine print
A closer reading of the fine print, however, suggests that the outlook may not be
nearly as favorable. For one, the FY12 budget estimates are predicated on optimistic
assumptions of tax buoyancy. It is estimated that the tax buoyancy in FY11 will be
about 1.2 (rate of growth of gross tax collections being 20 percent higher than
nominal GDP growth) ,whereas that of FY12 is being estimated at 1.3. Tax buoyancy
typically reduces as one proceeds into the recovery stage and so one would have
expected estimated tax buoyancy to reduce and not increase.
In addition, predictably, subsidies seem to have been under-budgeted again. While
the allocation for oil subsidies has been budgeted at Rs 240 billion (a welcome
departure from the Rs 31 billion of the previous year), even this allocation is
expected to cover only half the Government’s share of the under-recovery even if
crude stays at $90/barrel.
More concerning, food subsidies have been budgeted at the same amount as last year
despite the fact that higher minimum support prices, potentially higher procurements
levels, and a Food Security that is imminent could push the subsidy bill up by
another Rs 0-20,000 crore this year.
Similarly, the allocation for NREGA has been held at Rs 400 billion, even though
linking NREGA wages to CPI (as was reiterated by the Finance Minister) could
result in significantly higher allocations.
In sum, as the fiscal year proceeds and it becomes clear that allocations for subsidies
and key programs such as NREGA need to be revised upwards by up to 0.5 % of
GDP, the initial euphoria surrounding today’s budget may fade rapidly.
The magnitude of achieving a fiscal consolidation of this magnitude is better
understood as follows: net of asset sales, achieving the budgeted fiscal deficit would
entail a staggering fiscal consolidation of 1.7 % of GDP. In FY11, the budget
consolidation on the same measure was 0.2% of GDP, down from 6.9% in FY10 to
6.7% in FY11.
Bonds likely to remain stable until the supplementary
budgets
Bonds are expected to rally in the first half of this year on lower-than-anticipated
borrowing. While the bond market was expected net borrowing to print at Rs3.8
trillion, for FY12, today’s budget announced a borrowing program that was almost
Rs400 billion lower. However, if the risks listed above do materialize in the second
half of the year and credit demands pick up, bonds could come under pressure. We
believe the pressure point will likely be the first supplementary budget expected in
October.
FY11 fiscal deficit to print at 5.1 % of GDP, as expected
In addition, as was widely expected, revised estimates for the FY11 budget pegged
the FY11 deficit at 5.1 % of GDP, significantly lower than the 5.5 % that was
budgeted. Much of this, however, is on account of the fact that nominal GDP is
expected to grow at 20% -- significantly higher than the 12% budgeted – on account
of higher-than-forecasted inflation. This, in conjunction with the fact that 3G
spectrum sales boosted revenues by 1.4 % of GDP meant that the consolidation
almost happened inadvertently, and not because expenditures were particularly
curtailed.
Foreign retail investors now able to invest in mutual funds
Authorities also used the budget to announce that retail foreign investors will now be
directly allowed to invest in Indian equity mutual funds as long as they meet their
KYC requirements. This could potentially significantly increase capital inflows in
India in the coming quarters, and help buffer the risks associated on the external
accounts with falling FDI. In addition, the withholding tax infrastructure debt funds
(SPVs) has been reduced from 20% to 5%. Separately, the FII limit for local
currency corporate bond has been increased from $5bn to $25bn for infrastructure
bonds of residual maturity of more than 5 years.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
India Equity Strategy
FY12 Union Budget Review - Long on Promise
• FY12 Union Budget. The Budget for FY2012E announced today was
long on promise, but a bit short on numbers. No major changes in
taxation were expected and none were announced. The Finance
Minister outlined meaningful policy initiatives pertaining to fiscal
consolidation and financial sector reforms. The funding environment
for infrastructure projects was also liberalized.
• Lower fiscal deficit targeted, but underlying assumptions appear
optimistic. The targeted fiscal deficit of 4.6% is lower than market
expectations. But our Economists opine that subsidies appear to be
under provided for and tax buoyancy budgeted appears high at this
stage of the economic cycle. This concern weighed on financial
markets, causing them to pare early gains. However, while we think
investors will likely remain skeptical of the ability to achieve the
deficit target, the issue is unlikely to come to the fore until 2HFY12E.
Over the interim, the Government has substantial policy room to cope
with this risk once the state elections are concluded next quarter.
• 2011 markets outlook. Into the next quarter, the markets will likely
focus on the substantial policy agenda and progress herein. We remain
positive on Indian equities over 2011 but maintain that sustainable
returns will be back ended, as the policy initiatives fructify and high
inflation and tight liquidity roll over into the second half.
• Sector stance. Over the last quarter, our portfolio stance has been
biased toward global sectors – IT services, Energy and Metals and
regulated utilities. Going forward, we are looking to turn more
constructive on Financials and the Investment Cycle – particularly
private sector banks and industrials in the early part of the cycle.
Budget FY2012 - In line with expectations
The Finance Ministers Budget Speech for FY2012E was largely in line with our
expectations (please refer to “FY12(E) Union Budget Preview,” dated Feb 28, 2011).
1) There were no major changes in taxation. Individual tax payers gained
Rs2, 000 / annum due to the exemption limit for income tax being raised
from Rs160,000 to Rs180,000. The surcharge on corporate tax was reduced
from 7.5% to 5%, which should reduce the peak effective corporate tax rate
by about 60 bps. Contrary to expectations, however, the Finance Minister
did not raise excise duties (a 200 bps point increase was expected).
2) A substantial policy agenda was announced.
a) The Direct Tax Code (DTC) and Goods and Services Tax (GST)
are expected to be implemented next fiscal quarter. Separately, the
Finance Minister is targeting direct cash transfer of cooking fuel
subsidies to target households by next year. These measures when
implemented should help consolidate the fiscal position.
b) Insurance, pension and banking sector reforms are to be considered
over the near term (for details, please refer to the section on
Banks).
c) Funding norms for infrastructure projects have been liberalized (for
details please refer to the section on Infrastructure and Capital
Goods). Separately, the Land Acquisition (Amendment) Bill ad
Mines and Minerals (Development and Regulation) Bill have also
been tabled for consideration in the Budget session of Parliament.
Passage will mean a substantial leg up for the investment cycle.
3) The fiscal deficit for FY12E is targeted at 4.6% (better than earlier official
guidance of 4.8%). Correspondingly the Governments borrowing program is
pegged at Rs3.43 trillion, about Rs400 bn lower than earlier expectations.
But the assumptions behind the calculation appear a bit optimistic.
Subsidies appear to be under provided for and tax buoyancy at 1.3x nominal
GDP growth appears relatively high to us at this stage of the economic
cycle. Achieving the divestment target of Rs400 bn assumes that global
liquidity and risk aversion remain benign. Widening the tax net to include
more goods and services is, however, a positive. Expenditure estimates also
appear better anchored, both in terms of the quantum and the split between
Revenue and Capital Expenditure.
Market direction and portfolio stance
The financial markets were initially enthused by the policy initiatives announced and
the lower deficit and Government borrowing targeted. At one stage, equities were up
3%, bond yields declined 7-8 bps, and the rupee appreciated by about 0.2%. But
these gains were subsequently pared as skepticism emerged on some of the
assumptions in the Budget, particularly pertaining to the deficit.
We expect the skepticism to persist over the near term. But it is worth highlighting
that the risks associated with the deficit are unlikely to materialize meaningfully
before the second half, if at all. We do not expect any meaningful reduction to our
earnings estimates on account of the Budget provisions announced today. Currently,
we estimate earnings growth of 17% for the broad market for FY12. Also, the
Government does have better policy leg room to cope with some of these risks,
particularly subsidy reduction, once the state elections are concluded (May 2011).
We believe that into March-April investor attention will gradually shift to the policy
initiatives announced and the Government’s success in getting Parliamentary
approval for the Bills tabled. To reiterate, the Government has tabled nearly 32 Bills
in the current session of Parliament. We think debate and passage of these will
clarify Government policy on a number of grey areas and boost business confidence.
Our views on the equity markets for 2011 remain largely unchanged subsequent to
the Budget (for details, please refer to India Strategy: Year Ahead 2011 – Bumpy
Ride to Continue, dated January 7, 2011). We remain positive on the equity markets
for the year ahead, but believe sustainable returns will be back ended as the policy
initiatives announced fructify and as high inflation and tight liquidity roll over into
the year.
Over the last quarter, our portfolio stance has been biased toward global sectors – IT
services, Energy and Metals and regulated utilities. Going forward, we are looking to
turn more constructive on Financials and the Investment Cycle – particularly private
sector banks and industrials in the early part of the cycle.
Following, we present in the following pages a detailed assessment of the Budget by
our Economics and Sector teams
FY12 budget surprises positively but beware
of the fine print
Jahangir AzizAC, (91-22) 6157-3385, jahangir.x.aziz@jpmorgan.com,
J.P. Morgan India Private Limited
Sajjid Z Chinoy AC, (91-22) 6157-3386, sajjid.z.chinoy@jpmorgan.com,
J.P. Morgan India Private Limited
• FY12 fiscal deficit targeted at 4.6% of GDP, lower than the expected
4.8%
• Net borrowing announced to be Rs3.4 trillion, almost Rs400 billion
lower than expected
• Equity market heaved a sigh of relief on escaping feared increases in
taxes; bond yields rallied on the lower borrowing; and the INR
remained stable
• Net of asset sales, however, achieving this fiscal deficit target in FY12
would entail an effective fiscal consolidation of an unprecedented 1.7%
of GDP in one year
• With no substantive tax increases or expenditure cuts, the fiscal outturn
for FY12 could be significantly higher
• But these risks will begin to materialize only in 2HFY12, in the interim
we continue to expect the yield curve to flatten
• FY11 fiscal deficit expected to print at 5.1 % of GDP (budget target
5.5%) on account of 3G asset sales and higher nominal GDP
FY12 budget beats market expectations…
The Finance Minister pegged the FY12 fiscal deficit at 4.6% of GDP (consensus:
4.8% of GDP) and a corresponding market borrowing of Rs. 3.4 trillion, almost
Rs.400 billion lower than what the market had forecast, causing markets to rally
sharply. On the news, the equity market rose more than 3 percent in response, yields
fell by 7-8 basis points, and the rupee appreciated by about 0.2 percent. However,
much of these gains were pared back in the rest of the day.
The market cheered the fact that the government was able to deliver a lower-thananticipated
fiscal deficit without resorting to more broad-based increases in excise
duty, as was feared. On the contrary, the basic exemption for personal income taxes
was lifted from Rs. 1, 60,000 to Rs 1, 80,000 (including higher exemptions for senior
citizens) and the current surcharge for domestic companies was reduced from 7.5
percent to 5 percent. Further, total expenditure was only budgeted. In addition, gross
expenditure was only budgeted to grow a little over 3% over last year compared to a
10 percent increase the previous year. At first pass, therefore, it appeared that the
finance minister had avoided raising taxes by as much as he may have wanted and
instead resorted to curtailing expenditure growth to reduce the fiscal deficit.
…but beware of the fine print
A closer reading of the fine print, however, suggests that the outlook may not be
nearly as favorable. For one, the FY12 budget estimates are predicated on optimistic
assumptions of tax buoyancy. It is estimated that the tax buoyancy in FY11 will be
about 1.2 (rate of growth of gross tax collections being 20 percent higher than
nominal GDP growth) ,whereas that of FY12 is being estimated at 1.3. Tax buoyancy
typically reduces as one proceeds into the recovery stage and so one would have
expected estimated tax buoyancy to reduce and not increase.
In addition, predictably, subsidies seem to have been under-budgeted again. While
the allocation for oil subsidies has been budgeted at Rs 240 billion (a welcome
departure from the Rs 31 billion of the previous year), even this allocation is
expected to cover only half the Government’s share of the under-recovery even if
crude stays at $90/barrel.
More concerning, food subsidies have been budgeted at the same amount as last year
despite the fact that higher minimum support prices, potentially higher procurements
levels, and a Food Security that is imminent could push the subsidy bill up by
another Rs 0-20,000 crore this year.
Similarly, the allocation for NREGA has been held at Rs 400 billion, even though
linking NREGA wages to CPI (as was reiterated by the Finance Minister) could
result in significantly higher allocations.
In sum, as the fiscal year proceeds and it becomes clear that allocations for subsidies
and key programs such as NREGA need to be revised upwards by up to 0.5 % of
GDP, the initial euphoria surrounding today’s budget may fade rapidly.
The magnitude of achieving a fiscal consolidation of this magnitude is better
understood as follows: net of asset sales, achieving the budgeted fiscal deficit would
entail a staggering fiscal consolidation of 1.7 % of GDP. In FY11, the budget
consolidation on the same measure was 0.2% of GDP, down from 6.9% in FY10 to
6.7% in FY11.
Bonds likely to remain stable until the supplementary
budgets
Bonds are expected to rally in the first half of this year on lower-than-anticipated
borrowing. While the bond market was expected net borrowing to print at Rs3.8
trillion, for FY12, today’s budget announced a borrowing program that was almost
Rs400 billion lower. However, if the risks listed above do materialize in the second
half of the year and credit demands pick up, bonds could come under pressure. We
believe the pressure point will likely be the first supplementary budget expected in
October.
FY11 fiscal deficit to print at 5.1 % of GDP, as expected
In addition, as was widely expected, revised estimates for the FY11 budget pegged
the FY11 deficit at 5.1 % of GDP, significantly lower than the 5.5 % that was
budgeted. Much of this, however, is on account of the fact that nominal GDP is
expected to grow at 20% -- significantly higher than the 12% budgeted – on account
of higher-than-forecasted inflation. This, in conjunction with the fact that 3G
spectrum sales boosted revenues by 1.4 % of GDP meant that the consolidation
almost happened inadvertently, and not because expenditures were particularly
curtailed.
Foreign retail investors now able to invest in mutual funds
Authorities also used the budget to announce that retail foreign investors will now be
directly allowed to invest in Indian equity mutual funds as long as they meet their
KYC requirements. This could potentially significantly increase capital inflows in
India in the coming quarters, and help buffer the risks associated on the external
accounts with falling FDI. In addition, the withholding tax infrastructure debt funds
(SPVs) has been reduced from 20% to 5%. Separately, the FII limit for local
currency corporate bond has been increased from $5bn to $25bn for infrastructure
bonds of residual maturity of more than 5 years.
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