The broad theme of the FY18 budget remains on reducing the pain arising out of demonetisation and continuity of focusing on infrastructure and housing, says India Ratings and Research (India Ratings). The fiscal deficit target at 3.2% of GDP in FY18 is lower than expected and positive for money markets, this will ensure transmission of low rates and benefits to the banking sector. Higher MNREGA spending than was budgeted in FY17 budget and increasing allocation to INR480 billion aimed at reducing the demonetisation pain. This could be seen from the focus areas of the budget on agriculture/rural, MSME/informal sector and people who are in the lower income bracket.

Budget Arithmetic: The budget pegs 2016-17 (revised estimates) fiscal and revenue deficit at 3.2% and 2.1% of GDP respectively. The same for 2017-18 are pegged at 3.2% and 1.9% respectively. This shows some improvement in the quality of deficit, which is a welcome step and soothes, the nerves of the debt market. At the core of the fiscal arithmetic is the assumption regarding nominal GDP growth of 11.75%, assuming 7% to 7.4% real GDP growth the inflation as measured by the GDP deflator is expected to grow at 4.4% to 4.1%. With this range of the GDP deflator the probability of significant monetary easing in the rest of 2016-17 and 2017-18 appears to be very low.

 

Central government’s net tax revenues are expected to grow at 12.7% in 2017-18 (2016-17: 15.4%) translating in a net tax revenue buoyancy of marginally higher than 1. Aggregate net tax collection assumptions appear to be plausible, however, at sectoral level it appears to be slightly difficult. Personal income tax is expected to grow at 24.9% in 2017-18 (BE) from 22.8% growth in 2016-17 (RE), customs duties are expected to increase by 12.9% in 2017-18 from 3.2% in 2016-17, union excise duties are expected to grow by 5% in 2017-18 from 34.5% in 2017-18. While direct taxes are unlikely to undergo any changes in 2017-18, indirect taxes (customs, excise and service tax) are likely to undergo a change after the proposed implementation of goods and services tax.

 

Assumptions regarding expenditure appears to be more optimistic. Capital expenditure growth in 2017-18 is 10.7% almost same as 10.6% previous year. Revenue expenditure in 2017-18 is expected to grow 8.1% as against 12.5% in the previous year. More importantly non-interest revenue expenditure is budgeted to grow at just 8% in 2017-18 as against 13.5% growth in 2016-17. While non-interest revenue expenditure growth in 2016-17 is affected by salary revision, 8.0% growth in 2017-18 is optimistic.

 

Aspirational Divestment Target: Achieving 3.2% fiscal deficit target also depends on the government’s success in achieving the INR725 billion of disinvestment receipt in 2017-18, in 2016-17, the government expects INR455 billion disinvestment receipt as against INR565 billion budget estimate. However, the government is still quite far from achieving this revised target.

 

Tax Treat: Some relief has been given to the micro and small and medium enterprise sectors by reducing the rate of corporate tax to 25%. Similarly, the people who in the lower income bracket have got some relief in the form of a reduction in income tax by 50%. Even the increased focus on housing for poor/affordable housing is a step to reduce the pain arising of demonetisation. In all nothing transformative but a budget suited for the occasion.

 

Neutral for Bond Markets: Bond market gained comfort from the low gross market borrowing of INR5.8 trillion and net market borrowing number of INR4.23 trillion as buy-back is typically a tactical decision. The impact in the long term on bond market is likely to be neutral, as overall supply of government bonds continues to be in-line with the previous year’s trend. The bond market will start focusing on the combined statutory liquidity ratio securities supply since the net state development loans’ (SDL) issuances are likely to stand at par with the net central government borrowing. Consequently, the longer end of the yield curve will show a hardening bias, while the shorter end of the curve may remain anchored owing to the banking sector appetite. The 10-year G-sec yield could stay in range of 6.3%-6.5% till the end of FY17. However, SDL spread over G-sec could stay elevated at around the current range of 75bp-85bp. Fiscal prudence as also the government’s thrust on making the investment environment conducive for foreign investors will keep the sentiment in the currency markets positive. Against the backdrop of the US Fed’s monetary policy decision later tonight, the rupee is likely to trade largely in the range of 67.3/USD-68.1/USD in the near term.



No relief for Public Sector Banks: For the banking sector, the budget reinforced Ind-Ra’s thesis on rationing of growth capital for PSU banks, while keeping the option of providing bailout capital open. Modest growth target for agri lending also points to the fact that Govt. is cognizant and comfortable with PSU banks’ inability to grow at a rapid pace. Ind-Ra expects this to keep the demand for Additional Tier-1 bonds high even in FY18. Ind-Ra expects tier-1 capital requirement of at least INR750bn for FY18-19 even at a bare minimum CAGR of 8-9% for public sector banks.

 

Fillip  for Affordable Housing, Small borrowers: Affordable housing has been  given infrastructure status enhancing funding access as well as reducing borrowing costs,   pace of lending through NHB continues , eligibility parameters on tax benefits for developers have been expanded and higher spends are being directed through PM Awas Yojna. The budget also proposed 30% increase in MGNREGA and an increase in allocation of women workforce to 55% from 45% earlier. In Ind-Ra’s view this could provide a big boost for women borrowers availing MFI loans.

 

Infrastructure Push: The 12% yoy increase in budget allocation for the highway sector, notwithstanding an increase of 32% in the previous year, still provides a boost to the infrastructure space. India Ratings sees this as a much needed push, since the sector has seen an increase of 37% yoy in the total length constructed in FY16, apart from the increase in land acquisition. The government has ascribed importance to the missing link of adequate road connectivity to ports identifying 2,000 km of coastal roads. However, the timely execution of the same within the budgeted costs will be critical if the same needs to be implemented as planned. Additionally, the proposal of increase in the Carry forward of Minimum Alternate Tax to 15 years from 10 years is positive for Infrastructure Special Purpose Vehicles as there will be more cash flow available for debt service during the last 5 years (assuming average 15 years of bank debt).

 

Housing Boost:  Infrastructure status for affordable housing projects gives higher access to companies to the capital markets, since housing limits won’t be applicable. Larger area included in affordable housing under the tax benefit will also help reduce housing prices and increase financing opportunities. Affordable housing projects will get access to funding from various sources, including ECB. The overall housing focus will be positive for employment and the steel and cement sector. INR200bn NHB allocation is a big push for affordable housing finance companies namely AU housing, Gruh Finance, Repco. Infrastructure status to affordable housing will also lower borrowing cost for housing development companies. The 53% increase in allocation for PMs Awas Yojna to boost volumes for affordable housing finance companies.

 

Solar Gains is Thermals Loss: The second phase of solar development of 20GW will be positive for solar panel suppliers, namely Mundra Solar PV. The solar powering of 2000 railway stations will give a boost the the order books of solar developers, Tata Power Solar Systems Limited, Adani Renewable Energy LLP, Mahindra Susten Private Limited. India Ratings believes the second phase solar development needs to be routed through a centralised payment agency like SECI rather than directly selling it to the state, thus it will help solar capacities reach grid parity. Increasing solar capacities will however mean higher energy bill for more expensive power (for discoms). The overall solar push could further dent discoms' financials if not properly administered. Push for solar on the other hand is negative for thermal power projects. The one year delay in the completion of rural electrification to May 2018 from the earlier target will slow growth in electricity demand. The delay in the completion of rural electrification is negative for power generation companies. The lack of incentives for the wind sector is credit negative for companies in the sector namely Suzlon, Orient Green Power, Inox Wind, Indowind.

 

LNG Price Reduction to Benefit Consumers: The reduction in LNG custom duty will boost volumes for companies namely Petronet LNG Ltd (‘IND AA+’/Positive). For Petronet LNG term LNG landed price at Dahej to decline by 20 cents per mmbtu (at crude price of USD55/bbl). Imported LNG price reduction is beneficial for city gas players, namely Indraprashta Gas Limited (‘IND AAA’/Stable), Mahanagar Gas Limited, GAIL Gas Limited (‘IND AAA(SO)’/Stable). The governments focus on lowering kerosene consumption is positive for upstream companies as zero subsidy sharing is expected in FY18. Adding two strategic crude oil reserves will take the total crude oil capacity in India to 15.33mt and provide additional energy security. Synergistic benefits will flow to the oil public sector companies, as the government proposes to create integrated PSU oil major. The railways shifting from diesel to solar power will impact diesel consumption, since the railways consume 3.24% of diesel in India.

 

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Analyst Names

  • Dr Devendra Pant

    Chief Economist and Head Public Finance
    India Ratings and Research Pvt Ltd 601-9 Prakashdeep Building 7 Tolstoy Marg New Delhi 110001
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    Venkataraman Rajaraman

    Senior Director and Head Infrastructure and Project Finance
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    Abhishek Bhattacharya

    Director and Co Head Financial Institutions
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