On Tuesday, 23 January, eight days before finance minister Arun Jaitley unveils the last full budget of the National Democratic Alliance (NDA) government, India’s benchmark stock indices soared to new heights.
For the first time ever, the Bombay Stock Exchange’s 30-stock Sensex closed above 36,000 points at 36,139.98, and the National Stock Exchange’s Nifty above 11,000 points at 11,083.70 points, lifted by a tide of liquidity.
The budget that Jaitley unveils on 1 February will determine, at least partly, whether the stock rally, which has seen the Sensex gain more than 6% since the start of the year, on top of a 28% rise in 2017, has more legs.
A key concern is the likely introduction of a long-term capital gains tax on equities.
Bank of America-Merrill Lynch (BoFA-ML) wrote in a note that the rapid rise in equity markets seems to have reinforced arguments in favour of such a tax.
Noting that capital gains on other asset classes—debt and real estate—are subject to tax, BoFA-ML analysts wrote: “One of the key arguments in favour of taxing equities is to establish some sort of equality amongst asset classes.”
“We see little possibility that Budget 2018 delivers reasons for material upside to an already inflated market,” the note said, predicting that the Sensex would fall to 32,000 levels by the end of the year.
Market participants expect the budget to boost spending on housing and rural welfare to lift the rural economy, with an eye on the general election next year, which will be preceded by a string of state polls.
“Ahead of the general election, undoubtedly, the budget will be a populist one. At the same time, one needs to remember good economics can also result in a populist budget,” said Nilesh Shah, managing director, Kotak Mahindra Asset Management Co. Ltd.
The scope of the budget has narrowed significantly this year, said Manishi Raychaudhuri, head of Asia (ex-Japan), equity strategy, BNP Paribas Securities.
There are usually three aspects to the budget — expenditures, direct taxes and indirect taxes. The new indirect tax regime, the goods and services tax (GST), is now overseen by the GST Council, which is composed of state finance ministers and headed by Jaitley.
“So the ministry of finance has only two variables to really deal with—expenditures and direct taxes... The leeway to tinker with personal income tax slabs looks quite limited. Hence expenditure will likely be the most crucial element this year,” Raychaudhuri said.
Market participants will keep a close eye on the extent of divergence from the planned fiscal consolidation path. The government had aimed at limiting the fiscal deficit to 3.2% of GDP this fiscal year and 3% in the next. The deficit had already reached 112% of this year’s target by November.
“A fiscal deficit of ~3.5% is foreseeable. This can rise further if GST collections don’t pick up meaningfully over FY19 (fiscal 2019),” said Dipen Sheth, head of institutional research at HDFC Securities Ltd. “Also, states will have to be compensated for shortfalls arising from this transition. The increased effective incidence of tax on services may provide some counter relief,” added Sheth.
Analysts at Morgan Stanley expect a fiscal deficit of 3.4-3.5% of GDP in FY18 and FY19, respectively. “The overarching issue that we/investors are watching for is the extent of divergence from the planned fiscal consolidation path or, more specifically, whether policymakers will be increasing the spending in the form of transfers to households, which would have an impact on macro stability,” Morgan Stanley analysts wrote in a report on 12 January.
The government is expected to increase asset sales to raise revenue, given the ambiguity surrounding GST collections.
“I am hoping to see a lot of assets sales. Instead of raising tax revenues, government should raise non-tax revenue,” said Rashesh Shah, chairman of Edelweiss Group. “I hope there is no change in the capital gains taxation, because ideally government should not tinker with that.”
Market participants also expect the budget to reveal details of a Rs 2.12 trillion recapitalization plan for state-run banks. This year will be the one in which debt-laden public sector banks will move towards better health as their capital is topped up and bad loan resolution accelerates, Axis Capital said in a note on 15 January.