Indian budget for FY 2019 laid greater emphasis on the rural economy

Priority Areas

As widely expected, the budget for FY 2018-2019 presented by the Government of India laid greater emphasis on the rural economy even as it continued to spend big on infrastructure. The focus on the rural economy, if implemented properly, is likely to have a dual impact by shielding the government politically from signs of distress among farmers, and also giving a boost to consumption.

As part of the initiatives for the rural economy, the finance minister announced a one-and-half time minimum support price of the cost of production for Kharif crops for farmers. This is akin to providing more money in the hand of the farmer but is also inflationary.

Another key initiative taken by the government is to introduce free healthcare for 100 million poor families or around 500 million people. This is modelled on similar lines as ‘Obamacare’ in the US but of a much bigger scale and size. The entire scheme is likely to be government-funded.

Infrastructure continues to remain a major focus for the government with the total fund outlay increasing by c.20%. Among sectors, Railway sector outlay has increased by 20% y/y compared to estimated spending in FY 2017-2018. Similarly for the Road Sector, the increase is 10% y/y. On affordable housing, the government has decided to establish a dedicated affordable housing fund under the National Housing Bank for priority sector lending. The government also plans to increase the airports capacity five times to 1 billion trips per year.

Fiscal Deficit

The Government of India has estimated FY 2017-2018 fiscal deficit target at 3.5% compared to an earlier target of 3.2%. The slippage is mainly on account of the fact that the government will receive GST revenues for only 11 months instead of the full year. While the shortfall has partly been made up by increase in direct tax collections and disinvestment proceeds, the gap still remains for the fiscal deficit to widen. The slippage is broadly in line with expectations as the macroeconomic picture did weaken slightly over the past three months owing to increase in oil prices and ongoing changes in Goods and Services Tax rates.

For FY 2018-2019, the government has estimated the fiscal deficit target at 3.3%, slightly higher than market estimates of 3.2%. While the slippage is slightly worrying, the positive side is that the numbers look credible and still follows the glide path to bring the deficit down to 3.0% over the next three years.

Taxes

With the indirect taxes subsumed under the GST, there was limited scope for tinkering with these. The government has proposed to increase custom duty across products in a bid to increase revenues and also encourage manufacturing within the country.

The direct tax regime has also remained broadly predictable. However, the government reduced the corporate tax for companies with turnover up to INR 2500 million by 5% to 25%. This group of companies account for nearly 90% of total companies registered. For individual tax payers, there was an introduction of a standard deduction for salaried people but also an increase in surcharge by 1%.

From a financial market point of view, the government introduced Long Term Capital Gains Tax of 10%. However, in order to sooth the pain, all unrealized profits up to 31 January 2018 will be exempted. This is in line with this government’s principle to not introduce taxes with retrospective effect. Dividend distributed by mutual funds will also come under the ambit of Long Term Capital Gains Tax.

Market Reaction

It was a volatile day of trading for financial markets in India as markets assessed the impact of introduction of long-term capital gains tax and slight slippage on deficit front. Overall, the Nifty index closed -0.1% lower while the INR weakened by -0.4% to 63.84 levels. However, yield on 10y government bond increased 15 bps to 7.58%.

The Big Picture

Overall, this is a budget based on a predictable line with the government preparing itself for elections over the next 12 months with greater focus on famers and low-income groups. Positively, it has broadly maintained the fiscal discipline displayed over the last four years. We expect growth to pick-up for the next 12 – 18 months as the effect of big ticket reforms such as the GST dissipates. The increased spending on the rural sector will also be a positive catalyst. From a markets perspective, the move in global markets will hold more sway from hereon. On the monetary policy front, we expect the Reserve Bank of India to remain on hold at its next meeting.