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Investment Insights

Suyash Choudhary

The RBI continued its recent streak of shocking markets by not just not cutting interest rates but explicitly shifting its stance to ‘neutral’ from ‘accommodative’. Key takeaways from the policy and the media call afterwards are as follows:

 

On CPI

 
1. While CPI has undershot RBI’s ‘5% with upside risk’ expectation, it is largely driven by 2 very volatile items: vegetables and pulses. The central bank expects that while pulses prices may remain soft, vegetable prices may potentially rebound as the effects of demonetization wear off. Excluding food and fuel, CPI is stuck around 4.9% since September. This could ‘set a floor on further downward movements in headline inflation and trigger second-order effects’.
 

2. In terms of future trajectory, the RBI expects CPI to be muted in Q1 2017 – 18 on favorable base effects and ‘lagged effects of demand compression’. But thereafter it is expected to reverse as ‘growth picks up and the output gap narrows’. Base effects also turn adverse from Q3 and Q4. On aggregate, the central bank expects CPI at 4 – 4.5% in the first half, and 4.5% – 5% in the second half of FY 18; with risks evenly balanced.
 

3. The RBI notes 3 significant upside risks: rising commodity prices, volatility in exchange rates on account of global financial market developments, and fuller effects of HRA component of 7th Pay Commission.
 

4. The commitment to bringing CPI ‘closer to 4% on a durable basis and in a calibrated manner’ is reiterated. This requires further significant decline in inflation expectations, especially as the services component of inflation that is sensitive to wage movements has been sticky.
 

On Growth
 

1. From an assessed level of 6.9% in current year, the RBI expects GVA growth to recover sharply in the next year. The reasons include: bounce back in discretionary consumer demand, rapid restoration of activity in cash intensive sectors, recent decline in lending rates spurring demand, and impetus from union budget. Given these, GVA is projected to be 7.4% for next year; with risks evenly balanced.
 

On Liquidity
 

1. The neutral stance has been reaffirmed with the assessment being that surplus liquidity will decline with progressive remonetization.  Nevertheless, the current abundant liquidity with banks is expected to persist in the early months of 2017 – 18.

 

Assessment and Takeaways

 

The RBI’s explicit change of stance effectively may be considered as marking the official end to the easing cycle. The change has been brought about to emphasize the need to move to 4% CPI on a durable basis in context of a still stubborn core inflation. The RBI and the MPC want to retain flexibility as they assess ‘how the transitory effects of demonetizaton on inflation and the output gap play out’. However, it is unlikely that there are further cuts in the pipeline so long as the broad market (and our) assessment holds true that CPI is unlikely to average below 4.5% for the year ahead. Even if it does, RBI may await confirmation over Q3 and Q4 which is when the MPC expects the maximum pressure on CPI to unfold. This delay may be advisable from another perspective as well: given RBI’s very justifiable concern with global financial risks, they will have more time to assess how these pressures are emerging later in the year.

 

The RBI’s overall assessment today is very much in line with our view that the rate cycle is broadly at an end. Indeed, we had flagged in a recent note the risk of not taking seriously the revision in RBI’s stance since the December policy (please refer “…But Seriously”, dated 13th January for details).  That said, we hadn’t expected that the RBI will put in place an explicit ‘marker’ so soon of a change in its stance.

 

From a portfolio standpoint, after having played the demonetization rally tactically, our strategy has been broadly focusing on the front end of the rate curve (upto 5 years) across our bond and gilt funds. We believe that these will continue to get anchored to a positive liquidity environment and very low bank deposit rates for the foreseeable future. We remain negative on long duration bonds, a stance which is reaffirmed with the policy today.

 

Please refer the previous note ‘…But Seriously (1)‘ here: http://www.idfcmf.com/insights/but-seriously/

 

Disclaimer:
 
MUTUAL FUND INVESTMENTS ARE SUBJECT TO MARKET RISKS, READ ALL SCHEME RELATED DOCUMENTS CAREFULLY.
 
The Disclosures of opinions/in house views/strategy incorporated herein is provided solely to enhance the transparency about the investment strategy / theme of the Scheme and should not be treated as endorsement of the views / opinions or as an investment advice. This document should not be construed as a research report or a recommendation to buy or sell any security. This document has been prepared on the basis of information, which is already available in publicly accessible media or developed through analysis of IDFC Mutual Fund. The information/ views / opinions provided is for informative purpose only and may have ceased to be current by the time it may reach the recipient, which should be taken into account before interpreting this document. The recipient should note and understand that the information provided above may not contain all the material aspects relevant for making an investment decision and the stocks may or may not continue to form part of the scheme’s portfolio in future. The decision of the Investment Manager may not always be profitable; as such decisions are based on the prevailing market conditions and the understanding of the Investment Manager. Actual market movements may vary from the anticipated trends. This information is subject to change without any prior notice. The Company reserves the right to make modifications and alterations to this statement as may be required from time to time. Neither IDFC Mutual Fund / IDFC AMC Trustee Co. Ltd./ IDFC Asset Management Co. Ltd nor IDFC, its Directors or representatives shall be liable for any damages whether direct or indirect, incidental, punitive special or consequential including lost revenue or lost profits that may arise from or in connection with the use of the information.

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IDFC MF

FY18 union budget walked the talk and performed a fine balancing act – focus on social expenditure and infrastructure without deviating much on the path of fiscal prudence. It is imperative to note the backdrop for the current year’s budget with mounting uncertainties on both global and domestic fronts. With demonetization temporarily disrupting the business environment and moderating economic growth, the market was expecting the government to respond with a dose of populism (cut in tax rates, rural packages, rise in tax deduction limits, etc.) in the budget. At the same time, anxiety was high around factors like LTCG and service tax hike. In absence of any such negative announcements in the budget and with fiscal deficit target at 3.2% for FY18, the budget addressed most of the concerns from equity market perspective.

 

Government stepped up its social expenditure which was up 11% in FY18 (on FY17RE). Allocation for MNREGS (Mahatma Gandhi National Rural Employment Guarantee Scheme) set at an all-time high of Rs48,000cr. At the same time focus on capex / infrastructure remains, with the total government infra investment projected to grow 10% YoY in FY18 (on FY17RE) to Rs3,96,000cr (US$58bn). As expected, investment in railways, roads, waterways and other transport infra remains the focus with allocations for roads up 13%, railways up 8% while capex on defense was flat. Disinvestment appears to be a big thrust for FY18 with budgeted revenues of Rs72,500cr (vs 45,500cr in FY17RE and Rs56,500cr in FY17BE).

 

FM provided relief to the low-income individual taxpayers and reduced corporate tax for small companies – the segments most impacted by demonetization, in our view. Personal income tax rates at lower end (income between Rs2,50,000 – Rs5,00,000) reduced from 10% to 5% i.e. an annual saving of Rs12,500. This is small saving for existing tax payers but in the larger context it’s an incentive for the non-payers to become tax compliant. For MSME, corporate income tax has been slashed from 30% to 25% for unlisted MSMEs with turnover less than Rs50cr. This is clearly with a view to promote job creation at MSMEs. As per the government’s data, almost 96% of companies (667,000) filing taxes will benefit.

 

Affordable housing has been given infrastructure status, which could result in lower cost of funding, higher liquidity and wider investor base. There are some further incentives given to developers of affordable housing. Currently, developers can claim 100% deduction on profits subject to certain restrictions like size of the house, geographical location and time taken to complete the project. This budget proposes minor relaxations in these conditions. This increases opportunity size for financiers in the affordable housing space.

 

The amount set forward for the recapitalization of PSU banks remained unchanged at Rs10,000cr for FY18, in line with the roadmap that had been set under the ‘Indradhanush’ scheme. However, the government assured that additional funds will be available for equity infusion in PSU banks, if required. The allocation for last year was Rs25,000cr of which full allocation has not yet happened.

 

Another relief was on NPA provision taxability with increase of allowable provision for NPA from 7.5% to 8.5% which will reduce tax liability of banks (particularly PSBs) who are already reeling under asset quality pressure & higher provisioning.

 

As a measure to deal with bank NPAs is to enhance capital flows into securitization industry through listing and trading of Security Receipts issued by a securitization company or a reconstruction company under the SARFAESI Act will be permitted in SEBI registered stock exchanges.

 

Govt. has indicated its plan to merge public sector oil/gas companies in order to create an ‘integrated’ player. This would perhaps create one public sector behemoth, intended to create efficiencies of capital and other resources. Import duties on LNG import has also been reduced to 2.5% from 5%, thus helping the imported fuel demand. Oil and Gas subsidy is reduced to Rs 27,500cr from Rs 29,000cr for FY17 revised estimates. FY18BE budgeted subsidy is reduced by 9% YoY to Rs 25,000cr.

 

Increased outlays on roads, housing, sanitation and electrification through various schemes would help improving rural economy. In the process, there would be significant opportunity to the construction, cement and metals sectors. A push for social housing should augur well for cement and low cost housing finance companies. For urban India, there is an 80% increase in allocation towards metro rail.

 

Considering the impending implementation of GST in the next few months, there were minimal announcements on indirect taxes which could have an impact on companies within the consumption basket. However, cigarette taxation has increased by 6-7% against an expectation of double digit excise hike so that should be a relief for ITC. This will be the lowest excise duty hike in the last 5 years. The budget has also introduced a cap of Rs 3lakh on cash transaction which can have some impact on high ticket consumption items.

 

Budget continued the government’s focus on improving credit flow to farmers, irrigation facilities, soil testing, crop-insurance coverage, and selling and distribution of produce. Fertiliser Subsidy maintained at Rs 70,000cr for 2017-18 (Urea Rs 49,768cr and NBS –Rs 20,232cr). The status quo on subsidy allocation is positive given benign input costs and expected cut in NBS for FY18E.

 

Higher outlay toward rural electrification is expected to increase rural power demand and lower distribution losses. This, in turn, would benefit the power generation segment. Higher budgetary allocation for renewable energy will also facilitate higher capacity additions in the segment through higher disbursement under various viability gap funding schemes and other central financial assistance.

 

Conclusion
 
Equity markets gave initial thumbs up to the budget getting comfort from 3.2% fiscal deficit target coupled with absence of any announcements on changes in Long term capital gain (LTCG) taxation.
 
Going forward, markets will continue to monitor earnings as the impact of demonetization has not been felt materially in the reported 3 Quarter numbers, so far.

 

Last year, the markets had corrected going in to the budget largely due to the risk off trade and bottomed out on the budget day. Thereafter as liquidity improved, we witnessed a rally. For the year ahead, the Union Budget appears to have calmed any frayed nerves, the global sentiments – the first 100 days of president Trump, US Fed’s trajectory on rate hikes and any geo-political sensitivities, however, would continue to influence the market direction.

 
Disclaimer:
 
MUTUAL FUND INVESTMENTS ARE SUBJECT TO MARKET RISKS, READ ALL SCHEME RELATED DOCUMENTS CAREFULLY.
 
The Disclosures of opinions/in house views/strategy incorporated herein is provided solely to enhance the transparency about the investment strategy / theme of the Scheme and should not be treated as endorsement of the views / opinions or as an investment advice. This document should not be construed as a research report or a recommendation to buy or sell any security. This document has been prepared on the basis of information, which is already available in publicly accessible media or developed through analysis of IDFC Mutual Fund. The information/ views / opinions provided is for informative purpose only and may have ceased to be current by the time it may reach the recipient, which should be taken into account before interpreting this document. The recipient should note and understand that the information provided above may not contain all the material aspects relevant for making an investment decision and the stocks may or may not continue to form part of the scheme’s portfolio in future. The decision of the Investment Manager may not always be profitable; as such decisions are based on the prevailing market conditions and the understanding of the Investment Manager. Actual market movements may vary from the anticipated trends. This information is subject to change without any prior notice. The Company reserves the right to make modifications and alterations to this statement as may be required from time to time. Neither IDFC Mutual Fund / IDFC AMC Trustee Co. Ltd./ IDFC Asset Management Co. Ltd nor IDFC, its Directors or representatives shall be liable for any damages whether direct or indirect, incidental, punitive special or consequential including lost revenue or lost profits that may arise from or in connection with the use of the information.

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Suyash Choudhary

The budget this year had a number of firsts that included a new and early date of presentation, doing away with plan / non plan classifications, and merging the railways budget with the centre. It also came in the backdrop of recommendations of the NK Singh committee. As the finance minister disclosed, the committee had recommended consolidating to 3% deficit for the next 3 years. It had provided for an ‘escape clause’ of 0.5% of GDP basis certain conditions (including from impact of economic reforms). Instead, the finance minister has decided to peg the deficit at 3.2% for this year and then go towards 3% from next year. However, while the escape clause has not been used this time around, he has kept with himself the option of reviewing this over the course of the year.

 

In his macro assessment for the country, the minister has sounded justifiably upbeat with respect to our achievements thus far on inflation, current account, fiscal deficit, as well as growth. However, quite prudently the focus continues on macro-stability given that the government sees three potential sources of global uncertainties ahead: Fed rate hikes, upswing in commodity prices especially of oil, and the recent moves towards more global protectionism.

 

Some of the key highlights are as follows:

 
1. Gross tax revenue is expected to grow at 12.2% from 17% in the current year. Under direct taxes, corporate tax growth rate is assumed to be largely flat at 9%, whereas personal income tax growth rate is assumed to be a shade higher at 25% (presumably also accounting for success of ongoing disclosure schemes). Importantly, the minister has prudently scaled back the spectacular 35% growth in excise duty this year to a more realistic 5% next year; as the effect of earlier hikes in duties fades in the year forward.
 
2. The expenditure budget is completely reformatted thereby making previous standard comparisons difficult. Nevertheless, total expenditure is slated to grow more modestly at 6.6% from 12.5% last year. Within this, revenue expenditure growth is 5.9% (12.8% last year) while capital expenditure will grow at 10.7% (10.6%) last year. Thus there isn’t just an expenditure compression but also the mix is more favorable (in favor of capital spending). Expenditure on centrally sponsored schemes is slated to grow slower at 13.4% from 20.5% in the previous year. Among other  individual items where money has been saved, worth mentioning are pension (growth of 2.4% vs 32.4% in previous year, presumably as one time effect of pension hikes last year fades) and defense (9.8% to 5.8%). Also bank recapitalization budget is only INR 10,000 crores for the year ahead, against INR 25,000 crores in the current year. It is likely that the expenditure budget has been kept conservative initially, but may get ramped up if revenue side proves to be more buoyant (as a net effect of collections from the ongoing black money investigations and the potential near term revenue disruptions down the line when GST gets implemented).
 

Takeaways
 

There is one stand-out in recent communications from the RBI Governor, chief economic advisor (via Economic Survey), and the finance minister (Budget speech): an escalation in concerns with respect to global financial volatility. The logical response to such a concern is one of renewed focus on domestic macro-stability. This seems to have been an input into maintaining fiscal prudence in the Budget. The same concern was perhaps in play when the RBI Governor surprised markets with a somewhat hawkish stance in the December policy; choosing to tighten his policy framework by emphasizing securing the 4% CPI target on a durable basis. In this context, the upcoming RBI policy is all the more interesting: should the governor re-emphasize the current theme of securing enduring macro-stability in context of a very uncertain global environment, the market may be finally forced to take note.

 

In any case, so long as we are close to the end of the cycle ( even if not actually at the end), the medium term theme for the bond markets should be of consistent curve steepening. This effect may be further helped by positive system liquidity in context of heavy gross bond supply. In line with this, our preference remains for the front end (upto 5 years) across our funds. It is to be noted that the budget hasn’t thrown in any major positive shocks with respect to bond supply: the gross borrowing program for the year ahead is flat from this year at INR 5,80,000crores. Adding state borrowings to this will take the gross number towards INR 10,50,000crores. Although this is somewhat lower than our initial estimate of around INR 11,00,000 crores, it is still a formidable number for the market to absorb in the absence of RBI bond purchases, with limited visibility of incremental rate cuts, and with a starting point of 10 year bond yield being less than 20 bps over the repo rate.

 
Disclaimer:
 
MUTUAL FUND INVESTMENTS ARE SUBJECT TO MARKET RISKS, READ ALL SCHEME RELATED DOCUMENTS CAREFULLY.
 
The Disclosures of opinions/in house views/strategy incorporated herein is provided solely to enhance the transparency about the investment strategy / theme of the Scheme and should not be treated as endorsement of the views / opinions or as an investment advice. This document should not be construed as a research report or a recommendation to buy or sell any security. This document has been prepared on the basis of information, which is already available in publicly accessible media or developed through analysis of IDFC Mutual Fund. The information/ views / opinions provided is for informative purpose only and may have ceased to be current by the time it may reach the recipient, which should be taken into account before interpreting this document. The recipient should note and understand that the information provided above may not contain all the material aspects relevant for making an investment decision and the stocks may or may not continue to form part of the scheme’s portfolio in future. The decision of the Investment Manager may not always be profitable; as such decisions are based on the prevailing market conditions and the understanding of the Investment Manager. Actual market movements may vary from the anticipated trends. This information is subject to change without any prior notice. The Company reserves the right to make modifications and alterations to this statement as may be required from time to time. Neither IDFC Mutual Fund / IDFC AMC Trustee Co. Ltd./ IDFC Asset Management Co. Ltd nor IDFC, its Directors or representatives shall be liable for any damages whether direct or indirect, incidental, punitive special or consequential including lost revenue or lost profits that may arise from or in connection with the use of the information.

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