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Suyash Choudhary

Global Policy Is Shifting, Responding To Slowing Growth

 

A lot has changed in the world over the past few months. A theme we have focused on is the changing narrative on growth which has gone from a synchronized recovery till late 2017 to significant growth divergences over most of 2018 to a synchronized slowdown since late 2018. A relatively more recent development is around policy responses to this slowdown. The starkest turn there is from the policy maker that matters the most to the world; the US Fed. From a place of forecasting multiple further rate hikes and keeping its balance sheet run down on ‘auto pilot’, the Fed has come a long way in a matter of months. For one it has turned ‘patient’ on rates. Two, balance sheet run offs are expected to end sometime late this year. Three, the Fed is in the process of discussions and debate around policy tools available to it for the next downturn. Notable amongst the discussions around this is a perspective that the Fed should allow inflation to overshoot its target at points in an economic cycle to make up for substantial periods of undershoots at other points, so that average inflation is maintained at target for the entire cycle. These debates will also add fuel to market expectations with respect to the Fed especially as growth slows and inflation continues to undershoot target.

 

China policy seems to have also turned with liquidity creation by the central bank and targeted credit getting stepped up, while the official narrative remains that they won’t go overboard with incremental credit. Indeed, given their overall debt to GDP ratios as also the fact that they only three years back had undertaken a substantial stimulus, there may actually only be limited room to again backstop growth. Finally, the European Central Bank (ECB) also seems to lately be getting perturbed by weaker growth over the past few months and may also soon undertake further rounds of long term lending operations.

 

With these developments, the risk that policy makers are ‘asleep on the wheel’ while growth deteriorates is significantly lesser. This is positive for emerging market (EM) currencies insofar that on the margin the risk of a disruptive downturn to growth leading to safe haven bids for the dollar is lesser. However, the pace of policy puts and their incremental efficacy in actually changing the momentum on growth in the near term is questionable. If at all, the incremental impact on growth data may only be visible around the latter part of the current year.

 

The Indian Perspective

 

India itself is struggling with growth drivers, after trying for some rebound early in 2018. There are two specific channels that are incrementally affecting our growth prospects. The first obviously is the international situation. Thus even though our trade dependence may be somewhat smaller, we are by no means immune to a global slowdown. The second reason is largely domestic. Financial conditions are significantly tight with some notable underlying aspects. A part of the economy as represented by housing finance companies (HFCs) and non-bank finance companies (NBFCs) has absorbed a significant chunk of incremental funds flow over the past few years. This is evident in bank credit to this sector, capital market raising, as well as growth in their own balance sheets. Parts of this sector are suddenly faced with a risk perception deterioration leading to a spike in incremental borrowing cost as well as constrained fund availability. This has obvious implications for some underlying areas especially real estate. The other more general point is that falling inflation hasn’t been commensurate with falling interest rates thus leading to a generalized real rate shock for the economy. This is happening largely owing to the fact that general government and public sector (PSU)company borrowings are causing severe excess supply pressures in the bond market. Thus the bond market is largely shut for non-government borrowers and even for PSU entities 10-year money is available today only in excess of 8.5%. Given a nominal GDP growth rate of around 11%, this creates a huge disincentive for an average economic entity to borrow for discretionary reasons. The government seems powerless in the near term to rectify this since a notable aspect of fiscal policy is the slide in indirect tax collection owing to GST still to stabilize and given the generalized slowdown. On GST, rate rationalization has been underway despite the underlying momentum not having stabilized yet thereby leading to further revenue losses. The hope here is for a ‘J’ curve effect on GST, which will down the line open up fiscal space for the government.

 

Monetary policy has potentially turned more decisive under the new Governor. He seems to be conclusively focused on growth given the RBI’s overall assessment that CPI is well contained around 4% or below for the foreseeable future. This seems the right approach for now in light of the significant challenges to local growth and the benign global backdrop provided by emerging global policy ‘puts’. Thus fears in some quarters that this is an undesirable change in policy direction are unwarranted, in our view. The test will come when the set up changes at some point in the future: for instance, if the phase of current benign global growth and dovish central banks changes.  That is when one will have to see whether RBI proves to be an adequate guardian for India’s macro stability. For now emphatic action may well be warranted and apart from rate cuts it is possible to envisage the central bank turning even more proactive on liquidity, especially if the growth – inflation mix remains as it is currently and the global backdrop remains sanguine.

 

Fixed Income Strategy

 

A benign global backdrop with an emphatic RBI Governor is ordinarily a bullish recipe for bonds. Certainly front end AAA corporate bonds between 2-  5 years are best placed in terms of risk versus reward to play this environment. The duration part of the curve has frustrated lately as the yield curve has incessantly steepened with market fearing supply absorption ahead. Our preference here, as indicated before, is via spread assets like SDLs and the best quality AAA corporate bonds; although we must admit to being 10 – 15 bps too early in this trade. Spreads to equivalent government bonds are now in the vicinity of 100 bps for these bonds. Also, the relative excess supply here fades seasonally over the next two quarters. Market for lower rated credits remains dislocated and we would continue to advise caution there. There is a genuine liquidity issue in the lower rate space and this is constraining true price discovery as well. One will have to wait for some of these issues to settle down, and in particular allow price discovery to start happening through the open market, before taking any sort of a serious relook at this space.

 

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 security may or may not continue to form part of the scheme’s portfolio in future.  Investors are advised to consult their own investment advisor before making any investment decision in light of their risk appetite, investment goals and horizon. 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 recent RBI policy, and more particularly the post policy interactions, distinctly bore the mark of the new Governor. Assessments made were bolder and unequivocally benign. There was much more sympathy for the government including for the recent interim budget which, it may be remembered, wasn’t as well accepted by the market. Indeed, the Governor went so far as to defend the GST assumptions in the budget and even highlighted that the slippage from targets is modest. The reaction function of RBI / MPC was laid out with much more decisiveness as the headline CPI as well. Also, the forecast for CPI seems more decisively sanguine with Governor Das indicating that the projections have taken into account the possible inflationary impact of the budget’s farm income scheme. In summary then the Governor seemed completely relaxed on CPI, including on the effect on it from the budget, and seemed firmly focused now on helping growth. In this context, the RBI assessed that some output gap may have again opened up versus its assessment in December that the output gap remains virtually closed.
 
While this commentary had already started expectations of another cut in April, the majority first reaction to the RBI’s inflation assessment was that it risked being a shade too sanguine. However, the recently released CPI data has aligned market much more firmly with the assessment made by the central bank. Thus the CPI for January at 2.05% has undershot market expectations by a full 50 bps or more. This will likely lead to RBI’s latest downwardly revised Q4 CPI estimate of 2.8% getting undershot again. Not just that, the Q3 FY 20 forecast of 3.9% now seems much more comfortable than before. The internals of the latest CPI print were quite subdued as well, as shown in the various cuts presented below (source for all charts is CEIC).
 
graph1_2617

 
Notable here is the deceleration in core CPI as the recent (mysterious) spikes in health and education have subsided. Although the level of core is still uncomfortably high, the directional view will matter more and so long as the momentum on this continues to be subdued it may not be a worry either for RBI or for markets. Also notable here is the chart on CPI ex of vegetables, fruits and pulses. Even excluding these 3 items that are in deflation currently, CPI is at its lowest ever in this CPI series.

 

Takeaways
 
As things stand, the new decisive RBI seems more in tune with both the global backdrop as well as local developments on CPI. The global slowdown in data continues and on the margin is inviting shifts from other central banks as well including, and most notably, from the US Fed. This then remains a very positive environment for bonds. With the last CPI undershoot locally, April rate cut is largely cemented in market’s expectation and one cannot rule out one more cut after that as well. This is especially if RBI gets more concrete signs that growth is slowing and output gap is widening more.
 
For bonds, historically the two large anchors have been inflation and fiscal. Each is however a necessary condition but not a sufficient one as the current phase in bonds is so painfully demonstrating. Thus if a few years back a discussion had ensued that India will probably post 3 successive years of sub 4% CPI, most may have opined that the 10 year government bond will likely be around 6.5% or lower. CPI has probably delivered and yet bonds are stuck in a frustratingly elevated range for now, and even after significant supply absorption by RBI via open market operations (OMOs) . Even more, state development loans (SDLs) and quasi sovereign AAA corporate bonds are a full 100 bps over the 10 year government bond and some 500 bps over average CPI! This is a simple instance of substantial crowding out and macro policy makers have to pay attention to this irrespective of optical consolidation endeavors for the public deficit. If a quasi-government institution is forced to borrow at 500 bps real yield (assuming that the current CPI is representative of the economy), then the bond market has to be considered shut for all practical purposes for long term borrowing by private companies.
 
From a bond strategy standpoint, and notwithstanding the above headwind, real money funds with active or long mandate may no longer be able to completely ignore the duration part of the curve. This is because the spread between say 4 year and 10 year has widened to almost 40 – 50 bps across SDLs and corporate bonds thereby making the latter somewhat more attractive. Also, from a ‘one and done’ for now kind of hypothesis with respect to rate cuts, most participants are now being forced to consider the possibility of even two more cuts in the current year. Also, given currency in circulation (CIC) trends, it is possible that OMOs continue into April as well. Our preference for duration is largely via the best quality AAA corporate bonds and SDL where spreads are at 100 bps or thereabouts over government bonds. While supply is a near term headwind to these bonds, this pressure is expected to considerably abate into the first part of the new financial year. Thus these constitute an attractive buy and hold trade if one is playing some sort of a structural trade on interest rates. For more conservative investors looking for better risk versus reward optimization, though, the 2- 5 year AAA corporate bond segment continues to look the best placed.
 
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 security may or may not continue to form part of the scheme’s portfolio in future. Investors are advised to consult their own investment advisor before making any investment decision in light of their risk appetite, investment goals and horizon. 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 Importance Of ‘First Principles’ When Investing In Debt Mutual Funds
 
A. Identifying Risk in Debt Mutual Funds (MFs)
 
There are two major types of risks associated with a debt MF:
 
1> Interest rate risk: Risk of loss owing to changes in interest rates. This risk is best captured by the duration of the fund.
 
2> Credit risk: Risk of loss owing to change in credit profile of an issuer that leads either to a downgrade or default.
 
B. Identifying own risk profile
 
Most investors in debt mutual funds have been or still are fixed deposit customers. Therefore, it is very important to appropriately identify one’s own risk profile while deciding where to invest. Obviously mutual funds cannot guarantee returns. Therefore if one wants a risk profile that is the closest to a fixed deposit, one has to choose a debt fund that controls both interest rate and credit risk.
 
Right away, one can notice an inconsistency in asset allocations done over the past few years. Thus interest rate risk has always been identified as risk; since it is obviously visible as daily volatility in net asset value (NAV). However, credit risk has largely been called ‘accrual’ and the risk associated here has been underappreciated. Indeed, one has often heard a debate of ‘duration versus accrual’, where ‘duration’ denotes funds that carry interest rate risk and ‘accrual’ denotes funds that carry credit risk. Thus as interest rates turn more volatile one hears the argument that investors should move from duration funds to accrual funds. This is may not be consistent advice; for a couple of reasons:
 
1. A move away from interest rate risk should not automatically mean the embracing of credit risk. Thus the more appropriate advice may have been: if you don’t like volatility associated with duration funds then move to funds with lower duration (short term funds for instance) while keeping credit quality constant. To illustrate further, suppose one were in a dynamic bond fund which was running a combination of AAA and government bonds, but of higher maturity. Then, if the investor wishes to curb the interest rate risk associated with the product, she should move to a short term fund which has lower maturity but has a similar credit risk, i.e. AAA and government bonds. However, by moving to credit risk funds that invest predominantly in AA and below the investor is adding credit risk just as she is reducing interest rate risk. This is akin to switching one risk for another and not really reducing the net risk in the portfolio.
 
2. A better approach is to follow an asset allocation table rather than follow tactical advice, which by itself generally follows the rear-view mirror. Thus if an investor into a mutual fund is conservative (which presumably most debt investors are) then majority of her allocations should be to products most likely to have conservative risk profiles. As explained above, these are funds that control both duration and credit risks. Full AAA funds in the low duration / short term / medium term / corporate bond / Banking PSU categories should fulfill this criterion to a large extent. Such funds should form the majority of allocation for conservative investors. For the rest, one can pursue so called ‘alpha’ oriented strategies. These could be either through funds that take interest rate risk (for instance dynamic bond funds) or those that take credit risk (credit risk funds) or both. So long as such allocations are kept to the margin (as decided basis investor’s risk appetite), then one needn’t do tactical reallocations from time to time. It is to be noted that such tactical reallocations are also tax inefficient or may be subject to exit loads. A probable asset allocation mistake made over the past few years is slotting credit risk funds under the low risk basket where a majority of a fixed income investor’s allocations are made.
 
C. The First Principles Requirements from a Mutual Fund (MF)
 
A MF is a pass through vehicle. It pools investor funds and invests them. In the case of debt fund, these investments are made in the debt market. At some point one or more investors can ask for their money back, if it is an open ended fund. On receiving this request, the fund manager has to sell securities and meet the redemption. As far as possible after this sale has been made and the redemption funded, the character of the fund (in terms of risk profile, company concentration etc) should be similar to what it was before. This is so that the fund remains consistent for the investors who are left behind.
 
The important point here from an investor’s standpoint is that the majority of investments should be liquid; which means that the fund manager should be able to sell them at least in ordinary market conditions. This is important for two reasons: 1> The fund should have ability to fund its redemption and in a manner that doesn’t alter the profile of the residual portfolio. Thus if the fund has a significant exposure to illiquid securities, the fund manager will only be able to sell the liquid part. What is left will have a higher concentration in illiquid securities, which is detrimental to investors who are left behind. 2> Illiquid securities by definition don’t have a market traded price. This means that they get valued on opinion rather than on actual market discovered price. This causes a risk that the NAV of the fund may not appropriately reflect the actual value of its underlying securities. This should be a cause for concern for both existing as well as new investors into the fund. This risk is quite real as market data shows that a majority of securities rated A and below haven’t traded at all since the beginning of this financial year. This creates a large illiquidity as well as price discovery risk for funds that are holding such paper.
 
D. Some False Premises
 
There are some false premises in debt fund investing that one should be aware of:
 
1. MFs can manage liquidity via exit loads: In many cases chiefly for credit risk funds, because a significant part of the portfolio consists of illiquid securities, the fund manager relies on suitable exit loads to deter redemption. In some sense, some sort of an asset liability management (ALM) framework is used. So asset maturity is in ‘buckets’ basis the exit load periods of investors. Exit loads are no doubt a large detriment for redeeming from a mutual fund. However, by no stretch of the imagination can they be relied upon as a sufficiently high detriment. As discussed before, MFs are pass through vehicles. They aren’t static balance sheets like a bank or non bank finance company (NBFCs) where liabilities may have a defined maturity profile. As has already been shown in the Indian market as well, if the investor concern is strong enough, she can pay exit load and redeem. This leaves the portfolio with all the problems described above in connection with illiquid securities. In some sense also, the point circles back to appropriate asset allocation. If the investor has allocated to credit risk funds under her predominant low risk bucket, then the likelihood of a panic exit is that much higher when things turn for the worse.
 
2. Even AAA can default, so why bother? : Recent events have evoked this response in certain quarters. As an admittedly extreme analogy this is somewhat akin to saying food can sometimes make you choke, so why eat! The probability of AAA defaulting is negligible. This has been proved with data over multiple decades. This doesn’t mean it can never happen. However, to use a once-in-a-blue moon default and paint a general principle is not advisable at all. Also with some due diligence, the weaker AAA can be generally weeded out by the fund manager in most cases.
 
Conclusions
 
The attempt here has been to highlight some first principles that will hopefully serve well when making allocations to fixed income mutual funds. Some of the key takeaways are summarized below:
 
1. Investors should first be aware of individual risk profile. Assuming debt investments are first made for conservatism, a majority of allocations should be to full AAA funds in the low duration / short term / medium term / corporate bond / Banking PSU categories.
 
2. Credit is a risk just like interest rates are. It can lead to both positive as well as negative outcomes. The key is to allocate to both credit and duration in the so-called ‘alpha’ bucket’ and not in the core debt allocation bucket.
 
3. An open ended debt mutual fund should first and foremost fulfill the criterion that a majority of its portfolio should have liquidity and price discovery via the open market. This enables seamless redemption management, consistency in portfolio profile even with inflows and redemptions, and the discovery of NAV that is largely accurate.
 
4. A lot of discussion on credit revolves around quality of manager and depth of research process. What is equally important, however, is to ask this: Is the nature of risk being taken consistent with the vehicle being used to take the risk? More specifically, are open ended mutual funds the appropriate vehicle to take on such positions?
 

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 security may or may not continue to form part of the scheme’s portfolio in future. Investors are best advised to consult their own investment advisor before making any investment decision in light of their risk appetite, investment goals and horizon. 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 RBI cut policy rates by 25 bps to 6.25% (voted 4-2) and changed the monetary policy stance from ‘calibrated tightening’ to ‘neutral’ (unanimous vote).

 
Some key points:
1. The MPC cut its CPI forecasts, with Q4 FY19 now being forecasted at 2.8% y/y (vs. the lower-than-expected actual print of 2.6% in Q3 FY19 and previous forecast of 2.7-3.2% for H2 FY19) and H1 FY20 at 3.2-3.4% (previously 3.8-4.2%). CPI for Q3 FY20 is forecasted at 3.9%. It assessed the risks to be broadly balanced around the central trajectory vs. ‘tilted to the upside’ earlier. The MPC noted its benign food inflation outlook, softer prices of items in the fuel-group, complete dissipation of the recent HRA hike and its current judgment of the recent jump in health and education CPI components to be a one-off phenomenon. However, it highlighted the reversal in vegetable prices, unclear oil price outlook, rising trade tensions, volatility in financial markets and the impact of various budget announcements (although only over a period of time) on increasing disposable incomes as upside risks.
 
2. On GDP growth, it noted slowing global growth/demand, rising trade tensions and the recent pickup in bank credit growth not being broad-based as headwinds. It projects FY20 real GDP growth at 7.4% (7.2-7.4% in H1 and 7.5% in Q3), with risks evenly balanced. Further, it mentioned the output gap has inched lower than potential (earlier assessment was it had closed) and the need to step up private investments and support consumption. On the global front, it acknowledged the recent moderation in economic activity in the U.S., Euro Area and China.
 
Takeaways:
 
The rate cut decision taken by the MPC is understandable, although market (including ourselves) had assigned a less than even chance of that happening today. This is largely owing to the context provided by the Budget and the expectation that the recent jump in core CPI, although owing largely to rural health and education, may cause RBI to take more time it its assessment. However, the cut can be justified owing to the persistent undershoot in headline CPI as well as more sanguine global environment, including worries on global growth. Indeed, that has been our framework for some time now. What stands out, however, is that the assessment is considerably more sanguine on almost all aspects. As an example, the Governor actually stepped in to defend the GST collection targets set by the government in the new budget; one which has been viewed with suspicion by most. Also, the impression given is that the new revised CPI targets take into account possible impact from the consumption stimulus offered by the government in the budget.
 
The policy clearly has the stamp of the new Governor. Assessments are bolder and interpretations are more sanguine. There is clear benefit of doubt for the government. Also, the focus seems conclusively back on headline CPI. All this means that the market may look forward to at least one more rate cut, given that the near forecast for CPI remains sanguine. Against this tailwind, however, the government is slated to borrow INR 36,000 crores extra in this financial year and a higher than expected INR 7,10,000 crores in the next financial year.
 

The obvious implication is for the yield curve to steepen as the market is called upon to take higher supply at the duration part of the curve. In duration our preference would be for quasi like SDL and corporate bonds rather than government bonds. While supply there is a near term problem, it typically dissipates into the new financial year. Also, starting spreads there are already reflecting higher supply. The most sustainable trade, however, is in 2 – 5 year AAA corporate bonds.
 
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 security may or may not continue to form part of the scheme’s portfolio in future. Investors are advised to consult their own investment advisor before making any investment decision in light of their risk appetite, investment goals and horizon. 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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Sreejith Balasubramanian

The debate on whether the interim budget was populist (owing to the direct income support for land-owning farmers and higher income tax exemption threshold of Rs. 5 lakhs) and was akin to a full budget (which set a new precedent for election year budgets) continues. In our budget-day note (Interim Budget FY20: Fixed Income Takeaways), we looked at the likely incremental fiscal impulse, higher scheduled borrowing and the key takeaways. In this note, we dig deeper to evaluate how the fiscal situation could eventually play out in FY19 and FY20. For this, we look at the year-to-date revenue/expenditure, year-on-year growth estimates and the conditions under which the estimates could be met. While we gauge how realistic the budget is, we also focus on the accounting details and the rising off-budget transactions.
 
FY19 RE vs. BE – Corporate tax strong but Income tax and GST estimates optimistic; Keep an eye for details and off-budget expenditure
 
1. Net tax revenue stays flat, despite a fall in gross tax revenue (read GST), essentially due to lower transfer to states. This is not just lower CGST-transfer owing to lower collections. Surprisingly, IGST transfer to all states is shown as zero in FY19 Revised Estimate (RE) vs. 21,000cr in FY19 Budget Estimate (BE).
 
2. Within gross tax receipts, Corporate Tax estimates could be met but Income Tax and GST could still disappoint.
 
– Corporate tax has been growing strongly this year. Further, the collection for a full FY was 1.48-1.55 times the April-December collections, in each of the previous four years. The ratio now required to meet FY19 target is very similar at 1.57.
 
– Income tax growth has been well below FY19 target. The collection for a full FY was 1.51-1.56 times the April-December collections, in each of the previous four years. The ratio now required to meet FY19 target is higher at 1.75.
 
– FY19RE CGST of Rs. 5.04 lakh crore assumes a monthly run rate of Rs. 42,000 crores vs. ~ Rs. 37,600 in April-January (CGA numbers for January 2019 are IDFC MF estimates based on PIB data). With only two months to go, we could see a shortfall of Rs. 8-10 thousand crores. However, higher retained-IGST and/or sharing of surplus compensation cess between the centre and states could offset this.
 
3. Overall non-tax revenue stays flat based on the assumption of ~ Rs. 20,000cr extra dividend from the RBI.
 
4. Disinvestments have been slow, but catching up, with ~ Rs. 34,200cr completed in April-December vs. the retained target of Rs. 80,000cr (43% of target completed)
 
5. Expenditure through the budget is only marginally higher, due to higher Capital expenditure. However, off-budget expenditure, better known as ‘Resources of public enterprises’ (excluded from the fiscal deficit calculation) is higher by ~1.6 lakh crore (0.9% of GDP). This is primarily on account of borrowing from Food Corporation of India (FCI), over and above the food subsidy provided by the government through the budget.
 
– Further, funding through ‘Other’ sources apart from Internal Resources, Bonds/Debentures and ECB/Suppliers credit increased by Rs. 1 lakh crore (0.5% of GDP).
– Such heavy and indirect off-budget expenditure questions the quality of the budget and the headline fiscal deficit number. Inclusion of FCI off-budget expenditure, state fiscal deficit and borrowings by the central and state PSEs push the fiscal deficit much higher.
 
6. Capital Expenditure through the budget could eventually fall slightly short, as it did in FY18, particularly when CapEx through PSEs has been revised much higher (although latter is primarily for FCI).
 
7. Despite the additional Rs. 20,000 crore expenditure on the direct income support for farmers, overall revenue expenditure for FY19BE and FY19RE is the same. On closer examination, while expenditure on ‘Central Sector Schemes/Projects’ increased by 19,200 crore (due to the farm package), ‘Other grants/loans/transfers’ reduced by Rs. 41,500 crore. This is owing to a cut in ‘Transfer to GST Compensation Fund’ (under the Department of Revenue) of Rs. 38,300 crores.
 
Figure 1: Budget and year-to-date numbers
 
graph1_2617

 
Source: CEIC, India Budget, IDFC MF Research. Note: FY19 y/y growth for Central GST, Integrated GST and GST compensation cess is calculated based on annualised FY18 numbers.
 
FY20BE – achievement of FY19RE holds the key
 
1. Gross tax revenue growth is estimated to be slower in FY20, partly due to the higher income-tax-exemption threshold of Rs. 5 lakhs.
 
2. Total central government GST collections is estimated to grow 18% y/y (21% for CGST) vs. nominal GDP growth of 11.5%. This assumes a monthly run rate of Rs. 63,400 crores in FY20 vs. ~Rs. 48,100 in April-January of FY19. This is not impossible but can be achieved only if much stronger compliance (invoice matching) is enforced and improves collections and, as anecdotal evidence suggests, the still-occurring CGST-set-off against the previous regime CENVAT on capital goods is completed at the earliest.
 
3. Non-tax revenue growth slows as the jump in receipts from dividends and economic services (mainly petroleum, roads & bridges and communication-services/spectrum-auctions) falls. Upside risk is the transfer of higher RBI surplus, subject to the decision of the recently constituted RBI Committee on Economic Capital Framework.
 
4. Although difficult to say whether the disinvestment target is realistic, given the current pace and quality, better and early planning next year should definitely help.
 
5. The recent preference for using higher portion of small savings to fund the deficit looks set to continue in FY20.
 
6. Growth in expenditure through the budget is set to slow as CapEx slows sharply and revenue expenditure picks up mildly.
 
7. Off-budget capital expenditure is estimated to fall from FY19 levels, but given the sharply higher FY19RE numbers (due to FCI borrowing), this may not materialise.
 
It is borrowing that finally matters but government guidance could improve.
 
1. Both gross and net borrowing (excluding switch, buyback and short-term borrowing) falls in FY19 vs. budget estimates, but rises vs. the numbers announced during the year.
 
2. Recent government guidance on gross borrowing has not been the best, owing to multiple and frequent revisions during the year (Figure 2). This could improve.
 
3. In FY20, bond supply from gross borrowing increases sharply and so does redemptions to ease following year pressure. Including buybacks, net borrowing is estimated to stay flat.
 
Figure 2: Government guidance on gross borrowing

 
graph1_2617

 
Source: CEIC, India Budget, IDFC MF Research. Note: 1) Gross borrowing excludes switch, buyback and short-term borrowing, 2) The month of announcement is indicated in brackets in the X-axis
 
Key takeaways
 
1. Within the revised estimates for FY19, Income Tax and GST collections appear a bit optimistic, while corporate tax collections are robust and should meet target.
 
2. This does not mean FY19 actuals exactly slip but a) slightly different revenue mix or b) proportionate expenditure cuts if tax revenues disappoint are possible.
 
3. Expenditure through the budget is only marginally higher in FY19, keeping the fiscal deficit at 3.4%, but expenditure through PSEs has risen.
 
4. Important to note are the accounting details such as a) IGST transfer to all states being shown as zero in FY19RE vs. 21,000cr in FY19BE, b) spike in off-budget expenditure (0.9% of GDP), particularly for FCI, c) the increased preference for funding these expenditures through ‘Other’ channels and d) the sharp cut in ‘Transfer to GST Compensation Fund’ (under the Department of Revenue) to keep revenue expenditure flat despite the outgo towards the farm package in FY19.
 
5. For FY20, meeting receipts would depend on increased GST compliance (invoice matching), RBI dividend transfer and realised disinvestments, but FY19 targets being met is even more crucial. If tax revenues eventually fall short in FY19, FY20BE y/y estimated growth would become higher and thus more difficult to achieve.
 
6. Finally, we are faced with higher-than-expected gross borrowing in both FY19 and FY20, but more importantly, there is scope for improvement in government guidance.

 
While the government has retained the glide path towards the fiscal deficit of 3% in FY21, the feasibility of achieving this has to be evaluated as the actual expenditure on newly announced schemes play out and the full budget is presented by the newly elected government in June/July of this year.
 
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 security may or may not continue to form part of the scheme’s portfolio in future. Investors are advised to consult their own investment advisor before making any investment decision in light of their risk appetite, investment goals and horizon. 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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Equity Investment Team

While the budget is an annual exercise of the government’s finances, a holistic way to analyse the budget is to look at the path chosen by the government over its entire term – if it has been consistent with its promises.
 
In this context, NDA’s governments 5th budget, despite the pressure of impending general elections has stayed largely true to the course of the previous 4 years.
 
The introduction of new subsidies, income support for farmers and increased food subsidy, will dent the spending on capital expenditure for FY20; capital expenditure has been the highlight of this government in all previous budgets.
 
Our Key takeaways from the Interim Budget:
 
Good:
 
• Boost to rural and urban middle income households
• Fiscal prudence largely maintained despite election pressures
• Commitment to adhere to the fiscal deficit glide path and attain 3% by 2021
 
Not So Good:
 
• Fiscal Deficit for FY20 expected to be 3.4% with no improvement over FY19.
• Increase in subsidies overshadows growth in Capital expenditure
• Fiscal math aided by high Goods and Services Tax (GST) growth assumptions and high divestment/ dividend targets
 
Smart:
 
• Revival of Real Estate sector by giving much needed sops
• Expansion of tax exemption to Rs 5 lakh provides much needed succour to the urban middle class

 
Please find the detailed presentation on Budget 2019 here.

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Suyash Choudhary

The Interim Budget largely delivered on the reflationary stimulus that was being anticipated. Key highlights as follows:

 
FY19 Revised Estimate (RE) fiscal deficit at 3.4% of Gross Domestic Product (GDP) (vs. FY19 Budget Estimate (BE) of 3.3%) and FY20 BE fiscal deficit also at 3.4% of GDP (vs. previously assumed 3.1% as per the glide path)

 

• Incremental fiscal impulse of minimum of Rs. 1.2 lakh crore
 
– Pradhan Mantri Kisan Samman Nidhi (direct income support for cultivable land owners) = Rs. 20,000cr in FY19 (0.11% of GDP) and Rs. 75,000cr in FY20 (0.36% of GDP) = Rs. 95,000 crores
 
– Higher income tax exemption threshold of Rs. 5lakhs vs. 2.5lakhs currently = Rs. 18,500 crores
 
– Higher standard deduction of Rs. 50,000 vs. Rs. 40,000 currently = Rs. 4,700 crores
 
– Other measures include higher interest subvention for agri-allied activities, higher TDS threshold on interest earned on bank/post office deposits, relief for investment in second residential house, etc.

 
Gross borrowing through dated securities to rise 24.3% y/y in FY20 (after falling 2.9% in FY19) and net borrowing to rise 11.9% in FY20 (vs. -6.2% in FY19)
 
Gross borrowing in FY19 higher by INR 36,000cr and net borrowing higher by ~ INR 31,000cr (vs. the revised numbers announced by the government during FY19). As per government sources, there may be 2 extra auctions of dated securities and the rest may be borrowed via treasury bills.
 
Total expenditure to grow 13.3% y/y in FY20 (vs. 11.5% growth in nominal GDP) after 14.7% in FY19 due to strong growth in revenue expenditure while capital expenditure growth is set to slow
 
Gross tax revenue to grow 13.5% in FY20 after 17.2% in FY19

 
GST revenue estimates for FY19 were revised downward by 1lakh crore as expected, owing to an equivalent shortfall in CGST collections, but is estimated to pick up by 18.2% y/y in FY20
 

 

graph1_2617

 
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Takeaways

 

1. The budget postpones again the fiscal consolidation targets. While there is a component of GST shortfall that has weighed on this consolidation, the next year’s revision is wholly owing to the new consumption stimuli embedded in the budget. When combined with state deficits as well as the heavy reliance on borrowing by public sector companies lately, this again proves that fiscal remains India’s weakest macro point.
 
2. The gross scheduled borrowing number at INR 7,10,000 crores is higher than market consensus expectations of around INR 6,50,000 crores. Again, combined with state and PSU borrowings this implies that bond market will likely have to contend with risks of crowding out, once RBI’s pace of open market operations (OMOs) tapers down the line.
 
3. There is a hefty almost 0.6% GDP worth of new announcements between the income support plan and the tax breaks for middle class which is almost entirely of the nature of a consumption stimulus. Indeed, while total spending via the budget is slated to grow at 13.3% next year (which is lower than the 14.7% done this year), the spending mix is now skewed heavily in favour of revenue spending.
 

It is likely that, on the margin, the RBI / MPC look at this budget with some amount of wariness; given that it not only doesn’t adhere to consolidation but also actively seeks to administer a consumption stimulus. This may imply that the shallow easing expected from the MPC may get pushed back. Also any easing now may be more a function of global themes rather than as a reward to the government for maintaining fiscal discipline. On the subject of global themes, the environment globally remains decidedly bond positive especially after a remarkable U-turn by the US Fed in its latest meeting. Thus it is likely that dollar and commodities remain well behaved and this may yet serve as some sort of a counterpoint to the disappointment offered today by the interim budget to the fixed income market.

 

From a strategy standpoint, focus should be on short to medium duration AAA oriented strategies. As discussed the global environment remains supportive, whereas local monetary policy will at worst remain neutral (and at best administer moderate easing). Longer end bonds may now tend to be more volatile given higher supply ahead, especially once pace of OMOs subsides post March / April.

 

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 security may or may not continue to form part of the scheme’s portfolio in future.  Investors are advised to consult their own investment advisor before making any investment decision in light of their risk appetite, investment goals and horizon. 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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