India Strategy:Budget –Fine balancing act

Event

Finance Minister has presented a middle-of-the-road kind of budget by stayingthe course on the fiscal consolidation path, improving the quality of spendingand focusing on rural/infra. However, the government has not delivered muchon tax rationalisation. With growth recovering and room for interest rate cuts,we recommend adding domestic cyclicals.

Impact

Avoids potential pitfalls: Despite some key state elections due over nextmonth or so and the backdrop of demonetisation, the government hasdisplayed discipline by not resorting to populist measures (like farm loanwaivers, unified basic income etc). The government set a fiscal deficit targetat 3.2% in FY18 and 3% in FY19 (3.5% in FY17). From a market perspective,the much feared and anticipated change to LTCG (long-term capital gains tax)on equities has not come through. Foreign investors have been exemptedfrom” Indirect tax provision,” removing overhang.

Credible math behind budget: Unlike previous budgets, the government hastaken realistic growth and revenue targets for FY18. The nominal GDP growthrate is projected to be 11.8%, in line with our expectations. Revenue growth ispegged at 12% against 17% in FY17. Interestingly, indirect tax growth is keptat only 8.8% but these numbers will change significantly once GST is rolledout. Net borrowing target at Rs3.25trn is also well below market expectations.

We maintain our view that RBI should cut interest rates by 50bps over thenext 6-12 months.

Incremental focus on rural/infra/mass housing: The quality of governmentspending is improving with 11% capex growth and only 6% revenueexpenditure growth. Most of the focus areas have seen ~10-12% growth inallocations. Refer to Fig 6. That said, there is are “big bang” announcementsaround new infra programs.

Falls short on tax cut expectations: There were widespread expectationsregarding the rationalisation of tax rates for corporates and individuals. Taxrate relief has been restricted to MSMEs and similarly individuals in the lowesttax bracket. There has been attempt at redistribution with slightly higher taxon higher income groups.

Outlook

Shift to domestic cyclicals especially with rural exposures: We expectthe rural economy to see a very strong pick-up in FY18 on the back of twogood harvests and higher government spend. With room for interest rate cutsopening, cyclicals would be the space to be in. We maintain an Overweightview of Financials, Consumer discretionary. Infrastructure sectors while keepunderweight on export oriented sectors. Our top picks are CROMPTON,HMCL, LT, ITC, LICHF, MMFS and HDFCB.