From the CIO
It is good to see the government focus on reviving growth. The reaction in the equity markets is a testament to that. It’s by far the best budget for equity markets. Lots of positive surprises and no major negatives.
The bond markets haven’t liked the budget at all. It’s a shock. No one expected that PM Modi will agree to shed his fiscal conservatism to such an extent. Long term Bond yields have already headed higher. We would expect the RBI to also begin normalization and interest rates hikes in the coming months. Bond yields have bottomed and the best of the returns from long term bond funds are behind us.
The key of course is the long-term outlook. This increase in spending over the next 4 years needs to revive growth back to at least the 7% level. If that happens, then the higher deficit will be forgiven. If not, high inflation and high deficits can cause macro instability in the years ahead.
Equity View
The pandemic & lockdown hit the Indian economy, in lieu of which we wanted a push for both capital & consumption in this budget.
Through the provisions of the Union Budget 2021-22, government has targeted increased spending on infra & other capital expenditure to kickstart the economy but, as witnessed through multiple rounds of stimulus announced last year, there is very little allocated to boost consumption.
On the contrary, the new ‘Agriculture Infrastructure Cess’ on petrol & diesel is inflationary and has the potential to reduce real income of the households thereby impacting near term consumption.
This time the government has followed a fiscally expansionary path to put the economy back on track. Though, the headline budgeted fiscal deficit numbers for FY21 & FY22 looks higher due to reclassification of NSSF [National Small SavingsFund] loans to FCI above the line.
Higher borrowings (even after adjusting for reclassification of FCI loan) by the government can crowd out the private sector demand for loans, until & unless, foreign flows in debts come to their rescue.
There have been some sector specific changes like change in FDI limit in insurance & scrappage policy for Autos which augurs well for respective sectors.
There were no significant changes on direct taxes.
Overall, the government’s planned spend on infra, if executed properly, has the potential to increase employment & expedite (though, boost to consumption would have expedited it much faster) the natural business cycle to revive corporate earnings which otherwise would be a gradual process. The earning upgrade cycle, similar to 2003-07 period, may give a fillip to equity returns.
Keep invested and use a staggered approach
Indian equities remain an attractive asset class and is expected to do well over the long term. Investors are advised to remain invested but stagger their fresh investments as the markets have run up recently.
Fixed Income View
From the bond market’s perspective, the budget had more negatives than positives.
Current fiscal year deficit of 9.5% of GDP and target of 6.8% for FY22 was a surprise. This, along with the extended fiscal consolidation roadmap indicate that the bond market will face heavy supply pressure not just in this year but over many years.
State governments may also pursue similar expansionary fiscal policy.
RBI’s role in facilitating this kind of market borrowing would be critical to determine its impact on the bond markets.
Nevertheless, it seems that the bond yields have already seen the bottom and reversal is coming sooner than anticipated.
Increased government spending for extended period and introduction of new cess & import duties on various products could also cause inflation to rise. The RBI may find it difficult to support the government’s borrowing program in this case.
Proposal to create a permanent institutional framework to provide liquidity will go a long way in the development of the corporate bond market. This will also bring down the liquidity and credit premiums and thus cost of capital for borrowers.
Lower return expectations
Investors should lower their returns expectations from fixed income funds and should follow a conservative approach while choosing fixed income products. Interest rate are likely to move higher in coming years. Long duration funds may face high volatility in coming months.
Gold View
Union Budget 2021 pleasantly surprised gold markets by announcing the reduction of custom duty on gold from 12.5% to 7.5%. However, introduction of levy called the Agriculture Infrastructure and Development cess of 2.5% will lead to less than the headline 5% reduction.
The immediate effect of this move will be that gold prices will decline to the extent of reduction of levies. All those holding gold will see the value erode to that extent whereas all those who want to buy more will get it relatively cheaper to that extent.
Still, this is a welcome move as it will reduce price distortions, bringing domestic gold prices closer to International prices to the extent of reduction in levy. It will enable more efficient functioning of the gold markets in India and discourage illicit gold imports of the precious metal.
Higher intervention through higher customs duty has all this while ensured that India could never be at the center of the global gold markets despite being the largest consumer and thus remain a price taker.
We hope this duty is incrementally reduced over the next few years to further remove the price distortions in form of levies and truly think about developing the gold sector and bring India at the center of International gold markets.
The Finance minister also set the ball rolling for the creation of the proposed spot gold exchange by announcing that the ministry will be notifying the Securities and Exchange Board of India (SEBI) as regulator for gold exchanges.
The creation of a spot gold exchange will bring twin benefits for Gold ETFs by adding to the liquidity pool as well as leading to more efficient price discovery.
Use the correction to add Gold to your portfolio
Gold remains as an efficient portfolio diversifier. Use the correction to increase allocation to Gold so that it occupies 10-15% of your overall portfolio.