A huge bet on growth

Investors sense potential for sustained corporate profits

Current market valuations in India imply that anyone buying or holding today has to believe that India is entering a period of sustained high economic and corporate profit growth. Any budget will be looked at through this lens by market participants. Do you feel more confident of long-term growth after the event?

One route to accelerate long-term growth would be through serious structural reform. That has not really been attempted in this Budget. There are no serious far reaching reforms, unlike the last Budget, such as privatisation of public sector banks, a serious attempt to monetise government assets and reduce the role of government in the economy, labour reforms or anything even remotely controversial. There are some steps to ease tax administration, speed up liquidation of companies, build a national register for land records, provide further incentives for startups and manufacturing companies and allow foreign universities into GIFT city. Steps taken at the margin, but nothing that will cause investors to get up and take notice.

The focus of this Budget is almost entirely on jump-starting government expenditure on the capital account, raising it to Rs 7.5 trillion, a jump of 25 per cent from the Rs 6 trillion spent in the revised estimates for FY22. It is actually a 36 per cent jump from Rs 5.5 trillion to Rs 7.5 trillion on a like to like basis, taking out Air India guarantees. This is a huge increase, especially considering this figure was Rs 4.26 trillion in FY21, a surge in capital spend of 76 per cent in two years. The tilt towards capital spending is clear from the fact that in the Budget estimates for FY23, revenue expenditure of the central government (excluding interest payments and grants for creation of capital assets) is actually budgeted to be down by 8.5 per cent. Of the incremental spending of the government in FY23, 85 per cent is going towards capital spend. There can be no clearer articulation of priority and intent. This capital spend focus has been made possible by a decline in subsidies by Rs 1.15 trillion and the flat spending on rural development at approximately Rs 2.6 trillion. In a year where many expected a Budget full of sops and subsidies, given the upcoming elections, investors will note the discipline exhibited by the government. They have tried to take the long view to maximise the growth potential of the country.

It is also a clear change in approach by the government. Even in FY22, rather than use the tax revenue bonanza to reduce the fiscal deficit further from the targeted 6.8 per cent, they spent all the increased revenue and kept the fiscal deficit at 6.9 per cent. In FY23, the fiscal deficit has been targeted at 6.4 per cent, a very gradual decline. The government has made a conscious choice that in an environment where it is still not convinced that private sector capital spending is poised to recover, it needs to carry the weight. The hope is that the government has the capacity to spend this quantum of money productively and that it will crowd in private investment eventually. I, for one, am more optimistic on the private sector investment cycle than many and thus the government stimulus may accelerate growth by more than many today recognise. If the enhanced outlays on government capital spend are able to accelerate infrastructure build, this will improve the long-term growth potential of the country.

Illustration: Binay Sinha

This is also a bet that the growth acceleration enabled by this stepped up investment will eventually lead to revenue buoyancy and enable fiscal consolidation over time. One can see why the stock market is excited. It senses growth acceleration and the potential for a sustained corporate profits upcycle, driven by the domestic economy. The fact that there were no changes in taxation has further helped the mood. No change in capital gains tax (in fact, a capping of the surcharge is a positive) and no attempts to bring in new taxes have definitely helped sentiment. Investors like stability and predictability. The question is only if the government has the capacity to spend this quantum of money productively. Instead of worrying too much about the fiscal deficit, the government is making a clear bet on growth. Growth, if delivered, will bail out the fisc as well.

The downside of all this spending is, of course, a slower reduction in the fiscal deficit than what bond markets would like. The government has clearly made a bet on growth. The market borrowing target for FY23 is a very large Rs 11.59 trillion on a net basis. This is a big jump from Rs 8.75 trillion in FY22 and will put pressure on the bond market and yields. This can be a problem with global financial conditions tightening and the Fed way behind the curve. As the Fed withdraws liquidity, financing large deficits may become more challenging. With equities flying, bond yields surged to 6.82 per cent, clearly reflecting debt investors’ worry on how the fiscal will be financed. Rising bond yields may hurt equities eventually, but for the moment the greater confidence on growth and corporate profits will trump any rise in yields in the minds of investors. The Reserve Bank Of India may also be needed to cap any rise in yields. It cannot be disorderly. One also needs to have an eye on the rupee. The government has chosen to bet on growth despite a more difficult global financial backdrop for capital flows to finance the deficit. One potential big disappointment for the bond markets was no clarification on the taxation of bond investors using Euroclear to buy and sell Indian sovereign bonds. This is a must to allow India to enter the global sovereign bond indices and trigger substantial debt inflows from foreign investors. It is baffling why this was not done, especially given the quantum of the borrowing programme and the tightening global liquidity. We will need the $30-45 billion of projected inflows any bond index inclusion will enable. It may be in the footnotes or will hopefully be announced after the Budget.

The Budget arithmetic seems quite conservative on the revenue front. Tax/GDP is forecast to decline from 10.8 per cent to 10.7 per cent, with gross tax revenues only forecast to rise by 9.6 per cent. Corporate tax and income tax revenues are forecast to rise by 13.4 per cent and 13.8 per cent, respectively. Given the bullishness of markets on corporate profits, these numbers are conservative. There is a decline of 15 per cent in excise revenues also built into the Budget arithmetic. The disinvestment numbers are also much more reasonable. FY22 has disinvestment receipts of Rs 78,000 crore and FY23 targets only Rs 65,000 crore. 

This Budget is making a huge bet that enhanced government capital spend will crowd in private sector investments and put the economy on a path to sustained long-term growth. Economic growth will eventually generate the revenues to consolidate the fiscal and also create the employment needed to sustain consumption. If the government can spend wisely and also finish implementing some of the reforms already announced in previous budgets, this may be a bet worth taking.

Equity markets like a government that is more worried about growth than the short-term fiscal position.

The writer is with Amansa Capital