Meanwhile, the Indian equity market has a rallied a whopping 90% from the March 2020 lows to hit all-time high levels. The market capitalisation of the top 500 companies is now 20% higher than the pre-Covid highs. Market valuations appear to be stretched, with Nifty trading at ~22 times one-year earnings, which is 3 standard deviations above the long-term mean of ~15 times.
Understandably, equity markets have become jittery ahead of the Budget, as even a small tinkering with the taxes, especially any increase in capital gains, or even personal income-tax, will be a negative surprise for the market.
India has managed the pandemic much better than many developed economies and the cost borne by the government has been manageable. The Finance Minister has been unequivocal about increasing capital expenditure for reviving the economy and creating jobs. At this juncture, the Budget is expected to be quite constructive. However, the fiscal room available even after considering the improving economy and better-than-expected tax collections is not very significant.
Nonetheless, the government will have to increase its spending to spur gross fixed capital formation to create jobs and long-term economic multipliers, leading to creation of more jobs in the private sector, which will be much bigger than the public sector. In this scenario, the broad contours to focus on in this Budget will be the following:
Job creation through infra focus, but also managing the funding challenges: This could mean more impetus on infrastructure and fiscal expansion using off-balance sheet structures. While the fiscal expansion appears to be challenging, considering the large fiscal deficit, which may expand to ~7.5% this financial year, but job creation through government activities is a necessity, as private capex continues to be sluggish.
Another important factor will be a possible impetus on the real estate sector, which can lead to significant job creation and spur long-term private investments.
Public health and vaccination rollout will be key focus areas: Public health has become very critical and further investment in the public health infrastructure seem very likely. The vaccination drive will be a very large project, involving significant government expenditure. The outlay for this mega project and possible funding structure could become critical aspects of the Budget.
Tax structures likely to be maintained: Corporate taxes were reduced in 2019 and this structure is likely to be maintained in FY22 to encourage private investments. Personal income-tax levels are also likely to be maintained, as additional taxes can disrupt consumption. The FY21 divestment target was quite steep and is unlikely to be met, which will get rolled over into FY22.
While these will be the broad contours of the Budget, what markets seem to be looking for is a reasonably conservative Budget. The current regime has always focused on fiscal discipline. Tax efficiency has improved, but personal income taxes have also gone up consistently. So, the jugglery of managing fiscal discipline and meeting the broader economic requirements will be key factors to watch out. The market will be watchful of bond yields, as RBI has maintained a very supportive stance thus far. Overall, the Budget is going to be a critical event at this juncture and the market is going to take cues from many aspects of this annual exercise.
Naveen Kulkarni is Chief Investment Officer of Axis Securities. Views are his own)