Amidst reviving global macros and receding headwinds in domestic recovery post demonetization, the Union Budget 2017-18 has focused on following key areas (1) meeting fiscal consolidation trajectory as envisaged under FRBM Act (fiscal deficit at 3.2% for FY18E and 3.0% for FY19E) (2) increased outlay for rural economy and infrastructure (3) buoyant net tax revenue, aided by receipts from demonetization.
Union Budget 2017-18 has also provided tax concessions to the lower middle income and salaried class, which is expected to boost consumption of basic goods. It is a pleasant balancing-act between managing fiscal discipline and stimulating economy by adequately providing for social infrastructure programmes. The Budget has accorded top priority to farm / rural, social and infrastructure sectors with enhanced allocations. It has calmed the nerves of equity market participants by maintaining status quo on taxation of long-term capital gains.
Fiscal Prudence Maintained
On the macro front, the Government has maintained its stance on fiscal deficit. It aims to contain the same at 3.2% for FY17-18E compared to 3.5% in FY16-17, and it aims to achieve fiscal consolidation mainly through 13% rise in net tax proceeds to Rs1,227bn and 60% increase in disinvestment proceeds to Rs725bn.
Tax Revenue Growth Assumes Buoyancy due to Demonetization
The Union Budget has projected a 12.2% rise in gross tax revenue, which appears to be realistic. Tax revenue of the Central Government shows a respectable improvement of 12.8% over last year, led by normalization of transfers towards states. Income Tax and Corporate Taxes have been projected to rise by ~25% and 9%, respectively. Growth in Income Tax assumes buoyancy due to augmented tax proceeds in the aftermath of demonetization.
Implications & Sectoral Impact
Fiscal prudence, increased thrust on rural / farming and housing sectors bode well for the broader economy. We see a benign interest rate scenario, going forward. Increasing allocation towards rural sector augurs well for the FMCG sector as it is expected to aid revival of rural demand. Lower government borrowings will help banking sector in terms of higher gain on excess SLR holdings. Also, increase in tax breaks for the Non Performing Assets (NPAs) from 7.5% to 8.5% augurs well for banking sector profitability. Increase in capital outlay seems to be positive for cement, infrastructure developers, capital goods and construction companies. Excise duty on cigarettes has been increased by just 6%, which is positive for companies like ITC considering that average excise hike in the past five years stood at over 15%. MUDRA outlay has been doubled, which will be good for the Micro Finance Institutions (MFIs) and newly created Small Finance Banks (SFBs). Thrust on affordable housing will be good for select realty players and small-ticket Housing Finance Companies (HFCs).
Outlook & Valuation
Sensex has rallied ~5.5% YTD led by value buying from domestic fund houses. Expectation of positive budget in the aftermath of demonetization also kept sentiment buoyant. Demonetization will impact earnings growth of companies in FY17E and markets will be able to assess the full impact only after 4QFY17E. Though the Government has indicated a contraction of ~0.5% in GDP growth in FY18E, we expect domestic recovery to pick-up over FY18-19E on the back of revival of rural demand, consumption boost and pick-up in infrastructure development activities. Currently, the Sensex is trading at 19.5x FY17E EPS, which is roughly at mean valuation of past 10 years. Downside from these levels seems limited owing to reasonable valuation, low base of earnings and likely pick-up after three lackadaisical years.