We have not seen such a bold budget in this century. Market friendly measures announced are much beyond expectations. Similarly, it will generate more economic benefits than forecasted, in the long-term. A reluctant market, which had corrected by 8 percent two weeks before the budget, swung positively. Excessive valuation, liquidity driven rally and apprehensions over likely budget announcements led the correction. Weak fiscal position and conservative approach used in last budgets, like increasing taxation and control over foreign investment had caused concerns over budget announcements. But a progressive and expansionary budget has completely shattered these concerns. The broad market rallied strongly, post the budget.
We have also become more positive after the budget. This is the correct time to be more proactive on domestic oriented businesses. Higher investment in equity is suggested as better economy and wealth creation is expected, led by the key reforms announced.
1. Privatization of PSUBs: This important reform, which was required for our financial industry was never undertaken. The inefficiency of PSUBs is well-known, banks tier 1 capital was continuously falling due to NPAs triggered by weak risk management, lack of accountability, corruption, political and labor issues. As an initial step, two PSUBs are expected to be privatized during the year which will lead to the path of correcting the PSUB sector, which accounts for a high share of 60% of India’s banking. It will also bring pressure on the industry to improve operation, technology, correct accounting and capital efficacy. It will lead to strong re-rating of PSUBs, which is available today at below the book valuation, due to weak balance sheet.
2. PLI schemes: To enhance India’s manufacturing competitiveness, quality, capability and economic capacity, subsidy based PLI scheme has been introduced in 13 sectors. This scheme has already been operational in three sectors before the budget. PLI scheme has received high level of interest and large capex led by both FDI and domestic investment. It will reduce imports and increase exports in the long-term and is very positive for the concerned industries.
3. Opening of insurance sector to 74% foreign equity: It will bring more foreign players and investment thereby improving domestic competition, services, capital and re-rating in the sector. This is also very positive for Indian Banking industry, which is currently operating insurance business under a subsidiary, enhancing the overall group and industry.
4. High disinvestment: Government will further open the economy by reducing its control on PSUs, including giants like LIC. Positive for private sector and will help reduce fiscal deficit in future.
5. Monetization of government assets: Similarly, government intends to sell operating public assets like highways, railways and airports to monetize and use funds for the development of new infrastructures.
6. Higher government spending: FRBM norms have been relaxed for the time being, to increase government spending with fiscal deficit target of 9.5% and 6.8% in FY21 and FY22. This is the first time the government is completely transparent about government expenditure, including off budget borrowing, and is not concerned about implications from international rating agencies. The huge capex will support the slowing domestic economy and benefit sectors like Infrastructure, Capital Goods and Consumption. The deficit will be funded by borrowings from RBI and market.
7. Scrappage Policy: To phase out old and unfit vehicles is a big positive policy for Auto and Ancillary industry.
No additional taxation has come as a blessing for the market. The Agri-Infra Cess on petrol and diesel, announced in the budget, is not an additional cost or tax in the economy. It will not additionally increase the market prices, as it is a Cess introduced after lowering the basis custom and excise duty on fuel accordingly. It is to create a development fund, which will be handed over to Agriculture Produce Market Committee (state wise) to improve the infrastructure facilities provided to the framers.
The government has taken the challenge to revive the economy based on an expansionary plan, at a time when private sector is not expected to invest during the down cycle. At the same time, government has also undertaken social responsibilities by providing high provision for healthcare and vaccination. Other than this the transparency of the financial statements is commendable. They have also adopted a conservative approach to forecast nominal GDP, revenue and expenditure growth. There is a possibility that the growth estimates may end-up higher as economy revives better from the expansionary budget. We can expect domestic funds to join the rally. DII net inflows, which are presently negative, can turn positive due to improvement in the economy cycle leading to earnings growth. Of course, a lot will depend on the execution of the expenditure plan.
Stronger than forecasted earnings growth will help further re-rating
Q3 results have led to a strong upgrade in estimates being much better than forecasted. Analysts have updated earnings growth forecast for FY21 (all the benefits will be seen in Q4) and FY22. We can expect further upgrades in future because of rebound in the economy post the progressive union budget.
Q3 results have provided a surprise package to the earnings growth. This growth will increase further as the economy performs better with rising expenditure. For example, for Nifty50 index, the consolidated 50 companies were expected to deliver a combined YoY PAT growth of 15 percent, which actually is two times better. This growth is supported by cyclical sectors like Auto, Cement, Oil and Gas and Metals. Consumption has also provided good growth while weakness is seen in Finance, NBFCs, Telecom and Construction. Slowdown in growth is visible in Chemicals and IT, which is expected to improve going forward while high growth continues in Pharma. The valuation of Nifty50, which had increased to the highest 1-year forward P/E of 22x before the budget, has come down to 20.5x in spite market being 15% higher, due to impressive earnings growth.
The medium-term rally is intact
We are vulnerable to short-term correction as the post budget performance is a good notch above the global and recent past budget rallies. Of course, it is supported by the most reformist measures ever announced. The super performance, not noticed in recent years, has triggered some caution in the market assuming that this momentum may stop being at over brought region and rising global volatility due to hike in bond yield.
Our understanding is that this sharp momentum is not triggered only by technical factors like short covering. It is supported by fundamental improvements, improving economy outlook due to upgrade in governments policy with reformist agenda, which will create sustained capital expenditure in domestic economy with FDI and FII investment.
The market has pockets which are both expensive and inexpensive. We also assume that this premium valuation is bound to stay robust during the year, led by earnings growth. To focus only on valuation could lead an incorrect perspective of investing in growth equity asset. So, it will be more about moving funds from stocks and sectors which are expensive to value buying and segments which will be benefited by higher capital expenditure and wealth generated by the reforms.
We can conclude that this as the best budget we have had for a long-time. The only concern to be noticed is that it is expansionary, which is required during a recession, but can lead to over enthusiasm, inflation and interest rate hike, if not structurally reversed in the medium-term. A short-term correction will be good for the market. This is a buy on dips market, and mid and small caps and cyclical stocks can outperform the market.
