Union Budget 2016-17 Fiscal Prudence and Hope!

February 2016

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Key highlights

Gross Domestic Product (GDP)

• Nominal GDP for financial year 2016-17 (FY17) is projected to grow at 11% year-on-year (YoY) vs

7.2% for FY16

• GDP deflator expected to turn positive with uptick in Wholesale Price Inflation

• Real GDP growth for FY16 accelerated to 7.6%

Revenue and expenditure

• Gross tax revenues are budgeted to grow 11.7% in FY17 vs 17.2% in FY16 - buoyancy in Excise

duty expected to continue

• Seventh Pay Commission - Under provisioning in the budget; referred to committee for

implementation

• Defence One Rank One Pension (OROP) - expenditure towards pension to increase

• Receipt from telecom and communications budgeted higher @ INR 990 billion

• Reduction on dependence on market debt; Gross market borrowing stable at INR 6.0 trillion and Net

market borrowing reduced marginally to INR 4.25 trillion

• Divestment target maintained at elevated levels at INR 565 billion notwithstanding the under-

achievement previously

Source: Indian Union Budget Document, February 2016

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Key highlights

Source: Indian Union Budget Document, February 2016

The Budget mostly lays out realistic numbers and a roadmap for long term growth

Fiscal consolidation

Fiscal deficit target maintained at 3.5% for FY17, primarily to provide credibility to Government’s

commitment

− Committee to be formed to provide Fiscal Responsibility and Budget Management (FRBM)

range instead of exact number going forward

Provisional estimate of the FY16 fiscal deficit is 3.9% of GDP, in line with the budget

Fiscal consolidation to continue in the medium term; target deficit 3.0% in FY18 and FY19

Subsidies

Budgeted at INR 2.5 trillion – food subsidy to form bulk of it

− Lower petroleum subsidy given the expectation of lower crude prices

− Government to implement ‘direct transfer benefits’ for fertilisers as well

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Key highlights

Other key announcements

• Goods and Service Tax (GST) bill to be introduced in the second half of current

budget session

• General Anti Avoidance Rule (GAAR) - prospective applicability from FY18

• Increased focus on agriculture, rural sector and social sector namely health, education

and skill development

• Introduction of 10% tax on dividend income if total dividend income crosses INR 1

million

• Bank capitalisation budgeted at INR 250 billion for FY17

Source: Indian Union Budget Document, February 2016

Budget impact on debt markets

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The debt markets perspective

• Commitment to fiscal deficit target is positive - over estimation of telecom receipt and

under provision for Seventh Pay Commission may create roadblock

• Greater discipline required to meet dis-investment targets

• Increase in centrally funded planned expenditure and more funds to the states

• Sticking to fiscal roadmap could provide the much needed room for monetary easing

by the Reserve Bank of India (RBI) over a period of time

• Expect government securities (G-sec) yields to remain range bound

• Balanced duration funds may provide an attractive opportunity over a one year horizon

as demand – supply dynamics continue to be negative for the upcoming fiscal

*Source: Indian Union Budget Document, February 2016

Budget

Estimates

Revised

Estimates Growth

2016 - 17 2015 - 16

INR Crs INR Crs

GDP at current prices 15,065,010 13,567,192 11.04%

Fiscal Deficit as % of GDP 3.5% 3.9%

Net Borrowings 425,181 440,608

Maturities 174,819 143,595

Gross Borrowings 600,000 584,203

Budget impact on equity markets

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The equity market perspective

Lack of major negatives is the biggest positive:

There were pre-budget fears about

• Increase in Service Tax

• Introduction of LTCG on equities in some form

• Change in the definition of ‘long term’ for taxation of equities

• Slip-up in the FRBM targets

• Irrational increase in populism

Source: Indian Union Budget Document, February 2016

None of the above was announced - this is the biggest positive from the Budget 2016

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The equity market perspective

Key Positives:

• Fiscal Discipline - roadmap retained at 3.9% for FY16, 3.5% for FY17

• Rural and social sectors - Increase in outlay (highest ever allocation for MNREGA and ~INR 150

billion for interest subvention to farmers)

• Road development - Budgetary outlay of ~INR 550 billion.

• NHAI to raise ~INR150 billion

• Centre and State outlay of ~INR190 billion and ~INR 80 billion for PMGSY

• Relaxation in FDI policy in Infrastructure, Pension, ARCs, Exchanges

• Introduction of comprehensive Bankruptcy Code

• Expansion of Direct Benefit Transfer and usage of Aadhaar

Key Negatives:

• PSU Bank recapitalisation outlay of INR 250 billion – lower than street expectation

• Hike in Securities Transaction Tax (STT) for Options (from 0.017% to 0.05%)

• No cut in Corporate tax rate except for small units – government committed to reduce it to 25% by

2019

• Levy of Infrastructure cess on Diesel, SUVs, and bigger cars

• No increase in personal income tax slabs

• Sunset clauses for accelerated depreciation, R&D etc.

Source: Indian Union Budget Document, February 2016

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Key sectoral impact

Source: Indian Union Budget Document, February 2016

Sector Measure Impact

Increase allocation to various sectors like Road, Irrigation, Rural

Electrification, Feeder separation for Power distribution.Positive for power and infrastructure companies

Distribution made out of income of SPVs to the REITs and INVITs

will not be subjected to Dividend Distribution Tax Positive for infrastructure and real estate companies

10 year tax holiday for any new infrastructure projects & SEZs set-

up beyond 01-Apr-2017 has been withdrawnNegative for Infrastructure companies

Accelerated depreciation capped at 40% wef 01-Apr-2017 Negative for Renewables sector

Capital infusion of INR 250 billion for PSU banks

Initial outlay for capital infusion seems inadequate but the

government will likely increase this amount if required. This

will improve capital adequacy of the PSU banks and help them

tide over the near term asset quality issues

Deduction for additional interest of INR 50000 for home loans up to

INR 3.5 million for first time buyers

This move is targeted towards boosting affordable housing and

should benefit housing finance companies

A comprehensive Code on Resolution of Financial Firms will be

introduced as bill in Parliament in 2016-2017

To provide resolution mechanism to deal with bankruptcy

situations in banks, insurance companies and financial sector

entities

Increase in FDI and ownership of sponsors in ARCsThis will enable ARCs to raise more capital and enable them to

buy more stressed assets and thereby help the banking system

Infrastructure

& Real Estate

Financials

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Key sectoral impact

Source: Indian Union Budget Document, February 2016

Sector Measure Impact

Rate of Oil Industries Development Cess on domestically produced

changed from flat INR 4500/MT to 20% ad-valorem

Positive for upstream in current scenario, though market

expectations were that ad-valorem rate to be lower

Clean energy cess on coal increased from INR 200/T to Rs 400/TPositive for gas utilities and will be negative for coal users like

metals, cement and utilities

Increase in import duty non-ferrous metals and alloysPositive as it will Improve domestic realisations for non-

ferrous companies

Reduction in export duty on bauxite and low grade iron ore to 15%

and 0% respectively

Increases input costs for domestic aluminum producers in case

of bauxite and will improve profitability of iron ore exporters

Increase in excise duty / cess for Jewellery, branded readymade

garments, passenger cars & Cigarettes

These measures would be slight negative for demand /

margins of the impacted companies

Thrust on significant increase in rural spends could act as a demand

driver for companies focused on rural economyPositive for rural economy focused companies

Healthcare

Lower exemption available on R&D spends could lead to higher tax

rates in the medium term, though this could be offset to an extent

by the roadmap for overall corporate tax reduction

Slightly negative for Pharma companies

Energy

Materials

Consumer

Sector

Budget – In summary

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To summarise

• Lack of Major Negatives is the biggest Positive, despite challenging macro environment

• The focus areas of the budget seems to be on Agriculture & Farmer welfare, Rural

sector development and Social sector

• Underpinnings of the policy document seem to be execution rather than grandeur

announcements. Eg: DBT extension to fertiliser sector, expanding the scope of

Aadhaar, highest ever allocation to MGNREGA, PMGSY, etc.

• Fiscal prudence, adherence to FRBM targets & lack of unpleasant taxation proposals

would be well received by the markets

• Risks – Revenue mobilisation through non-tax measures is welcome though the targets

for telecom spectrum auction & disinvestments appear stiff. Another risk emanates

from legal sanctity of the domestic black money disclosure scheme.

• Overall, Budget 2016-17 is a departure from the past as thought & resources are being

put where the heart is i.e., Rural, Social, Agriculture, Bottom of the pyramid, job

creation

Equity market outlook

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Equity: Look ahead

• India further elevates its “sweetness” amidst global turmoil: India is believed to be

one of the fastest growing economies in the world and growth is likely to accelerate in

the coming quarters.

• Investments: Slow pick up, but a gradual return of capital and an enabling

environment can unleash a multi-year cycle

• Supportive macro indicators: Growth revival, manageable twin deficits (fiscal &

trade), declining inflation, easing interest rate cycle and steady progress on reforms are

pillars of our sound economy

• Earnings revival and valuations: Expected to revive from 2HFY16 and its growth to

normalise valuation ratios to long term averages

• Risks: Risk of volatility from weak economic data from China, fear of impending US

Federal Reserve interest rate hike, geo-political risk, delays in reforms roadmap and

political logjam

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Equity markets – Themes 2015

Gross Domestic Product (GDP) growth Capital expenditure trends- New investment

cycle in nascent stage

Current Account Deficit - Narrowed Inflation likely to remain low

Source: CEIC, RBI, Morgan Stanley Research

E = Morgan Stanley Research Estimates.

Source: CEIC, HSBC Global Asset Management, data as of December 2015. Source: CEIC, RBI, Morgan Stanley Research .

Note: core CPI* = headline CPI ex. food & fuel. Source: CEIC, HSBC Global Asset Management, data

as of December 2015

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Earnings growth - Still higher compared to the rest of the world

Source: FactSet, MSCI, Morgan Stanley Research as of December 2015. For illustrative purposes only and does not constitute investment recommendation to buy or sell in the above-

mentioned index. Past performance is not indicative of future returns. E = Morgan Stanley Research Estimates

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Equity market – Valuations and Liquidity

1 year forward Sensex Price/Book

Return on equity set to rebound

Source: Motilal Oswal Securities Ltd data as of February 2016.

1 year trailing MSCI India Price/Earnings

Source: Morgan Stanley Research .

Foreign Institutional Investors (FII) have remained negative

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India outperforming Global Emerging Markets (GEM)

Source: RIMES, MSCI, Morgan Stanley Research as of January 2016

Thank You

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