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Cascading Goodness

Increased spending for social projects can improve systemic liquidity

Cascading Goodness
Cascading Goodness
The Union Budget has been a balancing act between political, social and economic factors. As has happened in the past, many policy announcements are now being made throughout the year, with the budget focusing on taxation and new spending measures. The positive economic data in terms of robust GDP growth has helped in higher tax-to-GDP ratio and reduce the deficit numbers. However, one needs to keep in mind that the headline deficit numbers do not reflect the bonds issued to compensate oil PSUs for the retail marketing losses. Hence, the actual numbers could be higher.

The silence continues on key issues like labour reforms, but there appears to be good progress on the taxation front through implementation of VAT and a move towards a GST (Goods and Services Tax) regime. The finance minister has desisted from taking populist moves like a hike in small savings rates. However, the measures targeting specific sectors is a throwback to the yesteryears of policymaking. The macroeconomic statements, along with those on fiscal consolidation, augur well for the future.

Overall, as expected, strong growth rates have resulted in additional revenues for the government. It is looking to allocate this to various social sector and infrastructure development programmes, especially the agricultural sector, to promote inclusive growth. As a bigger social stratum participates in the opportunities provided by strong growth, and as the benefits of these new initiatives trickle down, the overall economic activity is expected to get a boost over the medium to long term.

The key announcements pertaining to mutual funds have been—a) Infrastructure Funds and individual overseas investments through funds; b) Higher dividend distribution tax for money market/liquid funds and; c) Self-regulatory authority (SRO) concept being taken up with bodies like AMFI. We are seeking clarification on some of these items.

The markets have been under pressure in recent times due to various factors and the weakness in global markets had a greater impact on sentiments than the budgetary proposals. The technology sector has been under pressure due to the move to include income under MAT and bringing ESOPs under fringe benefit tax.

Other sectors that have come under pressure after the budget include cement, iron ore exporters and construction. The permission to allow mutual funds to launch dedicated infrastructure funds should help in directing more flows into the crucial sector. While there have been no major changes on the direct tax front, the measures announced for specific sectors are not in line with formulating a uniform tax policy for the corporate sector.

The sector-specific measures in the budget could result in downgrading of earnings for those sectors and the near-term sentiment is likely to remain bearish. Given the strong fundamentals, we believe that the medium to long-term outlook remains positive and investors can consider these levels as an entry point.

The progress on the fiscal deficit front is a positive for the debt markets with both revenue/fiscal deficit numbers being lower than projected and the next year's projections being in line with the FRBM Act. The increased spending plans for various social and infrastructure projects could improve systemic liquidity, if the flows materialise. While the various duty cuts are aimed at taming inflation, the pump-priming effect of this spending would mean that the central bank is left to ensure the curtailment of demand-side pressures through additional monetary measures.

The near-term outlook continues to be tight due to the fiscal year-end factors and investors will be watching the impact of the monetary and fiscal measures on credit growth and money supply. Given the recent increase in yields, accrual income component of returns will go up and investors can consider increasing allocations to fixed-income funds. Reining in fiscal deficit should help the long end of the curve and at this juncture, floating rate, short term income and FMPs appear to be ideal investment avenues.

(The writer is president, Franklin Templeton Investments, India.)
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