Divide to grow

 

 Instead of one-size-fits-all approach, Union Budget 2021 should mimic the targeted pandemic fiscal and monetary packages

 The market’s reaction to the Union budget can range from temporary exuberance, despondence, or indifference. The exercise always has elements of shock and awe. The comeback of the long-term capital gains tax on equities in the 2018 Budget was expected. There was debate happening about how India was turning into a tax haven. Scrapping of the dividend distribution tax and shifting the burden to the recipients in the 2020 Budget came out of the blue. The old regime had grown comfortably familiar to induce complacency. The introduction of retrospective taxation in the 2012 Budget was disturbing but inevitable. If not, Rs 2500-crore capital gains due from the sale of an Indian telecom asset by the foreign owner to Vodafone would have to be let go after the adverse Supreme Court ruling a couple of months earlier. Some insertions are so innocuous that they sink in only after a scrutiny of the fine print. The backlash against increase in surcharge to 25% from 15% for non-corporates, with taxable incomes between Rs 2 crore and Rs 5 crore, and to 37%, for those earning Rs 5 crore and more, taking the effective tax rate on them to 39% and 42.74%, in the 2019 Budget was brutal. FPIs pulled out almost US$150 billion in the subsequent three weeks. Nearly 40% of them were structured as trusts or associations of persons. The Nifty wiped out all the gains made in the year in the month since the presentation of the budget on 5 July. The misadventure was scotched end August. Each budget, therefore, is unique. It cries of desperation, confidence, or prudence, hinging on the spending record of the government. A dispensation focused on its vote bank will rarely bother about income-expenditure mismatch as when the 2008 Budget granted Rs60000-crore loan waiver to farmers. 

 

The possibility of the 2021 Budget turning out to be a routine ritual is stronger than throwing sucker punches. The checklist of what remains to be done is getting shorter. Standalone peak corporate impost is now a competitive 22%, without exemptions. The September 2019 announcement was two months after the annual event. 2020 Budget revised personal income tax, exempting earnings up to Rs 5 lakh. The rate up to the Rs 15 lakh slab has been slashed 10-15%. The scope for tinkering with the goods and services tax is outside the scope of the budget.  State finance ministers meet periodically to review the levy. Only 19% items have a 28% burden, with 60% in the 12-18% range. Bringing fuels in the uniform indirect tax regime is overdue but unlikely as it will plug a lucrative loophole to boost revenues. The fiscal deficit has already crossed the estimate of 3% and might spiral beyond 5% by the end of FY 2021. The temptation to tinker with surcharge and cess on corporate and personal tax rates will be strong. Going by the Securities and Exchange Board of India’s directive of collecting margins on each intra-day trade, instead of at the end of the day, points to a hike in the 15% short-term capital gains tax. Such a move will blunt criticism that the 500-basis-point difference with the long-term capital gains tax punishes serious investors.

Tempering the excitement of a buoyant capital market presenting plenty of opportunities to squeeze out juice will be the sombre reality of contraction of the economy in H1 of the current fiscal year, and a fragile recovery since then, resulting from the lockdowns to contain the outbreak of covid-19. Any misstep will be a setback to the Make-in-India campaign. At the same time, the circumspection might not last till next February. Turning hawkish will pivot on how fast the economy rebounds. Most multilateral and domestic institutions are forecasting double-digit, and the highest compared with other countries, economic expansion for India next fiscal year. Another important reason why the leadership might not want to spook the stock markets with short-sighted measures to cap borrowing is the elephant in the room: PSUs. The pandemic de-railed the divestment timetable of Air India and BPCL. Successful stake-sale of the long line-up in the space will achieve two objectives: keeping interest rates low and getting funds for social schemes, whose penetration is crucial to win states going for elections this year. Saddled with a huge vaccine bill, the finance minister can take a leaf from the three Atmanirhbar Bharat packages and the central bank’s two major fiscal initiatives during the peak of the pandemic: targeted support. Differentiated import duties based on the country of origin is a potent weapon. The proceeds can be used to enlarge the production-linked incentive scheme and offer subsidies to encourage local manufacturing.

-Mohan Sule

 

The Year of Rebalancing

 

What to do with growth stocks, PSUs, and legacy blue-chips in the portfolio on return to pre-covid-19 normalcy

 

If 2020 was the year of triumphing adversities, the New Year will be a period of introspection. Priorities will change as life gradually returns to the pre-covid-19 normalcy. The vaccination coverage is set to encompass the globe by the first half of 2021. Multiple products will compete on effectiveness and price. The challenge will be last-mile delivery. It is likely the entire western world and the prosperous nations in Asia will have completed the exercise entering the second half of the year. Equities’ rebound from the bottom anticipated the pandemic coming under control eventually. The record-breaking spree that followed is accounting for growth. The question is if the economy, hobbled by disruption in supply and distribution chains, has the stamina to sprint. The aim of the monetary and fiscal packages was to tide over the temporary slump in business. The outcome has been lopsided consumption. The shopping cart predominantly comprises food, hygiene products and utilities. Emerging from the medical crisis, the possibility is that demand for discretionary items will explode. The stock market is already visualizing such a scenario. Traditional industries are attracting attention for their tested business models as against the in-flavor tech providers with plenty of promise at high discounting. Buying is shifting to mid and small caps as investors wrestle with slowing returns of large, safe bets and untapped upside of promising risk-takers.

 

 

The problem is producers of non-essentials have absorbed the major impact of lockdowns. Capital expenditure has been put on hold to conserve cash. They might be not in the best of shape to meet the release of spends. The return to Old Economy boosted crude beyond US$50 in December, indicating inflation is gearing to recoil. Many manufacturers have taken a hike in prices beginning January.  The Reserve Bank of India will not be comfortable with consumer prices beyond 6% and the Federal Reserve will be happy if the 2% target is breached. The rollback of liquidity will begin. Investors’ dilemma will be whether to ignore the pressure on the margins for top-line growth. Companies balancing the pull of revenues and the pressure of higher input costs will see valuations soaring. Obviously, they will be at the top of the market or have a unique presence without comparable peers. In the crosshairs will be banks, expecting improvement in demand. A series of interventions has insulated them from the effects of the infectious outbreak. The central bank allowed one-time restructuring of non-performing loans. The Supreme Court put off recognition of bad assets after the end of the six-month moratorium on servicing. Dear and scarce money will test the mettle in managing slippages.

 

It will be make-or-break time for PSUs.  They have lagged in recovering from the March lows. There is no clarity about their future. IPOs used their monopoly as a bait. Many have minimum public float required to stay listed. Yet they are constituents of benchmarks because of their size. The opening up of practically the entire economy to the private sector has erased even the scarcity premium. Attempts to extract whatever juice is left through offer for sale in dribbles is worsening their plight. The Union government is squeezing cash from those quoting below book value through buybacks. Profitable enterprises have been told to ramp up dividends. The shareholders will have to decide between cutting losses and waiting for strategic sale, triggering an open offer, to unlock value. Some legacy holdings in the private sector, too, are evoking mixed feelings. Besides their foreign lineage and professional management, what is common between HUL, ITC and L&T is their mediocre growth record. Their five-year CAGR in revenues is in single digit and profit in teens. Ex-core competency contributors, tech and financial services now make up nearly 60% of infrastructure player L&T’s turnover. Branded foods, personal-care offerings, apparels, hotels, farm products and paper together consist 55% of cigarette maker ITC’s sales. HUL seems to be ceding space in the hygiene category in favor of the discretionary beauty- and personal-care portfolio, comprising 56% of the profitability. Risk-averse investors looking for longevity and transparency have a difficult choice: A pricey fare whose valuation seems to derive from sticking to being a play on its sector, a chameleon running helter-skelter, with over 30 subsidiaries and associates operating in diverse industries, to overcome its identity crisis, and an ageing thespian trying to be trendy by injecting the growth elixir of happening sectors to experience the adrenaline rush. 

 --Mohan Sule