On the day of the Union Budget announcement, there were two diverse trends in the capital market. On the one hand, the equity indices dipped sharply and then regained all their intraday losses. On the other hand bond yields shot up sharply by more than 23 bps in a short span after the borrowing program was out. Equity markets were impressed by the budget, but bond markets were not. Here is why!
First, a look at what it means for debt markets?
Broadly, there were two structural areas that were expected to be dealt with in the Union Budget but were not touched upon. Firstly, the bond markets were expecting the finance minister to issue a clarification on the likely date of inclusion of Indian government paper in the global bond indices. That was supposed to induce a surge in passive bond flows. However, the budget was silent on this topic. Secondly, the bond markets were expecting some big announcements on allowing sovereign foreign borrowings. However, the budget was silent on that aspect too.
What spooked the bond markets post the budget was none of the above factors. The bond prices cracked after the government announced a sharp increase in the government borrowing target for FY23. From Rs12 trillion in FY22, the borrowing limit has been raised to Rs14.9 trillion in FY23, a sequential increase of 23% in total borrowings. That is what led to a sell-off in the bonds and a spike in 10-year bond yields from 6.65% to 6.89% in a short span of time. Bond markets were wary about the yield impact of higher borrowings, the crowding out of private debt and the inflationary implications if these bonds devolved on the RBI. Clearly, bond markets were not too happy with the budget.
For equity markets, Budget 2022 set up a structural story
At the outset, there were no measures that promised instant gratification like scrapping of LTCG tax on equities, reduction of STT or cut in dividend tax. There was also no mention of additional tax sops to individuals. However, the budget did contain some important measures which could have a long range salutary impact on the markets. Let us look at five such announcements that could be value accretive to equities.
a) Lower fiscal deficit is always positive for FPI sentiments about India. The fiscal deficit at 6.9% for FY22 and estimated at 6.4% for FY23, is still way above FRBM targets. The good news is that the downward journey is being calibrated. Nirmala Sitharaman has spoken about reduction in fiscal deficit to below 4.5% by FY26. If revenues are supportive and subsidies can be reduced, as has been done in this budget, FRBM targets could be closer. This is a big boost for the medium-term and long-term perspective that foreign investors pencil for Indian equity markets.
b) From a macro perspective, the government has made two very important shifts. Firstly, it has given a big boost to capital expenditure, which has been raised by 35% yoy to Rs7.50 trillion. But more importantly, the government has cut down on subsidies on food and fertilizers. There has also been a cut in allocations for health, although the budget has clarified that it is only the temporary COVID relief that has been reduced. Overall, it is good that the expenditure pattern is shifting in favour of capex, which is likely to be value accretive in the medium term.
c) Look inward or Make in India is a strong capital market theme emanating from the Union Budget. Government has announced an increase in domestic defence capex allocation from 58% to 68%. This will be supported by an additional allocation of Rs.19,500 crore as PLI incentives for defence manufacturers. That is likely to be one of the key themes to drive markets in the coming year. Similar Make in India incentives have been extended in solar equipment also.
d) Budget 2022 has changed tack on disinvestments, which will be good in the long run. For instance, resources through disinvestments has been rightly underplayed. The divestment target for FY22 has been reduced from Rs175,000cr to Rs78,000cr. At the same time, the disinvestment target for FY23 has been reduced to Rs65,000cr. This is good news as the IPO arena will leave a wider room for private sector to tap the capital market, especially considering the queue of digital IPOs on the anvil.
e) Finally, Budget 2022 has underlined sustainable and digital themes as the market stories for the coming year. For example, the Budget 2022 has proposed new Battery Swapping policy to give a boost to alternative modes of transport like EVs. Above all, it is an acknowledgement to prioritize the EV ecosystem as the first step. Secondly, with big data likely to become central to emerging digital themes like AI, ML, IOT etc; Budget 2022 has accorded infrastructure status to data centres. In addition, the budget has also given special PLI incentives for the solar manufacturing sector.
To sum it up, the Budget 2022 may not offer any instant gratification to equity markets. But the building blocks of a secular growth story in equity markets are all there in the budget.