Resurrecting economic growth is taking centerstage this year for India, as the 2020 budget attempts deliver on multiple fronts. However, the budget announcement delivered on February 1 didn’t put forth any immediate measures to support falling consumption.
India Finance Minister Nirmala Sitharaman announced a cut to personal income tax rates, the introduction of a new alternative income tax structure, and trillion-rupee (US$14 billion) fund injections into the infrastructure and agriculture sectors, at the cost of missing the government’s deficit goal for a third year. This will push the budget deficit to 3.8% of gross domestic product (GDP) for FY2019-20 from a planned 3.3%. The FY21 fiscal target has been set at 3.5%, which we view as reasonable since there’s potential to bring in increased tax revenue if the economic growth picks up. The relaxation of the fiscal deficit target could potentially be a good counter-cyclical tool to support economic growth.
We saw a broad continuity in the government’s agenda from the previous year, even though the budget announcement didn’t provide much material upside. This includes increasing tax net and compliance; encouraging domestic manufacturing and infrastructure; high divestment targets; and encouraging the flow of foreign capital through maintaining fiscal prudence.
The announcement comes at a time when India’s GDP is expected to grow by 5.8% in 2020, a slower pace than the 6.8% growth in 2018 and marginally better than 2019, which was more recently revised downward to 4.8%.1 There were high expectations for the budget, but given recent weakness in India’s economy, the budget largely reflects the government’s decision to stay firmly on the fiscal consolidation path without any significant stimulus to the economy beyond perhaps some modest measures to boost income and infrastructure.
We can see the Indian government is making efforts to boost local businesses by removing the dividend distribution tax at an estimated cost of 250 billion rupees (US$3.5 billion). This could help lift corporate savings, and therefore revive the private capital expenditure cycle, which in turn could attract more foreign investors or international companies.
Start-up firms may also feel the impact as the government announced it would boost financing for small- to medium-sized enterprises in technology or export-oriented sectors.
Overall, we view this budget as an effort to propel growth in the right direction.
However, we think initiatives that would likely boost consumption were largely absent in the budget due to fiscal constraints. We believe the real key to demand stimulation and higher compliance lies in a reduction in the goods and services tax (GST), a tool now considered by the GST council, rather than a much-discussed budget item. If revenue momentum were to increase, we think the GST council will more likely have leeway to reduce GST rates for certain items.
Our investment case for India very much remains the same—it is a domestically oriented economy driven by internal demand and investment, low export share, favorable demographics, with a stable government who implement reforms targeting long-term sustainable growth. In the near term, we’d expect GDP growth to pick up in 2020, driven by rural income, counter-cyclical growth stimulus and export growth.
As we have observed in the past, corporate earnings growth has moderated in recent years, led by muted demand, a weak credit cycle and a tepid investment cycle. This, along with cheaper valuations in small- to mid-capitalization stocks, suggests to us that we’re over the hump. We believe the Indian economy and corporate earnings growth could be set for a gradual recovery over the next one to two years.
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1. Source: International Monetary Fund, World Economic Outlook, January 2020.