Key Theme – Capex to drive India growth

The government has made a big play on using capex to accelerate growth and employment in India. There are multiple threads to what should become a multi-year policy plan. While the budget is inflationary, it is a reasonable growth vs inflation trade-off, in our opinion.

Capital expenditure – all guns blazing

It is not often that this author gets excited about a Union budget – the last time was back in 2001. This will be remembered as a big event if execution holds up – Union Budget 2022 is a transformative policy document. And here we thought big bang policy documents as part of the budget was a thing of the past (cf. our budget expectations note)!

In our opinion, the government exceeded the market consensus expectations of a big splash in capital expenditure by a big margin – moving the capex budget from 1.7% of GDP in FY16-20 to the proposed 4.1% of GDP in FY23E is a big swing. It is also notable for the fact that buzz words (except for the avoidable Gati Shakti) and big blowsy announcements were absent from the Finance Minister’s (“FM”) speech – it was all specific and delivered sharply, concisely and with intent.

First, the specifics – the government plans to spend Rs7.5tn (= lac crores) on capex in FY23E, a 35% increase yoy – and that is 2.9% of India GDP. Further, it will provide Rs3.2tn as revenue expenditure to states for their infrastructure and capital spending plans – that takes the total to Rs10.7tn, 4.1% of India GDP.

Second, based on the content and tenor of the FM’s speech, it was clear that she was laying out the first step of a multi-year to use government capital spending to accelerate both corporate and employment growth in the country. To us, it also seems like the soft-spoken, former banker and current CEA, Sanjeev Sanyal has contributed significantly in laying out this long-term framework for future employment generation – the FM referred to his work in the post-budget press conference, too.

Third, the big concern with all such grandiose government plans is quality and timeline of execution – it is also why we old-timers absolutely loved the 2000-2004 government. The execution of the Golden Quadrilateral project was a seminal event in India’s infrastructure history.

In this context, we note that a significant part (~30-40%) of the Union government’s proposed spending will be under Nitin Gadkari, who has more than proved his execution skills in the past seven years. This gives us comfort.

Further, the government will be coming out with two substantative policy papers – one, on how metro rail networks can be funded in cities, existing and new. Two, a completely new approach to urban policies – there will be a new policy for urban development and integrated transport hubs. We are absolutely thrilled that the government is talking bread and butter issues about how to make urban life better for existing residents and new migrants to the cities – urban employment and growth are absolutely key to improving India’s overall productivity numbers and raising per capita incomes. And this is far removed from all the previous smart city hyperbole.

There is expanded coverage for the Prime Minister’s (“PM”) grand initiative of Nal se Jal – for connecting another 38m households in the upcoming year – an allocation of Rs600bn. Rs480bn has been allocated to the PM affordable housing scheme – to be spent on an incremental 8m houses in FY23E.

So, we are fairly confident that the Union government has the execution capability and intent to spend this money – we hope that the spending will start immediately in April and will not be back loaded – and we think that the current robust GST collection should embolden the government to do this. We are unable to speak with the same confidence about what the different state governments will do – your mileage will vary. Constructive state governments with the execution capabilities, such as Delhi, Gujarat, Maharashtra, Karnataka, should jump on this opportunity of taking Central money to make their cities, smaller towns, and roads better – once the new urban development policy is unveiled, we will have a better understanding of which states will benefit.

Why are we so excited? Multiple reasons

First and foremost, using taxpayers’ monies to build out more and better infrastructure is a significantly better government objective than spending it on subsidies – building infrastructure creates long-term, productive assets that lead to second-degree and third-degree effects of revenue and employment generation.

Second, while the common theory is that India has a demographic dividend – this can turn into a demographic curse very easily, given the nutrition, education, and per capita asset ownership levels of 90% of India’s population. In this context, a big-bang spending on building roads, rail and other infrastructure increases the employment potential for a vast number of India’s citizens – and, these are better quality jobs, compared with agriculture linked support jobs in rural and semi-rural areas.

The government also seems to be thinking of how to reform India’s failed massed education system to ensure the creation of another pillar of income improvement for India’s vast majority – the focus on using digital technologies and creating a better digital version of IGNOU is to be welcomed. We have to observe the execution levels in this area – the past track record does not give us much confidence, but this is a very critical long-term factor for India, as a country.

On the corporate side, a big-bang spending on infrastructure will create a significant demand pull on domestic manufacturing and services companies – given the virtually complete absence of major private capex in India since 2012, we think this will be a catalyst for Indian companies to start increasing their capacities to deliver, which will then have second and third-degree follow-on benefits for Indian companies.

Further, spending on infrastructure means that most of the value-add will be captured by Indian companies and their employees – there is very little that Chinese companies can do to compete in this space, say, especially given the Government’s tacit disapproval of Indian companies outsourcing to any Chinese EPC companies. If the government were to further indicate to Indian companies that this will be a multi-year plan, then Indian companies can start investing in products such as say, cladding, which is imported. We think that the PLI schemes have been such an indicator, but it would not harm to say this out explicitly, either.

Last but not the least, as government spending kickstarts major infrastructure projects again, we will start seeing a better outcome in non-performing loans from this sector – a significant portion of the NPAs is stuck with small and mid-size EPC companies, sometimes due to the previous litigious attitude of the NHAI, and new cashflow should unfreeze this logjam. This would improve the balance sheets of the public sector banks, allowing for a fresh cycle of loans. In this context, creation of the bad bank will also help. Further, as these MSMEs get back to growth, that will have a positive impact on employment generation – which will then also answer the question, where will non-urban consumer demand come from?

Fiscal metrics

This note is already too long – so I am going to provide a short summary of everything else! You can reach out to us if you have specific questions, and we will be happy to answer them.

Fiscal deficit pegged at 6.9% for FY22E. However, a consensus view is emerging that the government has low-balled its 4Q tax revenues, and so the deficit should be lower ~ 6.6-6.7%. This will be taken as a positive by the bond vigilantes (see below)
Fiscal deficit target is 6.4% for FY23E – normally, I would be gnashing my teeth at this continued dereliction of FRBM Act, but in this case, it is for a good cause!
LIC IPO should happen this year – so the revised disinvestment target of Rs780bn could be met. Warning from the FM – do not extrapolate to get to LIC’s valuations
Next year’s disinvestment target has been set at an anemic Rs650bn – the Finance Secretary said that it was better to set realistic expectations, and not distort markets
Defence spending has been increased marginally from Rs3.65 tn to Rs3.8 tn – but the big move here is to earmark 68% of defence purchases to domestic companies. The government will also set up an umbrella body for certification for all defence products, to be acquired locally
Rs500bn added to the ELCGS Fund – specifically for hospitality and related companies. The Fund size is now Rs5.0tn. The scheme itself has been extended to Mar 2023
Subsidy allocations for fuel and fertilisers have been moderately reduced. The food subsidy allocation is not clear – but it also seems lower than FY22E’s projection. Allocation for vaccine related spending is cut down to Rs50bn in FY23E from Rs350bn this year
30% tax on any crypto profits, no set-off for losses and a 1% TDS on all transactions – essentially a sledgehammer blow against onshore trading of crypto assets – “they are not currencies”, said the FM in her press conference!

The bond market throws a hissy fit

Yields suddenly spiked 10-12 bps once the market found that gross market borrowings is planned at Rs14.95tn in FY23E, against the estimates of Rs12.5-13.0bn
One part of this is linked to lower tax revenue estimates for FY23E – the cut in excise duties for petrol and diesel. However, the buoyancy in GST revenues could make this an under-estimate. The other part is the anemic disinvestment target – any improvement here will reduce borrowings
The higher borrowing target means that the RBI is even more hemmed in – and rate increases will come sooner rather than later
Bond markets never lie – it is warning us to stay away from all high-PE stocks and debt funds
Better tax revenues in 1H FY23E and/or disinvestment revenues could give the RBI a breather – this is something to watch out for

No personal income tax cuts

The government did not make any changes to the income tax slabs for personal taxes – so middle-class taxpayers will have to wait again. However, the expected improvement in the jobs market should be the positive take for this segment
The government did not increase any income taxes either for any categories either – as the FM was quick to point out
Small tax change for unlisted equities – LTCG surcharge will be capped at 15%, same as with listed equities
For startups – to get tax exemption benefits, incorporation date extended to Mar 2023
For manufacturing companies, the incorporation date to get the lower 15% tax rate has been extended to Mar 2024

Specific sectoral views

All the planned infra spending will be positive for infra/capex companies, followed by other companies in the supply chain
Primary beneficiaries – cement, other building material, pipes, steel, EPC companies and brownfield capex OEMs
Secondary beneficiaries – public sector banks, autos, FMCG
Tertiary beneficiaries – consumer durables, paint companies

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Budget 2022 – What did it deliver