Budget 2020: LTCG Relief A Missed Opportunity But Push For Private Investments Commendable, Says Ridham Desai
Finance Minister Nirmala Sitharaman’s decision to not remove long-term capital gains tax in the Union Budget 2020 is a missed opportunity but the focus on private investments is commendable, according to Morgan Stanley’s Ridham Desai.
An LTCG relief would have cemented the progress made after last year’s corporate tax cuts, Desai, head of India equity research and India equity strategist at Morgan Stanley India, told BloombergQuint in an interview, adding that it probably is one big reason why equity markets sold off after the budget.
The S&P BSE Sensex dropped nearly 1,000 points on Saturday after Sitharaman presented her second Budget as there were no measures to boost the financial services and real estate sectors. It also lacked big-ticket steps to boost rural economy and consumption.
The budget also failed to grab the low hanging fruit of boosting rural demand, and failed to lay down a larger privatisation agenda which would have brought buoyancy to the market, Desai, head of India equity research and India equity strategist at Morgan Stanley India, told BloombergQuint in an interview.
Emphasising the need to improve sentiment in the equity market, Desai, quoting billionaire investor George Soros, said while the real economy feeds into the stock market, the stock market also feeds into the real market.
We are now subservient to the global rally which we have been for several months. In January, we kind of broke away from that, but we give up everything on Saturday. So now, we’re back to Coronavirus, we’re back to U.S. macro we’re back to the Fed. Those are the factors that have been driving India.Ridham Desai of Morgan Stanley
But it isn’t all bad, as per Desai.
Despite the lack of a larger push, the government's decision to make dividends taxable at the individual level means companies will now opt for buybacks instead of dividends, he said. “I think buybacks will double in the next 12 months, because for companies where there are large, non-institutional and domestic investors, it makes sense to do buybacks and not dividends because the marginal rate on dividends is double that of buybacks.”
This will be a positive for the markets in the near term, he said.
On the economy front, Desai said Sitharaman’s efforts to induce a long-term investment cycle instead of boosting consumption in the short term is commendable and will soon bear fruits.
I think we need to get the private investment cycle back. They [government] have made that choice, which is why, they are going to fire the bullets at the private investment cycle and consumption will take care of itself at some stage.Ridham Desai of Morgan Stanley
On Sept. 22, Sitharaman had slashed corporate tax rates for manufacturing firms, allowing them to save money which could be used for investment. She continued this strategy in the Budget by removing dividend distribution tax on companies and announcing the Life Insurance Corporation IPO which will transfer assets to a private hand, he said.
The cumulative effect of all the stimulus that has been done in the last four, five months is not a small number, he said. “It’s a big number. Rs 2.1 lakh crore has gone into the corporate sector and that will spill over into the economy at some point in time.”
Watch | Morgan Stanley India’s Ridham Desai Breaks Down Budget 2020 And Its Impact On Indian Equities
Read the transcript here:
Ridham, your first take on the Budget because it clearly leaves the equity markets unimpressed.
The negatives are also relevant to expectations and so are positives. I think where this thing has gone wrong, is the run-up to the Budget—somehow an expectation was building up that it is going to be a big bang thing. So, there were various things that were coming into the market in terms of rumours and what eventually we got was just another Budget which is what we’ve been getting for years. So, I don’t know if the market was thinking 91-92. Certainly, it wasn’t like that, it wasn’t even 97 it was just another budget. I think that may be the source of disappointment, we can actually drill down to more specific stuff like I think you mentioned in the opening comment that there is no direct stimulus for rural consumption. You could say that the slowdown in rural consumption has been a primary reason for the recent growth disappointment and to that extent, at least I was expecting and I think the market was also expecting that the government will do something for farmers and will reverse the transcript trade which has been happening in the wrong direction which is from the farmers to richer people. But they have not done anything—in fact, if anything we’ve seen a decline in the spending and cash transfers are held constant.
The second area of disappointment maybe the fact that the market thought that the capital gains tax will go. I was not expecting it but was hoping for it because it was a very good way of stimulating risk capital flows and where we are in the group cycle, it would have been a good thing to do with very little cost to the government but they chose not to do it. To that extent, I think again the market may have been disappointed. I think there’s something amiss on privatisation which I thought this was the year in which we were finally moving away from piecemeal divestment to institutional investors in large part LIC and go to a full-fledged privatisation programme like it used to be in 2000 to 2003. But what we got was a mix. What we’ve been left with is to deal with Rs 1.2 trillion or Rs 2 trillion of potential supply. I mean, you may not get all of it, but we’re left with that potential supply to deal with. I think a bulk of it will be icy but it’s still a lot of supply that is waiting for the market. So, those will be the areas of disappointment.
The positive thing is that the government has not shifted its strategy. What’s the strategy? Since September, the government has basically undertaken this strategy that they need to lift corporate savings in order to get the private investment cycle back and to the extent that they cut tax rates in September, they achieved part of it and now they have cut DDT. So, a cumulative amount is worth Rs 2.1 trillion lift to corporate saving and at some point in time down the line, that will lift the private investment cycle which has been a structural problem for India. They are backing this up with the elevated capital spending on their own balance sheet. We may miss the absolute numbers, but the mix will still favour capital spending over revenue spending.
Just to pull that point up with regards to how the government at this point has actually chosen to focus more on the investment angle than just spurring the temporary consumption-driven expectation at the present. Whether there would be a boost to consumption rather than investment, they have chosen investment which would mean that recovery is not going to be very V shaped—I mean the growth to be staggered and take some time.
But we are seeing some signs of a recovery in growth. So yeah, it may not be V-shaped and I think they’re probably attempting to make it more sustainable, more durable so that’s the strategy. See, we can find faults to their strategy,but I don’t think it is the wrong strategy. You could have put some money into the hands of farmers and recovered the economy in the next three months but ultimately, I think we need to get the private investment cycle back and if you have only that many bullets in your armour, and you have to make that difficult choice. I think they have made that choice, which is why, they are going to fire the bullets at the private investment cycle and consumption will take care of itself at some stage. I think they are also probably influenced by the higher food prices of the last few months. I suspect those food prices may not sustain. So, we may not get the transfer of income to farmers as the current food prices suggest which were triggered by weather woes, but they are behind us. So very quickly, these food prices are going to come down.
If indeed something like that happens, there is an off-budget option available to maybe make some extra allocations. For example, PM Kisan has been very low. So, maybe that could have played in the minds—just off-budget. That is the option that is open.
The options to spend money are open because I have been opining, it’s not about only looking at the revenues and expenditure. Time comes when you have to look at your balance sheet, and the government’s balance sheet is actually okay mark-to-market. See, the debt is carried and market, the assets or not which is why it looks like the way it is and it’s a unique situation, not many countries around the world have that situation. The government has an enormous amount of ability to monetise assets. It’s probably not being aggressive enough but if it chooses to, I think it can sell a lot of assets in Indian revenues to fix it. So, what I call as the transfer from the public sector to the private sector which started with the RBI dividends going to the corporate tax cut, and has reduced in this budget because if you see line by line, you basically are selling LIC you are removing dividend distribution tax. So, that transfer continues,and you can probably do it more aggressively. I would suggest that let’s go for it, let’s go for 5 trillion rupees of privatisation and transfer a massive amount of the private sector, get the economy back. The revenues will then stabilise at higher levels and the budget deficit will be fine.
A question then to ask you for that to happen, the equity markets necessarily, do they
need to stay buoyant. We’ve seen possible others even when the markets were buoyant, BPCL and some of the others faced hurdles.
But, I am not suggesting capital markets here. I am suggesting privatisation. BPCL’s hurdles have nothing to do with buoyancy or like that in the stock market but I would actually make the point on buoyancy in the stock market is relating to being reflexive as George Soros had said, which is that, the share prices feed into the real economy and vice versa. So, it’s not a one-way transmission, it’s not the real economy only feed into share prices, the share prices also feed back. To that extent, we want to keep share prices in a good shape.
Has the budget done enough to do that?
No, it hasn’t. It hasn’t done that; we are now subservient to the global rally which we have been for several months. In January, we kind of broke away and we give up everything on Saturday. So now, we’re back. We’re back to Coronavirus, we are back to U.S. macro. We’re back to the Fed. Those are the factors that have been driving India. Even after the tax cut in September, India did not establish any idiosyncratic, underlying trend in the stock market. It didn’t.
So, LIC for one is going to be an IPO. So, that obviously is not going to need to go to any outside investors, it is going to take money off domestic.
Yes, that. But I also think that the budget is going to bring buybacks into play. So, I think buybacks will double in the next 12 months, because for companies where there are large, non-institutional and domestic investors, it makes sense to do buybacks and not dividends. Because the marginal rate on dividends is double that of buybacks. So, all those companies will go back to doing buybacks which had stopped temporarily last year because the buyback tax kicked in, and the arbitrage was taken away and all the arbitrage is opened up all over again. I was expecting that if DDT was removed, buyback tax will go simultaneously but it didn’t. To that extent, you have opened up the arbitrage again. So, we are back to doing buybacks and all those companies that are going to do buybacks, I think we will probably do well from a near-term perspective.
It seems to be a move or a thought towards how all of these capital rich companies, MNC companies would also continue to find favour now for the next 12 months.
I’m just wondering whether the investing strategy also moves in part towards
that? We will come towards that, but just wondering that one of those cash rich companies to what the market has done for the last 12 to 24 months which is reward
capital-light businesses which can fend for themselves for capital and not depend on the market because the market is clearly stout. Do you think that polarisation continues now?
I don’t think so because my operating view is that the growth cycle is turning. If the growth cycle is turning, it will favour businesses that are not necessarily asset light which has been the case for the past few years but the performance will shift away from large caps to mid caps, from quality to value, from defensives to cyclicals. But it is premised on this view that the growth cycle is turning which in turn is premised in a lot of things like stable terms of trade, oil is well behaved. A turn in global macro which is what our house view is, and of course the cumulative effect of all the stimulus that has been done in the last four-five months is not a small number. It’s a big number—Rs 2.1 trillion has gone into the corporate sector and those good looks will spill over into the economy at some point in time. So, my operating view is that the economy is turning and to that extent, these trades are shifting away. We may get a temporary halt because of the disappointment on Saturday, but it may be only a temporary halt. I think we will resume the train. Now the caveat here is, that Coronavirus doesn’t become a major issue and you can never rule it out. Precautionary principle warrants are very cautious stance on this. The good news is that governments are extremely alert because of recurring issues around these viruses but at some point in time- in humanities’ history, a virus is going to come and not be controllable. Corona is not that virus, so I don’t want to spell doomsday here, but it’s coming at some point in time. We will take care of Corona, I think, but we should be careful.
What kind of messaging do you think this has given to foreign investors? Who are
probably sitting on the sidelines to invest into India and do you think this will pick up the pace of that investment?
It’s largely I think mildly positive for foreign investors because you have this tax break for sovereign funds. So, there’s a certain pool of capital that you think you can attract and frankly that’s the pool of capital that’s willing to buy Indian assets. So, you’ve increased FPI limit in bonds. So, I think it is actually neutral-to-positive for foreigners. I think even DDT, to a great extent for those who don’t pay dividend tax in their own jurisdiction, now will benefit slightly. I don’t think they’ll benefit because I don’t think companies are lifting dividend payout. See, that’s not happening. It is not that 20 percent that they have saved, is going to shareholders. I think they’re going to keep that with them. So, it is not coming to shareholders. The dividends will only grow if profits grow, not because I just suddenly have a lesser tax to pay.
So, I think the only losers in this equation would be the promoters.
No, for companies where there are large, domestic, non-institutional shareholders, they will prefer to do buybacks. Now, they have some more money in the kitty now to do it because they’re going to save the dividend tax. So, I think buybacks will be the way to do it.
You think the budget in terms of sectoral expectations and what everybody expected
the budget to do for autos, real estate. Real estate particularly and infrastructure
a lot was dependent on this budget, do you think it fell short?
So, I think you know the budget is not the final word on measures. Suddenly, people feel that for this it is, we’re done. But actually, we’re not because since the last budget, we are getting announcements almost every week because there was a time when every Friday, we got announcements. It was for five-six Fridays on the trot. So, nothing prevents the government on doing something two weeks later. So, I don’t think the budget was the final document- there was an assumption which I started my comment on, that because of the news flow that is coming from Delhi, we felt that this is going to be the big bang thing. But I think the government will continue to do its stuff on the side, which is you will continue to get reforms. So, I don’t think it’s the final word but yes, I’m not sure what the budget could have done in real estate as such. I mean it can be done separately as well.
There was the interest subvention and probably increasing the scope of definition of affordable housing to include more..
That’s where I said, well they had a certain number of bullets in their armour, they fired it all in the corporate sector which is very consistent with their recent behaviour. So, they have not moved away from that. If you start interest subvention and all that, then you are now going to the consumer class. So, they are not stimulating consumption, they are stimulating investments. I cannot fault them for that strategy. Whether it works or not, we will figure, but it’s what they have started in September and are sticking to it.
One thing I was wondering. I titled my piece as ‘Budget and markets diversity at
play’ for a couple of reasons. I thought one, if you want to get a big bang, LIC
IPO as the last thing we should do is tinker around in a way which either by signal or otherwise makes people believe that insurance may not be as attractive or business as it used to be before the budget. Is that like the left hand not talking to the right hand or something that?
When we try to seek a rational flow in all these things, sometimes we struggle. It’s not unique to this budget. We have had it recurring over the past which is the left hand not talking to the right hand. The right hand wants to do LIC, the left hand says you should go. I think sometimes unintended consequences go through. For example, I will tell you one consequence that I saw. So, I think there was a very high intention to simplify taxation for individuals, but I think the consequence of the change is that it has actually with become more complicated. So, imagine invention and outcome are sometimes different. So, I’m actually expecting some clarification in a few days. We have already started seeing it and more are coming because I have so many questions. This LRS, 5 percent TCS- is it applicable to NRIs transferring money from their accounts in India? Because the section says, ‘money transferred out of India’. It doesn’t specify who transfers. So, it doesn’t comment on the residency of the individual transferring, it only comments on the location of the account. So, that’s a question, does it apply to NRIs moving money out of their local accounts? So, I think all these questions will be answered.
I don’t think we have got as many queries as people living in Dubai, asking questions on the taxation.
It is the par for the course for every budget. Every budget produces some questions and then they get answered in the subsequent days and then you get some rollbacks also because the policy was intended to be like this and goes this way and then suddenly, then people realise that this is not what they should be doing. I think this is the problem of having so much secrecy around the budget. It’s not a problem that can be solved because you cannot take away that secrecy there, because after all, a few individuals are sitting and debating and they cannot see through all issues and then they get feedback and then the feedback sometimes is very legitimate and then some rollback happens. I don’t think it’s not something to make fun of. It’s actually good that you get rollbacks because that means people are listening to you. Legitimate things should be reversed if they’re not correct.
It happened two-and-a-half months after the first budget, let’s hope it happens soon.
I just have one final question- irrespective of what happens to individual sectors, we are all talking about some near-term stimulus being given to sectors which can revive
sentiment. Real estate was one, maybe autos thought there was something here and a few others. Now, something about near term stimulus given?
No, that’s what I said they have continued to stick to the path of reviving the investment cycle.
That will be the long-term theory. I am just saying, short-term. Anything done?
No, they have not done it. There is not a single measure to boost sops. The lowest hanging fruit was rural consumption. If you look at the pain there. If you look at the quarter gone by, if you compare discretionary spending- companies that are engaged in selling discretionary stuff versus staples, you see the stark difference. It tells you something about the underlying economy. So, the lowest hanging fruit in my view was not even real estate, was actually rural consumption, it also subserves the electorate compulsions- like going after farmers and giving them cash would not have been such a bad idea but the government has chosen to remain focused. Now, I’m surprised that we’re all criticising them for this because in the past, we have criticised them for doing the other thing.
So exactly, let’s give them their due where it is which is, they have continued to focus on fixing the structural problem. I will recap the numbers. In 2003. corporate investments to GDP was 4 percent, in 2011 the number was 17, last year that number finished in the fives. So, we have gone like this. That 5 needs to go to 10, how do you get in at 10? That is the main focus of this government, if you get it back to 10, GDP growth will go back to 7.
Will it take three quarters extra? It may. Is it money well spent? It is. So, I think in the meanwhile they will hope, fingers crossed, that the global economy doesn’t stumble because otherwise, the strategy will get questioned. So, if the global economy turns as we think it will, again assuming that the Coronavirus doesn’t inflate, then I think you will get some of this consumption back because export growth, very quickly feeds into income, very quickly feeds into consumption and also starts feeding into investments. So, there is a little bit of assumption here that the global economy is stable. So, we don’t know the success of this strategy. We will only know with the passage of time and if it doesn’t work out, we look back and say, ‘see they should have done consumption, they went for investments and failed’, right?
Your Sensex target is of 45,000, does the Budget change a thing?
No, nothing has changed. I am not reacting in a knee-jerk fashion, the market reaction was a little overdone on Saturday but as I said, India was outperforming emerging markets by about 300 basis points. That’s gone. Now we come to Monday morning and India’s performance is on par with EM to date. So, I think that’s because that’s where it should be. So, any expectation that the budget was going to immediately stimulate growth, is out of the window. But that doesn’t mean that growth is turning because let’s not forget, there are a lot of cumulative actions that are taking place and we got some additional action taken in this budget. I really think that long-term capital gains tax was such an easy and simple thing to do and it should have been done and that would have basically not caused this massive reversal in sentiment. Now, it will take a while for this sentiment to turn. So, as I said, you’ve done so much of effort to bring the sentiment and then it goes down. Now you start all over again. So, that’s the problem.