FY2019 budget: Ability versus willingness to spend. We expect the government to show central fiscal deficit at 3.2% of GDP for FY2019, down from 3.4% for FY2018. It will likely project a strong pickup in indirect tax (GST) and divestment revenues to show higher infrastructure and rural spending. We do not expect any major changes to direct tax rates or capital gains tax regime. The next move in bond and equity markets will depend on greater visibility on the government’s fiscal position in about 2-3 months.
Government will project higher spending based on turnaround in GST revenues
We expect the government to show a significant increase in expenditure on infrastructure and rural economy in its FY2019 budget, matched by an increase in taxation revenues of 15%. We assume the government will show a 15% increase in indirect taxes, largely driven by its expectation of a pickup in GST revenues post the implementation of compliance systems (e-way bill system from February 2018 and invoice matching system sometime later). We model FY2019 central fiscal deficit at 3.2% versus 3.4% in FY2018.
No major changes in tax rates (direct or indirect) and capital gains tax
We do not expect the government to change corporate or income tax rates given the uncertainty around indirect tax revenues. It may increase the exemption limit for individuals by `50,000 in order to incentivize consumption and improve household sentiment. We would like to see the government announce a tax amnesty scheme for previous years for companies below a certain level of revenues in order to facilitate faster adoption of GST. Lastly, we doubt the government will change the capital gains tax regime for equities given (1) its negative impact on household savings and (2) its own large divestment program for FY2019.
Market will likely wait 2-3 months to assess the government’s fiscal situation
The bond and equity markets will likely wait for the expected turnaround in GST revenues over the next 2-3 months to assess the government’s fiscal position and borrowing program for FY2019 post the implementation of compliance systems. We expect a pickup in GST revenues but we could see further increase in bond yields and possible correction in equity multiples despite strong recovery in earnings in case GST revenues fall short of expectations.
The narrative of higher spending will also get tested if revenues disappoint
The equity market has pinned high hopes on increased government spending on housing and rural economy, which will drive consumption demand in FY2019. Stocks in housing, infrastructure and ‘rural’ sectors have jumped sharply in the past few months in anticipation of higher government spending and subsequent recovery in volumes, revenues and earnings. However, the government’s ability to spend will depend on its fiscal position. The market’s optimism may be belied if GST revenues were to fail to pick up meaningfully from current levels.
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