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Union budget provides capex push amidst fading covid; combination of ‘early cycle rise in interest rate’ and ‘nascent capex and profit cycle’ conducive for equities while high valuations a constraint

Progressive union budget to augment the investment cycle further – Union Budget FY23 was pro-growth by being expansionary and provided a counter-cyclical fiscal policy with focus on capex while ensuring inclusive developments with the FY22 fiscal deficit revised upwards to 6.9% from the earlier BE of 6.8% and FY 23 fiscal deficit pegged at 6.4% for FY23. Clear focus on medium to long term development with the blue print of Amrit Kaal.

Quality of spending continues to improve: There is a clear focus on improving the quality of spending with FY23 capex spend budgeted at Rs 7.5 trn (YoY growth of 35% over the FY22 BE of Rs 5.5tn) with emphasis on infrastructure development. Also for the current year (FY22), the capex has been revised upwards to Rs 6 tn which implies a very strong pick up in capex in the last quarter of FY22.

* Revenue expenditure for FY23 budgeted at Rs 31.9 tn is muted compared to 29.3 tn for FY22 BE and flat as compared to the RE for FY22 at Rs 31.7 tn.

* All the major subsidies will have lower allocations for FY23 as compared to the RE of FY22 (Fertiliser Rs 1 tn ; Food Rs 2.1 tn and Petroleum Rs 58 bn)

* Overall expenditure rises to Rs 39.4 tn in FY23 BE from Rs 34.8 tn in FY22BE.

Revenue receipt expectations appear credible -

* Overall revenue receipt expectations are modest with gross tax / GDP expected to remain constant at ~10.7% in FY23 or Rs 27.6 tn (Corporate tax Rs 7.2 tn, Income tax Rs 7 tn, customs Rs 2.1 tn, union excise duty Rs 3.35 tn and GST Rs 7.8 tn).

* Disinvestment target has been revised to a modest Rs 650 bn compared to the FY22BE of Rs 1.75 tn.

* Non-tax revenue (largely dividends and telecom receipts) is budgeted at a modest Rs2.7trn for FY23 against a FY22BE of Rs 2.4 trn

Higher gross market borrowing – Gross market borrowing for FY23 is expected to rise to Rs 14.95 tn as compared to Rs 12 tn in FY22 BE

Top picks and themes:

* Rising ‘investment rate’ including digital infra – L&T, NTPC, Power grid, Coal India, ONGC, Ultratech cement, Ashok Leyland, Bharti Airtel, Tata communications.

* Channelising savings, insurance and credit growth – SBI, HDFC Bank, Axis bank HDFC, SBI Life and ICICI Lombard general insurance.

* Pent-up demand (including real estate) – Tata Motors, TVS motors, Phoenix Mills and Greenpanel Industries.

* Exports & staples – Alkem, Dr. Reddy’s, Gujarat Fluorochemicals, Infosys, and Dabur

Early stage normalisation of interest rates accompanied by capex and profit cycle has not been negative for equities:

Empirical evidence suggests that the current trend of ‘normalisation’ of interest rates in an environment of rising investment and profit cycle has not negatively impacted stocks (for example the period between 2003-2008). On the other hand, rising interest rates and impending withdrawal of liquidity have negatively impacted stocks in a declining investment and profit cycle (2011-2013). Our observation is that the current environment for profit and investment cycle resembles the early stage of the 2003-08 cycle while the interest rate cycle has just started to turn from the bottom.

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