Staying focused on Quality

Union Budget FY21

The initial negative market reaction to the budget was more to do with unrealistic expectations than any negatives in the budget itself. As we argued last year, the impact of the budget on earnings and the market has diminished over time. The lack of fiscal space limits the scope of “game-changing” fiscal announcement, despite the hopes that are inevitably built up. Moreover, decisions on domestic indirect taxes have moved to the GST council, further diluting the importance of the budget. 

There were some positives that came through. The creative plan to divest existing roads by NHAI to create funding room for new road construction should help keep the momentum going. Also, the fact that FY20 gross borrowings were kept unchanged, along with manageable dated securities borrowing in FY21 cheered the bond markets. The focus on attracting foreign investment into the equity and bond markets via measures like DDT abolition, higher caps, and extension of the withholding tax concessions is the other major positive theme for the budget.

Some worries, however, persist. The revenue assumptions for FY21 are once again optimistic – both the gross tax revenue growth of 12% y/y and the Rs 2.1 trillion disinvestment target. The targets assume a tax buoyancy of 1.2x, which is higher than the average of 1.1x seen in the last five years. Any disappointment here will lead to cutbacks in expenditure in 4^th Quarter, a pattern observed for the last few years. Continued constraints on government spending are likely to prolong the growth downturn. 

No silver bullets

The absence of a stimulus for real estate and power also disappointed the market. There is a case of unrealistic expectations here. There are no silver bullets to solve the issues surrounding these sectors. Any heavy government intervention would create long-term issues of moral hazard, as it would be perceived as a bailout. Also, fiscal constraints limit the options. We remain skeptical of a broad-based recovery in the investment cycle for precisely this reason – the stress in real estate and parts of infrastructure will take some time to resolve.

Consumption recovery

The good news, however, is that a soft consumption recovery is underway. This is led by a favorable base, lower interest rates and a recovery in rural demand, given the good monsoon. We are not expecting a full-blown recovery as the cutback in government spending in 4QFY20 and the muted investment cycle continue to create an overhang. The growth numbers, however, should look better than the dismal prints of CY19.

Focused on quality

Against this backdrop, we continue to focus on quality stocks for our portfolio. The macro slowdown has been accompanied by market share concentration towards players with strong execution capabilities, coupled with fortress balance sheets. This is a recurring theme across multiple segments like financial services, retail and FMCG. Valuations are challenging for some of these companies, but we believe that the sustainability of growth is a more important driver than absolute valuations.