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Jaitley’s ‘Reform Budget’ Refreshing Amid Global Turmoil: Adrian Mowat

This budget alone can’t drive Indian market higher as global worries weigh in, says JPMorgan AMC

Finance Minister Arun Jaitley’s fourth Union Budget was a reform budget with its focus on transparency, and widening the tax base, said Adrian Mowat, Chief Emerging Market and Asian Equity Strategist at JPMorgan. The thrust on housing and infrastructure is a positive outcome but not entirely unexpected, he added.

Going forward, he does not expect the budget alone to drive the Indian market higher as uncertainties around the Trump administration’s policies and their impact on the pharma and information technology sectors may play spoilsport.

Here are edited excerpts from that conversation.

What did you make of finance minister had presented today?

I saw the Budget today, and it was very refreshing in what seems to be a very difficult policy world. We have a reform budget continuing, we have a budget that’s about transparency, widening the tax base, consistency in orthodox policy. It is very encouraging in the world that we live in at the moment. There will be a general positive tone taken from this budget. Even though one doesn’t necessarily see a big revelation in tax rates, the focus on spending makes it a reassuring reform budget.

The fact that he is stuck to about 3.2 percent fiscal deficit, marginally slipped from the 3 percent target, is that a cause of concern? Has he pretty much toed the line?

I think the way people are looking at these numbers is there’s a lot of uncertainties around tax revenue. So there is an upside argument on tax revenue on with demonetisation, with the broadening of the tax base, that’s the upside surprise which allowed them to hit the 3.2 percent target. You can also argue in the other way. We’ve got a degree of uncertainty in the economy, courtesy of demonetisation. The corporate sector will be a little bit wary about capex; they have lost the trend in their business with the noise around demonetisation. It has also been preoccupying businessmen’s time, working on how to run a business without cash. We’ve got a delay now in the implementation of GST and I think businesses will be cautious around the implementation of GST because it will be difficult to determine a trend in terms of revenue, inventories etc.

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What about the market? How do you think the market will digest this from here on? Do you believe this has enough fuel to take the market higher?

I don’t think so because you’ve got good stories around housing and infrastructure. But these were already areas where the market had a preference with good reason. I am very bullish in the medium term on the housing market in India. The Indian housing story is much smaller than China this point. It is a similar sized population. You got the real estate reform Act, plus some of the measures taken in this budget, and I think the speed with which the housing industry develops will surprise on the upside but ways to participate in the market is still relatively limited – property developers, the building material stocks which we still like are at relatively high valuations point at this in time. If you are looking at the housing finance companies their market cap is small relative to the overall financial centre. So, I don’t think this budget in itself will drive a sustained move in the Indian markets. We are quite concerned about two very big sectors in the Indian market, healthcare and IT which are adversely affected by U.S. policy. We are underweight those two sectors and will require a change in U.S. as supposed to change in India to make us less cautious on these sectors.

Do you expect capital flows in this capital year to be enhanced? Will the Budget trigger higher capital flows into India?

I think flows into emerging markets will be better this year than last year. If we were having a conversation 12 months ago, EM equities were hitting new lows, commodity prices were falling. So capital outflow is a big feature of the first quarter. You then got a recovery in markets and some capital inflows beginning to come in in the third quarter. We started this year with investors positioned bearishly on emerging markets; we did see outflows post the U.S. election, then in the last couple of weeks we are beginning to see some inflows. If we do deliver double-digit earnings growth, which we are pretty confident of in the emerging world, the dollar isn’t as strong as people fear, capital will return, both to the equity and fixed income markets in emerging markets and India will benefit from its share.

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Is there anything else in this budget that makes you look favourably at some of the sectoral plays?

It reinforces our positive sector biases. We were long building materials, housing stocks going into the budget. It has come through in an attractive way. We tended to avoid consumer staples, as expensive defensives. You get a relief rally in this budget as it does not make much sense to change excise taxes just ahead of the implementation of GST, so there is a sense of relief that some sin taxes weren’t increased.

We have also seen the government announce borrowing much less than last year, much less than expectations at least. What do you think this would mean for the bond market and your own outlook for the government 10-year paper?

There are a number of factors that work here for the bond markets. We do need to be conscious that we are forecasting three interest rate increases in the U.S. We are forecasting U.S. long bonds will finish the year at 2.85. So there is an upward pressure on global yields because the major reserve currency is increasing interest rates. That said, the environment in the emerging world tends to still be one of very modest inflation, no need for policymakers to be raising rates. So one hopes that we might see slightly lower rates in some of the bigger EMs such as Brazil and Russia. There is some conflicting forces at work here. I don’t think that you will get a sustained reduction in the long-term interest rates in any of the emerging markets, because of what’s going on in the U.S.

What is that you expected to see this budget that didn’t come through?

Well, there were hopes for a lower corporate tax rates. It was smaller businesses that came through but not the larger ones. This roadmap has been talked about for a while – reducing corporate tax rates. So I think that would be the main thing I would focus on. Perhaps there is also a degree of relief that there was no change in capital gains tax which have been rumoured which will obviously would help market sentiment.

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