Changes in Personal Income tax may not boost consumption: Neelkanth Mishra, Credit Suisse

Neelkanth Mishra, Co-Head of Equity Strategy, Asia Pacific and Equity Strategist, India, Credit Suisse, talks about the Budget 2020, its impact on domestic and foreign investors, divestment target, LIC's IPO and DDT among others during an interview with Anil Singhvi, Managing Editor, Zee Business. Excerpts:

What is your view on Budget 2020, i.e. it was a good or bad or neutral? 
I think it is a neutral budget. However, before the budget presentation, there was a fear among people including me that the government in response to challenges the economy is facing, like low revenue and tax collection, can reduce its expenditure. If it happens then it will hurt the economic growth. It was a bit comforting to see that expenditure to GDP ratio of the central government has increased this year (FY20) as well as for next year (FY21). It can be achieved with some targets related to taxes, which is less aggressive. Probably this is a reason that the bond market has rewarded and the bond yield has come down. Besides, the government has budgeted certain non-tax recedes via disinvestment and telecom but it will have to make efforts to achieve it. It seems to be achievable. However, possibilities are there that it may not achieve it but saying that it can't achieve it at this juncture, is not the right thing. The budget would have caused huge damages but it didn't happen as the government has maintained the expenditure growth, which has reduced the headwinds to a great extent that the economic growth would have faced. Interestingly, the numbers are credible and transparent. People were asking to keep the tax numbers credible i.e. it should not be kept at unbelievable levels.

See Zee Business Live TV streaming below:

Besides, if you are borrowing something beyond the balance sheet/the budget, then it should be told/informed but last year, the government handed over the food subsidy bill to the Food Corporation of India but the information was made public. Because, when such information is out it gives a feeling that the government has been hiding something. However, this time, they have explicitly informed that 0.85%, i.e. around Rs1.70 lakh crore this year and Rs1.86 lakh crore next year, will be borrowed off-budget/off-balance sheet. I think this transparency has been liked by the bond market, as well.

As you offer your advice and research to the investors across the world, foreign institutional investors (FIIs). So, let us know about the thing that they have liked and disliked in this budget? 
Domestic investors have expectations from the budget and I usually use a term, 'Muscle Memory' to define it. Between 1991 and 2004-05, there was a trend in which a big reform was announced in every budget and that's why we sit every year with a hope that reform can be announced. But in the case of foreign investors - who have their eyes open to see what is happening - budget is a process that provides details of received money and the way it was spent and what can be the deficit. And if the deficit number goes as per the expectations then they will move ahead. However, this time there was an expectation that the finance minister in her speech may announce a big scheme to solve the problem associated with non-banking finance companies (NBFCs), power distribution companies (Discoms) and real estate sector. So, there were some expectations on these three things but it doesn't mean that such an announcement can't be made. They can intervene in these segments later. So, I don't think that it will disappoint them a lot. There are certain things like an increase in the deposit insurance coverage of the banks, which would harm big banks but can benefit the smaller ones because they are safer now and depositors will feel safe over there. Similarly, the duty change on a cigarette will have an impact on certain companies. Likewise, if import duty is increased on fan and mixer grinder then the companies that make fan and mixer grinder will be benefitted. Thus there are slight changes but overall, this budget is a neutral budget for foreign investors.

The government has announced its plans to raise Rs2.10 lakh crore through divestment, where foreign investors will play an important role. Do you think that the government will be able to meet the target, if yes, then how? What is your view on the divestment/IPO of LIC?
LIC's IPO is essential to meet the divestment target of Rs2.10 lakh crore. How the government spends? It takes tax from someone and then spends it on someone. I have said that the expenditure to GDP ratio is increasing in FY21 as well then where the money is coming from? If you are collected tax from someone and then spend it then it will have minimal impact on the growth but if the government is spending after offloading its assets then, it is termed as counter-cyclical buffer. This is a process in which you are reviving the economy by spending the money that is raised by selling your assets. So, they have a thrust on non-tax resources for FY21, which is essential, so it has a macro-background.

As far as LIC's IPO is concerned and the government will be able to do it or not then I would like to say that this is a stretched target because the company is very big and you will take several months to make it ready for the IPO. The investment bankers who will be appointed will have to make the company ready for it and in the process, they will have to correct the disclosure norms of the insurance company. Before this, there is a need to turn LIC into a company which will require legislative changes and it will have to face opposition and several unions will also oppose the proposal. This is a bug policy statement and shows the government's resolve that it can take tuff decisions as the company with an asset size of 36-40 lakh crore can be a cash cow for the entire establishment. It will benefit several people. Listing it will need disclosure like today they present an annual report but post listing they will have to explain in a quarter. Improvement in disclosures will end the benefit of those who are reaping its benefits. Thus it is a big policy initiative. Possibly it may happen in 12 months or may not. But the fact is that it was announced and the government is increasing its expenditure through this sale. These two things are positive steps. 

Do you think that the changes introduced in the personal income tax for people with income up to Rs15 lakh will give a boost to consumption? 
I don't think so because our economy has grown a lot and currently stands around Rs220 trillion (about $3.1 trillion). If you provide a stimulus of Rs35-40 thousand crore to a $3.1 trillion economy them it won't affect a lot. It is a huge amount and keeping it below Rs1-1.50 lakh crore will not have any broad impact on the economy. If you are providing a tax cut at a time when there is a slowdown and the sentiments are not healthy then it acts as an incentive to save. The consumption boost will come only if they will move out and spend it. I don't think that it will give a consumption stimulus. Considering the size of the economy, I don't think that it will have a big impact even if it happens.

Government decisions also have an impact on state budgets. A huge amount of taxes reaches to the central government in the form of surcharges, which is not shared with states. The revised numbers of budget FY20 is showing a shortfall of Rs 3 lakh crore in the gross tax collection out of which Rs1.50 lakh crore will be borne by the state governments. When it comes to the ratio of sharing that is provided to the state government's has come down to 30-31% from 38-40%. It would have happened due to the pattern of calculation in GST, which is a bit different, but it has increased the pressure on the states. For instance, 30% of the revenue collected through income tax is shared by the state government but the surcharge is not shared. Interestingly, the taxes have gone up due to an increase in surcharges, which is not passed on to the states. This is why we hear stories that the government is not paying to the suppliers or their payments are getting delayed and we are anchored that it is happening from Delhi, i.e. the centre. But the reality is that the maximum of the suppliers has to deal with the state governments, who collectively spend 90% more than the central government. Therefore, their fiscal pressure is quite high still and their borrowings are fixed in October and any tax shortfall will lead to expenditure cut for them. I fear that the salaries of people in several states can be postponed until April, which will hurt the economy. But, there is no easy solution to it.

The government has eliminated the Dividend Distribution Tax (DDT) that is levied on companies. Should we consider it as a positive move or is negative as people will have to pay higher tax even on dividends?
This is a good question because it exemplifies the saying, 'There is No Free Lunch', this means that they will find the way to get the money. Thus, you were taxing the companies at 20-21% will move to people who fall under 30% tax and he/she will have to pay the effective tax rate. It may benefit the foreign investors but it is hard to say the same for the domestic investors because it will have a neutral impact on them.

How will the American Election and China's current situation affect Indian Market, if we have a collective view on the budget and the global market?
The headline industry like Nifty and Sensex will be supported. Amid US elections, the American government will adopt the easing path policy. It is a big economy and that's why its impact will be felt across the economies of the rest of the world. Secondly, it will be supportive for the markets and that's why if I have an outlook of 12 months then there is no stress on the Nifty and Sensex. However, a problem has surfaced where people are raising questions on demand in China like people are not going for a movie or having lunch/dinner outside or are not booking airline/train services, but there is no discussion on production. Analysis of China's GDP - which is one-sixth (about 15%) of the world's GDP - has been done. But a lot of discussions related to production hasn't been done and the fact is that 31% of the world's manufacturing happens in China and in the last 10-15 years the global supply chain has turned efficient that people have stopped keeping inventories for more than 2-4 weeks.

However, the production shut down in China due to Chinese New year has extended by 1 week from February 2, 2020, to February 9, 2020, maybe extended further because the number of deaths is going up. Such an extension can lead to a shortage in supply chain and I feel this uncertainty will continue for the next few weeks. The virus impact may come down with an increase in temperature. Strong efforts have been taken across the world. It's not a permanent problem but there will be uncertainty in the short term but if we talk about 12 months from now the Nifty, Sensex will be good.

The biggest question is what will happen to the small midcaps and when will the risk appetite start entering the market. As you must have seen in January that the small midcaps industries had performed better than Nifty. We have observed that from 7 out of 8 years mid-caps and small caps index had beat the Nifty and then they "give up" the outperformance in February. And, I think it will happen this time also. I think being risk-averse is the best thing to do until the economy doesn't recover sustainably.  

What is your model portfolio and will you make any changes in them after this budget?
I think interest rates should come down before growth recovery. You will not be able to recover by keeping the interest rate at 12% for the borrowers at a time when your nominal GDP which used to be 13-14% has gone down to 11-12% and has reached now to 8%. Therefore interest rates will come down and that's why rates sensitive have been kept on overweight. Few well-capitalised banks have underperformed after the results, therefore we are still overweight on them because we have a feeling that money will come to the market but the economy will not recover and people will stick to the same stocks. At the same time, you can see that the revenue growth rate of several consumer companies has gone down to 2-3% but their stocks are doing well because they are adopting the safety first-approach. So, our portfolio is focusing on safety like private banks and utilities. We are underweight on consumer discretionary as if there is no growth recovery in the economy or there is a delay then the car manufacturers and other discretionary will be at a loss. Similarly, some of the energy companies will also face losses. When it comes to cement companies then their prices are too high, therefore we are underweight on them.

Do you think that the fundamentals of the insurance sector have gone weak or they will not get the valuations that they were getting earlier? 
Financial savings behaviour doesn't change rapidly. I think that the quantum of financial savings is increasing, which means people will have money in their hands and they are saving just because real estate prices are too high and also because the consumption sentiments are low. Thus, financial savings will be available and it depends on the allocations. I feel a huge amount of money comes from the higher-income bracket so it should not have any direct effect.

As the government has given us their agenda and informed us that in the next 3-4 years, the exemptions will be abolished, which means it will have an impact on multiples and it is visible. But we will remain invested in the insurance sector due to its penetration. The expected derating has happened but the fundamentals of the business are intact. Interestingly, the expensive sector has turned a little cheap, which means one can buy.