India’s Budget – Pro-Growth (and What That Means for Stocks and Bonds)

Ray Sharma-Ong,Investment Director

India’s government unveiled its new budget on Feb 1. It’s a strategy that seeks to boost economic growth through higher capital expenditure and investment spending, while balancing fiscal consolidation.

While other countries are looking to tighten purse strings, India wants higher fiscal spending to support growth, which languishes some way behind its pre-Covid trend. This will cause the investment landscape to evolve and we look at what this means for equities and bonds.

Higher spending and fiscal consolidation needn’t be contradictory. The government can achieve this by:

  • pushing for faster growth to offset higher spending and moderating the deficit-to-gross domestic product (GDP) ratio (the deficit is gap between revenues and spending);
  • being conservative with revenue estimates that leave room for surprise tax revenue gains

Given the government’s prioritization on growth, we see potential opportunities in equities and certain segments of the bond market.

While other countries are looking to tighten purse strings, India wants higher fiscal spending to support growth, which languishes some way behind its pre-Covid trend.

The long (and longer) case for Indian equities

India’s equity market rests on a solid foundation. For example, corporate earnings and economic growth are expected to outpace most other markets this year. (Chart 1).

Combine this with a strong pro-growth budget, with its emphasis on infrastructure investment, and we see corporate earnings that can sustainably outpace nominal GDP growth.

That’s why, on the equities valuation front, we see premiums holding up better than for regional peers, which will ensure that this cycle has further to run.

India chart one

Source: IBES, abrdn (as at 01/02/22)

*Projections are offered as opinion and are not reflective of potential performance. Projections are not guaranteed and actual events or results may differ materially.

The budget will have a direct impact on three sectors that make up about 50% of major Indian stock market indices – financials, industrials and materials.

  • Financials – Indian banks will benefit from a government-led capital expenditure push (which supports overall loan demand and an eventual normalisation of global and Indian rates which supports interest income).
  • Industrials and Materials – the infrastructure push, especially with respect to multimodal transport planning connectivity (Gati Shakti), will assist railways and highways construction. This will lead to increased demand for materials such as cement.

Beyond the direct impact, secondary effects will include a gradual pickup in consumption, as well as an increase in corporate and consumer credit demand as activity normalises.

Government set for more borrowing, more bond issuance

We see 10-year Indian Government Bond (IGB) yields gradually moving towards the 7% level, with the sovereign bond yield curve steepening (yields increasing more for longer maturities).

This is due to two reasons:

  1. The government’s intention to borrow more in bond markets, with a larger portion of the fiscal deficit funded through government borrowings (Table 1);
  2. International investors delay coming in to absorb the additional supply of government bonds. This is because the budget did not touch on anticipated changes to capital gains tax rules for Indian government bond investments. This uncertainty will likely delay the inclusion of Indian bonds in global bond indices.

We expect the Reserve Bank of India (RBI) to absorb the increase in bond issuance through more active open market operations (OMOs), in which the central bank buys and sells short-term securities in the debt market.

These OMOs will help keep sovereign bond yields (and the cost of debt capital for corporates) in check. They will also make the sovereign yield curve attractive to investors.

India table one

BE: Budget Estimates
RE: Revised Estimates
As of: 1 Feb 2023
Source: India Ministry of Finance, Government of India, abrdn

Rating agencies – a case of ‘wait-and-see’

One possible fly in the ointment would be a sovereign ratings downgrade. The international credit rating agencies may be tempted to downgrade India’s government bonds to junk, from BBB-1 , because of these planned increases in government spending. This is a move that would damage investor confidence in both bond and equity markets.

However, we don’t see that happening for now. The government has delivered a growth-focused budget while demonstrating fiscal prudence by guiding India’s fiscal deficit along its path towards -4.5% of GDP by financial year (FY) 2026. (Chart 2). As such, we see growth being sufficient to offset the higher spending in the near term.

Looking further ahead, spending on capital expenditure, infrastructure and investments, will help boost potential growth while helping to keep public debt under control. The RBI can also keep government borrowing costs in check when setting interest rates.

All this helps keep nominal GDP-growth higher than the interest rate on the government’s debt, further supporting debt dynamics. The government will get the flexibility to consolidate its deficit at a faster pace in FY 2024/25.

India chart 2

Source: Government of India, abrdn (as at 01/02/22)

*Projections are offered as opinion and are not reflective of potential performance. Projections are not guaranteed and actual events or results may differ materially.

What does this mean for you?

Equities – Positive outlook over short- and medium-term. We see investment opportunities in multimodal transport planning connectivity (Gati Shakti), housing (PMAY) and renewable energy. Active management opportunities can also be found in vehicle financiers, solar manufacturers and real estate developers. Indirect beneficiaries of policies include companies associated with paint, cement, household supplies and mortgage financing that often aren’t found in the major indices. Given India’s low correlation to most markets (Chart 3), we see its equities offering a diversifying role in portfolios.

India chart 3

Source: Bloomberg, MSCI, abrdn (as at 03/02/22)

*Projections are offered as opinion and are not reflective of potential performance. Projections are not guaranteed and actual events or results may differ materially.

Bonds – We see opportunities in sovereign bonds. As India Government Bond (IGB) 10-year yields rise (as this is where most of the borrowing from the Indian government will come from), there will be attractive ‘carry and roll’ opportunities (Chart 4) – capturing the difference between the yield and the cost of borrowing (carry) and the capital gains when the yield falls in line with time remaining until maturity (roll) – for IGBs with tenors of three to seven years. In addition, these shorter-maturity securities also benefit from supply scarcity.

We see this as an ideal environment in which active management can thrive. We advise exposure via active allocation, as we see significant opportunities for outperformance by selectively targeting the steepness observed at short to medium tenors, while avoiding the 10-year region of the yield curve.

India chart four

Source: Bloomberg, abrdn (as at 03/02/22)

Rupee – We are neutral and see the currency being stable. While there are some pressures, these are balanced by the pro-growth fiscal stance supporting flows, progressive news around the government-owned Life Insurance Corporation of India’s (LIC) initial public offering and favourable first-quarter seasonality.

We also see the RBI’s foreign exchange reserve playing a significant role. Currently at US$634 billion, this is equivalent to 13 months of imports. Having this reserve cover supports increased imports linked to growth, with the RBI stepping in to absorb and dampen currency volatility when needed.

1 Standard & Poor’s credit ratings are expressed as letter grades that range from “AAA” to “D” to communicate the agency’s opinion of relative level of credit risk. Ratings from ‘AA’ to ‘CCC’ may be modified by the addition of a plus (+) or minus (-) sign to show relative standing within the major rating categories. The investment grade category is a rating from AAA to BBB-

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RISK WARNING

The value of investments, and the income from them, can go down as well as up and you may get back less than the amount invested.