Budget strikes the right chord on reviving investment

July 15, 2014

(Any opinions expressed here are those of the author and not of Thomson Reuters)

Finance Minister Arun Jaitley (C) poses as he leaves his office to present the federal budget for the 2014/15 fiscal year, in New Delhi July 10, 2014. REUTERS/StringerPatient, consistent baseline play rather than aggressive serve and volley — that about sums up the Narendra Modi-led government’s maiden budget.

Those expecting big bang announcements were left disappointed as Finance Minister Arun Jaitley rattled off a long list of small steps on Thursday. But the government is on the right track as it sets about the task of boosting investment and sentiment.

Certainly, India has pulled itself out of the tight corner it was in a year ago and started to regain the trust of global investors. The proof — at 23 percent, the CNX Nifty’s returns in the six months to the Union Budget are the best among major global equity indices.

More importantly, the surge has been driven mainly by foreign institutional investors (FIIs), who pumped in $6.3 billion in the quarter ended June and continue to hold a substantial portion of the market. FIIs now own 22.6 percent of the CNX Nifty and 14.8 percent of the remaining stocks in the CNX 500 pack.

In for the long haul, one could say.

Budget 2014/15 sets the stage for a re-rating in earnings over the next two to three years with its focus on core sectors such as infrastructure, power and mining of coal and iron ore. Measures such as correction of the inverted duty structure for industrial raw materials and extension of deduction on investments in plant and machinery should help in resolving a few immediate bottlenecks.

Steps towards job creation and the personal income tax sops given out should put more money in the consumer’s wallet and help revive domestic demand.

Increasing the foreign direct investment (FDI) limits in insurance and defence and allowing FDI participation in smaller real Labourers work at the construction site of a multi-level parking in  Chandigarh July 10, 2014. REUTERS/Ajay Vermaestate projects are initiatives in the right direction, while the assurance that the taxation regime will be stable and predictive will help soothe frayed nerves.

As an open invitation to FIIs for setting up base in India, the finance minister cleared the air on a long-standing concern regarding the taxation of their holdings. Many FIIs operate from outside India fearing that their holdings might be classified as business income and thereby attract much higher tax than capital assets. The budget clarified that such holdings would be classified as capital assets and will get the corresponding tax treatment.

But are these measures good enough to enthuse the investor community?

Rebooting India is an ongoing task and the budget is yet another step in this direction. The world is awash with liquidity and any performing economy should be able to attract investment. If anything, the measures outlined in the budget only increase India’s attractiveness for emerging market investors.

At the one-year forward price to earnings (P/E) ratio of 15+, the Indian market’s valuations are definitely more expensive than those of other BRIC nations, but the relative attractiveness of Indian markets justifies the premium.

Also, knowledge intensive sectors such as IT and pharmaceuticals comprise 23-24 percent of the Indian blue-chip indices, whereas the contribution to these sectors is not more than 6-7 percent for other emerging economies.

As I mentioned in my earlier columns, we continue to expect IT, pharmaceuticals and financials to drive the earnings momentum within the Nifty pack. Core, cyclical sectors will participate in earnings only in two-three years. Until then, the risk-reward ratio remains tilted towards the former ones.

We can’t rule out any correction due to possible deficient monsoon rains or external risks such as high oil prices. Such a correction should provide a good opportunity for investment in fundamentally strong companies. While riding the India growth story, long-term investors can’t go very wrong by sticking to fundamentals.

There’s much left in this match. For now, it’s Advantage India.

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