Indian Budget: Growth Mindset to Offset Fiscal Constraints

- Vikram Kotak

Dear Friends,

Hope this letter finds you in great health and spirit.

Amid Global volatility, Covid challenges, Higher Crude prices, Crypto fluctuations and Inflation worries, the Indian Finance Minister presented a very simple but Visionary Budget that lays down a clear path on 2 aspects.

1) Big push on reviving investment cycle through large allocations and incentives.

2) Tax on Crypto and Digital Assets at flat 30% bringing them into tax net and also this will benefit asset class like equity which has net taxation of 12% if invested over 1 year.

Let me start with Investment Cycle first.

The Indian Economy has expanded over the last few years with big drivers like service growth and consumption growth. It was long due to revive the investment cycle which can add one more pillar to the Indian growth story. The Finance Minister has set many enablers like the Production Linked Incentive (PLI) scheme in many sectors such as Textile, Electronics, and Chemicals. More importantly, Corporate tax rate cut was also set to boost the investment cycle. There couldn’t have been a more opportune time than this to increase Capex allocation at the cost of little more deficits which in turn will go long way for the Indian Economy in creating more jobs and industries.
I believe it’s the best time to take such measures in light of the global development of deglobalization, where every country is looking to achieve a certain level of self- sufficiency.

To put the above mentioned thing in perspective, this budget aims at Capex of 3% of GDP compared to a historical average of 1.7% of GDP for the last many years. In the last 2 years, budgetary allocation towards capital spending has nearly doubled. I see the biggest benefit of this is more localization, more jobs, and finally higher GDP growth if this is implemented as per plan, and the biggest risk to this plan is timely execution.

Moving to tax on Cryptos and Digital Assets -

According to market estimates, around 15 million Indians are believed to have made investments in private Cryptocurrency Assets. Cryptocurrency Investments in the nation increased from $ 1 billion in April 2019 to almost upwards of $ 20 billion by the end of 2021.
Despite such large holdings, there are no Regulatory framework, Surveillance policies and Tax structure around Cryptos and Digital Assets. This was partly addressed by budget 2022.

Income from the transfer of any Virtual Digital Assets (including Cryptos) shall be taxed at the rate of 30%, with no deduction other than acquisition cost. Also, loss from the transfer of Virtual Digital Assets cannot be set off against any other income. The gift of a Virtual Digital Asset would also attract tax incidence. It will also attract TDS on payment made in relation to transaction of Virtual Digital Assets @ 1% of such consideration above a monetary threshold.

Higher tax rates, uncertainty, and price discovery around Crypto will discourage people from investing in these assets. It is a positive move to curb retail participation in the Crypto segment. I believe this will safeguard many naive investors to invest in Crypto without adequate knowledge.
The announcement of tax @ 30% on the Digital Asset, coupled with the government launching its own digital currency, is an indication that the government intends to regulate alternate Digital Currencies. n our opinion, this will add to more retail participation in equity markets as retail Indian Investors may shift their allocation of digital assets (tax heavy & ambiguous asset class) to equity assets (more regulated, transparent and attracts lower taxes).

The overall budget is not expansive, unlike the earlier ones but it focuses on building self-sufficiency in manufacturing and improved infrastructure.
Let me come to short -term risk to India’s growth story. It’s ferocious inflation across Commodity baskets. Over the last 2 years, US CPI is up by 3 times whereas 10-year US bonds are at the same levels. It’s not only about US, most of the developed world and country like India is likely to see higher inflation going forward.
How long will it last? The Fed has been printing dollars over the years and they accelerated printing in pandemic times (in last two years, they printed over $4 trillion). With rising inflation and threat of rising interest rates along with the Fed tapering, we can see knee jerk reactions in various financial markets across the world.

COMMODITIES BASKETS are getting more volatile on the back of supply-side challenges with no major investment in oil and commodities in the last few years. Post Covid, pent up demand explosion with low supply is hitting inflation hard. Also food prices are touching two decades high. With oil prices, hitting new high at $91 currently, it’s almost up 80% in last one year. It means India needs to spend additional $50-60 billion going forward. Once yield hardens in the developed world which is round the corner, we will see a big impact on fund flows in emerging markets too. FII owns almost $ 750 billion of Indian equities and they have been selling over the last few months with more intensity. Just to give you a feel, FIIs have been a net seller in 2021 to the tune of $ 7 billion in secondary market vs. an average inflow over $12-13 billion over the last decade.

We believe RBI will increase interest rates by 50bps or more in 2022. It will harden the yield in a year, where private sector credit growth is likely to improve and the government borrowings will stand at net 44% more than last year. This will lead to higher interest rates and can impact economic growth in short term.

While everyone is cautiously looking forward to see how the year turns out, we at AceLansdowne are focused on discipline investment approach in sync with the investment strategy.