Dismal earnings return to haunt market as Budget 2015 offers nothing much to cheer

Legend has it that in 1972 when Chinese premier Zhou Enlai was asked about the impact of the French revolution on Western civilization, he replied: “It is too early to say”.

That response could hold true for what the stock market thinks about the Modi government’s first full-year Budget.

The lavish praises heaped on the Finance Minister by market gurus aside, the market in general appears a little confused by the Budget. It may have been much better than the interim Budget of July, but still lacked the two or three sentiment-boosting announcements that the market was hoping for.

Foreign institutional investors have reasons to be happy though.

The General Anti-Avoidance Rule (relating to abuse of Double Taxation Avoidance Agreement) has been deferred to by two years and will be applicable prospectively, the finance minister has clarified that the Minimum Alternate Tax will not be applicable on FIIs, and also offshore fund managers can set up office in India without any adverse tax consequences.

Keeping FIIs in good humour is crucial to the Finance Minister’s plan to raise Rs 70,000 crore by way of stake sales in public sector firms in the coming fiscal.

The positives for the market are the government’s efforts at a more predictable tax regime for industry and investors, measures to plug subsidy leakage, and increased spending on infrastructure.

There are no outright negatives from the stock market’s perspective, but some niggling worries remain.

For instance, the reduction in corporate tax will be simultaneously accompanied by a phased elimination of tax exemptions. In addition, companies to will be subject to the 2 percent surcharge on income above Rs 1 crore. Tax experts feel the removal of exemptions means some companies may end up with a tax rate higher than MAT. Good news for the government’s coffers. But how will India Inc react to it as it decodes the proposals over the next few days? That will have a bearing on sentiment.

The hike in freight rates in the Rail Budget last week was criticised by a section of the industry as being a hurdle to the Make in India project by pushing up logistics cost.

Noted industrialist Adi Godrej feels the Union Budget has done little to boost the manufacturing sector, while it does have other positives.

The increase in service tax and no hike in tax exemption limits for individuals too is a negative from the market perspective as it is seen dampening consumer sentiment.

JP Morgan economist Jahangir Aziz has said the government’s increasing reliance on indirect taxes like service, customs, excise, rather than direct taxes, to maximise revenues is a disturbing trend.

Higher spending on infrastructure is music to the market’s ears. The good thing is that investments stuck in stalled projects as a proportion of the GDP has not risen in the last three quarters.

But the government’s stated aim to boost infrastructure spend will also depend on how swiftly it is able to track issues relating to land and environment clearances, and reworking Public Private Partnership (PPP) contract rules to attract more private partnership.

Jaitley has said the 3 percent fiscal deficit target has been extended by a year, else public spending would have had to be curtailed, which in turn could delay the economic recovery.

However, some like economists Swaminathan Aiyar and ex-FM P Chidambaram have pointed out that the higher fiscal deficit is also to meet non-investment expenditures like salaries and interest payments.

The Budget has got a lukewarm response from rating agency Moody’s, which said that the Budget measures did not change its view on India’s credit profile either way.

But more important will be what the RBI thinks of the Finance Minister’s attempt to juggle fiscal consolidation and growth.

An out-of-turn cut in benchmark interest rates before the next credit policy on 7 April would mean the RBI is convinced about the government’s fiscal consolidation measures. And that good will be a big sentiment booster.

Until such time, the focus could shift back to corporate earnings. The December quarter numbers were dismal and things won’t improve much at least for the next couple of quarters, say analysts. Some analysts have already started marking down their earnings estimates for FY16. That makes Indian shares look expensive in the near term, though many fund managers feel they are not unreasonable in the context of a recovering economy.

The Budget may have plenty of positives from a 12-month perspective, but it will no longer be a talking point for the market beyond the next couple of weeks.