Our take on the Atmanirbhar Bharat package

By Morningstar Analysts |  20-05-20 | 

The government announced a fiscal package to provide relief to various segments and support the Indian economy’s fight against covid-19. With the announcement of the Atmanirbhar Bharat package, the government has tried to balance between immediate relief measures and structural reforms in various sectors. Although the details of the INR 20 lakh crores (~10% of GDP) package, which followed in five tranches, shows that the tilt is more towards providing credit/liquidity facility and medium-to-long term spending/reforms, rather than the much needed direct stimulus spending to revive consumption.

A host of the measures announced are focused on farmers, lower segment of the society, MSMEs, and the rural sector. Steps already announced, such as supplying food grains, gas cylinders, cash transfer, will provide some immediate respite to the poor, including migrants and farmers. The farm sector will be injected with additional liquidity via emergency working capital and Kisan credit card scheme. Much of this is dependent on how well small and marginal farmers are able to utilize additional credit. Increased allocation for MGNREGS will provide immediate employment boost to migrants and laborers. This should have a positive impact on rural consumption demand. EPF support to business and workers will provide some immediate relief.

Measures announced for the Medium Small and Micro Enterprises (MSMEs) will significantly improve the availability of credit. A 100% credit guarantee cover to banks and NBFCs on principal and interest should incentivize them to lend, but credit demand by MSMEs may see a muted response as the outlook for business activity remains weak. Loans will have a moratorium of twelve months on principal repayment, although the interest burden would increase. The revised definition of MSMEs to benefit setups from a long-term perspective.

The government also announced a special liquidity scheme for NBFCs/HFCs/MFIs as they are finding it difficult to raise money in the debt markets. Under this scheme, the investment will be made in both primary and secondary market transactions in investment-grade debt papers. This, along with Partial Credit Guarantee Scheme 2.0 for NBFCs/HFCs/MFIs, will ease concerns on the supply side, i.e. availability of credit. These measures will provide liquidity support and help in easing current stress in the NBFC space. RBI has also announced various measures to provide adequate liquidity to the banking system. Despite the combined efforts of the government and the RBI, risk-averse sentiment prevails, and banks continue to park chunk of money with RBI. From the credit demand side, businesses and individuals would be less keen on utilizing credit facility amid poor economic and business outlook.

Liquidity injection for DISCOMs should help in reducing the financial stress and improve distribution efficiency. Housing sector boost via an extension (up to March 2021 from March 2020) of Credit linked subsidy scheme (CLSS) under the Pradhan Mantri Awas Yojna (Affordable housing scheme) may not deliver desired results as the demand for residential projects could see a major hit.

Private sector participation in the coal and mineral sectors will improve efficiency and reduce import dependency. FDI limit in the defence manufacturing under automatic route will be raised from 49% to 74%. This should help in bringing down defence import bill over the long term.

The government is working on the next phase of Ease of Doing Business reforms relating to easy registration of property, fast disposal of commercial disputes, and simpler tax regime for making India one of the easiest places to do business. The government should act soon on this front as India could benefit from global manufacturers shifting hubs away from China/South Korea.

The government announced suspension of fresh initiation of insolvency proceedings under IBC up to one year, depending upon the pandemic situation. The central government will exclude the covid-19 related debt from the definition of ‘default’ under IBC to trigger insolvency proceedings. This should provide some relief in the current stressed market conditions.

The government will work towards the Privatization of PSEs in non-strategic sectors. The number of enterprises in strategic sectors will be only one to four, and others will be privatized/ merged/ brought under holding companies. This would help the government in consolidating PSEs, release capital, and improve overall efficiency.

Other schemes such as Agri infrastructure fund, micro food enterprises, Pradhan Mantri Matsya Sampada Yojana (PMMSY), Animal Husbandry Infrastructure Development Fund, extension of ESIC coverage and few others – are long drawn in nature and may not help on an immediate basis as a direct fiscal boost.

State net borrowing limits increased to 5% from 3% for FY2020-21. States have so far borrowed only 14% of the limit, whereas 86% of the authorized borrowing remains unutilized. The borrowing will be linked to specific reforms – universalisation of ‘One Nation One Ration card’, Ease of doing business, Power distribution and Urban local body revenues. Given that states usually borrow heavily in the later part of the year, we may see SDL spreads widening with the increased borrowing.

Fiscal budget at a glance – Tax revenue would see a significant shortfall in Q1 FY21 with muted business activity in Q1 FY21. Non-tax revenue could also see low realization – dependent on Air India, privatization of IDBI bank and LIC stake sale. Telecom spectrum dues may also be lower than budgeted. Petrol and diesel excise duty hike should fill in some gap. The government will be much more selective with budgetary spendings; particularly, capital expenditure may see a drop with the announcement of measures to fight against covid-19. The government has already announced additional market borrowing as one of the means to finance the fiscal gap. There may be further additional borrowing via dated securities or short-term instruments if the revenue collection worsens in the coming months. Market estimates suggests fiscal deficit to be in the range of 7%- 8% of GDP for FY2020-21.

The package announced has got a limited impact on boosting consumption demand in the short term. Market estimates suggests that the direct impact of reforms comes to around just 1% of GDP. To a large extent, the measures announced do not address the current stress in sectors such as hospitality, aviation, tourism, autos, real estate, etc. The reform measures announced would have a positive impact over the coming years, but the near term support largely remains unaddressed.

How Are We Positioned?

When markets are moving steadily higher, participants often take a long-term perspective to justify investment decisions. However, when markets tumble, the opposite is often true—they focus on the very short-term instead of the next decade. We remain focused on assessing market attractiveness across asset classes over the next ten years. The global growth slowdown amid the covid-19 outbreak casts doubt on the Indian growth story in the near term. However, over the medium to long term, productive capacity should return, reviving economic growth. Accordingly, our estimated 10-year valuation implied return is driven by a suitably strong trend growth and improving earnings for the Indian markets.

We at Morningstar follow a well-reasoned and principled framework for investing with one of our seven investment principles being ‘we’re valuation-driven investors.’

In the last couple of months, the portfolios underwent a major rebalancing activity. We decided to add equities with excess cash and debt to allow us to take advantage of better opportunities as equity market valuations saw improvement. We continue to review the markets, and our valuation implied return forecasts. Across all four portfolios, we are now slightly overweight domestic Large- cap equity, and our underweight position in domestic Mid and Small-cap equities is narrowed further with improving valuation-implied return forecasts.

On the international equity front, we have made adjustments via rebalancing weights to keep the allocation in line with the target. Based on our valuation-driven asset allocation approach, we are underweight U.S. equities as compared to our neutral or benchmark weight as U.S. equities continue to rank amongst our least favored country/region, due to high valuations on the back of a strong bull run over the last ten years up to 2019. Europe and Asia ex-Japan are relatively more attractive than U.S. equities, and we continue to remain overweight in Europe and Asia ex-Japan as compared to our benchmark allocation.

On the fixed-income side, we continue to favor medium-long term debt over cash and short-term debt as the real rates remain relatively attractive. Lately, corporate bond spreads have widened and are trading significantly above their long-term averages (+2 std. deviation from the historical mean) – reflecting a risk-averse sentiment despite adequate liquidity in the banking system. The risk premia across rating profile, (including AAA-rated issuers) increased amid weak business outlook and deteriorating willingness to lend to corporate borrowers. This, along with strong redemption pressure from mutual fund investors amid a flight to safety, led to a further rise in spreads. Although liquidity support announced by RBI and the government should improve the market sentiment. We are evaluating the credit segment, particularly the AAA and AA corporate bonds, given high credit spreads.

In this unique economic situation, we are actively reviewing our views across asset classes and portfolio positioning.

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