On 23 July 2024, Indian Finance Minister Nirmala Sitharaman presented the first full-year budget of NDA-3¹. The Budget 2024 aimed to set the stage for future reforms and outline a vision for the next five years. According to ICICI Prudential Asset Management Company (IPAMC)², the budget was a mixed bag. It met fiscal management goals and major expenditure targets but dampened sentiment slightly with capital gains tax announcements.

The budget hinted at future economic reforms to enhance productivity and efficiency, including digitalisation of government records, public service delivery, taxation, climate finance, and agriculture. Tariff rates on imports and exports were rationalised to improve India’s value-added manufacturing and exports. Infrastructure allocations remained unchanged, but the quality of expenditure improved, with increased focus on manufacturing, clean energy, and energy transition.

The budget also included details of an incentive scheme for first-time employees that may help 3 million jobseekers entering formal employment in manufacturing sectors for the first 4 years. An employer-focused scheme will also be put in place to incentivize additional job creation across all sectors. Meanwhile, the capital gains tax on short-term gains for selected financial assets rose from 15% to 20% and the tax on long-term gains for all financial and non-financial assets rose from 10% to 12.5%.

The government reaffirmed its commitment to fiscal consolidation, targeting a fiscal deficit of 4.5% by FY26 and improving FY25 guidance to 4.9%. Net borrowings of the government in FY25 are expected to be INR 11.6 tn.

Investment implications

Equities

According to Yuan Yiu Tsai, Portfolio Manager (Equities) at Eastspring Investments, the first budget from India’s coalition government reaffirms our view of policy continuity. In his view, the budget was well balanced across fiscal consolidation, capex spending and boosting consumption. Despite the negative surprise on the capital gains tax, the MSCI India Index recovered quickly from an intra-day low of -3%, potentially signaling a vote of confidence for India’s long-term growth narrative. as well as formalise the labour force over the medium-term.

Yuan Yiu welcomed the focus on employment, which has historically been one of the key challenges for the Indian economy. He believes that the new employment measures can help to create more jobs.

On the other hand, the increase in the capital gains tax rate for equities was a negative surprise, as it was not expected to be included in the current budget following the election outcome. However, Yuan Yiu believes that the increase is manageable when compared to 2018, when the long-term capital gains tax rose from 0% to 10%, causing an 8% market correction over 2 months. He does not expect the current increase to pose material headwinds to domestic flows.

Meanwhile, Yuan Yiu will be monitoring the property sector closely as the indexation benefit, which adjusts the purchase price of an asset for inflation to reduce taxable profits, was removed for real estate. Although the long-term capital gains tax on property sales was reduced from 20% to 12.5%, the removal of the indexation benefit can substantially increase the tax liability, especially on older homes. That said, Yuan Yiu believes that while the new measures may dampen investment demand on the premium housing segment, it should not affect the end-user/upgrader demand which has been the key driver of the current property upcycle.

Fixed income

Matthew Kok, Portfolio Manager (Fixed Income) at Eastspring Investments concurs that the budget was well conceived and welcomed the commitment towards fiscal consolidation. He notes that despite the increased budgeted expenditure of INR 500bn compared to the Interim Budget, the government retained market confidence through a lower-than-expected headline fiscal deficit number of 4.9%.

Matthew believes that the budget will be well-received by rating agencies like Standard & Poor’s, which upgraded India’s sovereign rating outlook to ‘positive’ from ‘stable’ in May. The agency has consistently highlighted India’s high fiscal deficit compared to similarly rated peers. A sovereign rating upgrade could trigger a rally in Indian Government Bonds (IGBs), as this positive move does not appear to be fully priced in yet.

Matthew notes that despite a lower fiscal deficit target, there was no significant reduction in FY25 borrowings, as most revisions were made through short-term Treasury-bills. The Reserve Bank of India appears to be consciously reducing short-term borrowing to extend the government's debt maturity profile. Consequently, the government debt and overall bond supply may not fall significantly beyond FY25.

The announcement of a higher bond switch amount, where shorter-term bonds are exchanged for longer-term bonds to reduce refinancing risks and smoothen the timing of bond repayments, implies that there will be more long-dated IGB issuances and less short-dated issuances than expected. This could cause some upward pressure on the long-end bond yields, particularly beyond the 10-year part of the curve. As such, we could see some steepening of the IGB curve over the coming months.

On balance, Matthew believes that the budget reinforces India’s robust economic fundamentals, creating a stable environment for IGB yields which is conducive for carry trades. Given the flat IGB curve and the relatively higher supply risk at the long end, he prefers the 5-to-10-year bonds.