IN THIS EDITION

 
     
 

 

 
     
 

 

 
     
 

 
 

The Union Budget for FY2018, on expected lines, has focused on the rural, agricultural, infrastructure and the MSME sector, while maintaining tight control on expenditure outlays. The slippage in fiscal deficit was expected, given the revenue disruption following structural changes such as the introduction of the Goods and Services Tax (GST). As a result, the Government now aims to pare its fiscal deficit to GDP ratio to 3.3% in FY2019 from 3.5% in FY2018. Post-GST there have been no new indirect taxes but customs duty has increased on several items, which is expected to boost local manufacturing. However, the manner in which many of the ambitious schemes are proposed to be funded is unclear and concerns on further fiscal slippage has pushed up bond yields, which is likely to impact corporate borrowing costs significantly.

Post budget, the Monetary Policy Committee (MPC), as expected, has left the repo rate unchanged at 6.0%, retained the neutral stance of the policy and reiterated the commitment towards achieving the medium-term inflation target of 4%. The MPC appears to have looked through the impact of the revision in house rent allowance (HRA) for Central Government employees on the recent uptick in the CPI inflation to 5.2% in December 2017. Moreover, the presence of mitigants, such as subdued capacity utilisation, moderate rural wage growth and the possibility of crude oil prices receding from the current levels, supported the MPC’s decision to maintain rates and persist with the neutral stance. Overall, the tone of the policy outlook was less hawkish than what the markets had started to fear. The caution regarding the need for vigilance around the evolving inflation scenario, clouded by upside risks, was counter-balanced by the emphasis on nurturing the nascent recovery through conducive and stable macro-financial management.

We also take a look at the impact of the budget on key infrastructure sectors. The Union Budget 2018-19 increased the capital outlay towards the infrastructure sector by 20.8% to Rs. 5.97 lakh crore with major capital expenditure allocated for transportation (Railways and Roads), telecommunication and affordable housing. A special focus this year has been on rural infrastructure through development of rural roads, houses, sanitation, irrigation and water supply infrastructure, which is expected to boost the rural economy. The budget also provided direction on the long-term projects being undertaken under the Smart Cities Mission and the AMRUT programme.

Finally, Insight also reflects on the Government of India’s (GoI)’s recently annouced bank-wise capital allocation under its Rs. 2.11-lakh crore bank recapitalisation programme. The decision to infuse capital into PSBs reiterates the GoI’s comittment to support all the PSBs to meet regulatory capital ratios and the capital infusion plans, which are expected to be sufficient for most of the PSBs to meet the regulatory capital ratios under the Basel III regulations. The recapitalisation will enable banks to reduce the net NPAs and improve capital ratios, going foreword.

The issue concludes with the regular features: monthly rating updates, upcoming ICRA events, and news features related to the company.

I hope you will find this newsletter useful and informative.

Best Regards

Anjan Ghosh
Chief Rating Officer, ICRA Ltd

 
 
 
 
     
  Tone of monetary policy less hawkish than feared  
 

In line with our expectations, the Monetary Policy Committee (MPC) left the repo rate unchanged at 6.0%, retained the neutral stance of the Monetary Policy and reiterated the commitment towards achieving the medium-term inflation target of 4%. As anticipated, the decision to keep the repo rate unchanged was not unanimous, with one MPC member voting for a hike of 25 bps.

In maintaining status quo, the MPC appears to have looked through the impact of the revision in house rent allowance (HRA) for Central Government employees on the recent uptick in the CPI inflation to 5.2% in December 2017. Moreover, the presence of mitigants, such as subdued capacity utilisation, moderate rural wage growth and the possibility of crude oil prices receding from the current levels, supported the MPC’s decision to maintain rates and persist with the neutral stance.

Based on these risks, the MPC revised its inflation estimate for Q4 FY2018 (including the HRA impact) to 5.1%, above its earlier forecast of 4.3-4.7% for H2 FY2018. Moreover, it expects the CPI inflation to harden to 5.1-5.6% in H1 FY2019, followed by a moderation to 4.5-4.6% in H2 FY2019, albeit with risks tilted to the upside. Notably, these forecasts entail an appreciable uptick, relative to the estimated average CPI inflation of around 3.6% for FY2018.

The MPC mildly revised its baseline expectation for GVA growth for FY2018 to 6.6% from 6.7%. It pegged the GVA growth forecast for FY2019 at 7.2% with risks evenly balanced, with an anticipated easing from 7.3-7.4% in H1 FY2019 to 7.1-7.2% in H2 FY2019. It attributed the improvement in FY2019 GVA growth to factors such as the stabilisation of the economy after transition to the GST; signs of a nascent investment revival; the ongoing recapitalisation of public sector banks and the prospect of rising exports on the back of an improving global economy.

Overall, the tone of the policy outlook was less hawkish than what the markets had started to fear. The caution regarding the need for vigilance around the evolving inflation scenario, clouded by upside risks, was counterbalanced by the emphasis on nurturing the nascent recovery through conducive and stable macro-financial management. This suggests that the MPC would prefer to wait for additional data on the extent to which the upside risks to inflation materialise. Therefore, it is unlikely to hike rates in the immediate term, in our view. However, if the CPI inflation exceeds the MPC's forecast in a sustained manner, a rate hike towards the second half of 2018 may not be ruled out.

 
     
  Infrastructure sector gets major budgetary support  
 

The Union Budget 2018-19 has significantly increased the capital outlay towards the infrastructure sector by 20.8% to Rs. 5.97 lakh crore with major capital expenditure allocated for transportation, telecommunication and affordable housing. The Railways and the Roads sectors are the key focus areas contributing over 45% of the total infrastructure capital outlay. While the capital outlay for the Railways has been budgeted to increase by 22.1% and that for roads and bridges has been budgeted to increase by 10.2%. The budget has also sharply increased the outlay for housing and urban development by 57% with the increase coming from higher expenditure under the Pradhan Mantri Awas Yojna (Urban). Higher allocation has also been provided for irrigation projects under the Pradhan Mantri Krishi Sinchai Yojna (PMKSY) which is up by 27.5% to Rs. 9,429 crore. Under this Rs. 6,000 crore is to be spent on 48 irrigation projects under the Accelerated Irrigation Benefits Programme (AIBP) and command area development. For strengthening the corporate bonds market, the Government, along with the regulators, will look at allowing investment in corporate bonds with a credit rating of A and above from the current rating threshold of AA and above. The impact of these announcements is largely expected to be positive for the infrastructure sector and will also provide opportunities for construction, and capital goods sectors.

While the capital outlay has been increased significantly, the budgetary allocations for many Infrastructure sectors are only marginally higher, thereby increasing the dependence on Internal and Extra Budgetary Resources (IEBR). The total budgetary allocations (including PBFF, CRF and GBS) to fund the ambitious new highway development programme (including Bharatmala) is estimated at Rs. 3,43,045 crore over FY2019-FY2022. Therefore, starting this budget, the allocations to the road ministry was expected to increase substantially; however, the increase in budgetary allocation (excluding PMGSY) has been moderate from Rs. 61,000 crore in FY2018RE (Rs. 64,900 crore in FY2018BE) to Rs. 71,000 crore in FY19BE. This will result in increased dependence on IEBR. For Bharatmala, the NHAI is expected to raise funds by monetising more assets through the toll-operate-transfer and Infrastructure Investment Trust routes (by transferring mature assets to SPVs). Similarly, budgetary allocations for the Railways are increased to Rs. 53,060 crore for FY2019BE in comparison to Rs. 40,000 cr during FY2018RE; however, these are lower than last year’s budget (Rs. 55,000 cr in FY18BE).

Besides increased capital outlay on Railways and Roads, the special focus of this budget has been on rural infrastructure through development of rural roads, houses, sanitation, irrigation and water supply infrastructure, which will provide a significant boost to the rural economy. The budget’s emphasis on the completion of ongoing high priority irrigation projects by increasing allocation under the PMKSY-AIBP also augurs well for the irrigation sector.

The budget also provided direction on the long-term projects being undertaken under the Smart Cities Mission and the AMRUT programme. So far, out of 100 cities planned for upgradation under the Smart Cities Mission, 99 cities have been selected. This programme will involve a total capital outlay of Rs. 2.04 lakh crore (projects worth Rs. 2,350 crore completed and work on Rs. 20,852 crore worth projects is under progress). Similarly, under the AMRUT programme, state-level plans for providing water supply in 500 cities with capex of Rs. 77,640 crore have been approved.

A deepening of the corporate bond markets is required to support long-term infrastructure financing, especially given the twin challenges faced by commercial banks - asset-liability management and increasing share of stressed assets. Relaxation of the rating threshold (from AA to A) is a positive as it would enable domestic insurance companies and pension funds to invest in corporate bonds, including those issued by the infrastructure sector.

 
     
  Banks recapitalisation will address PSBs capital requirements  
 

The Government of India (GoI), has recently annouced the bank-wise capital allocation under its Rs. 2.11 lakh crore bank recapitalisation pogramme. It has announced a bank-wise allocation of Rs 88,139 crore of capital (of which Rs 80,000 crore is recapitalisation bonds and Rs 8,139 crore is budgetary allocation).

The GoI has confirmed that the recapitalisation bonds will not have a Statutory Liquidity Ratio (SLR) status, but for a tenure of 10-15 years, the coupon on these bonds will be based on the average G-sec yields for the last three months with some spread.

The decision to infuse capital into PSBs reiterates GoI’s comittment to support all the PSBs to meet regulatory capital ratios and the capital infusion plans are expected to be sufficient for most of the PSBs to meet the regulatory capital ratios under Basel III regulations

As per ICRA’s estimates , the current capital allocation is based on the capital ratios and the NPA levels of individual banks and ability of these banks to absorb credit losses from their operations. While certain weaker banks have received much higher capital in relation to the March 31, 2018 regulatory requirements, reflecting higher credit provisioning, which these banks will require on their NPAs during the H2 FY2018, the next round of recapitalisation (Rs 64,861 crore in FY2019) could be based on the performance of the banks, with the stronger banks receiving higher share of the capital.

The recapitalisation will enable banks to reduce the net NPAs and improve capital ratios. However, as many PSBs are likely to continue reporting losses during FY2018 due to elevated provisioning levels, they are likely to remain under prompt corrective action framework, based on FY2018 financials, till they become profitable.

TThe recapitalisation will be equivalent to 1.5% of the risk weighted assets (RWA) of the bank, however, the capital ratios of the bank is unlikely to improve by an equivalent amount as a portion of this capital will be offsetted against the losses because of elveated credit provisions the banks will be required to make during H2 FY2018. Adjusting for the losses, the CET ratio for banks is likely to improve by 1% by the proposed recapitalisation.

 
     
     
 
           
 
   
m Rating Updates for the month of January 2018
   
Upcoming Events
   
February 2018: ICRA Conference on Credit and Bond Markets: Revival in Credit Growth: Challenges and Opportunities ahead
 
ICRA in News
 
The Hindu Business Line: February 09, 2018: Pause for now, rate hike later this year
Business Standard: February 05, 2018: Hawkish review ahead
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