How to play the higher fiscal deficit story in the Union Budget 2018
One of the key features of the Union Budget 2018 was the higher fiscal deficit guidance by 30 basis points. In fact, the 3% fiscal deficit target is being delayed by just about 2 years which is totally understandable as part of a larger counter-cyclical approach. But how can you as an investor play the budget?
Your inflation view
Our estimates of inflation are a critical component of our financial plan. Your future wealth creation is largely driven by how much of the real worth is eaten away by inflation. That is why inflation becomes so important. The budget has guided for a higher fiscal deficit and higher levels of rural spending. Both these factors put together are definitely going to be inflationary for the economy. Secondly, the budget has a lot of interesting sops for senior citizens like 5 times higher limits on bank interest and higher medical insurance coverage. This will improve their risk appetite and more liquidity could come into the market. The budget is conservatively pegging inflation at around 4.5% and with GDP growth coming back this is unlikely to shift down. That means two things. Firstly, you need to tone down your real return expectations and wealth creation targets in tune with higher inflation. Secondly, you need to look at the other option of increasing your monthly outlay or asset mix in a stepped manner so that your final goals are not largely impacted.
Interest rates to trend higher
The second outcome of the higher fiscal deficit and the more aggressive borrowing program of the government are higher bond yields. That is already evident in the bond markets where the 10-year yields are already up nearly 100 basis points in the last 5 months. Higher yields mean that your bond portfolio and your bond fund portfolio need to be tweaked to shift to relatively lower maturities. That is because higher maturity debt is more vulnerable to yield shifts. Bond prices are negatively related to bond yields. Also if you have allocated money to bond funds for the sake of stability and security then you need to be prepared for some notional losses on your portfolio.
Good news for equities
Ironically, in a budget that taxed LTCG, there still was some good news for equities. The higher fiscal deficit is being used to fund infrastructure and rural spending. Both are likely to be accretive for GDP growth and should be positive for equities. Secondly, the government has continued its drive against black money and that is not great news for asset classes like gold and property. Thirdly, higher yields make bond markets relatively less attractive. The bottom-line is that equities may still be the best way to play this budget, the tax on LTCG notwithstanding. That may be the key takeaway from the budget! ©