Gold falls, India rocks!
Our goal with The Daily Brief is to simplify the biggest stories in the Indian markets and help you understand what they mean. We won’t just tell you what happened, but why and how too. We do this show in both formats: video and audio. This piece curates the stories that we talk about.
Check out the audio here:
And the video is here:
In today’s episode, we look at 3 big stories:
- A closer look at the budget
- Gold fell by more than 5%
- Bajaj Finance is in a mixed state
A closer look at the budget
In yesterday’s episode, we briefly touched upon the key highlights from the budget and what it means for common people like you and I. Now that the dust has settled, let’s dive a little deeper and look at some of the bigger announcements and how they will affect various sectors in the markets. We know things might seem complicated, but we’ll keep everything super simple and relevant.
First up, the defence sector:
This sector has been on a roll. Over the past year, an index of defence stocks has surged by more than 98%! For comparison, the Nifty 50 has grown by about 24% in the same period.
This year’s union budget sheds light on why people are so bullish on defence. While overall spending on defence hasn’t increased much, the allocation of funds has shifted.
There are two key trends at play here:
The government is focusing on procuring new aircrafts, which means there’s a push towards modernising equipment. This could benefit aerospace companies and suppliers.
There’s a stronger emphasis on indigenisation of defence spending. The government is trying to reduce foreign dependence, especially given the Russia-Ukraine conflict and the increasingly fragmented global landscape. It makes sense to rely less on other countries for crucial defence equipment.
Next, let’s talk about the fiscal deficit:
In the recent elections, the ruling BJP didn’t get the outright majority it expected, leading to a coalition government. This often means a more welfare-oriented budget. However, instead of lavish spending, the government is focusing on fiscal consolidation, aiming to maintain budgetary discipline.
This budget sets a fiscal deficit target of 4.9% of GDP, down from last year’s estimate of 5.6% and the interim budget’s projection of 5.1%.
Why is this happening? The government is in a good financial position to start the year, thanks to the 1 lakh crore dividend from the RBI. This financial cushion has allowed the government to announce spending on educational initiatives, as we mentioned in yesterday’s episode.
The government’s gross market borrowing for the financial year is budgeted at Rs 14.01 lakh crore, slightly lower than the 14.13 lakh crore announced during the interim budget in February.
So, what does this mean?
Unlike a household budget, governments often run a deficit, spending more than they earn through taxes and other revenues. They borrow money by issuing government bonds. This time, the government is borrowing slightly less than expected. With inflation under control in India and the US, and with the US Federal Reserve expected to cut interest rates in September, the RBI might also cut rates starting in December. Indian government bonds being part of the JP Morgan Emerging Markets bond market index guarantees inflows into government bonds. These factors will put downward pressure on government bond yields, potentially keeping the benchmark 10-year government bond yield in the 6.5-7% range. This is beneficial for the government as it reduces borrowing costs.
Now, let’s shift to the power and energy sector:
This sector is crucial due to the destructive impact of climate change. In previous episodes, we’ve discussed how heat waves have hurt the economy this year. Heat waves are just one of many climate-related issues. Addressing climate change requires trillions of dollars in investment.
In the budget, the allocation for renewable energy has increased to Rs 188 billion, about 2.5 times last year’s investment. While this is a significant number, it’s still far from what’s needed. However, as a relatively poor country, India cannot spend as much as the US.
There’s a specific focus on solar energy, with the allocation rising from 48 billion to 100 billion. These numbers are significant but still fall short of what’s required. Yet, given our financial constraints, it’s a step in the right direction.
Moving on to the real estate sector beyond what we discussed yesterday:
The big news is the removal of indexation benefits from real estate transactions. If you’re unfamiliar with indexation benefits, don’t worry—I’ll explain.
When you sell a property, you usually pay tax on the profit. Indexation adjusts the original purchase price to account for inflation over time. It’s the government’s way of acknowledging that a rupee today isn’t worth what it was when you bought the property.
For example, if you bought a house for 100 rupees in 2000 and sold it for 200 rupees in 2020, without indexation, you’d pay tax on the 100 rupee profit. But with indexation, if the 100 rupees you paid in 2000 is worth 150 rupees due to inflation by 2020, you’d only pay tax on the 50 rupee profit (200 minus 150).
Previously, the government allowed indexation benefits, but this budget has removed them. To compensate, taxes have been reduced from 20% to 12.5%. The government is also pushing states to reduce stamp duty, especially for women buyers, to address gender imbalances in property ownership.
Existing real estate investors hoping to sell might be affected by this move.
Lastly, let’s discuss the reduction in import duty on gold:
The import duty on gold has been reduced from 15% to 6%. While this is good for new buyers, it reduces the value of gold that Indians currently hold, leading to a drop in gold ETF and mutual fund prices.
Gold is one of India’s biggest imports, crucial for the gems and jewellery industry. Lower import duty will likely increase gold demand and reduce smuggling incentives, an ongoing issue in India. As we approach the festive season, it will be interesting to see how much demand rises.
Gold fell by more than 5%
Gold prices fell by more than 5% on budget day, and while that sounds bad, it was actually due to positive news. The finance minister announced a cut in customs duty on gold from 15% to 6%. Here’s an interesting tidbit: gold is the second biggest part of India’s household assets, with real estate being the first.
But why is the government being so generous with gold import duties?
Let’s go back a bit. The last time the government increased the customs duty on gold was in 2022, right when Russia invaded Ukraine. Back then, crude prices were soaring, and both inflation and the rupee were under pressure. The government increased the duty to curb gold imports, which would have exacerbated the situation.
Fast forward to now, the government is in a much better spot regarding the current account deficit and inflation, so reducing the import duty makes sense.
Another reason is smuggling. No joke—India imports a lot of gold, accounting for over 5% of all imports. This number would be even higher if we include smuggled gold. Smugglers have all sorts of tricks, like overreporting gold imports, declaring fake exports, and swapping real gold with imitation jewelry through passengers, often bribing officials. In 2023, 60% of gold smuggling cases were in coastal states like Maharashtra, Tamil Nadu, and Kerala.
There's also the jobs angle to this announcement - the jewelry sector employs a significant number of people. Sanjay Kumar Agarwal, Chairman of the Central Board of Excise and Customs, mentioned that gold is crucial for the gems and jewelry sector, which employs around 50 lakh people and contributes nearly 8% to India’s exports. Reducing the duty helps curb illegal imports and supports this vital sector.
So, what does this mean for jewelry companies?
According to the managing director and CEO of Senco Gold Ltd on CNBC, organized players hedge their inventory through MCX or gold loans from banks, so there’s no major impact on their stock. The real focus is on the expected rise in demand, especially with the festive season around the corner.
Here’s a key point he made: The reduction in duty provides a benefit of about 590 INR per gram or 5,90,000 INR per kilogram. Initially, consumers might see a benefit of 300-350 INR per gram, gradually increasing to 550-600 INR per gram. So, with the festive season approaching, we can expect a rise in demand.
But what does this mean for companies that lend money against gold, like Muthoot Finance? According to George Muthoot, the chairman of the company, gold prices don’t really affect the demand for loans. People borrow money when they need it, regardless of whether gold prices are high or low.
Meanwhile, there’s another development in the gold space. The RBI isn’t too happy with some banks and gold loan companies due to how gold loans are handled through fintech startups. The RBI found some inconsistencies during audits, leading banks to talk to their fintech partners to fix the issues. They might even pause gold loan disbursements through these startups temporarily to ensure everything is done correctly.
Bajaj Finance is in a mixed state
IIFL recently put out a report saying that bad loans in the microfinance sector are increasing slightly. States like Tamil Nadu, West Bengal, and Madhya Pradesh are seeing more overdue loans.
Credit growth in India post-pandemic has been skyrocketing. Unsecured personal loans, for example, have been growing at over 30% compared to the pre-pandemic rate of 10-15%.
This rapid growth in unsecured personal loans has made the RBI nervous. To curb this, the RBI increased the risk weightage by 25%. Let me simplify this with an example:
Imagine a bank gives a Rs. 10,000 unsecured personal loan to a borrower. Previously, the bank needed to set aside Rs. 10,000 as a buffer against defaults. But under the new rule, they now need to set aside 125%, or Rs. 12,500.
This move seems to be working as the growth of these unsecured loans appears to be slowing down.
But why bring this up? It turns out that microfinance isn’t the only sector showing signs of stress.
Bajaj Finance, India's largest non-banking lender with a market cap of over four lakh crore rupees, provides a good lens to understand trends in unsecured lending.
While this quarter seemed okay for Bajaj Finance, the rise in their Non-Performing Assets (NPAs) is concerning. Their bad loans increased from 0.31% last year to 0.38% this year, and loan collections have declined across the board.
Before diving into specifics, let’s clarify how banks classify loans based on credit risk—the chance that a borrower might not be able to pay back.
During an earnings call, the management said:
“Loan losses and provisions in Q1 were elevated primarily due to muted collection efficiencies."
They further noted: "Given elevated Stage 2 assets, loan losses may remain at current levels in Q2 and should start to normalize by Q3."
In simple terms, Stage 2 loans are starting to show signs of trouble. Borrowers are facing issues but haven’t completely defaulted yet. The number of loans in this category is increasing—it went up by ₹865 crore from the previous quarter because people are repaying less.
In such situations, financial institutions set aside money as a buffer, and Bajaj Finance did the same. However, it wasn’t enough, so they had to dip into an additional ₹105 crore for loan losses.
The net loan losses and provisions, after using this buffer, amounted to ₹1,685 crore, which is 1.99% of the average outstanding loans.
Overall, Bajaj Finance’s rising bad loans are a concern, but this is just one quarter. The increase could be due to elections, heatwaves, or seasonal effects. We’ll have to wait and see if this is an isolated issue or the start of a larger problem.
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