A very positive Budget

The Union Budget has finally come out on Friday after a long wait and this event was specially awaited to see the governments’ commitment towards economic reforms and fiscal consolidation. After the insipid Railway Budget and a dull economic survey it was important to see that the Budget has a focus and direction.

The budget clearly has a vision with focus on fiscal consolidation, economic growth, increasing investments on infrastructure, urban development and promoting growth in consumption via tax reductions. One of the important factor was the acceptance that the Budget is a statement of the policies to be followed by the government.

The budget is positive for the financial, capital goods and infrastructure sectors. The estimate of fiscal deficit and its future reduction timelines is positive for private investments as the crowding out of private investments will be avoided. The reduction in net government borrowings for next year by a level of Rs 40,000 Crores combined with the large disinvestment target should be taken positively by the markets.
One question that has come up is whether the budget is inflationary due to rollback measures as well as increase in fuel prices. The key here is that a roll back was not only imminent but also desirable in order to improve the fiscal situation. In the immediate term there will be an impact on taking the inflation up by around 0.5-0.7%, however the control on government expenditure for next year and a growth of just 8% is a big positive. Some quarters believe that the reduction in government spending will drag the economy. However the reality is that the private sector is a better allocator of capital and as such more liquidity available for consumption and investment is more important. As it is government spending has moved up sharply over the last two years and now it is important to focus on productivity of expenditure and shifting the onus to the private sector and consumers.

Over the last few weeks the prices of lot of primary products specially food products have come off sharply and are likely to remain soft given the projections of Rabi Crop food grain production and a sharp increase in the availability of products like Onions and Potatoes. Sugar prices also seem to have peaked out and should fall sharply over the next year. Incidentally it is today important to understand the impact of sugar price on the Wholesale Price Index based inflation in India. Sugar has around 3% weightage in the WPI and over the last one year till January sugar prices were up 60% at the wholesale level, as such 1.8% of the overall 8.5% inflation is explained by sugar prices alone. Similarly given the expectations of a bumper sugar crop in India next year sugar prices should be down 25-30% over the year which will lead to sugar alone pulling down the WPI by a full one percentage point.

The thrust on clean energy and improving agricultural productivity is also very positive for companies operating in these sectors. Tax breaks on farm modernization as well as on setting up cold storage and warehousing infrastructure are positive. There is clearly a recognition in the government that clean energy can be promoted by measures that include a carrot and stick policy. As such the imposition of cess on coal as well as increase of allocation towards renewal energy investments by over 60% is a welcome step.

The increase in tax slabs is a big positive for consumption as the tax liability goes down. The focus on investments across sectors will boost employment and be overall positive for consumption. Sectors like automobiles and banking which had got battered prior to the budget due to expectations of a higher government borrowing leading to a increase in interest rates and also due to some recommendations in the Parikh Committee which proposed higher duties on Diesel vehicles which did not come through.

The imposition of service tax on some new services like airline tickets, lease income and payments prior to the completion certificate for buildings might be a short term concern for companies in these sectors. However given the momentum in the economic recovery I do not see this as a very long term negative. Airline ticket prices are likely to move up by 5-6% and similarly it can have an impact of 4-5% on real estate prices in the near term. However given the fact that builders in India have been increasing prices sharply over the last few months and this has led to a reduction in volume growth it might be difficult for them to pass on this tax imposition.

The budget per se is likely to be taken very positively by investors and given the fact that on the run up to the budget the Futures and Options segment was very light and a lot of speculators and hedge funds that were short on the markets are likely to cover over the next few days. If this is backed by positive movements in the Global markets we should see the markets moving up sharply over the next few days. The key question today to me is whether the corrective phase of the markets is over and the markets will move towards new highs immediately or we will see one more correction in the markets before the big positive up move takes place. To be frank I am also not sure on this right now. The main reason for this is that the global situation still seems to be uncertain and given the fact that markets are strongly correlated in the short run.

However the Budget can be a game changer in a manner where the probability that the Indian markets will outperform as there is clarity on markets stabilizing and moving up has increased sharply. The movement of the markets over the next few days will indicate which way the markets will move in the short run.

The probability of a Sovereign rating upgrade of India has improved with the process of fiscal consolidation getting initiated in right earnest. Economic growth of 8% plus, a strong financial system combined with low household and corporate debt levels & a sharply reducing fiscal deficit should lead to continuous upgrades in India’s rating over the next few years.

On an overall basis this budget will be supportive for sustaining and improving the growth of the economy.

The markets are shaping up for a very strong move on the upside by the end of the year 2010 and we could see an upside of 25-30% from the current levels.

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