Budget “Read”, on to implementation now

Given the reputation of the Finance Minister there were hopes of big bang announcements in the Union Budget this time. However the budget turned out to be devoid of any major earth shattering announcements both on the negative and positive side. I believe that the two major positives that I saw in the budget were no increase in excise and service taxes and the investment allowance. Last year, despite a slowing economy the then Finance Minister had increased taxes which had two negative impacts; firstly it added to inflation in an already inflationary environment & secondly it created a further drag on growth. In an economy like India the only way of reducing the fiscal deficit in any significant manner is to induce growth & control subsidies. The government has already moved on controlling subsidies over the last few months & now is the time for growth as the operating leverage that is associated with higher growth leads to better profitability and better revenue for the government. The other positive thing is the Investment Allowance of 15%, which is quite significant and will reduce the cost of capital for companies investing over the next two years. If the assumption is that the government is working on improving the investment climate then this move can improve the return on capital employed significantly for companies that start their investment cycle over the next few months. Over achievement of the Fiscal Deficit for this year and providing a credible figure for the next year was another positive.

The key negatives of the budget were; there was hardly any move taken to increase retail participation in the equity markets. Besides small tinkering with the RGESS scheme there were no incentives. A greater upfront incentive for Mutual Fund investment would have been a big positive. The important thing today is to increase domestic participation into the equity markets as the easing of FII norms that have been announced are welcome, however they do not address the issue at hand. FII flows as it is have been strong. The other negative was the bigger than expected Gross Borrowing figure for next year, although the net figure at Rs 484000 Cr seems to be below the Rs 500000 Cr level and a just a 5% increase over the current years level. A sovereign fund raising was the most appropriate thing to do at this stage given the fact that global interest rates are very low and the government can raise 20 year money at around 4.5%. This would have eased crowding out of private investments and reduced the pressure on the Rupee at a time of high Current Account Deficit.

The plan expenditure of the government saw a severe squeeze in 2012-13 and was aimed at controlling the Fiscal Deficit at a time of low revenue growth for the government. This is set to increase by nearly 30% in the following year and should aid economic growth at a time when economic activity has bottomed out. The action now shifts to governance and taking decisions to foster the investment cycle. For this the follow-up meetings of the Cabinet Committee on Investments will be keenly watched. The budget has hinted at greater investment in Coal mining and Road projects. This will be keenly watched by the markets going forward.

Overall in my view this budget is one that does not have the components to move the markets in either direction on a standalone basis. However if all the talk is converted into implementation in the near future then it can be positive for the economy as well as the markets. 

On the global front the one move that most economists and market watchers seem to be missing at this time is the significant cut in lot of commodity prices over the last 4 weeks. Crude oil prices are down nearly 8% and are also 15% lower than the same time last year. Similarly lot of industrial commodity prices like Copper  (down 8% over the last one month with inventories highest in the last 18 months), Aluminum ( down 7%, with multiyear high inventories)etc. also have been under pressure. The fall in global gold, silver etc precious metals has been seen by everyone where gold prices are off more than 10% off their recent peaks seen in October 2012 and silver prices are off by over 20%. Similarly benchmark palm oil prices are down 10% in the same period and down 30% over the last one year, Rubber prices are off 10%  and so on.  All these commodity price movements indicate a significant moderation in global price pressures on the Indian inflation scenario. Domestic demand driven inflation is as it is absent in the Indian economy today.Last year due to the increase in excise and service tax in the budget we saw large price spikes in the months of March and April. These are likely to be absent this time. In conclusion on an overall basis, if the INR does not fall big time due to a wave of global risk aversion we should see headline inflation fall off very sharply over the next three months. 

The parabolic rise in Gold prices over the last 10 years has been a major contributor to the increase in India’s current account deficit. 2013 should be the first year, after several years where we will see the average gold price decline by 10%.

The Indian economy grew at a rate of 6.5% in FY 2011-12 and the growth fell off to 5% (estimated) in FY 2012-12 at a time of high inflation, very tight monetary policy, severe curtailment of government expenditure and a total absence of private sector investment. The Finance Minister has estimated that growth will go back to 6.5% this year. Most economists seem to skeptical on this. However the reality is that a combination of higher government expenditure ( estimated to grow 16.5% instead of 9.7% last year), lower interest rates as well as a much improved investment climate can take growth back to 6.5% quite easily. RBI officials hae also welcomed the budget yesterday. We also need to realize that the global scenario is much more benign than what it was last year with credit markets showing a great level of stability. Global growth is also expected to be better than last year. 

On an overall basis the markets are trading at valuations that are supportive of an upmove over the course of rest of the year. Even large interest rate sensitive stocks have seen a severe fall in the run up to the budget. The fall on the mid cap side of the market has been even more drastic. Given that this time the budget has also coincided with the expiry of the derivatives market it has created further volatility. At the beginning of the year looking at the valuations and the macro picture I had expected a return of  15-18% from the markets in 2013. Till date we are down around 3%. Nothing seems to have happened which warrants a change in view, in fact global cues have been much more positive than I expected with improvement in growth outlook across most countries and significant positive performance from most major markets. Indiaat this stage is one of the worst performing markets in the year 2013 and things should only improve going forward.