The Q3, 2011-12 estimate of 6.1 per cent GDP growth paradoxically brought some cheer. It was the slowest quarter since Jan-March 2009 when the last economic cycle bottomed out at 5.8 per cent. Although GDP growth may fall a little lower, or stagnate at the current levels for a few quarters, the southwards trend should be close to bottoming.
The Budget, good or bad, will be key to revival or continuing slowdown. A bad Budget will avoid tackling the fiscal deficit, or addressing policy issues. It may inflate subsidies and entitlements further, or hike tax rates violently. A good Budget will try to hold the deficit, and stimulate recovery.
The market is likely to react instantly to a bad Budget by selling equity down. But even if there’s a good Budget, in the sense of policy measures that help macro-economy and corporates, it may not instantly trigger a big stock market rally.
What can the Budget do to spark revival? What is unlikely? It would be rational to forget about GST. The GST is likely to be delayed for at least another fiscal and more likely, postponed till after the next general elections. given lack of consensus between states and Centre. It’s unlikely any attempt will be made to aggressively push GST after the recent assembly results.
So, assume the current tax system continues. Rule out big cuts in tax, excise and customs rates. The fiscal deficit is way too high, There isn’t going to be cut backs on subsidies for fear of losing votes. In the given situation, the government is more likely to seek higher tax revenues than gamble on cuts. The best one can hope for is tax revenue neutrality and some positive sector-specific stuff.
Nor is there central cash to spare for big-ticket infrastructure spending. Policy constraints in various infrastructure sectors may be eased to attract private funding. There could be a lifting of some FDI limits and restrictions. There may also be measures to create financing structures suitable for infrastructure financing.
But the roadblocks impeding infrastructure investments also include slow environmental clearances, huge amounts of litigation and persistent issues with land acquisition. The Budget is unlikely to do much about those except make encouraging noises.
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What a good Budget can do, given those constraints, is focus on PSU disinvestments and aim for fiscal consolidation that way. Some attempts may also be made to run government more efficiently, even if subsidies are not reduced. If the telecom imbroglio gets fixed, there may even be some revenue coming through there as well.
None of this sounds terribly exciting. In all probability, the Budget won’t drive bulls into instant frenzy. There could be elements however, which would keep investors interested. Expectations aren’t very high, which is always good, if you’re looking for a bull run. Since GST isn’t expected, if it is introduced, against all odds, there could be a huge burst of buying. Ditto if there are subsidy cuts or tax cuts.
But there is a problem in terms of timing for the financial trader. Traders want quick returns. An average-tending-to-good Budget may receive a lukewarm or negative response. While monetary shifts like changes in interest rates translate instantly into higher (or lower) equity prices, fiscal shifts don’t necessarily have the same instant effect.
The market is moving into pre-Budget mode and it’s likely to push higher in the next few sessions. Budget day itself will almost certainly see a lot of volatility. There could be a temporary sell-off if there aren’t enough positive measures. Equally, there could be a rally through the next fortnight.
One way to exploit this promise of volatility is by using options, which allow two-way bets. The Nifty has moved 350 points in the past three weeks. Assume, for argument’s sake that it may move 350 Nifty points in either direction in the next two weeks. That would mean either the 5000 Nifty put or the 5600 Nifty call will be struck. The 5000 put was last traded at a premium of 25 and the 5600 call was traded at 37 implying slightly more bullish expectations.
If the market does see a big swing, the option that’s struck will see its premium rise, probably till about 100, while the other option will drop to 5 or less. Net-net, that could mean a 60-70 per cent return for somebody who holds both options through the next 10 sessions. This sort of position is called a long strangle. It’s worth looking at, even if you’re not a habitual option trader, when there’s a strong presumption of volatility without a clear sense of direction.