Buy on the rumour, sell on the news” seems to me the best explanation of the stock market’s swoon during and after the finance minister’s Budget speech yesterday. It was a reaction which surprised me at the time and continues to do so.
As I listened to the Budget speech I found few negative surprises and several positive ones. Accordingly in penning this column, I find myself both attempting to evaluate the Budget (or more accurately the Budget speech), and trying to understand and explain the negative market reaction.
What did I like about the speech? Most of all, I thought it provided a clear and coherent structure for the issues facing the finance minister, and the priority and sequencing accorded to these.
In the order of exposition these were: the importance to India both of globalisation and of sustained fast growth; the strategy for short-term revival given the continued uncertainties in the global environment; the need to return to a medium-term fiscal path once the global economy had revealed its true colour (and the Thirteenth Finance Commission had reported); and finally the government’s plans for enhancing the delivery of important public goods through enhanced outlay and improved governance.
Many will feel that this is a shop-worn and hackneyed bill of goods. I disagree. In my mind the Congress party has never fully embraced the centrality of growth as the key objective of economic policy, and large and influential parts of the party remain ambivalent about the virtues of globalisation.
Given the disorder in the world economy, the present would have been a tempting moment to bewail the imperfections of the global order. To their credit neither the Economic Survey nor the finance minister succumbed to this temptation.
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I also take considerable comfort from the fact that this articulation is provided by a finance minister who is one of the most seasoned members of his party, and must be exquisitely alert to the nuances of the senior leadership’s preferences. To my ear, his formulation and tone were a lot more encouraging than, for example, the President’s address to Parliament.
In the tradition of President Obama’s inaugural address, I saw the speech as a point of reference from which future policy actions would flow, in such areas as disinvestment, financial sector reform, tax reform and the like. The market saw things rather differently. It presumably interpreted the lack of specificity on such hot issues as FDI in insurance, deregulation of petroleum prices, specific commitment to recapitalise public sector banks or specific pieces of financial sector legislation as signs of continued division within Congress ranks and an unwillingness to act while political capital is strong. Only time will tell.
Atmospherics apart, the Budget seemed to me to have a clear strategy for economic revival, even while deferring fiscal consolidation. Here, I found considerable consistency between the excellent analysis of the Economic Survey and the specific actions in the Budget.
Most economists, myself included, had assumed that the major impact of the economic slowdown on the demand side of the economy was likely to fall on private investment. Of course 2008-09 was a peculiar year, with the second half radically different from the first. Even so, as Table 1.3 of the Survey points out, the important slowdown over the year as a whole was in private consumption, which contributed only 27 per cent to growth in FY09 as against 54 per cent in FY08. By contrast the contribution of gross fixed capital formation was virtually unaltered, contributing 42 per cent of the year’s growth.
To me it makes perfect sense for a short-term revival strategy to focus on reactivating private consumption while both exports and private investment catch their breath. As the minister noted, the reliefs provided on personal income tax have largely come from corporate taxation, as the direct tax proposals are revenue-neutral.
Finally, though, one must turn to the budgetary aggregates, and these are indeed disconcerting, with the central government fiscal deficit at 6 per cent for FY09 rising to a projected 6.8 per cent in FY09. Fiscal marksmanship in recent years has been poor, and some Rs 44,000 crore is expected from unspecified non-tax revenue, presumably some combination of asset sales and spectrum auction revenues.
While some progress in fiscal consolidation was made in 2004-2007 under the FRBM, it was patently not enough. As a result we lack adequate room for maneuver in the present downturn. Conversely, the slow pace of fiscal adjustment that was achieved at a time of torrid growth makes one pessimistic that much more aggressive adjustment will be achieved in the years ahead.
I do not believe that our growth prospects are sufficiently well-established to withdraw fiscal stimulus at this time. And I believe that our vulnerability is much lower if we can restore fast growth. But the negative reaction of the equity markets is a possible warning that we are on a rather short leash. The first shoe has fallen; the others need to follow sooner rather than later.
Suman Bery, Director-general, NCAER