As we enter Budget week, I see an almost universal pessimistic tendency amongst market participants, despite the markets being up 13 per cent from the lows of December, even after a six per cent correction from recent peaks. The rout of the ruling party in the recent state elections is being assumed as reason enough for the government to turn dangerously populist. Remember, this is not the last but the second-last budget to be presented by the United Progressive Alliance (UPA) government. So, there is no pressing need to be unduly populist (especially since no state elections are due for over a year).
The headline worry of FY12 has been fiscal profligacy (the fisc has slipped close to 100 bps vs the budgetary estimate of 4.6 per cent of gross domestic product). Contrary to current sentiment, I would bet for a small but meaningful fiscal consolidation in this year’s budget. This, and this alone, might be enough of a spark to get the markets going. How might this become possible?
The government has to work simultaneously on two fronts - increase tax collections and cap expenditure. Despite all odds, the economy has been growing at 12-13 per cent in nominal terms every year, driven largely by services, which has long ago outgrown manufacturing and agriculture. It might surprise most of us that the services sector accounts for almost 60 per cent of GDP but contributes under 10 per cent to overall tax collection! A higher (and more broad-based) service tax will be the easiest tax hike to push through. This will also work towards increasing the tax/GDP ratio of India, which, funny as it may sound, is among the lowest in comparable economies at around 10 per cent.
On the spending front, the chief culprit has been subsidies (on fuels, fertilisers and food), but I am expecting a diesel price rise which can absorb most of the recent run-up in crude. Nevertheless, the fisc as well as the balance of payments (and hence, stability of the rupee) remain tied to the movement of crude prices. Another global risk source is fertiliser prices, currently depressed owing to weak global demand from the large importing nations, besides India.
FY12 was a year in which everything that could have gone wrong did actually go wrong, especially for the Indian stock market. Apart from fiscal slippage and high interest rates, many other negatives affected markets. These included global macro headwinds, higher crude prices, local policy paralysis, political wrangling and pressure on government from civil society. In FY13, many of these storms would have partly subsided. Government-led impetus for a host of capital-intensive and economically important sectors might change market outlook faster than most people think. Also, softening of interest rates is a consensus call from hereon. Yes, it might take longer than aspired, but will surely have a salubrious effect on the stock markets. A confluence of negatives for two years running is possible, of course, but unlikely.
The author is president and co-head, Wholesale Capital Markets, Edelweiss Financial Services
