The 2013 Budget was presented against the backdrop of acute pessimism on account of mounting fiscal and current account deficits, high inflation and interest rates, falling domestic savings, lull in new projects, a raft of stalled infrastructure and other projects, limping corporate profitability and an unhelpful global economy.
The equity market reaction to the Budget was swift and fierce. The verdict appeared to be that the Budget did not do enough for either reviving the investment cycle or promoting savings and investment — the two legs on which market expectations stood. To be fair, the provision for investment allowance of 15 per cent for new investments in plant and machinery in excess of Rs 100 crore was a step in the right direction. However, given the size of the problem relating to several stalled investments pending some governmental approval or the other, entrepreneurs are unlikely to invest in new capacity creation – helping growth and employment generation – just because of the new provision.
The escalating current account deficit and its mirror image - the large savings–investment gap - required decisive action towards export promotion, import moderation and incentives for long-term savings. The Budget fell short in addressing these issues. However some control on the fiscal deficit, probably because of the threat of a rating downgrade, as also the restraint evinced on further multiplying the largely misdirected and leaky social spending programmes in a pre-election Budget are the key positives of the Budget.
With the Budget out of the way, what could be the outlook for equities? While the Budget was certainly a missed opportunity to revive investor confidence, it is not a given that the prevailing weak market sentiment would continue. With the 22 per cent rise in dollar terms in the Sensex in 2012, largely driven by robust foreign institutional investor (FII) inflows, the market has been substantially re-rated. At 14 times FY14 earnings, the market can no longer be considered cheap, especially with the outlook on earnings growth continuing to be dim.
Analysts continue to downgrade corporate earnings estimates on the back of headwinds on top line growth and margins. The only other factor that can sustain current market levels is FIIs. Recent rumblings of a potential end to the monetary easing in the US were quickly denied by the Fed chairman following the market's violent reaction. The debt ceiling negotiations in the US could lead to a satisfactory conclusion, albeit with some hiccups.
The post-election scenario in Italy has been a cause of worry with a sharp spike in Italian bond yields. Here too, some solution to the political impasse would hopefully be found soon and a measure of normalcy would return to the European bourses. The proposed amendment relating to tax residency certificates issued by countries with whom India has double taxation avoidance agreements is a new irritant. However, the government appears to be in a conciliatory mood to put these apprehensions to rest.
So, investors would do well to be cautious because without the support of robust earnings growth, at current valuations, Indian equities are highly vulnerable to FII flows that could be volatile with the fast-changing global dynamics.
The author is managing director, Dalton Capital Advisors (India) Pvt Ltd
