Budget may have long-term impact on various asset classes
March, 02nd 2010
There are two ways for an investor to gain from the Budget proposals. The most common strategy is to pick up sectors or a group of companies most likely to shine from various Budget proposals. Every Budget has its favourites in terms of tax proposals, sops and budgetary allocation. This tilts the playing field in favour of certain companies. The investor can juice-up his returns by betting on these stocks. And like every year, the Budget proposals for FY10-11 are likely to benefit some sectors and may hurt others.
The impact of the Budget, however, goes beyond simple sectoral arbitrage. The government is the biggest economic actor and the budgetary proposals touch everything and everybody in some manner or the other. While in a normal year, this cascading affect is small and short-term in nature; this Budget is likely to set in motion factors that may have significant and long-term impact on asset classes, especially fixed income and equities.
First, consider the macroeconomic background to the current Budget. The past two financials years were among the toughest for the Indian economy and its regulator, the government. First, the economy had to face spiralling crude oil prices, which came close to turning Indias economic apple cart upside down, second was the tsunami of the global financial crisis, which nearly wiped-off all economic gains of the past decade. Ultimately, the government was able to contain both the crisis with clever use of various fiscal and monetary measures; but it was not a costless exercise. The measures such as oil and fertilisers bonds, sixth pay commission awards, farmers debt waiver scheme and deep cuts in indirect taxes, did bring immediate succour to consumers, farmers and corporates, but it also burned a deep hole Indias public finance that threatened the long-term viability of the countrys growth story itself. (See chart below)
By the end of the FY09, Indias fiscal deficit excess of the government expenses over its revenues was nearing 10% of the GDP forcing the government to scale-up its borrowing programme. This had two immediate effects. First, it greatly pushed up the demand for goods and services in the economy and helped in the build up of inflationary expectations. Second, a hike in government debt issuance sent the yield curve up for all kinds of debt instruments. This had an adverse impact on investment and consumption, especially high-value items which are bought on credit.
Slowdown in investment means a lower capital formation that pulls down the long-term growth potential of the economy and manifests itself in the form of a lower GDP growth in the subsequent period. In normal course, the government can compensate for lower private investment by boosting the public investment but higher fiscal deficit comes in the way. Not surprisingly, bank credit an indirect measure of the level of investment has been slowing down since the beginning of 2009.
Historically, every episode of high fiscal deficit is followed by a period of poor economic growth. The lost decade of 1990s was preceded by a long-episode of persistent high fiscal deficit in the late 1980s and early 1990s. Inversely, declining fiscal deficit and falling interest rates preceded the economic and stock market boom that started in 2003. (See chart above).
Lower interest helps equities in many ways, such as it provides boost to corporate earnings by lowering companies interest burden, it makes companies easier to finance large capital intensive projects and most-importantly lower yield on fixed-income instruments, such as bonds and bank deposits, improves attraction of equities and thus fuels a stock market boom.
So for investors, the biggest issue for FM in the run up to the Budget was Indias rising deficit. And thankfully, FM delivered on this count despite all odds. A lot will, however, depended on the credibility of the Budget projections. If Pranab Mukjerhee achieves next years target and sticks to the roadmap to bring fiscal deficit down to a sustainable level of below 4% in the next three years, it could be one of the biggest ever stimulus for India Inc and the stock market. It will translate into lower interest rate, greater investments, higher growth and a booming market. It will also have a rub-off effect on real estate and commodities and their investors. Fixed-income investors such as retirees and pensioners who mostly invest in bank deposits should, however, brace for declining yields on their investments.
The exact impact will however differ from sector to sector. One clear winner is the banking sector. Other beneficiaries will be capital intensive sectors such as power, infrastructure, metals, cement, capital goods, auto mobiles and oil & gas. The Budget proposals, such as rise in I-T slabs and expansion of welfare and social services also hint at a re-prioritisation of the government expenditure towards raising the level of consumption in the economy. In due course it will put more money in the hands of the consumers and lift the fortunes of companies in the entire consumer goods space.