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Budget: All eyes on how the stock markets will react
July, 06th 2009

The Economic Survey is always difficult to evaluate in terms of its actual importance. It summarises data and presents projections; it expresses the opinions of influential people. So it definitely incorporates crucial market signals. But the opinions expressed in the Survey are never acted upon in entirety.

This time around, the Survey was awaited with more eagerness than usual. UPA-II is minus the Left and its baggage. There is a global recession to deal with. Public finances are under stress. In analogy with 1991, this gives the government more leeway for reforms.

The projections are optimistic. The ES estimates strong recovery through the second half of 2009-10. The possibility of 7.75 per cent GDP growth in 2009-10 is much higher than the 6.5 per cent mooted one quarter ago. This projection is backed by a World Bank estimate that India could hit 8 per cent growth.

Obviously 7.75 per cent is a best-case scenario. High growth could be partially due to a base-effect, given the weak second half of 2008-09. But it would also require the fulfilment of several optimistic assumptions. To wit, the US economy must bottom out by the third quarter of calendar 2009. The monsoon must be reasonable. Private consumption must surge.

Quite likely this best-case scenario will not pan out. More interestingly, the ES suggests a long string of reforms. It recommends raising FDI limits in sectors such as insurance, defence and retail. It suggests price decontrol in politically-sensitive commodities like petro-products, sugar and fertilisers.

It offers a formula for better subsidy targeting with ceilings on subsidy for cooking gas cylinders. It suggests simplification of tax codes. It suggests making 3G spectrum freely tradable. If all this is not radical enough, it also mentions specific labour reforms.

Most of these are trial balloons. It is useful for any government to throw new suggestions into the public space and register the reactions. It is doubtful that this Budget at least will carry out much in the way of structural change. Any changes that do occur are more likely to be incorporated into the 2010-11 Budget.

However, the Survey does indicate an openness to new ideas. As a result, the mood going into Budget week is one of slightly heightened optimism. The market would respond with great enthusiasm if even some of the suggestions were incorporated.

Market movements of the past month or so have discounted the high probability of a bland Budget that maintains status quo until February 2010. Most market men were expecting no more than a few vague promises of change to come from the Finance Minister.

The ES puts sharper focus on expectations and that could be a two-edged sword. Anticipated reforms may put "animal spirits" back into the economy. But it may also set up the stock market and the commodities market for collapse if those expectations are not met by February 2010.

Given that the Indian economy is driven by intervention, every Budget is an important event. There is usually a bull-run prior to the Budget and post-Budget movements are always volatile, though not necessarily bullish.

This Budget is more important than most. Many ES suggestions are more radical than the softly socialist Congress High Command would be comfortable with. But that was also true between 1991-93. Reforms were undertaken out of desperation, not because politicians wanted them.

Speaking personally, my base-line expectations remains that of a status quo Budget. I'd also expect the projections of 7.75 per cent to be scaled down considerably by the second half of the fiscal. But if the Budget does actually deliver more than that, the bull-run will acquire fresh legs.

For a short-term trader, the risks involved in going short or staying out of the market may be higher than the risks involved in going long. The logic is simple. If the Budget is status quo, the market will not fall much. It will rise sharply if there is some reform thrown into the mix. 

The rewards for going short are relatively low and the risk for going long are relatively low since there isn't much downside. Conversely, the rewards for going long would be high and short-traders could get badly hurt.

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