Stock market traders are keenly aware the finance minister has a tough time ahead of him on budget day, but so far, they’ve been reluctant to bet against him pulling a rabbit out of his hat.
Given the well-known difficulties the government faces in expanding the fiscal deficit, there has been a remarkable reluctance by the bears, who were badly burnt after the election results, to build up short positions ahead of the budget. That is why the rollover in Nifty futures was so low.
As a note by Anagram Securities Ltd points out, “Short side traders are wary of losing money on a positive budget, like they lost it on election results. If the budget is positive, there will be a rush to close long derivative positions and if it disappoints, there won’t be a buying support which usually exists from short sellers.” That means the downside risk in case the budget disappoints is high.
On the other hand, it can be argued that much of the expectations from a good budget have already been factored in. A large part of the liquidity that rushed to Indian markets after the election results was riding on hope that the verdict would unleash a raft of policy changes. For instance, analysts have been predicting a rise in spending on infrastructure, but that seems to be already built into the price, with the BSE (Bombay Stock Exchange) Capital Goods Index rising 51% from its close on 15 May (before the election results were announced), compared with a 21% rise in the Sensex.
The chart shows that of the 18 Union budgets presented since liberalization, the market was lower in 14 instances a month after the budget. Ahmed Raza Khan / Mint
The BSE Power Index, reflecting the renewed emphasis on the power sector, is up 31% since 15 May.
The broad expectations from the budget are well-known: spending on both physical and social infrastructure, possibly higher food subsidies and the provision of low-cost housing to meet election promises, some sectoral sops, a possible withdrawal of sops on sectors doing well such as services, a plan for disinvestment, some reforms such as hiking foreign direct investment limit for insurance and much talk on reining in the fiscal deficit in the future.
The key dilemma for the government, of course, is how to give another dose of fiscal stimulus without raising an alarm about the deficit. Since it’s necessary to give a signal to international investors that the government is serious about wanting to curb the deficit and since capital inflows are important in keeping interest rates low, it’s important for the government not to stretch the deficit. At the same time, much of the recent improvement in the economy has been on the back of government spending. How will they reconcile these objectives? HSBC economist Robert Prior-Wandesforde says, “The finance minister will attempt to square the circle by arguing that the various programmes will be financed from stronger economic growth (expect some bullish growth projections), with the sale of government stakes in some state-controlled companies also helping out. The trouble with this approach is that many of the spending measures are likely to be permanent in nature while the divestments are one-off. In other words, the structural budget deficit is in danger of rising when it should be falling.”
Higher than previously estimated receipts from the auction of third-generation telecom licences will also help and the government is likely to try and fund a part of the infrastructure push through the private sector by offering more incentives.
Consumption is likely to be shored up through the various rural spending programmes. Morgan Stanley estimates show that extra government spending in FY09 amounted to 8.5% of gross domestic product (GDP), with an additional fiscal stimulus of 2.4% of GDP, the Sixth Pay Commission largesse of 0.4% of GDP, a farm loan waiver amounting to 1.1% of GDP, National Rural Employment Guarantee Scheme spending of 0.6% of GDP and fertilizer and oil subsidies of 2.1% and 1.9% of GDP, respectively.
Nevertheless, as Macquarie economist Rajiv Malik points out, “The improving outlook also diminishes the need for a big-bang stimulus package.”
As the chart shows, of the 18 Union budgets presented since liberalization, the market was lower in 14 instances a month after the budget. But as Morgan Stanley’s India strategist Ridham Desai has argued, “This time—since we expect the finance minister to deliver a reform-oriented budget—history may not necessarily be relevant.” That’s what the bears are afraid of.
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