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The impact of lower deficit on equities

The impact of lower deficit on equities
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First Published: Sun, Feb 14 2010. 09 42 PM IST

Updated: Sun, Feb 14 2010. 09 42 PM IST
Everybody is agreed that the forthcoming Budget will see a reduction in the fiscal deficit, which was budgeted at 6.8% of gross domestic product (GDP) for the current fiscal. According to the government’s medium-term fiscal policy statement, the fiscal deficit was forecast at 5.5% of GDP for 2010-11. If it sticks to that target, it will mean a hefty reduction in the deficit by 1.3 percentage points. What impact will the fiscal tightening have on the equity markets?
We looked at previous episodes where big cuts had been made in the fiscal deficit. One such cut had been made in 1994-95, when the fiscal deficit was pruned to 5.68% from 6.96% in 1993-94. Another such episode occurred in 1999-2000, when the deficit fell to 5.36% from 6.47% in the previous year. And then there was the sharp cutback in 2003-04 to 4.48% from 5.91% in the previous year. There was also a reduction of the deficit from 3.45% of GDP in 2006-07 to 2.69% in 2007-08, but that was in a very different environment.
What was the effect of the budgets of 1994-95, 1999-00 and 2003-04 on the markets?
In 1994, the Sensex was at 3,994 points by the end of January, went up to 4,286 by end-February and was back at 3,746 by end-April. It then fluctuated around 4,000 points for the rest of the year.
At the end of January 1999, the Sensex was at 3,315. It was almost the same at 3,399 by end-February, but fell to 3,325 by April-end before starting a climb that saw it move up to 5,005 by the end of the year.
In 2003, the Sensex was at 3,250 at end-January, little changed at 3,283 by end-February and drifted down thereafter to 2,959 by the end of April, before starting a huge rally that saw it double by the end of December.
Both in 1999 and 2003, the market went up because fund flows to emerging markets increased at the time and India got its share. In 1999, we had the dotcom boom, and, in 2003, the beginning of the global bull run. In 1994, on the other hand, monetary policy was being tightened in the US. What matters most for asset prices in the Indian stock market is global liquidity, rather than domestic policy.
Write to us at marktomarket@livemint.com
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First Published: Sun, Feb 14 2010. 09 42 PM IST