A 'No Masala' Budget

Dal, roti, chawal – a no masala Budget

The markets were looking for a booster – something to keep the party going. The Finance Minister has delivered a seemingly dull and sobering statement of accounts.

There is nothing in the budget for near term investors. No big announcements; no divestment plans; no bail out of the robber barons who call themselves real estate developers; no special favours to large industrial groups and business houses.

No, this was not a budget with any Viagra. We all came to the party to have some wild fun: the finance minister gave us a few quotes from Kautilya and spoke about marriage. Kind of a dampener for traders on a mission for a one-night stand.

Their actions proved it. Within minutes of Pranab Mukherjee indicating more rural efforts and little for the punters on Dalal Street, the markets tanked. The graphs were like boulders falling off a cliff. The BSE-30 Index slumped -870 points (-5.8%) and was lucky to stay above the 14,000 levels to close at 14,043.

If the election results started the party, could this budget have ended it?

No Viagra, just some dal

Yes, I am disappointed. Not because I came to the markets for a one night stand, but because this budget was a dal-roti-chawal budget. Good, basic food for the stomach but nothing for the taste buds. It lacked that little masala, that extra spice to tell you how you felt as you digested the food.

I was hoping that the Finance Minister would announce a higher interest rate tax incentive for homes less than Rs 20 lakhs in value. And, while it is difficult to cut taxes when the government deficits are increasing, an increase in the exemption limit for the lower and middle class would have been a good psychological boost. And while I was keen to see some statement on divestment, I was hoping that there would be a limited change in FDI rules in insurance. I am not a supporter of the lobby that says increased foreign ownership of insurance companies in India is a must for economic growth.

But the budget has some really important long-term statements within its scope of being an annual accounting exercise. The focus on rural India, on helping those at the lowest rung of the economic ladder with the guaranteed job employment schemes – are all very good. Every rupee allocated to the poor should be welcomed. Every rupee that finds its way to the poor – and more will with the increased usage of the Right To Information Act – is building a base for the sustainability of a 6.5% rate of growth in India’s GDP.

The decision to remove the tax surcharge, to make the tax code simpler, to give full tax deduction to donations to political parties, and to remove the Fringe Benefit Tax are all moves in the right direction. Simplicity dilutes the power of corruption.

Kautilya at work?

Yet, the budget has failed in explaining how it will take India to a 9% rate of growth in the long term. Or how the borrowings and deficit-financing will be met. Maybe that will be announced on another forum. We need to remember that the budget is open to a debate in Parliament and sale of shares in government-owned entities will draw the familiar criticisms from political ideologies fighting for their survival.

The Finance Minister may be doing a little bit of Kautilya here: only revealing what is necessary when it is necessary – and staying away from the unnecessary. From an economic perspective, the government has no choice but to sell its stakes in many companies. The rich have no choice but to pay their fair share of taxes. The politicians have maybe 3 years to start delivering on what they have failed to provide for the poor. Or the next election will be won by the Naxalites! Last year’s budget was an HUF budget. And I had said we need 19 more of those budgets. Well, we need 18 more such budgets now.

And every time the HUF budget is announced there is a risk that the stock markets will sell off. Let the stock markets do what they want to. The markets are not gods, or beacons, or any kind of barometer for policy making. They have become gambling dens where speculators come for one night stands. The Finance Minister may not have banned the P-Note punting money that slips into India under the FII policy, but he has probably burnt them. May they stay away from India while we build the country.

The noise and wild mood swings of the short term speculators and P-Note holders should not scare us from investing for the long term. As long term investors, we know you can find great companies in growing economies. And we will continue to look for them in earnest.

Yes, I liked the dal-roti-chawal – it is good basic food, but I did miss the masala. Is this the end of the party? No, we can still make a case for an Index of 21,000 by June 2010. The budget would have given the market momentum to make that level more visible.

COMMENT FROM THE FUND MANAGERS

Mr. Atul Kumar (Fund Manager – Equity)

The Union Budget has largely focused on:

1) Continuing the rural/agriculture initiatives of the UPA Government, and

2) Boosting infrastructure.

Overall, the equity markets reacted negatively, with the BSE dropping by almost 6%, as some of expectations such as disinvestment in PSUs and increase in FDI in Insurance did not come through.

Using funds from India Infrastructure Finance Company Limited (IIFCL) is a good way to increase the credit flow to infrastructure for projects where the banks were finding it difficult to lend. The government has also increased allocation to highways by 23%, to the railways by 46%, and to urban infrastructure by 87%. The budget has outlined higher spending or benefits for power and gas grids.

On the agriculture/rural side, debt relief to farmers (available if they pay 75% of their dues) has been extended by 6 months to 31 December 2009. As was expected, there has been a huge increase in outlay under flagship projects – NREGS (144%), Bharat Nirman (45%), Rural Housing (63%).

On the personal taxation front, one of the biggest expectations was the increase in interest benefit from Rs. 150,000 to Rs. 250,000 for housing loans which was not met. But there were two positives: the reduction in surcharge and an increase in the tax exemption limit by Rs.10, 000.

On the corporate tax side, removal of Fringe Benefit Tax is a big plus. As expected, Section 10 benefits for IT companies are extended for a year. There has been increase in MAT from 10% to 15% - but this is not a sign of concern.

The stock markets were expecting some good news on education, FDI in insurance, and privatization. This has not happened. But announcements on these and other reforms could come later.

We remain positive on investing in the stock market for the long term.

Mr. Arvind Chari (Fund Manger – Fixed Income)

Government side-steps fiscal prudence - opts for growth

Fiscal Deficit pegged at 6.8% of GDP - it is way above expectations - and might trigger a downgrade by S&P and Moody’s of our credit rating. This could reduce inflows into India and can increase the cost of borrowing overseas for corporate

The gross market borrowing (issuance of government securities) to be more than Rs. 450,000 crore (revised upwards from Rs. 388,000 crore in the interim budget)

Fixed income markets disappointed - and rightly so - bond yields up by 25/30 basis points.

Excess borrowing would mean continued issuance of almost Rs 30,000 crore every month. Banks incremental SLR demand for government securities amounts to only Rs 12,000 to 15,000 crore every month

So this excess supply would have to be absorbed by insurance companies / FII and the RBI

Expect 10 year government bond yields to stay between 6.85% - 7.0%. The borrowing calendar which would be announced by tomorrow would give further clue on the trend. We expect it to be front-loaded and hence there would be pressure on yields to rise in the near term

The Government is banking on 3G revenues of Rs 25,000 - 30,000 cr in a big way to boost its revenues

The only positive from borrowing perspective could be a higher dis-investment number. They have only budgeted around Rs 1,000 crore from dis-investment. So any excess on that account could lower the borrowing figure.

The excess liquidity situation currently and low inflation has given the government courage to run such high deficits. This is not sustainable.

I do believe that the great Indian bond rally is over; prices of bonds will start to decline (as interest rates move higher); overall, we might get upward moves on bond prices but these could be moves of 20-40 basis points (0.20% to 0.40%) on some near-term news, but investing in long-term bonds is not safe – you could lose capital value if interest rates increase and the price of the bonds decline.

Above article is authored by Quantum.

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