Expectations from Budget soar post reform steps

Finance Minister P Chidambaram has started something that cannot be stopped, as any roadblocks to these will result in a economic catastrophe.

There are high expectations from the government after the foreign direct investment (FDI) reforms in retail, diesel price decontrol and commitment to lower fiscal deficit. Indian equity, bond and currency markets expect the government to continue its push on pragmatism rather than populism.

The markets are not really concerned about reforms. The fact the government had the courage to act on a controversial limit increase in FDI in the retail sector and also allow oil companies to price fuel at market rates (albeit with some clauses but a major step forward all the same) has the markets seeing the government in a different light. Talk of “Policy Paralysis” has turned to “Bold Measures” to improve quality of economic growth.

The markets want the government to be prudent on its policies. Lower subsidies, wider tax net, rational allocation of scarce funds and reasonable policies for the industry are more than what the markets could ask for. The ruling Congress and its allies need not worry about the policies as they will lead to lower fiscal deficit, inflation, government bond yields and interest rates and an improvement in portfolio flows and the currency.

Hopes of a good budget for 2013-14, with economy friendly measures rather than voter friendly one, are rising. The big question the markets are now asking is whether Chidambaram can deliver on these higher expectations.

The Sensex and Nifty at 20,000 and 6,100 levels, respectively, 10-year government bond yield at 7.85 percent and the rupee at 53.80 against the dollar have all rallied over the last few months on the back of the government’s reform steps.

The markets at higher levels are stopping and wondering whether the government will continue on its prudent path.

The market expectation in terms of GDP growth is not very high. In fact mention of high rates of GDP growth by the government will work negatively as markets will immediately factor in higher inflation. High inflation is something neither the economy nor the markets want, as the consequences have been severe as seen in the last few years. GDP growth rates at below 7 percent levels in 2014 and between 7 percent and 8 percent levels in 2015 are fine for the markets as it shows that growth is happening without raising inflation expectations.

The government is under no pressure to show extraordinary growth rates of over 9 percent levels seen in the 2004-08 period.

In fact China is also content with growth in the 8-9 percent region rather than the high double digit growth seen in the 2000-2010 period. China has its own worries of over investment, bad loans, social inequality and corruption and is finding that stable, quality growth is better than scorching unstable growth.

The markets also understand that there will be pain in the short term for long-term gains. Full pass through of administered prices to the end-user will result in higher inflation in the near term but a lower fiscal deficit will bring down long term inflation expectations.

Lower government spending can lead to sectors dependent of government largess showing growth slowdown but that slowdown will be taken care of by sectors that thrive on efficiencies. Markets are prepared for a longer haul this time around.

The message from the markets to the FM is clear, we will support you if you continue to do what you are doing but all bets are off is there is any change in the roadmap for the economy.

Arjun Parthasarathy is the Editor of www.investorsareidiots.com a web site for investors.