Sucheta Dalal :Why nobody is talking of a dream Budget...
Sucheta Dalal

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Why nobody is talking of a dream Budget...  

Feb 27, 2006

Although finance minister P Chidambaram would like to appear cool to how the stock market reacts to his Budget and his policy initiatives, big market players think otherwise.


An industrialist tells me that the FM is “obsessed” with the Sensex. We will take as read, Mr Chidambaram’s vehement denial to such an assertion. But with the Sensex already well above 10,200, there is serious worry in the financial community about the sustainability of prices at these levels, since the government has little leeway in pursing economic reforms.


Interestingly, research reports of all leading brokerage houses indicate a great deal of pragmatism about the Budget. There is a realisation that the minister has to make nuanced policy announcements and de-emphasise reforms; that is probably why nobody is talking about a ‘Dream Budget.’ In sharp contrast to the hyperbole and exaggerated importance attached by the media to the actual Budget speech, money managers and analysts are taking a longer term perspective in addressing their investor base.


Many see the Budget speech, on February 28, as a statement of intentions. With West Bengal elections round the corner, the Budget will be dominated by populist themes and major policy initiatives may have to be publicly negotiated with the Left parties. Ironically, the United Progressive Alliance’s (UPA) communist allies are a bigger headache for it than the Opposition, which is more focused on embarrassing the government on political issues rather than economic ones. Consequently, every reform measure will be met with belligerence by the Leftists, seeking to display their power over the UPA government.


One influential brokerage firm says that no ‘hard reforms’ can be expected in this Budget and all big announcements will have to be negotiated. Other firms have said similar things in different ways. Interestingly, the biggest private banks are set to foray into the rural market and see it as their next big growth market. This provides the perfect opportunity for the finance minister to please the financial community by announcing facilitating policies that could give a thrust to rural development and accelerated credit to farmers. Indeed, the market strongly expects policy announcements to give a fillip to rural development and to incentivise state governments to push rural infrastructure development, including power and irrigation, as well as health and education facilities.


• The FM is likely to make nuanced policy announcements, de-emphasise reforms

• Likely reform enablers like divestment will be activated only after Bengal polls

• A post-May revival will benefit long-term investors in blue-chip stocks


The Bharat Nirman project already meets some of these objectives. The Budget may concentrate its attention on food processing, farm retail and other infrastructure that empowers farmers and helps to optimise their realisation on farm produce. This would include steps to link farmers to commodity trading bourses by refining ‘warehousing’ receipts to make them easily tradable. Hopefully, these measures will pass muster with Leftists, who understand subsidies rather than reforms.


Disinvestment of public sector undertakings (PSUs) has virtually ground to a halt, but large brokerage houses predict a big revival once the West Bengal elections are out of the way. This is an extremely candid but accurate assessment of communist hypocrisy about reforms. Like PSU disinvestment, investment advisors believe there will be several reform enablers contained in the Budget speech, which will be activated only after the Bengal elections. These may include permission for foreign direct investment (FDI) in the retail sector and real estate. If this turns out to be correct, a post-May revival will benefit long-term investors in blue chip stocks.


The capital market expects the FM to continue his effort at greater fiscal responsibility by achieving a small cut in revenue deficit and fiscal deficit. A booming economy, leading to higher revenue receipts, greater realisation of corporate tax and personal income tax, coupled with good expenditure management, should allow the FM crucial elbow room to do so. Happily, the economic growth momentum is expected to be sustained in the coming year. This will ensure continued foreign portfolio flows into India and a healthy capital market in the long term.


The need for correction of unsustainable oil subsidies is a strong Budget expectation. Here, the market grape-vine strongly believes the new petroleum minister will persuade Mr Chidambaram to reduce custom duties as a part of the rationalisation process. Will he succeed? It must be remembered that the government’s revenue collection will meet targets or fall just a shade short, because of the jump in customs revenue, led by the ad valorem component of tax on oil. One universal expectation is that the fringe benefit tax will be hugely modified, but the finance minister will stubbornly refuse to scrap it. Mr Chidambaram could well turn this expectation into a nasty surprise through perfunctory changes. After all, the minister has always defended the tax very strongly.


A common theme across all Budget documents is a high degree of complacency that the FM will not touch capital market-related taxes such as securities transaction tax or capital gains tax. Instead, the market expects more concessions for debt funds (capital gains and dividend distribution tax), long-term fixed deposits with banks and certain types of mutual funds. Similarly, the service tax base is also expected to be increased by bringing newer sectors into the tax net and excise and customs duties will continue to be rationalised.


In conclusion, it is safe to say, from the investor perspective, that extreme reactions to the Budget speech may be foolish. However, with the Sensex at an overheated 10,200-plus, it is anybody’s guess what Tuesday will bring.


-- Sucheta Dalal