Sucheta Dalal :Capital Market Takes Stock (1 March 2002)
Sucheta Dalal

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Capital Market Takes Stock (1 March 2002)  

The long faces at all industry congregations that were beamed live by national networks and a steep 144 point drop in the Sensex (which is a 175 point drop intraday) are enough to unnerve any finance minister. But once again, finance minister Yashwant Sinha’s budget is hounded by bad luck. Let us not forget that the budget was presented in the background of large scale violence in Gujarat, the threat of a bandh in Maharashtra, political uncertainty that has developed after the Bharatiya Janata Party’s defeat in the assembly elections, and a potentially explosive situation that is developing over the Vishwa Hindu Parishad’s determination to build the temple at Ayodhya. This means that even on a normal day, the market would have been volatile and depressed. Given this scenario, Sinha’s budget received a bigger drubbing than it probably deserved. It is true that the budget is not as scintillating as his ill-starred effort last year, and his ability to control the fiscal deficit at 5.3 per cent of GDP will remain a worry especially because he is silent on that front. Having said that, the budget has plenty of positive features which have temporarily been ignored by the market.

Sinha has proposed extremely constructive reforms in agriculture, power, urban renewal programmes, education, infrastructure and the many statutes relating to these sectors. He has also taken some politically difficult steps towards the withdrawal of subsidies. But the implementation of many of his proposals is largely dependent on cooperation from states. The capital market’s initial reaction is always to the here and now situation. And as far as that goes, it is almost as though Sinha’s budget has deliberately attacked investor sentiment.

The average Indian investor who is disenchanted with the primary market and battered by the collapse of Unit Trust of India and the speculative excesses of 2000-01 justifiably expected specific reliefs in the budget. Instead, Sinha gave him a dividend tax, a surcharge on income tax, and corporate tax. But it is the dividend tax that best reflects Sinha’s insensitivity to market sentiment. The disappointment over the imposition of dividend tax is probably as disproportionate as the jubilation over its withdrawal a few years ago. Had the finance minister realised it, he would probably have weighed whether the revenue collected through dividend tax was worth the negative reaction that it produced. Also, while Sinha has promised some amendments to the Securities and Exchange Board of India Act to give more powers to the capital market watchdog, these will only boost investor sentiment if Sebi demonstrates its willingness to use the powers to protect investors and clean up the capital market.

The disappointment over the budget is also a reflection of high expectations that were built in the run up to it. The accelerated pace of public sector units sell-offs, the promise of labour reforms, and the decision to permit 49 per cent equity to foreign banks had all been announced just weeks before the budget. This had naturally led investors to expect a dynamic budget that would aggressively cut the small savings rate in order to reduce interest rates and accelerate growth. However, Sinha chickened out and in the process pleased nobody. His decision to cut the savings rate by just 50 bases points not only hurt and angered small savers and pensioners but it also disappointed industry.

I should also point out that the implications of several of Sinha’s efforts towards increased capital account convertibility have yet to be fully understood. For instance, R Balakrishnan, chief executive officer, First India Asset Management makes the interesting point that allowing Indian mutual funds to invest in foreign sovereign debt will help asset management companies having foreign parentage and expertise in such markets. However, he points out that “investments in such niche areas need to be capped as a percentage of total assets managed”, otherwise, “investors are likely to desert domestic funds and put money into offshore investments since the rupee depreciation will compensate returns available in India”. Balakrishnan argues that the same logic should also allow Indian investors to hold a fixed deposit in foreign currency. Will Mr Sinha respond?

As far as specific stocks go, large speculative positions had been built up in PSU scrips, especially bank stocks, on the expectation that the budget would take steps towards bank privatisation. The huge intraday drop of 13 per cent in State Bank of India happened because this expectation failed to materialise. However if the government follows up quickly with the bill on banking sector reforms, which is proposed to strengthen creditors rights, then banks stocks could look up again. Similarly, the long languishing IDBI scrip could look up if it is provided more operating flexibility.

The lowering of customs duty hit cement stocks that were buoyant because of the cement cartel’s ability to hike domestic prices. Information technology stocks did the most damage to stock indices because of the increased taxation on these companies and saw a huge fall in market favourites such as Infosys, Satyam, Wipro and Digital Global Soft. However, selling pressure was seen across sectors such as telecom, engineering, banking and consumer durables. Over the next few weeks a lot will depend on the political situation and a better reading of the fine print in various sectors. If the Ayodhya problem does not flare up, the market would probably begin to turn steady. Foreign institutional investors who have little to complain about would probably resume pumping in nearly Rs 100 crore a day into Indian stocks. (FIIs have already been bullish about India and the removal of segment restrictions has cheered them immensely). Several leading market operators are already busy talking up the market after trading hours by announcing their plans to resume their bullish purchases.

If the government shows some determination in implementing the budget proposals then the short-term disappointment would soon be forgotten. If it fails to push ahead with the promised privatisation and reforms, it faces the prospect of a downgrade of its sovereign credit rating. The political situation is equally important. If the Ayodhya issue lurches out of control, stock prices could move precipitously south.

-- Sucheta Dalal