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Budget 2013: A chance to leave ‘policy paralysis’ behind

By Geoff Lewis
February 8, 2013

(Any opinions expressed here are those of the author, and not those of Reuters)

In India, the government continues to both talk a good game and walk a decent game, having apparently learnt its lesson after a prolonged period of policy paralysis, before gaining a fresh lease of life with last summer’s economic reforms.

This year also, the government of Manmohan Singh has been unusually active ahead of the budget, scheduled for Feb. 28. Finance Minister P. Chidambaram has just completed a global road show.

In meetings with foreign leaders and institutional investors, Chidambaram spread the gospel that his government is serious about restraining the budget deficit and getting back on track with India’s planned fiscal consolidation. To attack the fiscal deficit, diesel subsidies are being curtailed and passenger ticket prices for trains are being increased.

Chidambaram’s road show may have raised expectations in the investment community with regard to what this year’s budget will contain. The majority of foreign fund managers, however, unlike local residents, normally have fairly low expectations of, and limited interest in, India’s annual budget exercise. With its perennial disappointments in budgetary control, poor implementation record and frequent bias towards populist measures, the Indian budget normally plays very little part in the strategic decisions of foreign fund managers to increase their exposure in India.

The stock market expects that sufficient efforts by the finance ministry to control public spending will be rewarded by further interest rate cuts from India’s central bank, the Reserve Bank of India (RBI). These can now occur given the additional space for monetary easing brought about by ameliorating inflation. Though some broker estimates of another 100 basis points of cuts in 2013 may appear to be a cut or two too far.

We regard the RBI as a well managed, cautious central bank. The inflation guidance in the policy statement accompanying the 25 bps cut in rates on Jan. 30 indicates clearly that the RBI expects the government to do its bit on budget day. If it does, there is a promise from the RBI that improving inflation conditions provide an ”opportunity for monetary policy to act in conjunction with fiscal and other measures to stem the growth risks.”

While lower interest rates will certainly help, what the Indian economy desperately needs and what the stock market craves most is a resumption in fixed asset investment.

So far, FIIs are keeping the faith with India. Portfolio inflows have remained steady and remarkably consistent, indicating that India remains one of the preferred destinations in the Asia Pacific. India has underperformed the Asian rally YTD, and there are good quality stocks whose share prices have retreated 10 percent or so, providing a good entry point to the market for investors. We note that the rupee has also strengthened as the government prepares to attack the fiscal deficit with more vigour.

There is an element of hope in all this; notably the hope that the moribund investment data will start to improve sequentially over the next 6 months. That would have a big impact in our view, reinvigorating quality Indian stocks, the infrastructure sector and the market overall. The potential downside would be if the government, besides engaging in fiscal housekeeping on Feb. 28, unveils too many populist sops ahead of elections in 2014.

With a chance to put ‘policy paralysis’ behind him and secure his place in history as the leading champion of India’s economic and financial reforms, we wish Manmohan Singh (and Chidambaram) well and await the upcoming Indian budget with an unusual degree of interest.

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