‎India Markets Weekahead: Correction could follow budget week

July 6, 2014

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

Last week’s robust pre-budget rally belied expectations, with the Nifty closing up more than 3 percent at a record high of 7,751‎. Automobile sales, manufacturing PMI as well as services PMI showed an uptick. The Iraq turmoil seems to have taken a back seat with oil prices receding from a nine-month peak. A rally in world markets, with life highs for the DJIA and S&P 500, also aided sentiment.

India’s fiscal deficit in the first two months has already touched 45.6 percent of the full-year target. Though this would have been a negative indicator, the markets welcomed Finance Minister Arun Jaitley’s remarks about focusing on fiscal consolidation against “mindless populism“.

The budget on July 10‎ would be a tightrope walk for the finance minister. Political necessities would not allow a drastic reduction in subsidies, although Jaitley may set a road map for their gradual reduction. Income tax payers may not get a huge relief but there could be a token increase in exemption limits.

It would be important for the finance minister to direct new investments into productive asset creation rather than pure financial investments, which we have witnessed during this “rally of hope”. The government needs to kick start the economy and, for this, they need investments to flow in not only from overseas institutions but also channelize domestic savings. I expect the finance minister to provide tax breaks for investments, especially for infrastructure and manufacturing.

Infrastructure would be a major focus area to generate employment directly as well in the feeder sectors. It cannot depend entirely on investors and thus the budget allocation for this sector would a prime indicator of the government’s focus.

A record divestment target of over 700 billion rupees could help rein in the runaway fiscal deficit to a certain extent though it’s not sustainable in the long term. The fiscal deficit is bound to breach the earlier benchmark of 4.1 percent but one would need to see whether rating agencies give higher weightage for growth, thus avoiding a downgrade.

With tax revenues lagging the interim budget estimates, non-tax revenues could be the only saviour. The key player in the India re-building story would be the investor, whether overseas or domestic, without whose support the building blocks will fall apart. The budget would focus on displaying the right intent to ensure that the flows continue and the plans are implemented smoothly, including the divestment targets.

Markets have been moving up relentlessly amid an “over-valuation” based on investor trust that the Narendra Modi government would steer the economy into a growth path. Though the finance minister may espouse “short-term pain for long-term gains”, the markets generally do not have the ability to bear pain. A correction could follow budget week and I would wait for sanity to return before investing  in the markets for long-term gains‎.

(For full coverage of budget 2014, click here)

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