Budget 2011 – Virtuous spiral of Indian economy remains

undisturbed, our asset allocation remains same 

March 7, 2011, Sensex @ 18200
 
Macro Economic Fundamentals
 
Given the scam tainted and a weak government, expectations from the budget were on the lower side.  Moreover,
there was concern that stimulus measures instituted post global crisis will be largely withdrawn. Important point was
to evaluate whether this budget facilitates a virtuous spiral which allows demand to continue without causing
inflation for a much longer period of time.
 
Last year, it was predominantly consumption that had driven the Indian economy forward. But very soon, inflation
pressures started appearing. Some of it was due to uncontrollable factors including commodity and oil price rise
because of global economy picking up.  However, largely it was due to plunder on a very big and brazen scale. The
same money if employed honestly and efficiently could have created a much better infrastructure and left room for
industry to augment its capacity.
 
Everybody was relieved that the government has not done anything to disturb the upward trend in consumption
virtuous spiral. There were a few measures to sustain the consumption, for example, a reduction in personal taxation
and not increasing the excise duty for several industries, notably auto and FMCG sector. Service tax has also been
maintained at a constant rate.
 
Buoyant growth has given the government confidence to come up with impressive fiscal deficit numbers. The
finance minister claimed that fiscal deficit was down this year to 5.1% of GDP against the targeted 5.5% and would
decline to 4.6%.  Government borrowing will be limited to Rs 3.43 lakh crore rupees, thus not crowding out and
leaving some room for industry to fund its expansion.
 
There is confidence that Indian economy will grow at 9% in the year 2011-12. This might be accompanied by
moderating inflation because of RBI’s monetary tightening and might allow the central bank to take a mid cycle
pause.
 
An optimistic scenario will be where industry finds the wherewithal to create additional capacity, infrastructure
execution improves, agriculture picks up and the supply side problems decrease, at least to a certain extent, thus
taking care of increasing aspirations and demand of growing India.
 
 
GDP Components
 
The budget took care of C (consumption) part of GDP by his taxation proposals.  Revival in I (Investment) part of
GDP is supported by relatively high savings rate and the rate of gross capital formation in India. The reduced
government borrowing number leaves enough headroom for private sector borrowing. The finance minister has also
reduced the surcharge on corporate income tax. All these measures along with inherent strength of the corporate
sector brighten the industrial outlook in the medium term.  G (government) part is given fillip by significant
allocations to education, health and food security, thus supporting inclusive and equitable growth. Overall, Indian
economy is expected to fire on all cylinders for a number of years.
 

Revival of Pending Reforms

 
The finance minister announced that he will take forward long pending reforms. The decision to press ahead with
the Direct Taxes Code and transition to a countrywide GST (goods and services tax) are welcome reform measures.
Additionally, there is a plan to initiate delivering subsidies through cash transfers for kerosene, fertilisers and LPG.
He also wants to push ahead with seven old financial sector bills, including those relating to insurance and banking
reforms. 
 

Infrastructure & Agriculture Push

 
This has continued from the previous year, with the push for Infrastructure progressing this year too. Government
allocation is now going to be 23% higher than last year, amounting to Rs. 2.14 lakh crores.  Investment of Rs.
20,000 in designated infrastructure bonds to be deducted from taxable income, instituted last year has been
extended. He has also raised FII limits in Infrastructure corporate bond space from 5 billion USD to 25 billion
USD. Additionally, the excise on large power plants is reduced.
 
He has added Rs 3000 crore to NABARD share capital and Rs 10000 crore to its short term credit fund and 3%
interest subsidies to farmers. Additionally, he has granted infrastructure status to cold storage chains. These steps
will increase agri sector’s contribution to GDP.
 

Effect on Financial Markets

 
There is a positive effect on both equity and bond markets. Indian economy is poised to grow at even higher rates
and stocks in the long run are related to economic growth.  Banking, FMCG, Auto, Pharmaceuticals and
Infrastructure stocks should do well.
 
With good fiscal deficit projections, bonds also rallied, with 10-year bond yields going down to 7.94 from their pre
budget level of 8.1%.
 
 
Risk Factors
 
·         Whether fiscal deficit figures are realistic, for example whether oil subsidy could remain at Rs 23640 crore
·         Geopolitical factors especially the unrest in the Middle East and impact on oil prices
·         Continuing misgovernance with corruption
·         Supply side problems in agriculture and execution of infrastructure projects
·         Inflation, especially food process
·         Foreign fund flows finding other destination
·         Implementation of reforms
 
 
Our Recommended Asset Allocation
 
Our recommended asset allocation for long-term money remains same as in my 2011 concise market view note of
Jan 2011.  Long-term money should remain invested in Indian equities. Short term money should be in debt funds
but not gilt funds since bond yields can start moving up. Gold because of its safe haven status should be an
important, though small, part of the portfolio.
 
For NRIs, investing a part of their savings in Indian equities and debt markets will be beneficial. The currency is
also in a long term uptrend and that becomes an additional attractive factor.
 
The principles of valuation, diversification and time horizon remain sacrosanct.