Budget Report

The finance minister has opted for a soft approach in his budget speech in parliament on Friday. While the spending on infrastructure and other essentials should be welcomed, the lack of the much needed reforms is worrisome.

The fiscal deficit (the excess amount that the Govt spends over what it generates) is set to touch 5.9% of GDP this year and Mr. Mukherjee’s target for next year is 5.1%. This is the biggest cause for worry in this budget speech. Most economists agree that a fiscal deficit of below 3% is acceptable. That we are over-shooting that level by almost double this year and, slated to do so next year also, does not augur well for the economy. Government borrowing will shoot up (to meet the under recoveries)  and it will add to the inflationary pressures as well as keep the interest rates for the economy  uncomfortably high. I expect debt investments will continue to do well in the coming year. I also expect the high rates on home loans, personal loans and auto loans to continue.

The equity market reacted negatively to the budget. The markets were hoping for some big reforms especially the introduction of the Direct Tax Code (or DTC). The lack of any new policy initiatives and also the raising of the Central Excise Duty by 20% will not be taken happily by the market. The fiscal deficit situation could also weigh in on the market. I expect the market will react negatively in the short term before global factors once again will take over sentiments.

The Rupee continued to hover in the 49-51 range to the dollar. We continue to see Foreign Institutional Investors (FII’s) bring money to the market. However, their reaction to the budget needs to be closely watched. I expect the dollar to trade in the same range with a slightly negative bias.

The increase in the import duty of Gold is a welcome move. Gold is still seen as an investment by most Indians and we’ve been importing record quantities every year. The high price of Gold has begun to affect the current account deficit (balance of imports vs exports) and is adding to the inflation. Gold is a dead asset, as in it does not actually add value in any way to the economy. The move to raise the prices of Gold should be welcomed and investors should look at other more productive avenues for their investments.

The move to increase the income tax slabs is a positive. However, this exercise needs to be inflation linked if it is to have any relevance. There are already moves to link the slabs to the inflation index. The Rajiv Gandhi Equity scheme also seems promising. It is directed at bringing more middle-class participation in the equity markets by offering them more tax incentives.

Over-all I feel that this was a chance missed by Mr. Mukherjee. I understand the political compulsions with the drubbing received in the last elections and Ms Banerjee’s ire over the railway budget. It was the compulsions of coalition politics. But, India needs some big reforms of the type introduced in 1991to take it on the next trajectory of growth. Those kind of reforms and foresight were lacking in this budget speech. The next budget will be the last one delivered by this Govt. We can expect it to be a populist budget which will further strain the Govt’s finances. This was probably the last chance for this Govt to implement the much needed reforms.