A Budget with few negatives, than a surfeit of positives

The stock market's biggest worry was that the Budget was likely to be a populist one, given the upcoming elections in key states and also to repair the loss of credibility to the government in the wake of the recent scams. The 400-plus point jump in the Sensex immediately after the finance minister's speech ended, suggests that the Budget turned out to be much better than the most optimistic of market expectations. Investors have quite a few things to cheer about in the Budget. A lower than expected fiscal deficit target of 4.6% for FY12 (5.1% for the current fiscal), a targeted decrease in subsidies, lower market borrowing by the government, reduction in corporate surcharge, more spending power to consumers through an increase in income tax exemption limit, and permission for foreign investors to invest in Indian mutual funds.

The key question is whether the Budget will reverse the bearish trend that has gripped the market since the start of this calendar, or if not, at least arrest the downtrend for the time being. Many market experts are doubtful if the Budget in itself can change the near term course of the market, today's spectacular rally notwithstanding.

While the finance minister has largely steered clear of any major populist measures, there are doubts if he will be able to stick to his targets on fiscal deficit and subsidies.
More so on the latter, because of surging oil prices and the turmoil in the Middle East. Economists point out that the lower subsidies (food, oil and fertiliser) target seems to suggest some kind of decontrol in prices going forward. There is widespread skepticism on whether the government will be able to do that, given political compulsions.

Allowing foreign investors to invest in Indian mutual funds is welcome. But whether it will translate into huge inflows into domestic mutual funds remains to be seen. After having net pumped in around USD 29 billion into Indian shares in 2010, foreign funds have pulled out around USD 3 billion so far in 2011, as outlook on emerging markets in general has soured, and prospects for developing markets are looking better. So giving overseas investors an additional channel for investment is unlikely to change their view on India as an investment destination.   

There was too much pessimism in the run-up to the budget, with the market having fallen nearly 20% from its highs touched in November 2010 on a combination of domestic and international events. Fund managers attribute today's rally to the fact that the market was oversold, and a market neutral Budget prompted most bears to cover up their short positions.

But there are far too many macro worries for the market to be able to shrug off easily. And that is what will set the tone in the coming days. The government has been unable to get a handle on inflation, and there is a consensus among market participants that interest rates could rise further near term. December quarter earnings of companies from most sectors showed rising input costs putting pressure on operating margins. And analysts do not expect any dramatic improvement, at least for the current quarter, as higher interest costs add to the burden.

Most brokerages have already starting lowering earnings estimates for the companies they track.Earlier this month, Bank of America Merrill Lynch hosted an investor conference.
"The company presentations reinforced our broad macro view that margin pressures will lead to earnings downgrades," said the Merrill report after the conference.
Emkay Share & Stock Brokers revised earnings of 74 companies after the December quarter earnings. Of these earnings of 47 companies were downgraded.

But the biggest worry of all has been the sharp spike in oil prices because of the recent unrest in North Africa. Should oil prices continue to stay high, the finance minister's Budget targets for FY12 could go awry.

A strong rally is unlikely till foreign investors resume pouring in money the way they had been in 2010. Given the present domestic and international factors, that seems to be a tall order, at least in the short term.