Feb 27, 2013 01:27 PM IST | Source: CNBC-TV18

Budget 2013: Investors eye growth-deficit balance, says Ridham Desai

Ridham Desai of Morgan Stanley thinks the European woes are to be blamed for the beating that the market took. According to him, a slightly aggressive Railway Budget may have fared well for the market.

A disappointing Railway Budget failed to meet market expectations and Indian equity benchmarks saw heavy selling pressure on Tuesday with the Sensex losing more than 300 points. As the market heads to the Union Budget on February 28, expectations are low and Udayan Mukherjee, Managing Editor of CNBC-TV18 believes it may have set the stage for a 7 to 8 percent rally post Budget.
Ridham Desai of Morgan Stanley thinks the European woes are to be blamed for the beating that the market took. According to him, a slightly aggressive Railway Budget may have fared well for the market. However, "What the Railway Budget does is fairly distinct from what the Union Budget does. So, I think the Union Budget will be a different day," feels Desai.

Besides, Desai added that investors are looking at a tight balance between growth and fiscal deficit. As a result, all eyes will be on the Union Budget to see what the finance minister comes up with in terms of curtailing the deficit and improving growth, he opined.

Here is the edited transcript of the interview on CNBC-TV18.

Q: Is the market a bit worried that the Railway Budget is focused so much on austerity? It did not look like it was very investment or growth oriented. Could it be something like that in the Union Budget, the focus will be on fiscal deficit, but it will not do too much for growth and that may not cut too much ice with the market?

Desai: Yes, I think we are suddenly getting into a situation where the options are not that many. So expectations need to be reined in, which is what the market is doing right now. It is keeping its expectations low. Today, I think it was mostly to do with Europe and far too little to do with the Railway Budget. I don’t think the market was really looking at that.

It was Europe that was calling the shots. Maybe if the Railway Budget had been a bit more aggressive, it may have helped the market in the latter half of the day, but it didn't. I don't think that should be read as a signal to what the Union Budget is going to be. Historically, the two of them have not necessarily been linked. What the Railway Budget does is fairly distinct from what the Union Budget does. So, I think the Union Budget will be a different day.

Q: What are investors more focused on, people that you talk to? Are they more focused on the fiscal deficit issues or after this earnings season, are they starting to fret more about growth because they buy India for growth, not for lower fiscal deficit. On that they will measure the Budget and on whether the FM can do something to really restart growth?

Desai: Indeed it is a tight balance between growth and fiscal deficit. But, let me just step back and go back to the point that Homi was making. The most crucial aspect is the fiscal deficit and let's not forget that.

In the last five years, if you consider 7 percent as India's consolidated fiscal deficit, the number where it should be and which would translate into a central fiscal deficit of say 4.5 percent, we have exceeded that 7 percent by cumulative 8 percentage point of gross domestic product (GDP) in the last five years.

We have been running between 7 and 10 percent. We are now inching back to 7 percent. Hopefully, that will be the target for next year. What that has done is it has taken real rates into negative territory and what that has done is the lag financial savings have got crushed.

Financial savings today, the last number that you have got form Central Statistical Organisation (CSO) is at 8 percent of GDP, which is the number we used to have in the early 1990s. Why has that happened? That has happened because you have run a very large fiscal deficit. You have brought down real rates to negative territories and you have boosted consumption.

So you have to engineer a reversal of that process and I think that reversal started in September last year with the FM taking office. I think he saw that as a central issue hurting the economy, hurting growth, hurting savings and I think he is addressing that. It is an ongoing process. This Budget will confirm that he is on that path and I think that's the primary thing that investors are looking for.

I think it is a point that Ashok made and he said that the maths should add up. It should not look like it has been put in place and it is window-dressed, as we call it.  If the math is genuine, if the fiscal consolidation path is on, I think investors will react very favourably. At the same time, there is risk to growth. Certainly, if you are going to cut the government expenditure sharply as the government is doing and that process will continue for the next six months, there will be some risk to growth. You need to offset that with proper incentives inside the Budget. So that is the fine balancing act that he has to achieve on Thursday.

I think the FM is capable of doing that because from what I have seen of him over the years and especially over the past six months, I think he has actually got a good grasp of these issues. So, he understands that he needs to balance these two in order to generate a better cycle for India.

So first take care of the macro stability risk, which I think is on course and then also try and address some of the growth issues which I think is also happening both inside and outside the Budget. That's the fine balance that investors will look for.

Q: Do you think that short-term capital gains or Securities Transaction Tax (STT) maybe slashed?

Desai: He will probably go for fixed deposits. I think that’s far more effective. Cutting short-term capital gains tax may not really change the game for financial savings. If you want to lift financial savings, the biggest component is bank deposits and that has really been lethargic.

So you lift the net returns on bank deposit by saying that instead of Rs 15,000 take Rs 50,000 tax free, put it into a bank deposit because that money comes back into the economy and actually creates greater economic activity. It is of greater benefit to the stock market than cutting gains tax.

So, I would concur with Ashok that there is limited value in actually tinkering with the capital gains tax. You could then start arguing about dividend tax, can we cut that? I think that is actually more effective than capital gains tax as it is the tax that everybody anyway pays when dividends are distributed. It lifts net returns to investors. So, I think fixed deposit limits could be enhanced and you could improve the returns there and then probably influence some flows into banks.

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