Pranab to market: here's the good news

 The headlines are bullish. On the topline, GDP growth for 2011-12 is projected to be higher at 9% against the 8.6% registered in 2010-11. Inflation expected to come down (from average levels of 9% plus in 2010-11) on the back of the RBI’s tight monetary policy stance. The current account deficit is expected to come down on a better mix of capital flows and fiscal deficit projected at 4.6% of GDP for 2011-12 against a revised estimate of 5.1% of GDP for 2010-11.

Over and above the topline, the bottomline has also delivered with net market borrowings budgeted at Rs 3,43,000 crore against market expectations of Rs 3,80,000 crore. The feel-good topline and bottomline is accompanied by encouragement of capital flows. Foreign individual investors will be allowed to invest in Indian equities through mutual funds. FII limit for corporate bonds issued by infrastructure companies has been raised from USD 5 billion to US$ 25 billion, with the total FII debt cap at $40 billion. And, finally, there are no significant changes in the tax structure. The budget comes as a balm for the jittery markets and the latter have taken their cue to rally from lows.

Indian bonds, equities and currencies have been hit by worries on inflation, rising oil prices globally, corruption scams in the country and uncertainty on the nature of the budget. The Sensex was down 15% in the calendar year to date, bond yields were trading at close to fiscal year highs and the rupee was down over 3% from highs seen in late 2010.

The market-friendly budget provides some amount of relief for the markets. The budget will at least make sure markets do not go down further, if not go higher, from current levels. However, global events such as a spike in oil prices, loss of global risk appetite, hike in interest rates by central banks in inflation-hit countries, etc, can affect sentiments adversely.

The budget specifics are not as encouraging as the headlines. The provision for subsidies is understated, with fertiliser and fuel subsidies budgeted at Rs 50,000 crore and Rs 24,000 crore respectively. The subsidies are rising due to oil prices trading at US$ 110 a barrel with estimates for 2010-11 at close to Rs 100,000 crore for both fertiliser and fuel. The revised estimates for 2010-11 for fertiliser and fuel subsidies do not reflect the current realities and the budget is silent on the treatment of the rising subsidy bill. Tax revenues are budgeted to increase by 18% over revised estimates for 2010-11, but there is no corresponding large-scale change in the tax structure. The budget expects higher growth rates to bring in higher tax revenues. There are no concrete reform proposals in the budget while expenditure (plan and non plan) is budgeted to increase by 3.3%. The higher tax collection coupled with a lower rise in expenditure has enabled the government to project a lower borrowing. 

The government may not be as lucky as it was last year in the revenue front. Tax collections were healthy with corporate tax collection growing by 25% and indirect tax collections growing by over 40%. The one-time revenue of over Rs 1,06,000 crore on spectrum auctions inflated the revenue figures of last year. Fiscal 2011-12 will be challenging for the government on the revenue front. The persistent high inflation will eat into corporate margins, high oil prices will lead to growth concerns and tighter monetary policy ( government is signalling that the RBI will tighten policy further to combat rising inflation expectations) will impact credit growth. The government, on the other hand, cannot control its expenditure due to its sticky nature. Interest payments on loans form over 20% of total expenditure while the subsidy bill will only go up rather than come down if oil prices remain at higher levels.

The finance minister may be able to please the markets temporarily with upbeat headlines, but if the markets remain hardnosed the optics hardly matter.

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