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    Default Budget may have long-term impact on various asset classes

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    [DOWN]There are two ways for an investor to gain from the Budget proposals. The most common strategy is to pick up sectors or a group of companies most
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    likely to shine from various Budget proposals. Every Budget has its favourites in terms of tax proposals, sops and budgetary allocation. This tilts the playing field in favour of certain companies. The investor can juice-up his returns by betting on these stocks. And like every year, the Budget proposals for FY10-11 are likely to benefit some sectors and may hurt others. (See Budget Winners on Page 4).

    The impact of the Budget, however, goes beyond simple sectoral arbitrage. The government is the biggest economic actor and the budgetary proposals touch everything and everybody in some manner or the other. While in a normal year, this cascading affect is small and short-term in nature; this Budget is likely to set in motion factors that may have significant and long-term impact on asset classes, especially fixed income and equities.

    First, consider the macroeconomic background to the current Budget. The past two financials years were among the toughest for the Indian economy and its regulator, the government. First, the economy had to face spiralling crude oil prices, which came close to turning India’s economic apple cart upside down, second was the tsunami of the global financial crisis, which nearly wiped-off all economic gains of the past decade. Ultimately, the government was able to contain both the crisis with clever use of various fiscal and monetary measures; but it was not a costless exercise. The measures such as oil and fertilisers bonds, sixth pay commission awards, farmer’s debt waiver scheme and deep cuts in indirect taxes, did bring immediate succour to consumers, farmers and corporates, but it also burned a deep hole India’s public finance that threatened the long-term viability of the country’s growth story itself. (See chart below)

    By the end of the FY09, India’s fiscal deficit — excess of the government expenses over its revenues — was nearing 10% of the GDP forcing the government to scale-up its borrowing programme. This had two immediate effects. First, it greatly pushed up the demand for goods and services in the economy and helped in the build up of inflationary expectations. Second, a hike in government debt issuance sent the yield curve up for all kinds of debt instruments. This had an adverse impact on investment and consumption, especially high-value items which are bought on credit. Slowdown in investment means a lower capital formation that pulls down the long-term growth potential of the economy and manifests itself in the form of a lower GDP growth in the subsequent period. In normal course, the government can compensate for lower private investment by boosting the public investment but higher fiscal deficit comes in the way. Not surprisingly, bank credit — an indirect measure of the level of investment — has been slowing down since the beginning of 2009.



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