The reaction by the markets to the budget was negative. The Sensex and Nifty fell over 1.5% each, the Indian Rupee (INR) fell close to a percent while the ten year bond yield rose by 8bps. Equity market volumes touched record highs of Rs 427,000 crores as derivative market volumes jumped 100%.
The negative market reaction to the budget was largely caused by a few factors affecting sentiments of investors. On the equity side, increase of surcharge in corporate tax and dividend distribution tax from 5% to 10% for domestic companies hurt market sentiments. The INR followed equity markets down as FII’s sold around Rs 1300 crores of equity.
Bond yields rose on the back of higher than expected borrowing numbers. The government is borrowing a net of Rs 484,000 crores and a gross of Rs 629,000 crores while the markets expected a lower gross borrowing number as the government had hinted of using its excess cash balances of Rs 80,000 crores for debt repayment. The gross borrowing number on a pure net borrowing plus redemption basis is Rs 579,000 crores and the government is planning to carry out a switch of illiquid to liquid securities for Rs 50,000 crores.
The question is whether the post budget fall in markets will continue or will markets stabilize at lower levels and climb up again?
Markets will stabilize at lower levels and climb up. The budget itself is not going to do much for the economy in terms of taking it up or bringing it down. GDP growth is estimated in a 6.1% to 7% range for 2013-14 from growth levels of 5% in fiscal 2012-13. The budget does not have enough thrust in spending or reforms to take up GDP growth by 1% and above. Plan expenditure for 2013-14 is pegged 29.4% higher in the coming fiscal but it remains to be seen if the target will be achieved.
The budget on the other is addressing some pressing problems of the economy in terms of deficits. Fiscal deficit issue is being addressed with commitment to lower fiscal deficit to 3.6% of GDP in 2015-16. The government has not stuck to earlier fiscal deficit targets but this time around the weak INR, that is trading around 6% off all time lows, is forcing it to act on deficits. The fact that the government achieved a 5.2% fiscal deficit in 2012-13 despite GDP growth falling to ten year lows indicates the keen eye on deficit numbers.
The FM is also watchful of the current account deficit (CAD) that is trending at all time highs of 4.6% of GDP as of first half of 2012-13. The FM is looking to plug the CAD through foreign capital flows and for more flows to come through the macro fundamentals of the economy must strengthen. Hence lower fiscal deficit and lower inflation is the priority for the government. Inflation as measured by the WPI (Wholesale Price Index) is down from levels of 9% to levels of 6.5% over the last one and half years. Inflation is expected to stay at around 6% to 6.5% levels in 2013-14 despite weak economic growth as prices of administered goods is passed on to the consumer.
The economy correction process is not short and easy. It is long and painful as growth is sacrificed for long term fiscal consolidation. India is in the long and painful path of economic correction and that is wholly positive for markets. Lower fiscal deficit and lower inflation will bring down interest rates in the economy leading to lower bond yields.
Equities will start doing well as the economy is seen, as being on the mend while a good equity market will bring in capital flows leading to a stronger INR. Global factors of central bank liquidity and good prospects of growth in the US on the back of improving housing and labour market will help Indian equities stabilize and run up going forward.
Short term volatility will be high for markets but that is part and parcel of the game.