How do you asses the Budget?

Will the investors benefit from the Budget? Will the markets rise or fall after it?

What should an investor do after the Budget?

The UPA government will present the Union Budget for 2011-12 to the Parliament on February 28, 2011.

Those who want to follow it need to focus on some crucial aspects of it and understand whether expectations have been met.

This five-part series will focus on these aspects and on the Budget day, investors can separate the wheat from the chaff and draw up their investment strategies after the announcements.

Key themes of the Budget
The main issues facing the government are inflation and finances. Inflation has been persistently high for almost a year-and-a-half now, with the Wholesale Price Index for all commodities ruling at 8.3% for January. Inflation had touched highs of 11.2% in 2010 and is expected to close the fiscal ending March 31 at 7% levels.

The primary article index, which includes food and fuel, is ruling at close to 15% levels after topping 20% last December. The voters are hit by high prices and that is politically unacceptable and hence the government’s focus on inflation. The anti-inflation measures will be keenly watched by the market.

Government finances
At a time when the government is fighting scams which have caused huge losses to the exchequer (2G scam loss is pegged anywhere between Rs55,000 crore and Rs175,000 crore) and evading questions on black money stashed abroad, the way the government goes about managing the revenue expenditure gap is critical.

The most common indicator of the revenue expenditure gap is the fiscal deficit. It is shown as a percentage to GDP and is forecast at 4.8% of GDP for the next fiscal.

It is pegged at 5.5% of GDP for the current fiscal, but is expected to be slightly below that because of one-time revenues of over `100,000 crores that the government got from the auction of 3G spectrum held some months back.

However, the headline fiscal deficit must be looked at in conjunction with the funding of the deficit. The deficit is funded by market borrowings - that is, the issue of government securities or bonds. If the government’s market borrowings exceed expectations, yields on bonds will rise, and vice-versa.

(Note: When yields rise, prices of bonds will fall, causing losses to those who hold it. Yields and prices of bonds move in opposite directions because the face value and maturity value of the bonds are the same; Also, interest rates and yields move in the same direction).

Any rise in the yields on government bonds is detrimental to the economy because interest costs will go up and corporate profits will come down and investments will be hit. A fall in yields is good for the economy (yields fall when interest rates fall) and corporates will have higher incomes and will be more enthused to invest.

These are not hard and fast rules as many other factors also determine interest rates but investors can focus on these two critical factors.