Budget 2011: Providing the spur to capital flows

The budget has pleasantly surprised the market since expectations were at the nadir. The overall tilt is positive for capital flows and it has sown the seeds of double-digit growth.

With limited scope to curtail spending, the budget has focused on enhancing revenue receipts. Instead of hiking tax rates, it has rightly widened the tax base by bringing more services under the ambit of service tax, etc. and ensuring higher compliance.

To get the quantum of tax arrears in perspective, a 25% recovery from tax arrears can fund our oil under-recoveries. Further, reduction in the deficit is also important to complement monetary policy efforts to tame inflation, which is difficult for the Reserve Bank of India to do single handedly.

A lower-than-expected government borrowing programme of Rs343,000 crore (expectations of Rs370,000-390,000 crore) surprised the bond market and provided much-needed relief.

This will not only help the government in better managing its borrowing programme but also ensure that there is no crowding out of private capex plans at this juncture.

It is also positive for the banking sector as it will ensure that the upside to the long-term interest rates gets capped.

At the same time, the short-term rates will also ease in the first quarter of the next fiscal with increased government spending and easing liquidity.

Another key beneficiary of the budget is the infrastructure sector. Along with other measures in this direction, the proposal to set up infrastructure funds and the cut in withholding tax on foreign institutional investment in such funds from 20% to 5% is a smart move.

It will foster FII inflows in these funds as demonstrated by the South Korean experience. Within a month of removal of withholding tax by South Korea (May 2009), net purchases of Korean bonds by foreign investors rose by over 300% to $7.7 billion.

The move to allow foreign individual who meet the Securities and Exchange Board of India’s KYC norms to invest in domestic mutual fund is a huge sentiment booster for the equity markets.

It will diversify the sources of inflows to Indian equities and also open a new source of funding for our current account deficit. Further, the disinvestment target of Rs40,000 crore is achievable and will also attract equity flows.

The budget has lalso addressed the critical areas of infrastructure development, agriculture supply constraints and enhancing governance standards.

Fiscal consolidation focus will help India manage global shocks and foster sustainability of economic growth.

Along with banking and infrastructure, sectors like auto, construction and real estate also stand to benefit from the budget, while IT and cement are impacted adversely as expected.

Post the correction, the valuations have become more reasonable. With most of the local challenges apparently priced in, global events like rising oil prices and a sell-off in global equities are possibly the greatest risks for the markets at present. However, given that Indian equities have already undergone substantial correction, the margin of safety has become very high. Once the global uncertainty fades out, India can clearly deliver best equity performance.

Vikram Kotak is chief investment officer, Birla SunLife Insurance