Comment

The Budget announcement for the current fiscal year, managed to disappoint a large section of the market expecting big-bang reforms. Mirroring that disappointment the equity market finished lower by over 850 points and the rupee slipped by over 1% against the US dollar.

A closer look at the Budget proposals however, shows that it has all the essential elements to maintain India’s position as an attractive destination for the foreign investors, particularly the FIIs in the short as well as the medium-term.Ultra-easy monetary policy being followed by some of the major global central banks, with the US Federal Reserve at the forefront, stabilising financial system and signs of global economic turnaround have fed the risk appetite of investors over recent months. In this backdrop, the Union Budget promises to provide another round of fiscal support to the ongoing economic recovery in India.

With greater public spending allocation to infrastructure and the UPA flagship schemes, especially the successful NREGS, the government has ensured that the fiscal stimulus in the Budget is largely focused on improving the productive capacity of the economy over the medium-term and supporting rural consumption. The thrust to private consumption through tax relief to households is also helpful in providing momentum to growth in the short term. These steps could help attract more portfolio inflows over a period of time.

At the same time, introduction a new direct tax code in the next 45 days, implementation of a nationwide goods and services tax (GST) by April 2010 and the removal of fringe benefit tax and commodities transaction tax are aimed at simplifying the tax code in the country, by removing the multiplicity of indirect taxes and making tax regulations up to date with the economic reality.

These again are critical steps from the perspective of attracting greater foreign direct investments, as tax code of a country is critical in the decision to invest. Some FDI policy relaxations could also be in the pipeline. The Economic Survey presented before the Budget suggested that FDI limits could be raised for certain sectors.

The Budget has however, missed the opportunity of imposing some kind of time bound commitment for reducing the fiscal deficit to more manageable levels. The funding of the fiscal deficit, which has been pegged at 6.8% of GDP for this year, largely through market borrowings can keep upward pressure on interest rates. Any improvement in corporate capacity expansion activity can face roadblocks, if local interest rates remain high.

Private capex has been the main driver of growth in the 5-year period when the economy registered 8.9% average growth. Thus to maintain high levels of growth, it is imperative that the government curbs its fiscal deficit over a period of time.

Similarly financial sector reforms find no mention which can enable the economy to shore up the domestic resource mobilisation and help in maintaining softer interest rates.
In conclusion, the equity market correction seen post the Budget announcement, could end up attracting more portfolio inflows and help the rupee in the process.

The Indian unit as it is seems poised for some appreciation over the next 3-6 months, helped by an improvement in the external fundamentals of the economy. The trade deficit has shrunk and the capital inflows are picking up.

The author is Senior Economist ABN Amro Bank