Union Budget 2012 - A Balancing Act

The Congress party-led government has been battered by a series of setbacks that curtailed its ability to implement reforms and curb populist spending. The UPA government played it safe in unveiling its 2012/13 budget, pledging reforms but setting only modest targets for trimming a ballooning fiscal deficit, disappointing bond market investors. The finance minister set a fiscal deficit target of 5.1% of GDP for the fiscal year that begins in April, down from an expected 5.9% in the current year.

This year's figure, however, ended up far above the 4.6% it had originally targeted in its budget a year ago. The government, hard-pressed for cash, proposes to levy additional indirect taxes of Rs 45,940 crores for 2012-13 at a time when the industry is facing slowdown in demand. However, certain initiatives like liberalising the external commercial borrowing (ECB) rules and boost to investment particularly in infrastructure sector were hailed by industry leaders. 

The Budget is negative for the rupee, because high twin deficits and high inflation (boosted by large government spending) may discourage some foreign investors. It is also negative for government bonds. RBI has less scope for rate cut now. On the subsidy front, this is a missed opportunity, because there were expectations that these may be restricted. The government has only given an outline on various important issues. The other worry is that the borrowing doesn't seem to be coming down.

Market Impact:

Over the last 1 month, Indian markets are down 5% and have underperformed several global markets, despite strong FII inflows of USD 9 bn in CY12 to date. The underperformance is on the back of several prevailing uncertainties and headwinds. Oil prices climbing over USD120/bbl will prevent pass-through thus piling up under-recoveries and pent-up inflation, making RBI's task of inflation management difficult. Election outcome in Uttar Pradesh has not helped the cause of the Centre, and the posturing of some UPA allies makes the political coalition rather fragile. Prior to Budget 2012, expected moderation in inflation was a key catalyst for markets, as it would have most likely implied a rate cut cycle beginning RBI's April 2012 monetary policy. 

Now, any meaningful rate cut becomes highly debatable given increased inflationary pressures on the back of higher indirect taxes and likely hikes in administered prices. With a 15% rally in YTD CY12, markets are trading back at their long-period average P/E of 15x. Expect markets to remain range-bound over the next few months as oil prices and political realignment take centre stage.

Mr. Rajnish Kumar
Executive Vice President, Fullerton Securities.