Budget may not spark bull run

Last Updated: Sun, Feb 24, 2013 05:11 hrs

This will be the last full Budget of the UPA II government. The 2014 February budget will probably be a Vote-on-Account with elections due. Instead of trying to guess in micro detail what the provisions of the Budget will be, it is probably better to point at a few broad trends.

The FM has little room for manoeuvre. There is a large Fiscal Deficit, a record Trade Gap and a record Current Account Deficit. There are credible threats of sovereign downgrades. There is the impending shadow of elections.

Whatever projections and estimates are announced in the Budget and the Economic Survey will be swallowed only with magnum helpings of salt. The track record of estimates has been quite abysmal in the last three years. A laundry list of projections have been missed by large margins and a stream of optimistic official statements have all looked absurd in hindsight. On top of that, the fear of downgrades is a powerful incentive in favour of window-dressing.

Given the situation, the FM must find ways to stimulate growth and at the same time, find money to fund entitlements and subsidies, which no government can cut in election year. The first compulsion implies that he probably can't raise taxes much. He must hope that faster growth will lead to larger tax-revenues. He can't unleash a regime of tax-raids either. Raids would impact already-stagnant growth and irritate the business community, which must be tapped soon for political contributions.

The much-anticipated GST may not happen. It is a radical change in tax policy and it would inevitably cause disruption in the short run, despite its obvious merits. It requires delicate negotiations between Centre and states as well. This makes GST too risky for election year.

Expenditure side, there isn't room for counter-cyclical pump priming, given the Fisc. The need to keep subsidy taps flowing may mean a reduction in real terms, post-inflation, in gross budgetary support for planned expenditure.

There is a need to encourage exports to narrow the Trade Gap. So, there may be sops to key export-oriented industries. There may also be selective import duties on "non-essential" items such as gold. The FM may also gamble on a falling rupee making imports more expensive (and exports more competitive).

Given the Current Account deficit and the external debt, India will need massive forex inflows to prevent reserve depletion. The excess of external obligations over reserves is around $80 billion, and hence, 2013-14 inflows will need to be in the region of $80 billion (FDI and FII portfolio investments combined). This target is unlikely to be met. But there may be further liberalisation on FDI regulations. The government will also go easy on contentious tax cases because India cannot afford to have potential investors pulling back this year.

Electoral compulsions imply that a lot of hawala money currently stashed abroad will need to find routes back into India to fund forthcoming political campaigns. Hence, Participatory Notes will continue to flourish since that is a convenient route to round-tripping.

It's possible that the FM may gamble on cutting customs duties on specific imports like construction machinery, and other infrastructure related items. But I cannot see direct tax rates being cut in broad terms.

Mr Chidambaram likes creative, unusual imposts. Hence, speculation about a Wealth Tax of some sort and a Commodity Transaction Tax. There is also a chance he will come up with some sort of amnesty scheme for tax evaders as he did in 1997, or some gold-use related scheme.

I don't think he'll tinker with the current treatment of dividends (tax free for recipients) and of equity capital gains (tax-free long-term) because the market reactions would be very negative. A buoyant stock market is a must to ensure the disinvestment programme continues.

Since public investments in infrastructure have dwindled, the FM has to find ways of attracting private investments. This could mean positive changes in infrastructure-related policy, including financing models geared to financing typically long tenure, capital-intensive projects. Maybe he will look to energise the corporate bond market as well.

Expectations aren't high. Growth has fallen and looks unlikely to immediately accelerate. The FIIs, who have driven the bull-run of the past few months, have discounted that and decided to live with it. Domestic investors are either bearish, or betting on falling rates.

If the FM can skillfully navigate all the issues and challenges and deliver a half-decent Finance Bill, he may well get a thumbs-up from the market. The odds however, seem stacked against the Budget sparking off a major bull run. There are just too many negative variables.

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