Vijay Kumar Gaba

 The finance minister seems to have reinvigorated the animal spirits of Indian entrepreneurs and financial market participants. The Union Budget for FY22, is perhaps the most celebrated budget after the “Dream Budget” presented by the then Finance Minister P. Chidambaram in 1996.

This is also perhaps the first time when markets have cheered higher fiscal deficit. This ought to be taken as a sign of rising assertive India, which is fully aware of its importance in global order and refuses to be bogged down by unreasoned views of global rating agencies.

The market also cheered the fact that after dithering for six years, this NDA finance minister has picked up the threads from Vajpayee led NDA.

The finance minister has spoken about “privatization” of a majority of CPSEs, instead of “disinvestment of minority stakes”, as was the case in NDA-1.

The massive thrust on infrastructure building to ward off the impact of economic sanctions imposed in the wake of 1998 nuclear tests and bursts of dotcom bubble etc. was the hallmark of Vajpayee government. His government gave up government monopolies on Coal, Ports, Airports, Mobile Telephony, Roads, Power, Oil & gas exploration etc.; and introduced schemes like SEZ to encourage domestic investments. The incumbent finance minister has also ignored the fiscal slippages due to pandemic induced lockdown and focused on investment in infrastructure building.

It is widely expected that this Budget could unleash third round of Economic Reforms (Reform 3.0), after 1991-1994 and 1999-2001. It is therefore pertinent to evaluate whether the incumbent government has learned lessons from the earlier rounds of reform and adequate precautions are being taken to ensure that collateral damage of reforms could be minimized. For example—

·         Opening of Indian economy to global competition in early 1990s, led to redundancy of numerous small and medium sized Indian producers. This led to a surge in bad loans in the financial system and eventually led to failure of gigantic institutions like UTI, ICICI, and IDBI etc. High interest rates, higher inflation and sharp depreciation in INR during 1991-1998 were also partly associated with the reforms.

·         Massive investment in infrastructure building during NDA-1 regime resulted in massive demand-supply match. The investment resulted in accelerated growth during 2003-2008 period, but led to bankruptcy of many infrastructure projects (power, roads, airports, telecom, Oil & Gas etc.) due to lack of demand and strained finances. Schemes like SEZ were implemented without adequate regulatory framework, and was eventually reduced to land grabbing exercise by unscrupulous entrepreneurs. A part of the present day stress in banking system could be attributed to the projects initiated in early 2000s.

·         Both rounds of reforms resulted in two very popular governments not getting re-elected.

We shall have to see that the government does not lose sight of the severe stress in unorganized sector and burgeoning household debt.

I also found the following points in budget that may need closer scrutiny of investors:

·         Most of the development programs announced and funds allocated are for a period of 5-6 years. This effectively means that the government is resorting to long term plans, as was the case in (now scrapped) Planning Commission era. The only difference is that NITI Aayog the body that replaced the Planning Commission, may not be holding wide and deep consultation with State Governments on various issues, even though the number of central schemes transferred to the States has increased materially.

·         It is now many years since FRBM targets have been violated. It may be time to scrap this law and work out a more practical legislative framework. It would be prudent to stringently control the Revenue Deficit rather than bother too much about fiscal deficit in this phase of growth. Borrowing for investment should not be considered a problem so long servicing is not an issue.

·         The government continues to place very high reliance on high rate Small Savings for financing the fiscal deficit; while the sourcing from very low cost external debt is minimal. The appropriateness of this strategy needs to be evaluated.

·         Allocation for Information Technology and Education in FY22BE is less than the FY21BE. Similarly, allocation for Health in FY22BE is less than FY21RE; and allocation for Scientific Departments in FY22BE is less than FY21BE.

This does not sound congruent with the core ideas of the budget.

·         Corporate Tax collection target for FY22BE is lower than the FY20 actual collections. This needs to be corroborated with projected 14.5% rise in nominal GDP.

·         It is proposed to pre fill IT returns with details of income from salary, interest, dividend and capital gains from listed securities.

The government must make sure that it remains a facility for the tax payers and does not become a source of harassment. For example consider this. IT department will take data of capital gain on listed stock from Stock Exchanges. This data will be based on gross trade prices. In case of frequent traders the charges (brokerage, STT, Stamp Duty etc.) may be more than the amount of gain itself. Obviously, tax payers will have to correct the pre filled amount in the returns. If department runs a variance check, a large number of returns may be pointed oout and this could potentially lead to harassment of tax payers.

 Ricky Ponting, the former captain of the Australian cricket team, commented during a TV show on Sunday that Indian team may not be able to score 200 runs in the fourth inning of the third test match played in Sydney. Ponting was obviously trolled badly on unforgiving social media for his “prejudiced” and “audacious” forecast. India went on to score more than 300 runs and even managed to draw the test. Ponting later clarified that his “view” was based on the condition of the pitch on fourth day. The pitch did not deteriorate on fifth day as expected. Nothing much should be read into his statement. He need not have presented his defense. The social media would have forgotten his statement in couple of days, anyways.

The stock market experts (strategists, analysts, fund managers and seasoned investors etc.) who stick their neck out and make forecast about the market trends and likely levels of benchmark indices often face the situation like Ponting; especially for past 2 months those who are cautious on the market and warning a sharp correction are consistently at the receiving end. Regardless, the markets will keep rewarding investors and keep having corrections.

Moving on to business, I found the following five points worth noting from media reports in past couple of days. In my view, these five points aptly highlight the internal conflicts and challenges within the policymaking framework, and pose potential risk for the seemingly unstoppable stock rally.

1.    The road transport and highways minister Nitin Gadkari, highlighted that probably steel and cement manufacturers have made cartels to keep the prices artificially higher. The two being the key inputs for physical infrastructure development, may lead to material rise in the cost of development and even hamper the viability of projects. He even proposed a regulator for monitoring process of steel and cement (see here).

In UPA-1 tenure, the then finance minister tried to hit the cement cartel by introducing differential tariff structure based on price per bag, Rs190 being the differential point. Should the market expect something similar in weeks to come? In 2007-2008 the differential pricing and price regulation only helped the government in raking higher revenue. The industry and private consumers did not benefit much. (see here)

Besides, the suggestion for a pricing regulator also highlights the tendency of the government to impose deeper and wider regulation to control various segments of the economy. This is obviously contrary to the commitment of “less government more governance.” It also confirms the rising policy unpredictability.

2.    WPI inflation has now risen for seventh consecutive month led by food (see here). Energy prices have also been rising steadily over past few months. This may require a rethink on the RBI premise that food inflation may be mostly a seasonal phenomenon and wane in few months due to base effect. If the food & energy inflation persists, the second round effect may begin to become pronounced from the next quarter. The hopes of a meaningful monetary easing may be belied; and even fears of a rate hike might begin to bother markets.

3.    Many analysts are interpreting higher food inflation as good for rural income (and hence consumption demand); and higher energy prices as good for languishing energy sector stocks. “Cyclical” is projected to be the mood of this spring (see here). Higher energy prices shall reduce at least some of the cost advantage of cement and steel producers that has led to sharp earnings upgrades.

4.    The finance minister has earnestly committed a historic budget 2021. She went on to say that this shall be a budget unlike any presented in past 100yrs (see here).

There is no empirical evidence to support the finance ministers’ inclination to think radically or take risks. During the course of 2020, she made many attempts to enthuse the markets with a series of “historic” stimulus packages; but was hardly found inspiring by the markets.

The good thing is that markets may not be placing much high hopes from the budget; and the finance minister has a chance to surprise the markets this time. The bad thing is that no one is expecting higher taxes; even though the reports are indicating a serious discussion within the government about a Covid cess (see here). The ugly thing is that LTCG is again in the agenda of various budget discussions.

5.    TCS has reported an excellent set of numbers. Most other IT companies are expected to follow the suit. The Nifty IT has yielded a return of ~66% in past 12 months; ~89% in past 24 months; and 122% in past 36 months. In past 1 month, the IT sector has yielded a return of ~18% vs (~17% for Nifty in past 12 months). In past couple of months, most brokerages have published uber bullish reports on the sector, forecasting strong returns over next 2-3years. IT sector along with pharma, has been a massive outperformer for past 3yrs, over all other sectors.

The question is whether risk reward in the sector is still as attractive as it was a year ago?

In my view, the market is now running like a Formula One car. It can see the challenges and obstructions but cannot afford to stop or slow down. So far it has negotiated the sharp turns and obstructions brilliantly. But at least I cannot say with confidence that about the next mile. I am therefore happy watching the race sitting at the fringes, till it lasts. I have no intention of entering the track with my Alto K10 to compete with Ferrari SF90.