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Devangshu Datta: Triple-witching on Budget day

Potentially explosive developments on the global financial front could upstage the impact of Chidambaram's February 28 show

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In US trader parlance, a financial settlement is often referred to as a “witching day” in an apparent reference to the opening scene of Shakespeare’s “The Scottish Play”, which superstitious actors never mention by name. It’s double-witching, or triple-witching, if several settlements coincide.

Well, the Budget happens to be on the last Thursday of February, which means that it will coincide with the derivatives settlement. That should mean plenty of hubble, bubble, toil and trouble all round. To add to the inevitable tension surrounding the United Progressive Alliance’s last full Budget, there’s potentially explosive developments on the global financial front. Those could actually upstage P Chidambaram’s attempts to turn the Indian economy around.

Despite lacklustre US economic trends, there are signals that the US Federal Reserve may cut back on its (QE) programme earlier than expected. The possibility came up at the last Federal Open Markets Committee (FOMC) meeting. One of FOMC’s more influential members, James Bullard of the St Louis Federal Reserve, has tried to allay fears after the minutes of the meeting were released. (BATTLE OF THE BULL RUN)

But the mere prospect of lower liquidity sent global markets into panic. Most trading models assume that QE will continue until there is a major uptick in US labour markets. A fade out in liquidity would certainly affect financial institutional investor (FII) allocations into India and other emerging markets.

The second event, a rating downgrade of sterling-denominated UK government debt set off what could be a tectonic upheaval in forex rates. The Great Britain Pound (GBP) dropped versus major currencies. Third, Japan will announce its new central bank governor next week. The changeover is due in mid-March. The new “governor-san” (there’s a 99.99 per cent chance it will be a man) will be expected to follow through on “Abenomics”, loosening up and depreciating the yen.

Forex markets aren’t always logical but given euro weakness, GBP weakness, and yen weakness, the dollar should appreciate further. The long dollar-rupee recommendation made earlier still remains worth holding and a short GBP-rupee or a short yen-rupee may both be worthwhile.

The direction of the Indian stock market has been set by attitudes over the past year. Domestic institutions have been consistently bearish, while the FIIs pumped in money. In February too, FIIs remained strongly bullish but the buying eased off in the last week. Some analysts are seeing this as a generic reaction in emerging economies owing to rumours of QE cutbacks. Others are seeing this as a cooling off on India in particular.

It’s probably too early to tell. FIIs tend to cutback on their pre-Budget positioning, and then take a stance based on their reading of the document. Buying may be reinforced if they like the Budget. Or, they could sell in massive quantities. We will only get an inkling early into the March settlement.

Apart from the Budget, the Reserve Bank of India (RBI’s) release of the new banking license guidelines is still being digested. It could lead to selective buying into non-banking financial companies (NBFCs) that could become banks. It could also trigger indiscriminate selling of currently listed banks.

The financial index – the Bank Nifty – crashed last week, losing more ground than the overall market. I’d say the combination of higher provisioning for restructured loans (“the end of regulatory forbearance”, as RBI called it) , tougher norms for re-classifications and the possibility of aggressive competition might mean an extended period of bearishness for the more fragile public sector banks at the very least. On the NBFC front, Goldman has just downgraded HDFC from “neutral” to “sell”, which could mean a change in the institutional attitude to the housing finance major.

In the midst of all this, the Budget could be a defining document. Chidambaram has a tough task. He faces a combination of large, intractable deficits. It’s an election year Budget. So, he dare not cut back entitlements and subsidies. Nor can he risk triggering a sovereign rating downgrade given external obligations exceed reserves by $80-85 billion.

If he raises new taxes, or increases rates, or gives a free hand to the income tax department to conduct raids, he risks alienating the business community, which will then cut back on its campaign contributions. In addition, nobody places much faith in official estimates and projections after all the howlers we’ve seen in the past three years.

Early signals indicate that gross budgetary support for the Twelfth Five-Year Plan might be where the finance minister tightens the belt. Doing this in the opening year of the Plan pretty much ensures the projections will never be met. Also, I’d guess that the goods and services tax will not happen. It would be too disruptive and require too much Centre-state negotiation. The General Anti-Avoidance Rules, or GAAR will also be delayed, and there will probably be further easing of foreign direct investment norms because India really needs the overseas money.

The good thing is, expectations aren’t high and if the Budget is sane and credible, the market will probably accept it with relief. Technically, the indices have corrected significantly in the past five sessions, mainly on reduced FII buying and heavy domestic retail selling. There has been no signs of the usual pre-Budget rally and optimism.

If the Nifty falls below 5,750 (another two per cent lower) , the long-term trend would start looking questionable. On the other hand, a “good” Budget with a few positive surprises could easily push the pricelines back towards new 2013 highs.

The odds in any given year are significantly in favour of going short in the five to 10 sessions following the Budget. But then, the odds in any given year are also in favour of being long in the five to 10 sessions before the Budget. This year, the market has lost ground before the Budget. Could that imply a pullback after the document is released?

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