Gold could be a good hedge

If the economy enters a period of stagflation, its returns will outpace other assets

This Budget will be perhaps the most important since the ‘liberalisation era’ started. The verifiable high speed data indicates that the economy has slowed to the point where it’s contracting, although the official gross domestic product (GDP) estimate is that of a growth slowdown rather than contraction. 

Inflation is up, well above the northern limit of the Reserve Bank of India’s (RBI's) buffer zone so there's no room for rate cuts. Tax collection estimates will be missed by a big margin, pushing the fiscal deficit well above target this year.  Yet, the government might need to cut taxes in 2020-21 to stimulate consumption. 

Widespread protests have disrupted normal life and commerce, with the government shutting down the digital economy in multiple states. The international reaction to this has been cautious, with investors cutting exposure to government debt. An adverse international response to the Kashmir policy and the protests against CAA, NRC and NPR could trigger more cuts in India weight. 

The Budget has to address this crisis of confidence. The corporate tax cuts create room for private investment but that will not happen until consumption improves. The Budget must kickstart consumption while maintaining some degree of control over the fiscal deficit. 

At the same time, other arms of government have to try to put a lid on inflation. The RBI cannot do this because the prime cause of inflation is spiralling food prices. Food prices have risen due to supply side constraints, and hiking interest rates will make little difference. Good harvests will help, and so would imports to tide over shortages. 

Consumption and its corollary, private sector investment, will only improve if consumer confidence improves. Part of this – a very important part – would depend on calming the anxiety and anger that has brought millions onto the streets. The Budget could help matters along by cutting personal income tax while other arms of the government have to find ways to cool the anger.  

Along with direct tax cuts, pulling more items into lower Goods and Services Tax (GST) slabs to lower indirect tax rates, would help.  This would, however, require the cooperation of the states and that is a question mark. States run by non-BJP governments may not cooperate with changes that will affect their share. It is now obvious that a flawed GST design with a large number of rates, and monstrous compliance barriers, has had a negative impact on growth and consumption.  Rather than inducing informal businesses to migrate to the formal economy, it had led to them shutting down.  

Cutting tax rates would also mean finding other means to boost government finances. That means the Budget must make a genuine push towards disinvestment, rather than relying on transfers from RBI, and cross holdings between government-controlled companies. 

None of this will be easy.  Some of the goals may be contradictory.  For example, higher food prices generally translates into better rural consumption, but it causes inflation. If the government doesn't find a balance, the 2020-21 fiscal could see a further slide in economic momentum.  

Unfortunately, this government's track record doesn't inspire confidence in its ability to deliver on the economic front.  It's made one poor policy decision after another.  It has also divested itself of experts who could have helped formulate a policy turnaround.  

Corporate results have been lacklustre which is not surprising. The stock market has narrowed but it has continued to ride up because the index heavyweights have received investments. Part of the reason for this is that investors are hoping against hope that the economy will turn around.   

If the Budget doesn't address the above concerns, the hope could turn to despair. The economy may not have bottomed out yet.  The market could plummet if there's a bout of serious post Budget selling.  This would create a serious problem for investors looking to rebalance asset allocation: debt assets will not give decent returns in a scenario of rising inflation. 

One possible hedge is moving into hard currency assets.  Another hedge could be gold. The precious metal is a traditional hedge against rising inflation.  It is also a haven in times of policy uncertainty. If the economy enters a period of stagflation, gold would outpace other assets in terms of returns.