Budget 2012: Balance between fiscal consolidation and growth needed

As the ‘A-Team’ at the finance ministry sits down to finalise the budget, the market is abuzz with optimism. Markets have moved up almost 20% over the last two months. All eyes are now on the FM’s announcements on March 16th. Presently a large part of the uptick in the stock markets is because of global liquidity, infused especially by the European Central Bank’s Long Term Re-Financing Operations (LTRO).

Last year the Indian economy was whiplashed by four forces— sticky inflation forcing the RBI to raise the interest rates aggressively, lingering policy paralysis as the government battled multiple political issues, large fiscal slippages leading to crowding out of private sector and of course uncertain global macroeconomic backdrop, particularly the European debt crisis.

But since December we have seen some improvement on several of these factors. Inflation is showing signs of coming under control, recently reaching the sub 7% levels. If this trend continues, RBI will most likely cut interest rates in the next policy announcement.
 
There also seems to be some action on the policy front like FDI in retail, Coal India FSA commitment, New telecom policy, Highway development etc. If Congress does well in the UP elections, the market is likely to interpret that as a positive signal, since this would make it stronger within the UPA coalition. In such a scenario the market expects the FM to take some important steps in the budget.
 
Given the fine balance the FM has to tread between managing fiscal deficit and growth, one of the options is to increase its revenues by increasing indirect taxes. The likely possibilities in this regard are: Increase in general excise duty to 12% and some specific sector such as diesel engine car and cigarettes can attract more duty, Bringing more services under the service tax net and marginal increase in corporate tax rate.
 
To jump start the economy and specifically investments, the market expects sops for the infra sector. To mention a few, Imposition of import duty on power equipment’s, Removal of cascading effect of Dividend Distribution Tax, extension of Section 80IA benefits beyond March 2012, increase in ceiling limit for claiming a home loan from Rs 1,50,000 to Rs 2,50,000 per year etc.

Markets would be keenly looking for fiscal deficit & subsidy figures and borrowing and divestment program. Market will be looking for a very fine balance between fiscal consolidation and growth orientation. We will have to wait and watch to see the action on the d day.
 
Given the turmoil that economy has faced last year, the market is looking keenly for some positive signals from the Finance Minister.

Vikas Khemani is President and Co-Head Wholesale Capital Markets, Edelweiss Securities Ltd