Devangshu Datta: Music in stock market

However, domestic consumption will determine the success or failure of the Budget

This Budget could be described as “informally interim”. If the Goods and Services Tax (GST) comes through, there will be huge changes in taxes. The Budget also avoids assessing the impact of demonetisation and there’s paucity of data from the second half.  That data would mean a revision of the Revised Estimates. So, few of the numbers are trustworthy. Most market-watchers will make their judgments based on one macro-number — the fiscal deficit. The finance minister (FM) says the (Central) fiscal deficit will be held to 3.2 per cent of gross domestic product (GDP). This is higher than the three per cent target set earlier but lower than the 3.5 per cent target of 2016-17.

 
It’s likely that the 2016-17 target will not be achieved. The fiscal deficit hit 94 per cent of the targeted amount by December 2016 and it may overshoot in the fourth quarter. GDP estimates have been pared down for the second half, which also means a smaller denominator. Anyhow the FM’s statement that he’s targeting 3.2 per cent was by and large, met with relief. People feared a big expansion of expenditure. Note that the Economic Survey pegs the combined fiscal deficit of all the states at another three per cent with UDAY likely to add another one per cent. Taken together, that overall fiscal deficit of 7.5 per cent is uncomfortable.

 
 The FM also promised to rein in government borrowings, which means that bond market players will have a chance to deal in non-government paper. If that target is adhered to, yields should fall.  It should be noted that yields actually rose after the Budget. A generic fall in interest rates is, however, likely if the Reserve Bank of India (RBI) cuts rates and the policy statement this week should offer some clues. Will lower rates revive private consumption? That is the best, perhaps the only hope. Government spending has not been enough to kick-start the investment cycle in the past couple of years. And, it’s unlikely to be enough in 2017-18.

 

The Budget assumes 25 per cent rise in personal income tax (I-T) collections. Tinkering with rates cannot yield this — in fact, the change in I-T rates is estimated to lead to net revenue foregone of about Rs 13,000 crore. Perhaps punitive returns from demonetisation would improve I-T collections. But, a 25 per cent rise must assume employment gains and salary hikes, which in turn depends on high business activity and high profitability. 
 
Employment generation was pathetic, with less than 150,000 jobs generated in 2015, according to Labour Bureau data. Since over 12 million people enter the workforce every year, 99 per cent of them joined the ranks of the unemployed. Lack of employment affects consumption and the demonetisation has also reduced the consumption demand. Job generation is driven by the informal sector, which contributes over 80 per cent of new employment. The demonetisation has led to job losses there. If employment doesn’t improve rapidly, it’s hard to see private consumption reviving to the extent required.

 
 It’s hard to see how high growth can be sustained in 2017-18 except on the back of domestic factors. There are conflicting trends overseas and export-led growth is unlikely. There’s some growth revival in the European Union and commodity trends in metals and energy seem bullish. But, the UK is in near-recession and struggling with Brexit, while Trump is doing his best to block trade.
 
India’s Anglo-centric business culture means that about 18-19 per cent of goods exports are oriented to the UK and US, while over 65 per cent of information technology (IT) services revenue come from the UK-US combined. Those revenues will be hit. Overall, exports, including IT and pharmaceuticals, are likely to struggle in 2017-18, while the import bill will rise if crude oil does harden.

 
The market has responded with a relief rally that looks optimistic. Given no signs of major growth acceleration, it’s hard to justify market-wide price-to-earnings ratios of 23-plus. However, as an investment banker famously said during the Global Subprime Crisis, “While the music’s playing, you have to dance”. So, investors will dive into stocks even at very high valuations.
 
Metals is one area where the up-cycle provides fundamental justification for higher share prices. Real estate has bounced and housing finance could do well. In sectors like fast-moving consumer goods, automobiles, financial services, even in banking, private domestic consumption is key. That’s the pillar on which this Budget will stand or fall.