Budget India 2009-10

As the Finance Minister Pranab Mukherjee rose to present the Budget in Parliament at 11a.m on the 6th of July,2009, the stock market shot up in hope and expectations. 90 minutes later, when he was winding up his Budget speech, the Market fell by more than 5%- the biggest fall ever on a budget day-. An analysis of the Budget would reveal that it is a well balanced budget aiming for growth through increased expenditure and satisfying the social sectors as promised in the UPA's manifesto.

Then why did the market tank? Firstly, the market movement should not be taken as a yardstick to judge the overall budget. Probably a lot of hype was built around this budget by the media stating it to be the "Big Budget" especially after the ease with which the Congress won the Elections.The media made it look that without the "Left party", there was no hurdles left. The Economic survey report which was tabled a couple of days prior to the Budget day did not help matters as it laid out a grand vision for India but without any time frame or road map.

The Budget per se tried to increase domestic demand by putting money in the hands of the rural people and allocating spends on Infrastructure. The NREGA scheme(National rural employment guarantee scheme), abolition of Surcharge in income tax, abolition of the fringe benefit tax etc.. would create wealth in the hands of the people and would increase spending. For the first time, the Budget provides for Rs ten lakh crores(Rs 10 trillion) expenditure. The revenues at Rs six lakh crore(Rs 6 trillion) makes the Fiscal deficit at 6.8% of the GDP( Rs.58 trillion). This obviously is a huge figure which is to be made up by borrowings.

Certain facts emanate out of this deficit. The huge borrowings would push the Bond yields up and the interest rates to harden. With the Government borrowing so much , will it elbow out the private sector borrowings? The growth can never fructify without the private sector participation. The government's stated policy is also to go in for public-private sector partnership(PPP).

It was also praiseworthy that the Finance minister did not take the retrograde step of rolling back the excise duty cuts he unfolded just prior to the elections as part of the economic stimulus package. What was missing was a clear road map for disinvestment in PSU's and the participation of FDI's(Foriegn direct investment) in Banking and Insurance sectors. One is pretty sure the Government would go in for disinvestment to raise the necessary fund but Pranab Mukherjee could have articulated this better.

Of course, the choice before the Finance Minister was to either please the FII's(Foriegn Institutional investors) with deep pockets or the 1.2 billion Indians. The Minister chose the latter and rightly so.

Fed rate- who calls the shots?

The U.S Federal fund rate is the rate that banks charge each other for overnight loans of Federal funds which are the reserves held by banks at the Fed. This rate is about 3% lower than the prime lending rate. Any change in the Fed rate will have direct implication on the lending rate to consumers & corporate & a bearing on the economic activity & inflation.

The FOMC(Federal open market committee) headed by the Fed reserve chairman is empowered to do the Fed rate change. But recent happenings in the U.S stock markets makes one to believe that the capital market has a profound influence in the decision making process of the FOMC. The markets factor the rate cut ahead of time & keeps climbing up leaving virtually a "Hobson's choice" for the FOMC.

Take the example of the October 31st, 2007 FOMC meet. The data showed inflation was at comfort level with less than 2%, economy grew by 3% for the quarter( the highest for the year), labour figures were healthy. Of course the sub prime mess & credit problems were a concern. But having made a 50 basis point cut in their September meet & given the economic data, one would have thought that the rate would be left unchanged. But in reality, the FOMC made a 25 basis point cut. The Fed in their beige book comments recorded that the decision to cut rates was a "close call". One can only surmise & read between the lines that the Fed played the balancing act. After all this, the market which had gone up prior to the Fed meet, tanked in November with news of more write offs from Citi group & other credit problems.

That brings us to the main topic- Who calls the shots?- the Fed or the stock market influencing the decision. Had the Fed left the rate unchanged in October, they could have probably left their reputation intact. The Fed's main aim is to promote economic growth & control inflation thro' monetary policies. Stock markets are a measure of economy & not the economy itself.

In defence of the Fed, one can say that they are in an unenviable situation. Should their decision precipitate a fall in the market, it is not confined to just the U.S market but has a cascading effect on the global markets. The fallout is huge & that always weighs in the decision making process. The pressures are enormous but as they say " when the going gets tough, the tough gets going". That's what separates the great from the good.

World economy & Emerging markets

The world is seeing a sea change in the balance of economic power. There is a clear shift taking place towards the emerging economies. Why do we say that? Let's look at the facts.



The world GDP is about $ 49 trillion (at market exchange rates) & growing at 4% in 2007. U.S is still the biggest contributor with 25% of the global economy at $ 13.5 trillion followed by Japan & Germany. However, the emerging economies contribute to 30% of the world economy at market exchange rate. If we consider the purchasing-power parity(PPP), then the emerging economies constitute more than 50% of the world GDP. On a PPP basis China & India would occupy the second & fourth positions in world economy. As against a growth rate of 3% of U.S, China & India are having a tearaway growth of 11% & 9% respectively. The emerging economies contribute to 50% of the world GDP growth, 80% of the growth in oil demand is accounted for by them & hold 75% of the world foreign reserves.


The emerging economies have grown 35% in the last four years from 2003 & in the same period the emerging capital markets have grown four-fold compared to only 70% growth of S&P index in U.S. Brazil market has gone up by a whopping 900% during this period & China & India have gone up by more than 500%(source: JP Morgan). Some emerging markets are showing signs of "altitude sickness". As i write this, Shanghai markets have dropped 20% from this month high. However, there are still no indications for a bubble burst. Brazil is trading at a forward P/E(price/earning) of 12.5, China & India at about 22 as compared to the U.S at 15.



The low risk markets in emerging economies are Taiwan, South Korea, Malaysia, Thailand with their P/E ranging between 11.5-14. Also they have current account surplus. India on the other hand has shown a lot of exuberance in stock market due to high liquidity. But 85% of foreign investment in India have gone to debt or portfolio management this year. Most of this is in speculative stock markets. With a current account deficit of 2% to GDP, India is in a precarious position if there is a flight of foreign capital. Having said that, the Central bank is doing an excellent job by being proactive in steering the economy with high growth & moderate inflation. China appears less risky with a huge current account reserve & a break even budget balance/GDP.

That brings us to the often asked question of "decoupling". U.S is still a huge economy. But the pace at which China & India are growing & there is no reason why they won't in the future, it's a matter of time down the future when the markets will decouple from U.S. If after 20 years someone asks you " when will U.S decouple from China & India", don't be surprised.