Irrational expectations

The stock markets have reacted negatively to the budget. The Sensex and the Nifty dropped 209 points and 63 points, respectively, on the budget day. As always the stock market behaviour is sought to be rationalised. Stock market specialists, who have been quoted in the media, have expressed disappointment over the budget proposals essentially on two counts. One, a general complaint that the Finance Minister has lost a unique opportunity to reverse the economic slowdown and more immediately perk up the investor sentiment, which has been at a low ebb. Two, more specifically, there are no radical measures to check the burgeoning fiscal deficit, which, the Finance Minister admitted, will touch 5.9 per cent of the GDP. That would be a full 1.3 percentage points higher than the 4.6 per cent budgeted for last year. Since a large proportion of the fiscal deficit is attributed to the payment of subsidies (food, fuel and fertilizer), the disappointment is really over the inability of the Finance Minister to check them. Stock market reaction The stock market's negative reaction is, of course, reflected in the fall in individual stocks. As the saturation coverage of stock market reactions in the financial press shows, some would have gained but many more would have lost. Either the expected budgetary sop did not materialise or the sector has been subjected to fresh taxes. The hike in service tax and Cenvat by two percentage points and the almost universal coverage of the former have cast a fresh burden in many cases. Reactions such as the above should not cause any major impact over the medium-term. It is likely that the markets will pick up the positive features of the budget sooner rather than later. The alleged shortcomings will then be seen as positives. The hike in indirect taxes, for instance, is a fiscal necessity. The Finance Minister has merely restored what obtained during the pre-crisis period. Moreover, the move was totally anticipated by most serious budget watchers. The same critics would have been up in arms, if, for some reason, the budget had not extended the tax. What would that move have done to the goal of fiscal balance? Earnest attempt One needs to appreciate the fact that the budget is an earnest attempt at winning back credibility. Last year's projections — on fiscal deficit and growth rates — were way off the mark. That made the task of those preparing the budget this year particularly onerous. They would have had to overcome scepticism over estimates and assumptions relating to key parameters. The budget's cautious approach should have a greater degree of acceptability. A ‘bolder' approach such as cutting down subsidies drastically would be hardly credible going by past record. That is which reducing the fiscal deficit by 0.8 percentage point to 5.1 per cent by March next seems to be a good idea. It is definitely middle-of-the-road does not carry forward fiscal consolidation in a decisive way but is eminently realistic. The budget's subsidy tab for next year, at Rs.1.90 lakh crore, also seems to be based on more realistic assumptions. The last two budgets seriously underestimated the subsidy burden. Constrains of coalition politics That the Finance Minister's ability to take ‘bolder' decisions has been constrained by coalition politics is well known. Even stock markets have realised this. It would have been naive to think that the general budget would pass muster with ‘grand reform' measures, when very basic steps to revive the railways in the form of passenger fare increases could be opposed and that too by a coalition partner, even at the risk of causing political instability. Measures such as decontrolling diesel prices would have been controversial anyway. Why risk the budget itself by taking on such measures simultaneously? More than any other time, expectations from the budget were low. This ought to work to the advantage of the government. Even the markets would realise that the budget proposals, uninspiring as they are, have a better chance of being implemented. It follows that, once the lowered expectations are met, the government can pursue a more vigorous economic policy. And talking of an agenda of reform it will be more rewarding to concentrate on the nuts and bolts as it were rather than aim for impractical steps such as large scale asset sale by public sector enterprises. The government can pursue a number of items, which are part of reforms but can be implemented without the glare of publicity and political discord. Pursuit of seminal reform measures such as the DTC and the GST will be more rewarding and also help in regaining credibility.