Move over YVR, it's PC's turn! - Views on News from Equitymaster

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Move over YVR, it's PC's turn!

Feb 26, 2007

As we enter 'the' week when Mr. P. Chidambaram (PC), in his role as the Finance Minister (FM) will announce the fourth 'Union Budget' of the current UPA government, anxiety is palpable all across. Whether one is at a social gathering, or a business conference, the 'hot' topic is 'what the FM will do with taxes'. The effect of this uncertainty seems to be most visible in the stock markets, if one were to take intro account the weakness in stock prices over the past two weeks, with the benchmark indices declining by 5% alone in the week gone by.

Union Budget 2007-08

Of course, inflation concerns and continued rise in cost of capital has also taken its toll on equities over the first two months of this year. While the underlying uncertainty of the possible announcements in the Union Budget will be cleared by Wednesday noon (February 28th, day of the budget announcement), investors need to be cautious with respect to a more fundamental reason that could dent sentiment in the medium term - uncertainty on Dr. Y. V. Reddy's (YVR) stance on interest rates.

An overriding concern faced by the Reserve Bank of India (RBI) is the persistently high growth of bank credit, with attendant worries relating to the quality of the same (credit). In this context, the RBI has consistently emphasised careful monitoring of the health of credit and non-performing assets (NPAs). Especially, the sharp increase in credit to sectors such as housing, commercial real estate and retail loans have been worrisome.

It is well known that monetary policy operates cumulatively and with lags that can range between 12 to 18 months, depending on the specifics of the economy. It is in this context that beginning in mid-2003, the RBI started a gradual withdrawal of accommodation. Since September 2004, the central bank has raised the repo and reverse repo rates by 125 and 150 basis points respectively, and the CRR (cash reserve ratio) by 100 basis points. It has also raised the risk weights in case of housing loans (from 50% to 75%), commercial real estate (from 100% to 150%) and consumer credit (from 100% to 125%). The effect of these hikes is already being witnessed in terms of rising capital cost for India Inc.

While such vibrations (and actions) from the RBI may sound alarming bells for India Inc., which is in need of large amount of capital to fund its anticipated growth requirements (through capacity additions), there are even more concerns for the government, which is indeed the largest borrower of all. Interest payments of the Central government are 3.5% of GDP. As interest rates are raised (by the RBI) to keep inflation in check, the government will borrow still more to pay out more!

Please continue with the expenditure reform!

If wishes were horses!
Inflation and interest rate concerns notwithstanding, the markets may remain jittery over the next few days, first in anticipation of what the FM does on February 28th, and post that, why he did so or did not do so! As for us, without asking for the moon, we simply want that he initiate the processes so that:

  • Government lives within its means,
  • Environment for fostering entrepreneurship is created,
  • Greater investment is done in human development, and
  • Tax regime is simplified (from all its complexities and unending schedules)

This is all we wish from the FM, as he is about to present the Union Budget. Enter Mr. PC, not the magician!

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