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FM wins over markets

Feb 28, 2001

The Finance Minister must surely be smiling. The budget, in contrast to the earlier year, has drawn an emphatic response from the stock markets. At close the benchmark BSE Sensex had gained over 4.4%. The Union Budget probably surpassed expectations of even the most optimistic of investors. The key factors driving the general market sentiment are:

  • A decline in interest rates on small savings, signaling a lower interest rate scenario.
  • Removal of surcharge on corporate and income tax (however a 2% surcharge for Gujarat relief has been retained).
  • Reduction in dividend tax from 20% to 10%.
  • Enhancing FII limit to 49%

The reduction in the interest rate on small savings deposits is probably one very important measure initiated in the budget. It will have an impact of reducing the overall cost of funds in the economy, thus stimulating both investment and consumption. What this implies is that the Reserve Bank of India has more elbowroom to cut interest rates.

  • Does India need a rate cut?

    The substantial reduction of surcharge on taxes (income and corporate) will give individuals and companies more purchasing power. This should again augur well for the economy, which has been witnessing a slowdown in consumption and investment activity. Similarly, the impact of the reduction in dividend tax will depend on how companies respond to it. Companies could either raise payouts or alternatively choose to retain the funds. Either ways the funds would be available for either consumption or investment activity. It is apparent that these three initiatives will provide much more liquidity to companies and individuals. In such a scenario a lift in consumption and investment expenditure is likely.

    The enhancing of the FII limit on the other hand will give some reprieve to the markets ahead of the implementation of the MSCI Index, which calculates market weights of stocks in its index on the basis of free float (shares available for purchase).

    One of the main beneficiaries of the interest rate cut will be the government, which is the largest borrower in the market. In FY01 it borrowed in excess of Rs 1,000 bn and in FY02E it will again borrow a similar amount. The magnitude of the benefit can be easily quantified. A 150 basis point decline in rates will save the government Rs 15 bn! Just to put this number in perspective, the government revenue expenditure under the head ‘Electricity’ is Rs 30 bn.

    The FM has also taken some ‘politically’ harsh steps (surprisingly, the government seems to be finally biting the bullet!). First, is the implementation of committee recommendations (due in June 2001) to cut down the size of the government. Second, the finance minister seems to have made a categorical statement as far as complete/partial decontrol of the petroleum, fertilizer, sugar and drugs sectors is concerned. The announcement of these measures is laudable. However, one can only hope that the implementation will actually take place, given the nature of our polity.

    Ofcourse, the FM could have done much more for the infrastructure sector. The hike in plan outlay for the road sector (up 93%) is indeed laudable. However, much more needs to be done, especially in the power sector.

    Nevertheless, the markets are rejoicing. The bulls seem to be back in full force. However, (there is always a however!), one needs to be careful lest markets over react. As they always do.

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