The budget was a clear indication that the UPA government, now at the half way mark of its elected term, will be increasingly driven by political compulsions rather than by rational economic policy.
Not that politics driving economics is anything new. The oil companies have suffered over the past two years because of the governments refusal to endorse its own oil reforms in 2004 and to allow the pass-through of rising oil prices to the Indian consumer. Sugar companies have their set of woes as do the airline companies.
But the budget announcement hit some new "lows" along with the stock indices. Managing inflation by increasing excise duty on cement and applying duties on export of iron ore only tamper with free market economics just when corporate India has learnt to be globally competitive. Construction companies have been hard hit by the retrospective withdrawal of tax exemption on income of sub contractors for road projects. In a single stroke the market capitalization of many sectors was reduced by 35%.
And if curbing inflation is an objective there were some googlies that, if used on the misjudged wickets of the Caribbean, would surely have won India its match against Bangladesh. Commercial space will attract service tax. How renting a shop or office gets defined as a "service" is beyond comprehension. The measure is inflationary in nature and will further increase rents in an over heated market. Increase in dividend distribution tax applicable to corporates and dividend distribution tax by mutual funds is misguided and amounts to double taxation. Now there are unconfirmed reports of a 2% cess on vacant land in urban areas. These selective, seemingly random and mindless measures only serve to increase the tax burden on bonafide tax payers. And these will, inevitably, be passed on to the final conusmer in the form of higher product prices.
The markets have reacted adversely to all these decisions as they have artificially distorted the earnings of many industries. While wishing to deal sternly with inflation, the government has brilliantly caused a dis-inflation in share prices which have recovered only in the last fortnight. Commodity price control is being done through banning forward contracts in these products! These measures don't add up: inflation will not be curtailed, the opposition will not be silenced, and questions on India's commitment to free market reforms will beging anew.
Political compulsions also dominate non-budget activity - and this is only going to escalate. Mumbai's airport expansion, crucial for it to be a designated financial hub, is held to ransom by dwellers who unauthorisedly occupy IAAI land. They are supported by the ruling party's legislator! With not a single powerful UP congress leader emerging to lead the party and no grass root mobilization of voters the Congress is expected to perform dismally in the UP assembly elections. The leading regional parties, SP and BSP. will carve out the votes between themselves leaving the residual to the Congress and others.
So where does this leave us?
With more uncertainty and some conviction that policy initiatives from the government have no visibility except for being largely detrimental and driven by the compulsion of the vote bank. Markets generally react unfavourably to uncertainty and even more to inconsistent economic policies. Corporate earnings for FY07 and FY08 are already reflected in the valuations of stocks. The indices are likely to move sideways and stay range bound. The preoccupation of the government with politics will only increase over the next 2 years. Investors ignore these trends at their own peril.
This article is authored by Atul Kumar, Managing Director, Practical Financial Services P Ltd, Member NSE. He can be reached at firstname.lastname@example.org