The Hindu : Business : Expectations from Budget

Online edition of India's National Newspaper
Monday, Feb 21, 2005

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Expectations from Budget

Will the high stock market valuations raise the stake for the Finance Minister and make the budget market friendly, asks C. R. L. Narasimhan.

THE SENSEX reached its all time highs when it crossed 6700 to 6719 during intra-day trading on February 14. Such record setting movements of stock indices are in many ways ephemeral: new peaks that will be scaled although one is not sure when this will happen. On the other side, share prices need not — in fact, last week they did not — move upward always. There was a sharp drop during mid-week followed by a mild rally on Friday. The Sensex closed the week at 6584. For now, however, there is plenty of optimism in the wake of high valuations. The main reason for this is that the Sensex and other benchmark indices have been consistently trading at such high levels that investors are getting used to them.

One indication of the buoyant mood is the record mobilisation by equity-based schemes of mutual funds recently. Conventional investment advice will be to shun equities when the indices are at such unprecedented highs. Another pointer to the optimistic mood: ahead of the Union budget analysts are not talking of sharp drops, to say a below 6000 Sensex.

In most post-budget sessions earlier, the stock markets had fallen. There were specific issues each time. Last year's post-budget fall in the indices was due to a badly drafted proposal to tax securities transactions. The proposal had to be reworked.

On the other hand, there have always been exaggerated expectations from the Union budget. However, no matter how hard the Finance Minister tries to frame "market friendly'' budget proposals, the stock markets are left disappointed because they expected more. It is this aspect of managing "market expectations'' ahead of the Union budget that requires to be addressed by Finance Ministers. Unless, of course, policy makers learn to live with whatever messages the share prices convey in the post budget session. In many ways, the latter course is the more prudent one at least for now: the stock market mechanism in India is not yet equipped to be a barometer, good enough to either test economic policy or to gauge its effects.

A sense of deja vu

With less than ten days for the Union budget there is a sense of deja vu. There has been the usual speculation over "reform oriented'' policies. But the exceptionally high level of stock prices is unique to this year. Does it increase the stake and make the Finance Minister's task even more difficult? The budget aside, two key questions remain valid: will these high stock prices be sustained thereby vindicating the optimism? Second, what are the factors that contributed to the record rise in the benchmark indices?

Answers to the two interrelated queries are many. The record inflow through foreign institutional investors has been one well-recognised factor. The performance of the UPA Government is another. Here the Government's track record is being evaluated as much in terms of the absence of "negatives'' as on the positives. Have not the Government and the coalition partners stayed clear of any market unfriendly action even if the reform credentials of the Prime Minister and the Finance Minister have not been fully reflected in official policies?

The disinvestment programme, so far this year, has comprised just the NTPC issue. The creation of a Disinvestment Fund (set for April) is actually the revival of an old idea, meant more to win over political opposition rather than further the cause of economic reform more directly.

There is a similar mixed reaction to the other facet of economic reform having a bearing on the stock market. The Government has managed to hike the foreign direct investment limit in telecom to 74 per cent but the policy relating to private sector banks is facing political hurdles.

Economic fundamentals have had an important influence over stock prices. The advance estimate for GDP growth this year is 6.9 per cent over last year's 8.5 per cent.

Strong fundamentals

All the sectors — agriculture, industry and services — are performing well although agriculture with a projected growth of just 1.1 per cent qualifies to be in that category only because it was earlier expected to do far worse. Sound economic fundamentals are reflected in corporate earnings: companies, whose scrips form the 30 share Sensex, have reported a 38 per cent increase in earnings in the third quarter on top of 24 per cent and 27 per cent growth in the second and first quarters respectively. However, more than 88 per cent of the improved earnings are attributed to just five of the index based companies.

Almost all of them such as ONGC and Reliance have benefited from high global commodity prices. Despite good corporate earnings, the valuations look steep with a trailing price earnings ratio of more than 16 for this year.

The caution over overdependence on portfolio investments from abroad is justified, although right now no one wants to say anything that will even remotely discourage the overseas investors. Yet interest rates are on the upswing in the U.S. and there is a distinct possibility that these overseas funds will reverse direction in the coming months.

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