When money talks...

There's an old New York adage that goes "Money talks, Bullshit walks".

It is belied when it comes to reactions about the Budget - the money spouts wholesale BS. Regardless of the actual merits, the public responses from the business community range through various shades of ecstatic, grateful or at the harshest, diplomatically disappointed. This is understandable - the man who reads out that speech has the power to make life very difficult for anybody with money.
One can't expect honest reactions from the Opposition either - the responses from there will always be negative. Whoever is in power, the Opposition always has plenty of ammunition to damn the Budget. Government finances are messy and complex, and if you're looking for logical holes in Budgeting, there will always be plenty.

This year however, it's difficult to find much to say, positive or otherwise. This is a "nothing" Budget. Pranab-babu has held excise and customs rates more or less where they were; he's hiked the personal income tax limit by just enough to balance off inflation; he's tinkered here and there.

There are no big bang reforms but nor is there anything that appears very ill-advised or iniquitous. On the tax front, he's presumably waiting for all the Centre-state negotiations on the GST front to result in some sort of agreement.

This Budget therefore, is a bet on status quo. Most projections suggest that Indian and global GDP growth will strengthen through 2010-11. That cyclical growth in itself, should deliver enough buoyancy in tax revenues to cut the Fiscal Deficit a bit. If the calculations go awry, too bad. By missing out on reforms, the Budget actually imposes a large opportunity cost on the economy. But it is an invisible cost, so few people will bother to point out, let alone try to quantify it.

My personal belief is that the projections will be missed for several reasons. One is that the trouble in Arabia has already escalated enough to ensure that crude and gas prices will be high through the next year. A booming global economy can handle higher crude prices, if driven by strong demand.

But this price rise is driven by (justifiable) fears of supply disruption and neither the Indian nor the global economy is actually in a boom phase. So it will cause inflation, lead to a widening Indian trade deficit and it may put a brake on recovery.

A second major reason for scepticism is that a strong performance from agriculture is part and parcel of the optimistic GDP growth projections for 2011-12. The official trend growth rate in Indian agriculture is very low. In the absence of reforms, is there any concrete reason to assume that it will double or more, in 2011-12?

Whenever Sarkari projections depend on agriculture doing well, there are usually major fudges and prayers involved. The sector provides a lot of employment but it also contributes less than 20 per cent of GDP, which is one reason why the Indian economy is structurally messed up and prone to large distribution inequalities.

In 1991-92, the agri-sector contributed around 33 per cent of GDP. The rapid growth of services and industry has since left it behind. This is normal - in developed economies, agriculture usually accounts for less than 5 per cent of GDP. But unfortunately labour hasn't moved into other sectors quickly enough in India. Around 40 per cent of the population contributes around 80 per cent of the GDP, which means unemployment and poverty for the other 60 per cent.

At another level, agri-predictions are literally about as accurate as weather predictions so, they cannot be relied on. Second, agri-stats are pretty much impossible to independently check, for anybody outside government, and hence, they are difficult to challenge.

However leaving fudges aside, while verbal reactions to the Budget are generally motivated and need to be parsed carefully for truth, (if any), actions taken in the stockmarket are an honest barometer of opinion. Whatever investors may say, they deploy cash in ways they consider will earn the best returns.

The market response has been interesting. The benchmark indices are up by over 4 per cent, and that's quite substantial, since there's been just two sessions since the Budget. The gains have come on decent volumes and they've been distributed across the board. Those are good signs.

What is disturbing is the type of participation we've seen. Over Rs 36,000 crore of equity was traded across BSE+NSE on Feb 28 and March 1. In those two sessions, the domestic institutional investors (DIIs) bought a net Rs 413 crore while the foreign investors (FIIs) bought a net Rs 378 crore.

That's a lukewarm response from the guys with the deep pockets. It means that most of the Budget trading participation was retail. A high proportion of the trading was not for delivery. It's possible that all the institutions are still holding back as they try to make sense of the Budget in all its glorious detail. But this is not a terribly complicated Budget as Budgets go. There's nothing unexpected about it.

More likely, the institutions don't see the Budget making a big difference either way and therefore, see no reason to be more than mildly enthusiastic. We'll know more in the next 10 sessions or so, about institutional attitude.

One good thing about this Budget in that there's no obvious negative sectoral biases. Looking at it from a broad personal finance perspective, that means it's not necessary for investors to change their asset allocation weights. Stick with whatever you find to be the most comfortable mix of equity/debt / real estate and other assets.

If you're a passive long-term investor who works your cash through SIPs in diversified mutual funds, continue doing so. If you're an active investor, who focusses on a portfolio of businesses that you understand, this Budget gives you no reason to review your chosen selection methods either.

Again, speaking personally, I'd stay underweight on financials because inflation has probably not played out yet, due to the potential for oil-shocks if nothing else. But through the Oct-Dec 2010 quarter (the last for which we have stats), the FII were taking exposures in the financial sector. So it's possible that they think the inflation cycle is close to peaking. Stock prices across the financial sector could actually bounce before inflation is actually tamed because of that perception.

During that same period (Q3 2010-11), the DIIs went overweight in consumer-driven sectors. That's closer to conventional wisdom in that the GDP mix for 2011-12 is heavily reliant on consumption which will contribute close to two-thirds of GDP.

In terms of valuations, @5500 approx, the Nifty is trading at a weighted average PE of 21 (last four quarters, weighted by market capitalisation). That's high, if it's compared to historic valuation levels (averaging 17-18). It's high, compared to projected EPS growth rates over the next 2-3 quarters. It's high in the context of rising interest rates. Stagger out equity exposures because we could see further falls in stock prices. This is why an automatic averaging down mechanism like SIPs make sense.