The market had gone into the Union Budget expecting the worst, so there was little room for further disappointment, when the actual announcements were made. Though there was a sudden flurry of selling in stocks when Finance Minister Arun Jaitley announced that dividend will now be subjected to taxation, above a certain threshold and STT on options was raised, but that did not last long. A sharp rally in bond prices, spilled over into a currency and then finally into the stock prices. Last week I wrote that there is enough room for the Indian rupee to appreciate post Budget, and that appreciation can take prices to even as low as 67.50 levels. The actual appreciation has been much more than that. Indian rupee has gained all the way towards 67.00 levels against the US dollar. Indian rupee has recouped much of the losses that it had registered since end of last year, when it had closed around 66.15/20 levels on spot. A flurry of liquidation in the speculative short position in the Indian rupee and well-timed intervention did the trick. The Union Budget played its part in lifting sentiments.
There are two key aspects of the Union Budget.
1) Statement of Accounts
2) Policy Intent
Key takeaways on statement of Accounts:
i) Government has reverted to fiscal consolidation in this budget. This is a positive development for the bond market, both in terms of preponing of rate cuts in 2017 as well offering some relief to the oversupply problems in debt market this year.
i) Quality of the assumptions to arrive at the gross fiscal deficit. Government has budgeted a double digit growth in net tax revenues after a 4.9% jump in FY 16. One may accept the growth on the back of expected success of Black money disclosure scheme. At the same time they have banked on a substantial jump in non-tax revenues like disinvestment, spectrum and dividends. They estimate around 3.2 Lakh crore on this head, which may appear aggressive.
iii) Revenue to capital mix in expenditure. Mix has deteriorated from last budget as revenue expenditure has grown more than capital expenditure. One can blame the slippage on back of 7CPC, OROP and MGNREGS etc.
2) Policy Intent:-
Providing a statutory backing to Aadhaar, digitisation of land records and creation of dispute resolution council are steps in the right direction.
Government has also focused on rural India. Higher allocation to Panchayat and Municipality is a step in that direction. At the same time they have focused on RIPM- ROAD, IRRIGATION, POWER AND MARKET. Target of 100% electrification of villages by mid-2018 is a single biggest transformation change that can happen to Indian Villages. Availability of power can lead to quantum jump in consumerism and digital delivery of SWASTH, SIKSHA AND GOVERNANCE. At the same time, e-market for agriculture through amendment of APMC act is also commendable initiative.
Union Budget has provided a backdrop in which Indian rupee has been able to recouple with the global backdrop, which is favouring risk assets and emerging market currencies since second week of February. World markets have managed to recoup a part of the losses that it suffered during the month of January, as hopes of fresh round of monetary stimulus from ECB makes rounds. European central bank meets on 10th of this month, and it is widely expected that they would announce a further cut into the negative yielding deposit rates as well as increase the size of the quantitative easing program. ECB hinted at such steps in its previous meeting and hence would not like to disappoint market participants like it did in December. However, it must also be said that the economic outlook for the Eurozone has remained stable and hence it does not warrant any large scale tweaking of the monetary easing policies. One must remember that negative interest rate policy has plenty of unintended consequences as it destroys the basic logic of investment and savings. However, I continue to believe that much of these steps are being undertaken to not only protect domestic demand from leaking out into the world economy but also grab a larger share of the shrinking pie of global trade. One can refer to these steps as economic protectionist measures, expected to flow through a weaker exchange rate, but well packaged or sugar coated for public consumption.
Apart from the European Central bank meeting market will also process the just released US jobs report. The headline number remains quite impressive, with 242,000 jobs created during the month of February; unemployment rate remained unchanged at 4.9% but wage growth weakened. However, the devil lay in the detail. In the US economy, with manufacturing sector, transportation and natural resource sector feeling the heat of commodity rout, world economic slowdown and strong US Dollar is unable to create much in terms of jobs. Even the financial sector has seen job growth weaken. These are high paying sectors and they losing momentum does not augur well for future prosperity of the economy. Therefore, much of the job growth is now coming from the relatively low paying sectors of services like health care and social assistance, retail trade, food services and drinking places, and private educational services and temporary helps in businesses. During the month of January-February, nearly 75% of the headline jobs were created by these low paying sectors. The shift in job market in the US is also showing itself in the loss of momentum in the consumer confidence, small business surveys and even service sector PMI data. We can see these concerns get reflected in the upcoming meeting of the US Federal reserve. US Fed has guided for 4 more hikes this year, which appears untenable, as market is penciling in just one more hike this year. However, there has been an improvement in the odds for a hike, which stands at 70% for December, after a recovery in the stock markets. It is interesting, how we have moved away from an era, where it was supposed that the US Fed has got a Put Option or floor under the stock market, thanks to its unstated policy of easing when faced with an equity sell-off, to a proverbial call option or ceiling, by way of hiking if the markets rally too much.
Indian rupee is now basking in the glory of a weak US dollar and expected easing from ECB. However, mean reversion models indicate that RBI may not be too comfortable with a value beyond 66.50/67.00 levels on spot, as it is already hurting our competitiveness, in a challenging environment for global trade. The central bank may look to shore up reserves, that it has lost, around USD 8/10 billion, thanks to revaluation impact and intervention. Hence, we may see the Rupee stabilise between 66.50/67.00 levels on spot over the month of March. Therefore, a range of 66.50/67.00 to 67.50/68.00 can play out till RBI meeting in April, where it is expected to reduce policy rates by another 25 bps.