Negatives

Prices of FMCGs, pharma and software stocks had moved up sharply. The Sensex moved up as the weightage of these stocks in the index is high.

Can one argue that the rise is due to the return of the feel-good factor? The chambers of commerce and industry are already changing their initial stance on the budget. Investors must be cautious - the feel-good factor could be based on a misconception and could change soon. Let me explain.

The government has now brought the rural and agriculture sector for increased attention. This is good, for an improvement in rural earnings can drive demand for goods. But many of the initiatives will depend on local effort. In reality, these efforts will take 2-3 years to show up in results and that too,if the government sustains these efforts in succeeding years.

So the feel-good on this score is to be tempered with a realisation that these are long-term measures. Next. Now that the industry has got some protective benefits, will it invest more? In my view, the squeeze on growth and profit margins experienced by the industry would make it very cautious about further investments. In an environ of overcapacity, if corporates survive today, it is because of slimming down.

It is difficult to see industrialists jumping on to another bout of expansion, without a consolidation phase. And let us now turn to what the budget did to improve the macroeconomic scenario. Nothing much indeed.

The government has conveniently bypassed several crucial issues. Reining in fiscal deficit, cutting subsidies and downsizing government has not been addressed. It is doubtful if the fiscal deficit can be contained at the 4 per cent level forecast in the budget. No effort is being made to monitor and moderate plan and non-planexpenditure.

The expenditure commission is bound to take considerable time. Also one will have to wait and see what percentage of the salary bill will be cut in the next 2-3 years. Or for that matter if the government sticks to the promise of zero-based budgeting. In reality, the basic assumptions of the budget themselves raise the question of credibility. The growth rate in tax revenue has been envisaged at 21 per cent, whereas the actual growth in 1998-99 has been only 14.5 per cent.

On the expenditure side, the non-plan expenditure is projected to increase by only 6.2 per cent, while the actual growth in 1998-99 was 23.4 per cent. Making such unrealistic assumptions will only make life difficult for the industry in years further down the lane. For as this gap widens, the possibility of excise and corporate taxes being further hiked in the future years cannot be ruled out. Another weakness in the economy is that external liabilities now accounted at Rs.56,000 crores would be substantially more atcurrent rates.

A depreciating rupee will make it further worse. While a rupee depreciation might help exports, one needs to assess the impact of such depreciation on the liabilities arising out of the Resurgent India bonds or for that matter, future FII portfolio investments, which have been offered protection from exchange rate depreciation. The protection offered to FIIs on this score gives them an advantage over the local players. The playing ground is not level to all.

Now let us come down to the specific market behaviour. The infotech sector is up, more as a relief from the threat of an imposition of service tax. The earning model for software companies continue to be the same, except in selected areas like telecom software. Marketmen can well recall the fact that the fear about imposition of a service tax on software industry cropped up just a week before the budget.

Price rise in these stocks have now gone far above the needed correction for the fear-oriented slide. Take Infosys for example.Currently ex-bonus, ex-budget, it commands a price earning multiple of around 70. Last year, it was commanding a multiple of only 50. What is it in the budget that has changed the earning model for Infosys that the price earning multiple should move up from 50 to 70. What is true of Infosys is true of several others. The current flare-up in stock prices is certainly selective and mainly in software and pharma. Banking stocks are now catching up. The rise in prices of cement stocks are well-moderated, probably on the lower side in relation to the improvement in prospect for the cement companies.

As to pharma stocks, one needs to remember this. Sinha has only announced that a task force will study into the current price control. Not much public discussion has begun on the subject, I am afraid. Pharma prices are always a tussle between corporate profits and medicines at affordable prices for the masses.

One cannot import the western model here, since there, most of the medical cost is taken care of by thepublic health system. There is no such cover here and the government will be forced to think on the impact of the intended relaxation on public welfare. No one disputes the need for the pharma industry to earn more, so that they have resources to apply in research.

But there have also been models in some western countries, where the government has sought to cap the profit on pharma companies as a certain percentage of return on networth.

In summation, prices of FMCG, pharma and software stocks appear to have run far ahead of what the future really holds for them, post-budget. On Thursday morning, I see the reaction has already begun.

Copyright © 1999 Indian Express Newspapers (Bombay) Ltd.

Net Express

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