Budget 2018: What Equities And Bond Markets Tell Us

While the equity markets seem to have comprehensively disapproved of Jaitley’s last full budget, the response of bond prices indicate the likelihood of hardening interest rates in the future

Two needles moved decisively after Union finance minister Arun Jaitley announced his budget for 2018-19. Both movements provide some clues on how to read the budget.

The first needle—indicating stock market health—oscillated wildly during Jaitley’s speech and continued to fluctuate thereafter. The BSE Sensex started floating downwards soon after the finance minister began reading his budget speech on Thursday morning, disheartened by the heavy overload of social sector announcements. It then dropped further on news of a new long-term capital gains (LTCG) tax, recovered slightly and ended the day marginally below opening levels. But, on Friday, it capsized as the full weight of the budget sank in. By the time markets closed on Friday, Sensex had lost almost 900 points, or close to 2.5%, over its Wednesday closing.

This sell-off can be read in multiple ways. The charitable justification is that the stock market was over-valued and investors needed an excuse to make a correction. The moderate explanation is that investors are unhappy with the budget maths, the expenditure programme, the lack of visible funding sources, lack of clarity over the generous spending programme and the red light flashing over the fiscal deficit levels. The extreme view is that the sell-off revealed a marked distaste for the new LTCG levy, an inexplicable 42% jump in the securities transaction tax collection next year (raising fears that the tax rate might be increased in the interim) and the inclusion of equity mutual funds in the dividend distribution tax net.

The Sensex started floating downwards soon after Jaitley began reading his budget speech, disheartened by the heavy overload of social sector announcements. Photo courtesy: AFP and Mint.

In short, whatever the reason, it does seem that the equity markets have comprehensively disapproved of Jaitley’s last full budget. It’s perhaps also an expression of the market’s scepticism with the numbers.

For example, there is no accounting for many of the grandiose spending schemes. Analysts are clueless how either the minimum support price programme for farmers, or the ambitious health coverage scheme, will be financed. There are doubts even about some of the capital expenditure schemes. Many of these are likely to be launched in conjunction with states, giving rise to a fresh wave of cynicism about their viability.

In most cases, the policy architecture is yet to be worked out. Making announcements before finalizing the policy contours is a curious practice, somewhat like a nervous sentry shooting first and asking questions later.

Some disingenuous measures on the personal tax front might have also left a bad taste. For example, a standard deduction of Rs 40,000 that was announced as relief for the salaried taxpayers was negated the next moment by an increase in cess from 3% to 4%. In fact, the budget relies heavily on cess collection, a revenue source which the centre does not have to share with states, betraying signs of nervousness not only about revenue collection but also about the impending political battles that lie ahead.

The second needle—bond markets—is providing a far more layered story of what lies ahead. Reacting to budget arithmetic, especially the government’s spending and planned borrowing programme for 2018-19, 10-year government bond prices fell and yields rose, indicating the likelihood of hardening interest rates in the future. The Reserve Bank of India (RBI) announces its sixth bi-monthly monetary policy on 7 February and it will be interesting to see what emerges.

One thing is certain though: the prospect of a rate cut now seems to have receded. On the contrary, RBI is likely to adopt a tightening stance, with oil prices rising globally, bank credit picking up, money supply growth clocking 10.7%, the government’s borrowing programme looking unrealistic and poised to breach the budgeted target (just like the current year) and general uncertainty over how the government’s proposals will impact the price line.

For example, there are questions over whether the 50% increase in kharif minimum support price will impact the consumer price line or whether it has already been priced in.

Pressure on yields will emerge from another front if Jaitley’s plans for the corporate bond markets take off. Jaitley’s speech stated that securities markets regulator Securities and Exchanges Board of India will soon come out with rules that will compel large corporates to source 25% of borrowings from the corporate bond market. In addition, he said many sectoral regulators will be asked to relax investment rules in their respective industries; for example, the insurance regulator might henceforth allow insurance companies to invest in A-rated bonds when the current rules draw the line at AA-rating. To facilitate growth of the corporate bond market, Jaitley also promised to reform the stamp duty regime in consultation with states.

Even if we leave aside the oddity of telling corporates where to borrow, the development has the potential to affect government bond yields and, subsequently, interest rates. While the government has kept its FY19 borrowing programme largely the same as FY18 (Rs6.06 trillion against Rs6.05 trillion), any additional borrowings over the budget target is likely to have consequences for interest rates.

And as the ruling Bharatiya Janata Party gets into election mode—as was evident from the budget speech’s tone and tenor—and spending gets subjected to realpolitik, the likelihood of a bloated borrowing programme and deviation from the fiscal deficit glide path cannot be ruled out. It’s election season after all.

The above article was written for Mint newspaper. It can also be read here

Will Jaitley Sow The Right Seeds?

As Finance Minister Arun Jaitley prepares to present the Budget on February 1, one issue will dominate his mindspace: agriculture. With large sections of India’s population depending on the farm sector, continuing distress has reached crisis proportions.

And this predicament manifested itself in the recent Gujarat elections where the BJP retained its majority but lost 16 seats from its 2012 tally. After the polls, Gujarat Chief Secretary J N Singh attributed this loss to farmer distress and unemployment. The distressing after-effects of demonetisation were felt most acutely in the agrarian economy.

This year sees Assembly elections in eight states, of which the predominantly agri-states Madhya Pradesh, Rajasthan and Chhattisgarh are currently ruled by the BJP. And in the 2019 general elections, the BJP will be forced to defend its 2014 majority. Hence, agriculture and allied industries will surely play a significant role in shaping the Budget.

Agriculture has been in deep crisis for some time now: The Central Statistics Office’s advance estimates for 2017-18 GDP growth show agriculture growing at 2.1 per cent in the current fiscal against 4.9 per cent during 2016-17.

Apart from the long-term structural issues ignored by all governments so far—fragmented land-holdings impairing productivity, constraints in the input (water, credit, seeds, fertilisers) supply chain, insufficient forward linkages, lack of market access, wastage—the current year has seen some additional low points. The Budget will focus on three areas in agriculture that will convince farmers to vote the BJP back.

Infrastructure: Weather reports showed that 2017 monsoons were bountiful, with a minor deficit. However, there were spatial disparities in distribution of rainfall. This affected kharif sowing in Uttar Pradesh, Haryana, Punjab and Madhya Pradesh with pockets of stress recorded in Maharashtra and Karnataka.

This affected output and consequently incomes. It also brought home the age-old problem of how the slow pace of irrigation—covering only 40 per cent of cultivable land—has made agriculture overly dependent on monsoons. With frequent droughts, this infrastructure deficit translates into lower crop and incomes.

For example, an October 2017 presentation from rating agency Crisil showed MP felt the highest stress, with deficient rainfall aggravated by poor irrigation infrastructure. It also singled out Rajasthan, MP and Chhattisgarh which showed a dip in profits earned per hectare during 2017. Jaitley may decide to increase the budget allocation for irrigation, having allotted lower amounts in the previous years. There also needs to be a review of the money spent on irrigation projects which are not being used to their potential.

Sliding prices: During 2017, the arbitrary market structures and policies yielded lower profits for farmers, even with losses in some areas. Loss of income due to sliding prices is critical to understanding farmer distress. This even prompted farmer organisations to request Jaitley to ensure some kind of assured income for farmers in the Budget. The story of declining farmer income is illustrative of the policy missteps by the government.

For example, faulty signals to farmers in the previous year, especially through higher minimum support price (MSP) for certain crops (pulses, for example) led to a bumper crop in 2017. But callous trade policy, especially regarding free imports, led to a glut. To top this, the government’s procurement target was inexplicably kept at a low percentage of the total harvest. Prices inevitably crashed well below MSP and farmers had to sell their crop at non-remunerative prices.

There is also the undeniable shadow of the trader community—the BJP’s traditional vote bank—looming over the Centre’s agriculture policy. The government’s MSP policy has been floundering for a while because of insufficient education leading to low levels of awareness among farmers, inaccessible procurement centres forcing farmers to sell to local traders for lesser prices (in many cases to the local moneylender) and graft in the official procurement system.

The Centre’s eNAM (electronic National Agriculture Market) which provides farmers a platform for selling their produce by linking them electronically with traders across the country is still a work in progress.

Policy Politics: In an open letter to Jaitley, Ajay Vir Jakhar, chairman of Punjab State Farmers’ Commission, has argued that the government’s policies must pivot from “Food Policy” to “Farmers’ Policy”. This is a major change in focus and would require complete overhauling of the farm policy. This suggestion also encapsulates within it the dilemma that confronts policymakers: Should they design policy to ensure food for all at all costs or ensure fair income-generation opportunities for farmers that will also lead to food security?

The policy framework should also examine how to deal with farm-related payments which are entangled in red tape. For example, the crop insurance programme—Pradhan Mantri Fasal Bima Yojana, launched in 2016—has drowned farmers in a sea of paperwork and failed to provide either adequate or timely compensation. The failure of this scheme has been cited as one reasons for Gujarat farmers, especially Saurashtra-based farmers, to change their voting preferences.

Jaitley’s earlier Budgets devoted many sections and paragraphs to the farm economy. However, many of these policies, schemes and announcements were seen as course corrections, tinkering with existing schemes or just plain grandstanding. February 1 should give him an opportunity to make some substantive changes in the farm sector.

The above article was written for New Indian Express and can also be read here