February 2011: Questionable budget deficit projection

Equity markets in India were weak through the month and finished February down 3.1%. Including the 10.2% fall in January, the Indian market is now down 13% in the calendar year 2011. Partly due to the high cash component and partly because the portfolio stocks did better than the overall market, our portfolios continue to do much better than the market.

Though the fall during the earlier part of the year was led by the telecom scams and related uncertainty, Feb 2011 weakness was largely due to uncertainty in Libya and the continuing concerns about stability in the Middle East and North Africa and the resultant impact on oil prices. Oil prices have spiked over the last few months and this can have a very negative impact for India’s current account deficit and on inflation. If the price hike is not passed on to consumers, there will be an adverse impact on the fiscal deficit. The next few weeks need to be watched closely for any dramatic worsening of the situation from current levels.

The other big event for the month was the Union budget – the day of the presentation of the budget was marked with a lot of volatility as the market digested the event. While on the face of it, the fiscal deficit projection of 4.6% of GDP looks remarkable, the details suggest that the numbers are a bit optimistic. Given that as per the Finance Minister, the net impact of his tax proposals is net neutral, it is difficult to understand how revenues are expected to grow 24% on a 9% real GDP growth expectation. This probably assumes either a very high rate of inflation (thus increasing the nominal GDP significantly) or much higher tax compliance. Expense growth at only 13% also seems on the optimistic side. Particularly baffling is the oil subsidy of only Rs 23,000 cr. All in all, whether the fiscal deficit of 4.6% would actually get achieved is a big question mark.

The weakness over the past few weeks has started to throw up some interesting opportunities. A few of the companies with exceptionally good business fundamentals are available at attractive prices, though the same can not be said for the market as a whole. Statistical evidence suggests that some of these stocks are nearing prices where one can start to commit capital with a reasonably high probability of more than satisfactory returns over the next 12-24 months. These stocks, though not trading at the perfect entry price, are trading within about 5-15% from their buy points. We are fairly excited about the probable summer sale in the stock markets.