Will the budget rein in the deficit?

The prime agenda of this budget,one of the most critical ones in recent times,will be to set right the loose fiscal policy and cut the deficit substantially. The exit strategy will dictate a roll-back of tax cuts. It will also allow little room for increase in expenditure. We expect the government to budget a FY11 fiscal deficit of around 5.5 per cent of GDP (around 150-175 basis points lower than in FY10). Save for the partial rollback of the fiscal stimulus,we do not expect any major sector-specific policy or tax-related measures.

History shows that India does not get a poor monsoon for two consecutive years. With the law of averages on our side,we can hope for adequate rainfall this year.

The global economy continues to be uncertain. How different countries tackle what is likely to be a slow and gradual recovery and how the US dollar moves are variables that are hard to predict. The withdrawal of stimulus globally seems imminent. But what is not clear is the pace at which this will be done. It also remains to be seen whether Western economies will be able to sustain the recovery in the absence of fiscal and monetary support from their governments and central banks.

The India story

Compared to its Western counterparts,India seems better placed,if not comfortably positioned. The country’s domestic consumption remains robust. In many industries penetration is still low and the potential of a number of market segments is yet to be explored.

On the back of strong tailwinds,corporate earnings could grow rapidly,especially since growth has been flat for the past two years.

In addition,a lot of capacity has been added — in cement,refining,auto and power generation. A study done by us reveals that in many areas a lot of capacity will be added till FY12,resulting in an increase of 50 per cent or more over the capacity existing in FY08.

Thus,the Indian economy is well positioned because of an enabling growth environment.

The laggards will be sectors where 50 per cent or more of the growth comes from global demand. In those areas,we will have to live with uncertainty. How aluminium prices or refining margins will move over the next 12-24 months is hard to estimate.

Crystal gazing

Given the influence of the above-mentioned factors,Indian equities could range anywhere between 14,000-20,000 in 2010. If the global economy picks up,commodity prices remain reasonably low,and refining margins recover,we have a real chance of getting close to the dizzying earnings growth rates of the past. But if the global growth cycle is not supportive and earnings suffer downgrades,then Indian equities are likely to float at the lower end of the band mentioned above.

But that’s the near-term scenario. If you look at a longer time horizon,there is enough light at the end of the tunnel. We are on the verge of transformation in several priority areas. The coming two years could well accomplish the following: access to affordable credit and insurance (a key ingredient of the government’s inclusive growth agenda); possible autonomy in oil pricing; increased availability of gas and enhanced investment in transmission and distribution (T&D) infrastructure; reduced fiscal deficit; implementation of the direct tax code; and implementation of goods and services tax (GST).

What should you do?

Whether or not equities score in 2010 is a difficult call to take but India surely will arrive. The scenario for the medium to long term is optimistic. We recommend value investments in stocks related to consumption,infrastructure and the rural economy,and in quality midcaps.

For the next five years,consumption is likely to be the prime growth theme in the country. At the bottom end of the demographic pyramid,income levels are rising much faster than earlier. This should provide a boost to demand for a host of goodies — cigarettes,toothpastes,vehicles,housing and so on. In all consumption-related sectors,volumes are likely to surpass their previous highs.

Rural India will continue to hog the limelight. If the monsoons are good,then the agricultural segment could script an enduring success story. The government’s infrastructure-related expenditures are likely to continue — in roads,bridges,power and other utilities. The government is likely to continue with the NREGS scheme,which has boosted demand at the bottom of the pyramid.

Finally,with the earnings momentum likely to sustain over the long term,intelligent investing will reap rich dividends. u

The author is vice president-research,India Infoline