India: Why Investors Don't Like the New Budget

India's stock market nose-dived after finance minister Pranab Mukherjee completed his nearly two-hour-long budget speech in Parliament on Monday. Why did the Sensex plunge 869 points when the FM did not do anything negative in terms of imposing new taxes on the corporate world?

In fact, he surprised businesses on the upside by not rolling back the 4% central excise duty cut effected over the past several months as part of a massive fiscal stimulus to deal with the economic recession engulfing the developed and many developing economies. India, of course, survived the deep recession and registered 6.7% GDP growth during 2008-09.

Mr Mukherjee also removed the much-disliked Fringe Benefit Tax which was a thorn in corporate India's flesh. He gave an even higher fiscal boost by increasing plan expenditure substantially. The total expenditure he had earmarked in his interim budget barely a month before the general elections was Rs 9,53,000 crore. He increased this to Rs 10,20,000 crore in the full budget he presented on Monday. He increased allocations for various social sector projects in a big way. He tried to throw goodies at everybody. Yet the stock market gave him thumbs down. Why?

This is largely because expectations had run very high that UPA's first budget would outline a big vision for economic reforms of the kind the markets and foreign investors love. A big PSU divestment road map, further liberalisation of the foreign investment regime, opening up of the financial sector, etc., had been somewhat priced in by the markets. The Economic Survey presented two days ago also sounded very positive on these reforms. In fact, the stock market had gone up after the Survey was presented.

These excessive expectations were belied, so the market's first response was to tank 870 points. However, the market will soon realise its folly and start looking at the budget proposals in a different light in the days ahead. The notion of economic reforms is also changing rapidly in the backdrop of what is happening around the world today. Mr Mukherjee deliberately recalled bank nationalization by Indira Gandhi as something that might have contributed to India's banking system weathering the global financial storm. The markets, perhaps, did not like the way the thought was articulated. It probably took it as a sign that financial sector reforms in India will happen very slowly, if at all.

After all India, as a growing economic power, would want its banks to achieve global scale and compete in the global market. But the notion of nationalisation can appear very inward looking. The overall perception Mr Mukherjee might have generated is one of being an old school, pre-liberalization finance minister who couldn't care less if the government had to spend its way out of recession. Massive increases in the outlay for various social sector schemes only reinforced this impression.

Before it's here, it's on the Bloomberg Terminal.