Budget and the
capital market
Whilst the
response of the capital market on the budget day was subdued, the next day it
rose smartly. It is difficult to see what encouragement it found in the budget,
unless it was relief that the budget was past without any upsets. That may be a
broader reaction. Industry is somewhat fearful of the left-centre joint venture
that runs the government. The left would like the government to soak the rich.
The Prime Minister has resisted its pressure, for he knows how a return to
punitive policies can upset enterprise and halt the virtuous cycle of
investment and growth. But it is impossible to tell where political necessity
may lead even the most sensible people. It was this fear, this sense of risk,
that held back the market in the weeks before the budget. Once the event was
behind and the tension released, the market sprang back to its previous trend.
Although the
small print may have been missed in a budget that celebrated big spending,
there are a number of aspects which may be quite favourable to the market. The
fiscal deficit, which represents the central government’s net borrowing
requirements, will rise only slightly from Rs 1.461 trillion to Rs 148.7
trillion. Since other monetary variables will rise by 11-12 per cent, the share
of central borrowings in financial flows is likely to come down. Add to this
the fact that the States also have cash to spare, and have been buying central
government’s treasury bills for lack of investment opportunities. It is clear
therefore that the need to finance governments is going to come down. This
implies that more money will become available for private financial
instruments, be it equity or debt instruments. In other words, a fall in the
ratio of government borrowings to financial flows will improve liquidity and
expand the supply of funds to the private sector.
Finance is
fungible; increased supply of finance will support the equity market. But that
is not the only change the finance minister proposed. Reserve Bank has for long
operated a market for government securities held by banks. It has till now
excluded other institutions from the market. Till last year, the market worked
on telephone; brokers called up bank treasury managers every day, asked what
they had to buy and sell, and matched orders. Since October last year, Reserve
Bank has operated an online market (which carries the awkward name of
Negotiated Dealing System electronic order matching module) where orders are
matched by the computer. That has improved liquidity and increased the volume
of transactions; but compared to the total value of government securities,
which exceeds Rs 22 trillion, the turnover is minuscule. Unless a broader
market is created, it will be impossible to extend the holders of government
securities beyond the current banks, financial institutions and mutual funds.
Now the finance minister has promised that Reserve Bank will admit mutual
funds, provident funds and pension funds to its market. He has also said that a
market for corporate bonds will be created, though he did not specify whether
it will be integrated with Reserve Bank’s market for government securities. But
either way, liquidity in debt should increase significantly if the finance
minister’s promises are kept.
His decision to
give tax exemption to interest on five-year bank deposits is a retrograde move.
The motivation behind it is clear: government-owned banks have complained to
him that mutual funds have been taking away long-term funds from them. But his
response is nevertheless mistaken. The shift from bank credit to debt funds
differentiated by ratings is desirable for two reasons: it enables investors to
choose the degree of risk they want to take in lending, and it makes them share
in the risk. Ideally, all debt should be securitized and tradeable; tradeable
debt funds are one way of packaging debt and making it marketable. Hence banks
should be encouraged to give customers a choice of risk-return combinations,
and they should be given the same tax treatment as mutual funds.
The government
is not in a mood for reforms; still, the finance minister should ask why debt,
equity and commodities cannot be traded in the same exchange or exchanges, why
Reserve Bank should run its own market for securities and not allow it to be
linked to National Stock Exchange, and why non-financial investors, including
personal investors, should not be given access to all the markets. Because they
are not allowed into the National Dealing System, they pay heavy intermediation
fees to banks, insurance companies, and mutual funds which in effect hold
government securities with their money. Reserve Bank likes that because it is a
protector and benefactor of banks. But the finance minister should not take
such a parochial view; it is his duty to protect the interest of personal
investors.
