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Takeaway: The FY13 budget stands to create either a meaningful buying opportunity or intense selling pressure across Indian financial markets.

SUMMARY BULLETS:

  • India's FY14 budget is due to be released on FEB 28; this is arguably the most important fiscal policy catalyst in India since the introduction of the FY12 budget roughly two years ago.
  • If Finance Minister Palaniappan Chidambaram’s deficit-reduction plan is interpreted favorably by the market (i.e. they rely more on actual spending cuts rather than aggressive economic growth and revenue assumptions), then the recent weakness across Indian financial markets may end shortly, as some showing of fiscal sobriety would allow the RBI to resume its monetary easing activity – the #1 factor behind the recent upswings across India’s equity, currency and bond markets (as expected, the RBI cut rates on 1/29).
  • If the aforementioned measures are not deemed credible, then expect continued weakness across Indian financial markets – at least over the next few weeks. That would likely be driven by a measured reversal of international capital flows.

The SENSEX is down -3.8% since it’s JAN 25th cycle-peak and the INR is down -1.6% vs. the USD since its FEB 5th cycle-peak and both continue to correct in line with our expectations.

All eyes are on the FEB 28th introduction of the FY14 Budget where Finance Minister Palaniappan Chidambaram is expected to announce steps to reduce the budget deficit to 4.8% of GDP in the upcoming fiscal year ending in MAR ‘14 and to 3% by FY17.

If Chidambaram’s deficit-reduction plan is interpreted favorably by the market (i.e. they rely more on actual spending cuts rather than aggressive economic growth and revenue assumptions), then the aforementioned corrections may end shortly, as some showing of fiscal sobriety would allow the RBI to resume its monetary easing activity – the #1 factor behind the recent upswings across India’s equity, currency and bond markets (the RBI cut rates on 1/29):

  • SENSEX is still up +5.6% from its 11/16 cycle-trough;
  • The INR is still up +2.9% from its 11/26 cycle-trough; and
  • India’s 10Y nominal yield is still down -43bps from its 11/23 cycle-peak.

If the aforementioned measures are not deemed credible, then expect continued weakness across Indian financial markets – at least over the next few weeks. That would likely be driven by a measured reversal of international capital flows.

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As outlined in our recent research notes on India, we’d eventually like to buy the SENSEX/INR a lot lower for a likely move to Quad #1 on our GIP chart in the 2Q13 to 3Q13 time frame (see: “PATIENCE SHOULD PAY DIVIDENDS IN INDIA” (1/8) and “INDIA & BRAZIL: UN-ACCORDING TO PLAN?” (1/29)). For now, India looks poised to record a brief visit to Quad #3 for the time being:

MAKE IT OR BREAK IT TIME FOR INDIA - INDIA

Our updated risk management levels on Indian equities are included in the chart below. Watch that TREND line carefully; a confirmed hold or breakdown will tell us all we need to know about what the FY14 budget portends for India's structural growth and inflation dynamics.

Stay tuned.

Darius Dale

Senior Analyst

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