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Takeaway: The weak FY14 budget proposal exposes the Indian economy and its financial markets to meaningful TAIL risks.

SUMMARY CONCLUSIONS:

  • For the third consecutive year, India’s beleaguered Finance Ministry disappoints investors with a complete joke of a budget outline, and, for the third consecutive year, Indian financial markets are threatening to selloff heading into [at least] the mid-summer months.
  • All told, India is a short here (equities and currency) until the market comes to grips with negative implications of this third-consecutive budget gaffe. As evidenced in the chart below which includes our refreshed quantitative risk management levels, India’s benchmark SENSEX is flirting with a TAIL line breakdown and is less than 2% away from that occurrence.
  • A confirmed breach of TAIL support will be explicit confirmation of our dour interpretation of India’s fiscal policy outlook, as well as our marginally hawkish monetary policy outlook. Specifically, the bear case for the Indian economy and its financial markets as outlined in our 1/8 note tiled: “PATIENCE SHOULD PAY DIVIDENDS IN INDIA” continues to be confirmed by the data.

***To get up to speed with our calls India’s previous two budget gaffes and the associated negative macroeconomic implications therein, please review the following two notes:

This past Monday, we put out a note titled, “MAKE IT OR BREAK IT TIME FOR INDIA” in which we laid the analytical groundwork for contextualizing today’s budget release. To the extent you’ve got exposure to Indian capital markets and are looking to get into the weeds a bit, please review that note as well. The key takeaway was as follows: “The FY13 budget stands to create either a meaningful buying opportunity or intense selling pressure across Indian financial markets.”

In the spirit of being frank, it is our view that Finance Minister Palaniappan Chidambaram missed big relative to expectations of meaningful fiscal retrenchment with his FY14 budget proposal. Moreover, today’s budget ‘miss’ is likely to apply “intense selling pressure across Indian financial markets” as we alluded to in Monday’s note.

To review the FY14 budget in greater detail, we posit the following highlights:

  • Total expenditures up +16.4% YoY to 16.7 trillion rupees;
  • Subsidy expenditures down -10.3% YoY to 2.3 trillion rupees;
  • Tax & fee receipts are projected to come in at +21.2% YoY to 10.6 trillion rupees;
  • Capital revenues are projected to grow +8.9% YoY to 6.1 trillion rupees (receipts from equity divestments projected up +132.6% YoY, LOL!); and
  • Real GDP growth in FY14 is projected to recover to +6.7% YoY from +5% in FY13-to-date (through 4Q), with the latter figure representing the slowest growth rate in 10 years and compares with a trailing 10Y average of +7.9%.

IS INDIAN TAIL RISK OFFICIALLY “ON”? - 1

 

IS INDIAN TAIL RISK OFFICIALLY “ON”? - 2

Simply put, relying on aggressive forecasts for tax & fee revenues growth predicated on an aggressive GDP growth assumption to help fuel a +16.4% ramp in public expenditures is a dangerous cocktail for India’s sovereign balance sheet. We expect official budget deficit projections to be revised wider in the coming quarters and for the associated markets to front-run this to some degree. Moreover, with India’s growth slowing to +4.5% YoY in 4Q12 (from +5.3% prior) as per this morning’s report, we do not consider it reasonable to anticipate such a demonstrable pickup in economic activity.

That said, however, India’s 2H13 growth outlook should brighten substantially, eventually giving Indian policymakers some degree of hope at least from a directional (i.e. not “absolute”) perspective. For now, however, the Indian economy is likely mired in Quad #3, as per our latest projections.

IS INDIAN TAIL RISK OFFICIALLY “ON”? - INDIA

 

IS INDIAN TAIL RISK OFFICIALLY “ON”? - 4

From an inflation perspective, the -10.3% decline in subsidies will translate directly to higher prices (i.e. inflation) for Indian consumers and businesses in the coming months. Specifically, energy subsidies are budgeted to decline -33%. While the +5.8% increase in food subsidies to 900 billion rupees is little more than a cunning attempt to buy votes ahead of the 2014 general elections, it should offset some of the inflationary pressures stemming from the de facto energy price hike.

On balance, any inflationary pressures stemming from the aforementioned decline in total subsidy expenditures should curb a fair amount of scope for the RBI to continue easing monetary policy at the margins, a view that is starting to be confirmed by India’s OIS market. That’s not good for foreign investors, who, until recently, were bidding up Indian capital markets on the heels of a [widely-perceived] outlook for aggressive monetary easing.

IS INDIAN TAIL RISK OFFICIALLY “ON”? - 5

Recall that on FEB 16, RBI Governor Duvvuri Subbarao said that he will “weigh the quality of the government’s fiscal adjustment,” and that “there is room for monetary easing, but that room is limited.” If Subbarao interprets this budget in line with our views, then that “room” just got a lot smaller.

A slowdown in “flows” similar to the ones we’ve seen in past cycles will, at the margins, exacerbate the funding of India’s twin deficits and further threaten the country’s already-shaky economic growth prospects. Moreover, a widening of either deficit relative to the economy will inch India closer to a full-blown balance of payments crisis. While that’s not necessarily a call we feel comfortable making at the current juncture, it remains a critical tail risk for India and a host of other EM economies.

IS INDIAN TAIL RISK OFFICIALLY “ON”? - 6

 

IS INDIAN TAIL RISK OFFICIALLY “ON”? - 7

For our updated thoughts on the rising potential for a broad swath of EM BOP crises over the long-term TAIL, please review our 2/20 note titled: “CURRENCY WAR UPDATE: THAILAND AND NEW ZEALAND SOUND THE ALARM BELL”. FYI: the rupee (USD/INR cross) isn’t trading just above all-time lows for no fundamental reason whatsoever. It would be a real shame if the Singh administration ultimately failed to deliver on so many opportunities to get India’s fiscal house in order and the country’s rampant inflation under control…

IS INDIAN TAIL RISK OFFICIALLY “ON”? - 8

All told, India is a short here (equities and currency) until the market comes to grips with negative implications of this third-consecutive budget gaffe. As evidenced in the chart below which includes our refreshed quantitative risk management levels, India’s benchmark SENSEX is flirting with a TAIL line breakdown and is less than 2% away from that occurrence.

IS INDIAN TAIL RISK OFFICIALLY “ON”? - India SENSEX

A confirmed breach of TAIL support will be explicit confirmation of our dour interpretation of India’s fiscal policy outlook, as well as our marginally hawkish monetary policy outlook. Specifically, the bear case for the Indian economy and its financial markets as outlined in our 1/8 note tiled: “PATIENCE SHOULD PAY DIVIDENDS IN INDIA” continues to be confirmed by the data.

Darius Dale

Senior Analyst