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A Low-Impact Budget

The FM presents a pre-election budget that doesn't change anything much for investors. However, the loan waiver could create long-term problems for banks

As expected, this was a low-impact budget from an investment perspective. No qualitative or quantitative change was made to the tax-saving investments one can make. On the face of it, the stock market's reaction to the budget has been negative. If one is to believe the obvious explanation then a major culprit is the increased short term capital gains tax. However, I don't really believe that this increased tax will have any lasting impact on the markets. I simply can't imagine any situation in which the investing or trading behaviour of any market participant will change because this tax has gone up from 10 per cent to 15 per cent. However, it will mean that when the time comes to pay the year's taxes, then traders will have to pull out that much more cash to pay tax and in that sense it does reduce investible cash from stocks. The increased short-term capital gains tax does increase the advantage that is represented by mutual funds as opposed to trading in stocks oneself. When a mutual fund buys and sells stocks, it does not pay any tax. Taxation comes in only when the fund investor redeems his mutual fund investment. Earlier this was an advantage of 10 per cent, now its 15 per cent.

As an investor, I believe the major impact will come from the farmers' loan waiver on banks as an investment. Banks have been something of a star investment in the recent past. There are two sectoral mutual funds focussed on banking and their performance has been far above that of any other kind of mutual fund. Also, there are more than a few banking funds that are in the process of being launched. I believe that the farmers' loan waiver will have a very deep impact on the credit culture in parts of the banking market where public sector banks have to have a strong presence. The idea that the government can step in and repay loans of a specific category of borrowers is a moral hazard of no small proportion. As one saw on TV almost immediately after the speech ended, small landholders who've diligently repaid their loans now consider themselves to be complete idiots. I'm certain that there will be many people around the country who will now stop repaying their loans and start agitating for loan waivers. I have a strong suspicion that this loan waiver by itself has the capability for converting PSU bank stocks and banking sector mutual funds into suspect investments.

That said, the loan waiver will, for the time being, improve the balance sheets of banks. It hasn't yet been publicised exactly how the mechanics of the waiver will work but I assume the government will just repay the lenders on behalf of the borrowers. In terms of actual funds flow, this means a huge chunk of cash being paid by the government to the banks. And since these were loans that were probably never coming back, it could well be a temporarily bonanza for banks. Of course, when they use the money to dole out fresh loans, they'll probably be saying a final good bye to it.

Till the next loan waiver, that is. I can see that Mr. Chidambaram may have started a dubious new tradition that will be hard for any future FM to put an end to.