The Hindu Business Line : Economists cannot predict the movement of stock markets

Apart from the Budget's immediate impact on stock movements, it is important to give the market at least a month for it to process and incorporate the Budget's implications into the market indices. DR SHANTO GHOSH, DIRECTOR AND PRINCIPAL ECONOMIST, DELOITTE, HASKINS AND SELLS, MUMBAI.

Is the annual Union Budget increasingly an economic policy statement rather than a bundle of fiscal measures? "That's right," says Dr Shanto Ghosh, Director and Principal Economist, Deloitte, Haskins and Sells, Mumbai.

In recent times the Budget is used as a platform to announce important policy initiatives, apart from fulfilling its usual role in providing details on the Central Government's current and future fiscal plans, he explains.

"However, I find this to be a healthy approach towards policy making," says Dr Ghosh. Here is more, from his interaction with Business Line:

Why is the shift healthy?

The Government plans its five-year policy initiatives and lays down the concrete steps it will undertake to achieve such goals. The Planning Commission plays an important role in this process.

However, there is currently no structured process whereby the policy makers can incorporate evolving domestic and international trends to fine-tune the process of achieving the Plan's longer-term goals.

Unpredictable changes in important macro variables (for instance, international crude price, currency movements in other markets and supply bottlenecks in the economy) need to be addressed on a year-to-year basis to monitor the movement of crucial sectors to achieve the longer-term objectives.

The Budget is used for effecting these short-term policy changes. It is backed by the revenue and expenditure streams of the Government and, as the Union Government assumes a significant role in India's GDP (gross domestic product), suitable fiscal measures spelt out in the Budget help add credibility to the policy changes announced.

What aspects of the macro-economy have received continued attention in recent Budgets? And which of them merit urgent attention in the forthcoming one?

Perhaps the most important macro-economic variable in the Budget that holds interest to all parties is the fiscal deficit. It is widely held by economists that continued and widening fiscal deficits make it harder for policy-makers to stabilise inflation in an economy.

Hence, it is argued, the Government should aim to balance its Budget (and maintain a surplus, if possible).

However, what is important to understand is that deficits per se are not inevitable evils, as Government spending has a key role to play in developing economies by diverting funds to much-needed infrastructure projects, which may not be forthcoming immediately if left to the market forces.

Thus it is pivotal to determine whether the fiscal deficits can be financed without continued borrowing in the long run.

In a country such as India, the Budget should focus more on social issues. Primary education, standard of living (access to sanitary drinking water, clean and hygienic living conditions, etc.), healthcare for the poor and the elderly and a more pro-active social security safety net is the need for the hour. The Budget focuses far too little on addressing these issues while discussing its plans for revenue and expenditure on a more macro level.

If the informal economy is as big as it is often made out to be how far can the Budget be effective in achieving its goals?

The size and impact of the informal sector (including informal employment) is a contentious and evolving area of academic research — particularly as it relies on methodologies and survey data that may vary from the true characteristics of the informal sector due to statistical reasons.

However, despite the ambiguities, it is fair to say that the size of the informal sector in India is a very large percentage of the country's GDP — with estimates ranging from 35 per cent to as high as 55 per cent!

Despite the presence of a large informal sector, it is nonetheless important to retain a discipline on revenue and expenses that pertain to the formal sector.

Economists have studied the link between the formal and informal sectors and found that the two are positively correlated.

Therefore, it is imperative that the Budget continues to work towards developing the formal sectors; measures of its effectiveness will vary if estimates do not account for the impact of the Budget on the informal sector. But that is no reason to dilute the importance of Budget-making in the economy.

Does monetary policy wield a greater power over macro-economic variables than the Budget does?

At the risk of oversimplifying matters, let me spell out the respective roles of monetary and fiscal policies in an economy. The role of monetary policy-makers is to fight inflation and manage the balance of payments in an economy (through an effective exchange rate policy). The role of fiscal policy, which is what the Budget reflects, is to target unemployment and growth.

Each of these macroeconomic variables feed into the other — growth, inflation, unemployment and exchange rate movements are not independent of each other. Hence, monetary and fiscal policies should also not be evaluated in isolation.

The effectiveness of monetary policy is driven by structural characteristics that lead to inflation or movements in the exchange rate.

There is the widespread belief that the current inflationary pressure being witnessed in India is due to supply bottlenecks. Monetary policy will have a smaller impact in combating inflation of this nature.

What are the five most important economic pointers that you look forward to in Budgets?

As everyone, my first focus is to look at the changes to the tax laws that are discussed in the Budget. Second, I also look for the incentives that are provided to improve productivity/employment in certain key sectors of the economy. Third, I look for policy changes that indicate greater attention to the social issues plaguing our country. Fourth, I look for signs of increasing fiscal accountability.

And finally, details suggesting greater fiscal decentralisation are also a very important element in the Budget.

How can economic discussion be made more widespread in the country? What are the essential economic fundamentals every citizen should have? Do you see the need to have a greater place for economics in education?

Economics, to many, is a forum for idle speculation regarding the economy. It suffers from scepticism since it lacks robustness in terms of predictability. However, it is, after all, a social science that studies the behaviour of firms, consumers, policy-makers, markets and a host of other matters.

The behaviour of these micro `units' that together constitute a larger economy is impossible to predict with precision — hence, economists rely on assumptions and make `if-then' predictions! Do these add value? I think they do, as they provide a framework for analysing macro and micro indicators in an economy.

I think the evolution of a subject should be organic and this holds true for economics as well. In terms of `gyan', there is one that I cannot emphasise enough — economists cannot predict the movement of stock markets! I say this with no qualms whatsoever.

On what to make of the stock market index movements in the course of the Budget speech.

Anecdotal evidence shows that stock market activity is greatly influenced by the Budget. (The highest number of trades ever recorded on NSE was 1.4 million trades, on 28 February 2001, the day of the Budget.) The stock market response to a Budget is often viewed as an important summary statistic of the "quality" of a Budget in terms of improving macro - economic prospects.

There is an interesting piece of academic research that studies the reaction of the Indian stock market to the Budget (Thomas and Shah, 2001). In my opinion, its two main findings are as follows:

The stock market appears to be fairly efficient at processing information contained in the Budget. This suggests that it is important to pay attention to how the stock market responds to the Budget as it incorporates its effectiveness quite efficiently.

Union Budgets add 10 per cent to the stock index, on average, and yield elevated volatility starting from the Budget date for the following 30 trading days or so. (However, this study was one in 2001 and this percentage is likely to be smaller given that the current index base is significantly higher now than what it was in 2001.)

This suggests that, apart from the immediate impact on the markets, it is also important to give at least a month for the markets to correctly process and incorporate the impact of the Budget into the market indices.

MuraliDe@gmail.com

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