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While the absence of an increase in small-savings rate could be seen as a positive, it also means that rates are unlikely to fall further from current levels.

THE Union Budget has been along expected lines and has followed the broad agenda set in the Common Minimum Programme (CMP).

It reiterates the reform process and has allocated additional resources to education, agriculture and infrastructure sectors. The macroeconomic statements along with those on fiscal consolidation augur well for the future.

The combination of proposals on the taxation front — reduction of short-term gains tax and abolishment of long-term capital gains tax — could lead to equities garnering a large allocation from investors.

The renewed emphasis on rural and infrastructure sectors are a positive and could lead to an increase in the purchasing power of the consumer over the medium-to-long term. The Finance Minister has desisted from taking populist moves such as a hike in small-savings rates.

Given the strong macroeconomic situation, there have not been any major reversal in policies and we expect the current growth drivers of the economy — highway projects, positive demographics, retail lending and outsourcing opportunities in sectors such as textiles, pharmaceuticals, autos and technology — to remain intact. Overall, the impact of the Budget is expected to be neutral. Given that in recent years major policy announcements have been made outside the Budget, one will have to wait and see if the same pattern is repeated.

Debt markets

The rise in excise duties on manufacturing imports might add to the inflationary pressures and higher spending on infrastructure and agricultural sectors might result in an increase in credit demand over the medium-to-short term.

The increase in the investment limit for FIIs in debt markets to $1.75 billion could improve liquidity to an extent, especially at the short end.

But, given the rise in global interest rates and with the rupee movement ceasing to be unidirectional, the arbitrage opportunities are reducing and this move might not have any significant impact.

While the absence of an increase in small-savings rate could be seen as a positive, it also means that rates are unlikely to fall further from current levels.

The 10-year benchmark yields touched a low of 5.67 per cent before closing the day at 5.82 per cent due to concerns over transaction tax and interest rate direction. Volumes in the debt markets could be impacted due to the confusion over applicability of transaction tax.

The statements made on the fiscal consolidation are a positive. Elimination of revenue deficit by 2008-09 and fiscal deficit at 4.4 per cent of GDP are sentiment-boosting announcements. The latter indicates that market borrowings for this fiscal year will not be much higher than earlier estimates. However, markets are awaiting clarification as to whether the transaction tax will be applicable to debt securities as well. Inflation and global interest rates will continue to play a major role in determining the direction of the markets going ahead.

Investors with a medium-time horizon should look to build a diversified fixed income portfolio with increased allocation to short-term fixed income, liquid and floating rate funds.

(Sourced from Franklin Templeton India)

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