Saturday, July 11, 2009


Market not happy over the Budget - Sinking and then rising a bit

What does a deficit mean ? There are many terms such as fiscal deficit, monetary deficit, revenue deficit, but the differences between are them are relevant for people involved in the field of economics. For the normal person on the street, a deficit means that you are spending more than you earn. A normal person cannot do this without getting into serious money problems, but a Government can (and in almost every case the world-over), does do this. How can a Government spend more than it can earn ? A Government does this through means of a deficit, that it either finances by printing more money, or by borrowing funds from the market.
Both cases cause problems for the economy as such, since if the Government prints more money, this essentially means that more money is being put into the system. More money, but the same amount of production means in simple terms - if you wanted something, and many others want the same thing, then the thing you want gets more expensive. In terms of the economy, if more money comes into the system, then things get more expensive and inflation rises.
If the Government borrows more money from the market, that is less money that is available to private companies to get from their market to meet their funds requirement, or if they need loans for capacity repair or expansion. Such reduction in the availability of funds means that loans for companies get more difficult and has an effect on the ability of private sector to rise above these bad economic times.
Why did the Government need so many funds that it was willing to increase the fiscal deficit to a point where it would be pointed out by economists as a risk ? Well, these are bad economic times and it is at these times that Governments the world over are putting more money into the economy to try to get out of these struggling times. In addition, the Government realized that politically, it has benefited through such measures such as the National Rural Employment Scheme, and it wants to make sure that it is pumping money into the rural sector, the agriculture based sector.
Why did the market react negatively to the Budget, and why am I writing about it after so many days ? Well, the market had been expecting some relief measures, or at least token gestures such as the removal of the Securities Transaction Tax. Instead what it got was no new seemingly market or industry oriented measures and no removal of the STT. Instead it got a much higher fiscal deficit and a seeming reversion to populism. And hence the initial bad reaction to the budget.
However, every year, there are more voices gaining ground that industry should stop looking to the budget as an earth-shaking event, instead treating it as a simple Profit and Loss statement of the Government. In addition, the initial depression of the market has subsided as it looks like there are faint signs of revival, and the realization that the budget did not make things worse, and if rural consumers get more income, that is a new market.
What should you do ? Unless, there are some earth shaking events, the long term prospects look good and you should stay invested for the medium to long term in fundamentally safe companies. Avoid risky companies unless you know what you are doing and you know the risk involved.

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