Budget 2023, Financial Markets & Keynes on Interest Rates: A Study of Short-term Reactions.

Introduction

The budget is a financial statement that outlines the government's short-term fiscal goals and is valid for one year. Nonetheless, the manner in which policymakers manage the fiscal deficit has consequences for future periods. The budget for 2023 informs projected revenues and expenditures, but in an election-year budget, it is difficult to regulate revenue expenditures; it is a parameter or may increase. Similarly, revenue receipts would be on expected lines if growth is consistent with its projections or experience a slight decline due to post-budget tax concessions or rationalization (also see, Bhanumurthy, 2023).

Consequently, fiscal deficit projections remain the focal point; however, even in an election-year budget, fiscal deficit projections cannot be traced back to populist positions. Regardless of which party is in power, every budget since 1991 has sought to achieve a predetermined development objective. The budgets recognize that India's post-planning domestic capabilities cannot compete internationally in an open-economy, market-friendly policy environment. It can enter a new technological frontier by adjusting to imports of intermediate and final goods that introduce innovations or newness in production processes. Imports also bring in a variety of goods that can sustain a higher level of consumption-driven economic growth. Even in election years, a road map and commitment to this development are necessary because the economy is adjusting to pandemic disruptions and job creation is a major concern. The current budget for 2023 identifies a number of areas of concern that call for reduced tariffs on sector-specific imports. Additionally, capital expenditures have increased to approximately 10 Lakh Crore rupees, primarily for physical and digital infrastructure. The plan then focuses on easing some immediate supply constraints that are preventing the adjustment to imported technology and intermediate goods.

Maintaining the government's fiscal glide path is a crucial factor to consider. If the fiscal deficit is out of control, it has repercussions for projected capital expenditures and commitment to development goals. As is typically the case with Indian responses, fiscal deficit challenges can result in a reduction in capex. In this situation, however, if the supply bottlenecks are not eliminated, there may be long-term consequences.

Management of revenues and expenditures is a component of deficit management. If, as is hoped, external borrowing and the 91-days Treasury Bills route are not resorted to, management also depends on the responses of the bond and stock markets as well as the reactions of various domestic real market participants to budget statements. However, the emphasis is not on the debt-to-GDP ratio, which financial markets also monitor and forecast, but rather on ultra-short-term budget responses (Hicks, 1935). It is an examination of a week or two's financial market responses that are unaffected by changes in the real sector or factor prices, etc.

Budget announcements have direct effects on key players such as market sentiment, and the financial markets. Policymakers have the option of informing participants about budget signals associated with specific development objectives and resulting fiscal deficits, and then allowing them to adjust. Given how financial markets operate, this would be a naive strategy, according to Keynes (1936). Investing in these markets can be guided by a budget-informed study of long-term prospects, or they can be guided solely by considerations of capital appreciation. In the latter case, not only would the participants anticipate budget proposals, but they would also employ more sophisticated strategies. Using the metaphor of a beauty contest, Keynes (1936: 156) explained how, to quote, ".... the prize being awarded to the competitor whose choice most nearly corresponds to the average preferences of the competitors as a whole; so that each competitor has to pick, not those faces which he himself finds prettiest, but which he thinks likeliest to catch the fancy of the other competitors, all of whom are looking at the problem from the same point of view. it is not a case of choosing those which, to the best of one's judgment, are really the prettiest, nor even those which average opinion genuinely thinks the prettiest. We have reached the third degree where we devote our intelligences to anticipating what average opinion expects the average opinion to be. And there are some, I believe, who practise the fourth, fifth and higher degrees."

If speculative investments reign supreme, financial market development can derail growth and fiscal deficit projections and place unwarranted strain on the economy. In order to moderate and modulate any excessively speculative market investments, policymakers should, when formulating budget announcements, try to anticipate what the "average option of the budget statement believes the average opinion to be". The policymakers can then plan the appropriate announcements and signals to influence the outcomes in favor of the budget objectives.

As we will discuss below, strategic options are not limited to the domestic participants alone. The Fed, for instance, is a large and significant player that would attempt to determine how different nations would organize their budgets and behave during the recovery phase following a pandemic, and then formulate its own plan.

Budget & Financial Markets

There is evidence that budget formulation took into account the behavior of market sentiments and the RBI, taking into account current conditions and anticipated budget fiscal deficits or government commitment to development. It would also be expected that the RBI would adhere to a stringent monetary policy, keeping in mind not only inflation control, but also the way in which its policy influences prices and financial market signals, which can play a role in an import-led development strategy. Given the tight monetary policy, it is anticipated that substitution principles will determine how the financial market, particularly the bond market, and other players respond to the budget.

Scenario 1: the Bond Market

In the months preceding the budget, the stock market has been declining, while bond yields have increased by approximately 7.5%. In addition to this, the anticipation of a budget deficit and government borrowing could have led to prior bond market commitments based on the anticipation of a lower post-budget yield (and higher capital gains). However, the budget proposal contains a surprise...