A personal take on various topics

The Fallacy of Inappropriate Metrics - Sensex and the Union Budget

This is the image of the floor of Lok Sabha.The Bombay Stock Exchange in India.

The Indian Union Budget for 2009 was presented earlier today by the finance minister. The stock market wasn’t pleased. The sensex fell 869.65 points. Oh the horror of it - the twitterverse had everyone tweeting about the sensex fall. And there were quite a few tweets citing the sensex drop as the evidence of a poor budget. We live in the times of haste, and that includes hasty judgement. This substantially increases the value of information thats immediately available, compared to that which might be available a little later. And what is more realtime than a feed, which is supposed to reflect the collective rational reaction based on sound market principles. Call it a metric, a soundbyte, an available topic to expound upon - the sensex is the favourite metric of every budget day. And it is so rationally driven, that even as last year or so as the economy grew by about 6%, the Sensex slipped from 21000 to 8000. The fact is the sensex is correlated with the economy - but only in the long term. Thats at least over a 3 year, and more likely a minimum 5 year period. In the short term it does not demonstrate sound rational collectivisim - it reflects the collective hopes, fears, exhilaration and panic. And that gets even more acute as you start measuring it over a shorter interval. So the Sensex movement over a few hours today ended up being interpreted as a judgement on the budget by the hoi polloi brought up on instant news, feedback and measurable metrics - where immediate measurability takes far more precedence over accuracy of the target value being measured - the quality of the budget. So why did the sensex plumment ? Apparently lack of FDI relaxations and high fiscal deficit. And why so ? I would submit it is likely because of two reasons : a) Restructuring, privatisation, and increased FDI lead to a substantial growth in investment momentum driven by sentiment including increased FII driven liquidity. This is expected to lead to increase in stock prices over the next few days / weeks or months. That the budget is a reflection of a thought process, which is meant to enhance the economy over the next few years notwithstanding. Afterall isn’t the sensex likely to stay flat (or perhaps even dip), if hypothetically the government presented a plan, which everyone had a high confidence in, but would boost the economy big big time - but only after 5 years. Afterall the Sensex is driven by the technicals of the next one to three months and not by the fundamentals of the next 5 years. b) Its also likely that many would’ve taken a position in advance betting on the sensex shooting up even at the slightest industry friendly purring noises made by the government. But when that did not happen, these positions would need to be quickly unwound. And unwinding in haste takes no prisoners. In which case the sensex movement was being driven more by the bets being placed in the past rather than the strategies being rolled out for the future. Whichever way you look at it, the Sensex given its short term focus, especially based on technicals is a poor proxy for the quality of the budget. But the media, having found it a favourite metric to keep on quoting, year on year after each budget, have erased that distinction in the readers and viewers mind. Little surprise many were expressing horror at such a poor budget which made the sensex plummet. And was the budget poor ? Far from it, the budget was one of the most consistent continuations of the governments articulated approach. For those who chose to follow the Finance Minister’s statements, it would be obvious that it was consistent with the goals that were laid out. Get out of the 6+% growth slot and into the 9% slot. Thats the priority. And everything else could follow in due course. The massive increase in expenditure was exactly what the industry was demanding. This was essentially a stimulus budget. Which is why the industrialists were sombrely defending the 6.8% deficit as not inappropriate in the current circumstances, even as the brokers were expressing disappointment. Maybe this budget was not imaginative - but imagination is not a necessary attribute towards a successful budget. And this budget stayed true to the stated government approach of inclusive growth, which is what the government had promised the nation - something the markets had completely forgot about in its euphoria and anticipation. Basically the markets did not account for the possibility that the government might actually keep its promise. The sensex just reflects a few hours of sentiment - not the quality of the budget, especially not in the short term. So to those who panned the budget, I would suggest the following - take the time to read the budget, reflect on it. Think about whether it is consistent with what the government promised the electorate. And if you still believe the budget sucks - by all means pan it, just don’t use the Sensex as the means to do so. And where is the sensex likely to go from here ? it might shoot up tomorrow itself, or it may decide that the party is over and take the flat route. But if the companies find that the demand expansion driven by the stimulus is starting to influence the corporate growth and profitability substantially, the sensex is likely to be far above today morning levels by the time the next budget is presented in 8 months.