How will the equity markets react to the Union Budget 2018? If the last few years are taken as a precedent, it is likely that the Sensex would appreciate in the month after the budget. That’s what Chart 1 shows. Since 2010, the Sensex has gone up six times out of nine in the month after the budget. But then, the benchmark index has also fallen eight out of nine times during the month prior to the budget. During this time, there was one interim budget as well.
“Historically, in a scenario of negative expectations from the Budget in the run-up to the event, market participants withheld their buying decisions and once the event is out of the way, they take exposure, which causes a bump-up in the market post the event," says Deepak Jasani, head (retail research) at HDFC Securities Ltd.
It is plausible that if markets are depressed prior to the budget, they move up after it, provided there aren’t any nasty surprises.
But what is unusual this time is that markets are already at an all-time high and valuations are pricey. This suggests that the room for big upsides is narrow.
Also, “market participants will have to deal with a fair amount of volatility on budget day, though even this volatility has been declining over the past 25 years", pointed out a report from Morgan Stanley Research dated 12 January.
The commentary on fiscal deficit will be an important thing to watch out for. As Morgan Stanley says, a higher fiscal deficit has multiple implications: a) it takes any case for a rate cut out of the picture as the risk of inflation rises, b) it supports growth and earnings in 2018, c) creates room for a further rise in long bond yields and d) it could eventually reduce the government’s ability to spend if oil prices spike and, thus, hurt growth. “We think the market is already pricing in some slippage on the fiscal front but the exact amount that is priced in is difficult to say," it added.
The government’s divestment target is crucial too. A number in excess of Rs75,000 crore will be negative for equity markets given the increased supply it brings in a year in which liquidity is expected to tighten, reckons Morgan Stanley.
The markets are also likely to punish an introduction of a long-term capital gains tax on shares, if it happens.
Still, even if the outcome of the budget is better than expectations, it will be foolhardy to expect big gains. “This time around, we do not expect a sharp surge in Indian indices post the Budget (upside if any, could be around 3-4% post the event) simply because valuations are currently fair to expensive unless something extraordinary/unthinkable is proposed in the Budget," says Jasani of HDFC Securities.
That said, Indian markets are now inextricably linked to global markets and the direction of global markets after the budget will matter a lot. Chart 2 shows that in the last nine instances, there have been three occasions when the direction of Indian and Asia ex-Japan markets diverged after the budget. One of them was in 2014, when the Indian markets went up substantially while Asian markets sagged, but that was due to hopes of a change in government. In the other instance in 2014, the difference wasn’t much. In 2015, it’s true Indian markets fell while Asia moved up, but the upmove in Asia was negligible. So while keeping an eye on the budget is important for investors, the other eye should be firmly fixed on global markets.