Mumbai: A lower fiscal deficit, an excise tax hike which had already been accounted for and a personal income tax bonanza led to a relief rally as Indian equities soared 2.5% when the finance minister presented the Union Budget.

It was short-lived however as investors pared some of the gains fearing inflationary consequences and questioned the assumptions on government spending increases in the next fiscal year.

Not convinced: The initial market rally was short-lived as investors pared some of the gains, fearing inflationary consequences. Arko Datta/Reuters

At the close of trading on Friday, India’s benchmark index, the Sensex, was 1.08% up from the previous close at 16,429.55, down from an intra-day high of 16,669.25, marking finance minister Pranab Mukherjee’s announcement that next year’s fiscal deficit would be capped at 5.5% and at 4.1% in the next two years. The 50-stock Nifty index closed 1.29% up at 4,922.3.

The Budget clarified the fiscal road map, bringing a measure of predictability, which buoyed the markets, said Nandip Vaidya, president of equities at India Infoline Ltd, the country’s largest listed brokerage.

“The expectations were not very high," Vaidya said. “The uncertainty is over and the intent is clear and positive."

“What the market liked most was the fiscal consolidation programme," said Alroy Lobo, chief strategist and global head of equity assets at Kotak Mahindra Asset Management Co. Ltd, which manages Rs36,781 crore. “The deficit numbers were good and there was a fair degree of short covering."

The debt markets were encouraged by the lower borrowing target of Rs3.45 trillion for the year, down from the current year’s record Rs4.5 trillion.

“The budget is positive for the bond markets," said G.A. Tadas, managing director of IDBI Gilts Ltd. “Although yields rose today because of the petroleum price increases, the borrowing is lower than expected and we should see a rally on Tuesday."

The benchmark 10-year government bond closed up 8.5 basis points to 7.885%.

G. Chokkalingam, head of equities at Barclays Wealth India, said the budget left investors free to concentrate on the good macro economic fundamentals such as the projected 7.2% growth figure for this fiscal year, proposed tax reforms that will kick in next year and the thrust on infrastructure, education and health.

“The era of uncertainty is over," said Chokkalingam. “Barring issues such as a poor monsoon or global incidents, the Budget has laid a foundation of solid wealth creation."

With profit being booked later in the day, clearly not all investors agreed.

“There was a lot of relief and the the assumptions made on the revenue side are fairly conservative," said Anoop Bhaskar, head of equities at UTI Asset Management Co. Ltd, which manages Rs74,510 crore. “But investors are concerned about the assumption on the expenditure side."

The expenditure hike of 8% is one of the lowest in recent years thanks to the modest allocations for subsidies and defence. For instance, the overall subsidy bill projected for next year is 11% lower, while the sum allocated for the Mahatma Gandhi National Rural Employment Guarantee Scheme is only Rs1,000 crore higher than the present fiscal.

The government expects asset sales and high-speed mobile spectrum auctions to be substantial sources of revenue next year.

“There is a fair bit of reliance on the 3G auction and disinvestment figures and if there’s any slippage on that front, it will be negative," said Lobo of Kotak. The sale of mobile spectrum, which will fetch the government Rs35,000 crore has been delayed for several months now.

While the budget is seen as positive, investors said they would look at global factors such as high debt in the Euro zone and banking regulations across the world in the medium term, besides valuations.

“One has to go through the fine print, but the signal is of moving to better fiscal health," said Vetri Subramanian, head of equities at Religare Asset management Co. Pvt. Ltd, which manages Rs13,823 crore. “But valuations are still high and have not dropped to attractive levels. We remain cautious on Indian equities."

At the sectoral level, auto stocks soared the most with the BSE Auto index up 4.74% as the 2% excise tax hike was on expected lines.

Banking scrips also gained a collective 2.26% after the Budget announced that the Reserve Bank of India was considering additional licences for the private sector.

The top gainer among the 50 Nifty stocks was Reliance Capital Ltd—a banking licence candidate—up 8.12% to close at Rs786.45.

It was followed by Tata Motors Ltd, which gained 7.21% to close at Rs715.55.

Ashwin Ramarathinam contributed to this story.