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Graphic: Naveen Kumar Saini/Mint
Graphic: Naveen Kumar Saini/Mint

Union budget and the eureka moment

Equity markets fell by 0.66% on Monday, the day budget was announced. That was reversed with a massive 3.4% jump on Tuesday. What gives?

Equity markets fell by 0.66% on Monday, the day budget was announced. That was reversed with a massive 3.4% jump on Tuesday. What gives? One explanation is that markets are playing catch-up with the gains seen in Asia. The MSCI India Index has plunged 13.5% since early-2016, against an 8.6% fall in MSCI Asia ex-Japan. Even global commodity prices have been trending up in this period. While India’s VIX (volatility index) has fallen in tandem with the CBOE (Chicago Board Options Exchange) VIX, our markets have not risen in the same fashion (see chart).

Short covering may be another explanation. Bearish calls on the budget based on a likely fiscal slippage and rumours on long-term capital gains tax on listed shares came unstuck.

If this upswing is short-lived, then the above reasons may explain why. But it could have happened on Monday too. Did something dawn more clearly on investors, as they slept on the budget’s proposals?

One clear message was on fiscal consolidation. By sticking to it, the government pleased investors, credit rating agencies and the Reserve Bank of India (RBI). It aided the cause for another rate cut. Lower rates should make it easier for banks, hit by bad loans and low credit growth. The bank index was up 3.5%.

Another message is the budget’s thrust. A rate cut (when it happens) will be positive for consumption, especially for urban consumers. The coming pay hike for government employees will also spur urban consumption.

On the rural side, the measures are more long-term in nature, such as building rural roads and irrigation projects, but these projects should create rural jobs. Lack of short-term boost to rural consumption may explain why the BSE FMCG index, ex-ITC Ltd, is not excited by the budget.

Still, if these factors play out as expected, the consumption engine should rev up, in turn improving capacity utilization. Companies will start to invest, helped by falling interest rates, reviving private sector capital investment. The government is anyway taking care of reviving infrastructure investments.

That’s the fairy tale story playing out. What can trip this dream run? The bank re-capitalization outlay was meagre. What if public sector banks remain in this mess for much longer? On Tuesday, RBI moved to allow banks’ revalued assets to qualify as Tier-I capital. Another risk is if food inflation rears its head, as consumption growth revives in rural areas. That has been a red flag in the past.

Also, analysts don’t seem very optimistic about an earnings recovery. HSBC Global Research continues to remain underweight on Indian equities. BNP Paribas in a note dated 1 March said that post-budget, investment acceleration and rural demand recovery may happen, but no earlier than the second half of 2016.

That view appears sensible. However, if Tuesday’s spike in equities develops into a trend, such views may change. Although fortune is said to favour the brave, the average investor may be better off waiting for the trend to set in before rushing in to ride this upswing.

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