A look at the performance of Indian equity markets in the past one month suggests expectations from the budget are running low. After all, the MSCI India Index has declined 1.4% in dollar terms in the past month, compared to a 5% increase in the MSCI Emerging Markets Index.

But note that the MSCI India Index was just taking a breather after the outperformance in May. In any case, the Indian markets are still trading at a hefty premium of about 45% to emerging markets, in terms of the forward price-earnings multiple.

Among other things, the rich valuations are being supported by high expectations of economic reforms and a recovery in the economy, analysts at Kotak Institutional Equities said in a 28 June note to clients.

“The market will keenly watch for indications of the government’s economic agenda in its second term," added the analysts. Given that this is the first budget in the government’s second term, investors will look closely for an articulation of the Centre’s plan to address the slowdown in the economy.

Some market watchers expect sops for troubled sectors such as the farm economy, housing and infrastructure. Of course, given the government’s fiscal constraints, the budget is unlikely to be packed with measures that aim to boost growth.

Even so, market participants have braced themselves for some slippage on the fiscal front. “Given that there is slowdown in economic activity and further cuts in expenditure won’t bode well, a 10 basis point fiscal slippage to, say, 3.5%, shouldn’t come as a damper for the stock market," said Sahil Kapoor, chief market strategist at Edelweiss Investment Research.

Kotak, in fact, has estimated fiscal slippage at 20 basis points for FY20. The bond market has priced in a minor slippage on the fiscal deficit front and expectations are that fiscal deficit of up to 3.6% of gross domestic product (GDP) will not result in any punishment.

This isn’t surprising. The government’s interim budget included generous assumptions on gross tax collections. As the chart alongside shows, goods and services tax collections are running far lower than initial budget estimates for the second year running. Excise duties are estimated at relatively high levels as well. On a gross basis, the tax revenue overestimation is as much as 80 basis points of GDP, said the head of research at a multinational brokerage firm, requesting anonymity. “It is essential that the government corrects its revenue assumptions when it presents the budget on Friday," he added.

As such, the markets will keenly look at the math behind the government’s fiscal deficit number, rather than the number itself.

If the new finance minister is able to point to credible non-tax sources to fund additional expenditure, that will naturally be cheered by the markets. But as things stand, there seems to be limited room for such a manoeuvre. In that case, the only hope for the markets is if there are some sentiment boosters–such as reduction in corporation tax or long-term capital gains tax on stocks–included in the budget speech.

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