Mumbai: Investors on Wednesday cheered the government’s decision to raise dearness allowance (DA) in the middle of the festival season, driving Indian markets up nearly 2% in a rally led by financial sector stocks.

The benchmark 30-share BSE Sensex closed 1.72% or 645.97 points higher at 38,177.95, while the 50-share Nifty closed at 11,313.30, up 186.90 points or 1.68%.

The five percentage point increase in DA to 17% will put more money in the hands of at least 5 million government employees and 6.5 million pensioners. The hike, which will cost the exchequer 16,000 crore, will be effective from July.

Deepak Jasani, head of retail research at HDFC Securities Ltd, attributed Wednesday’s rebound to bargain hunting as well, coming after six straight days of losses. “Sentiments also turned positive after the government hiked dearness allowance. Most emerging market stocks were headed lower for a third day on Wednesday as the US and China showed little signs of backing off from their trade dispute ahead of a crucial round of negotiations. However, later, European shares moved sharply higher and the Chinese currency in the offshore market jumped on Wednesday after a Bloomberg report said China was still open to agreeing a partial trade deal with the United States," he said.

The Bankex rose 3.67%, with State Bank of India, ICICI Bank, HDFC Bank and Kotak Mahindra Bank rising 3-5%.

According to Vinod Nair, head of research at Geojit Financial Services, banking stocks rallied on hopes of greater liquidity and consumption, as the plunge in bond yields indicates further room for rate cuts. “Further, the hike in DA will add impetus to festival demand. Going forward, the results season will dictate the market direction and investors are expecting some green shoots on account of festival demand and good monsoon," he said. The 10-year bond yield jumped 22 basis points to 6.45% on Wednesday.

(Graphic: Paras Jain/Mint)
(Graphic: Paras Jain/Mint)

After a bumper rally triggered by corporate tax cuts on 20 September, the markets had turned volatile ahead of second quarter earnings. Analysts said the tax cuts are a pro-investment stimulus, but will take time to show results, given the nature of the ongoing economic slowdown.

Rahul Singh, chief investment officer-equities at Tata Mutual Fund, said the 8-9% lift in Nifty earnings per share after the corporate tax cuts will provide support to stock valuations, in addition to the fact that India’s valuation premium to other emerging markets is at a more acceptable level now. “The recent privatization initiative indicates the government’s seriousness in tackling the economic slowdown and we believe that there is more to come in the coming weeks and months," he said.

Indian companies are set to report a drop in revenue and profit for the second straight quarter amid a slump in consumer demand that sent the government scrambling to boost investment and consumption through a raft of measures, including tax cuts for companies.

“It has been a year since the IL&FS crisis erupted and the repercussions of the same are still being felt, especially in financials. Besides NBFCs, banks too have started facing asset quality concerns now," Motilal Oswal Financial Services Ltd said in a note.

The brokerage firm said the earnings season will be more of the same—tepid and uneventful. The underlying demand slowdown in the domestic economy and weak global commodities prices are expected to take a toll on earnings with very few bright spots, if any, it said.