Budget and the Markets: Strange Bedfellows

Since 1991, Sensex has posted negative returns 14 out of 18 times one month preceding the budget.

Anil Kumar Satapathy

Markets usually have the tendency to go wild at the drop of a hat. And now when Pranab Mukherjee, is gearing up to present the Annual Financial Statement, or the Union Budget, for the next fiscal, the question that intrigues the investor community is that what’s there in the finance ministry’s kitty to cheer the markets. Even the best of minds choose to play it safe in the run up to the budget. Budget is a policy document that’s going to shape the economy for the next year. It influences every individual of this country to a varied extent. Usually, the stock markets experience a volatile phase just before and after the union budget, based on the expectations and interpretations of it. Stock markets last year greeted the budget with a record fall, with the Bombay Stock Exchange (BSE) sensitive index, Sensex, nosediving a whopping 869 points on concerns at the high fiscal deficit estimation. Mukherjee did not have many options as the country’s fate was loosely hanging in face of a severe global recession. However, this time the government is on a much firmer ground. The industrial growth is steadily picking up, and zoomed 16.8 percent, a 16-year high in January 2010. This has prompted many economists to call for a phased withdrawal of stimulus announced in the backdrop of the economic meltdown. Now, the government seems no longer under the recession pressure and has fiscal room to take policy actions. Moreover, the soaring inflation (8.56 percent in January) has further given UPA the much needed excuse to tighten its purse. So, looking at it this way, the markets are all set to see good reformist measures by the UPA government. Speaking figures Let’s look at some facts. The Sensex has lost 7.5 percent in 2010 to 16,152.59 (till February 14) points as the reverse flight of foreign funds from Indian markets continued unabated since mid-January. Foreign institutional investors (FIIs), who were the net buyer in 2009 with investments worth Rs 83,400 crore in domestic equities, has pulled out funds to the tune of USD 2.7 billion from the domestic bourses over the last 18 sessions (as on the week ended on February 14). "There will be no major FII buying activity in the market till the budget on February 26. After reviewing how the government looks at exiting the stimulus package as well as managing growth, the funds will churn their portfolio," Kishor P Ostwal, CMD of market analysis firm CNI Research, was quoted as saying by a news agency. Rajesh Jain, vice-president of stock brokering firm SMC Global, too has something similar to say. "Till the budget, the FIIs will stay away from making fresh investments and there may be some minor positive activity." True, there are some other global factors for the bearish phase the markets are currently witnessing. World indices too are seeing a bloodbath on fears of a spreading crisis in Eurozone. If investors were to go by the past trends, there’s not much comfort either. According to trends, Sensex usually posts negative returns for the one month preceding the budget. Since 1991, 14 out of 18 times the Sensex went into negative zone. Mostly the FIIs, insurance companies and brokerage companies, which expect the finance minister to deliver a reform-oriented budget that will incorporate tax cuts, fiscal consolidation, a divestment programme and infrastructure spending, pull out their money from the market in absence of the same. Notably, Sensex has gained only on four occasions: 1992, 1999, 2004 and 2006. It had plunged a record 11.4 percent a month after the budget announcement in 2001. The years when the market saw decline in the month after the budget announcement were, 2008 (7 percent), 2007 (0.4 percent), 2005 (3 percent), 2003 (5 percent), 2002 (2.6 percent) and 2000 (7.5 percent). A safe pair of hands Finance Minister Mukherjee has never been associated with reforms. He was mostly considered as “a safe pair of hands” who could calmly do the job without rocking the boat. With a fierce opposition making hue and cry over the record inflation figures, the government has not much choice, but to spend more on social schemes. This could put more pressure on the already burdened state coffers. However, absence of any major state election in the year may allow the Centre to take some bold steps. The government is also less likely to deregulate the fuel prices as recommended by the Kirit Parikh Committee and supported by the petroleum ministry. However, any positive step vis-à-vis deregulation of fuel prices will push up the shares of oil marketing companies. There could also be a decision on 3G spectrum auction. Pranab Mukherjee is reportedly insisting on the auction of the spectrum for third generate on mobile services, which could fetch above Rs 30,000 crore for the government helping it reduce the fiscal budget. One could expect minor changes in the income tax structure. Incidentally, the introduction of Direct Taxes Code in the next fiscal has already been ruled out, indicating the defensive attitude of the government. A defensive government is not good for the equity markets. Investors would find any reason to cheer if the government shies away from introducing reforms and increases expenditure. The sharp rebound in the factory production and steady improvement in the exports sector should remind the government of its responsibility to bring in fiscal prudence. Healthy markets, after all, are good for a healthy, expanding economy. Mukherjee should keep this in mind while giving the final touches to the budget.