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Every year, at the time of the Union Budget,  there is a lot of buzz. The common man waits for favourable announcements anxiously, but there are people who keenly follow what’s written between the lines. The Union Budget is perhaps the most watched event in the economic policy making in India. The core fiscal issues - taxation, expenditures, and the fiscal deficit - are obviously important for macroeconomics. When the government proposes changes in policies, the expected impact on the affected sector and its companies cause mayhems in the stock market. There is heavy buying and selling seen ahead of the Budget as investors analyse expected announcements and try to safeguard their investments.  The stock market reacts depending on how the investors interpret the economic activities.

Indian stock market at present

According to Equity Master, share markets in India have continued the momentum and are currently trading near all-time high levels. Sectoral indices are trading on a positive note, with stocks in the banking sector and stocks in the metal sector leading the gains.

Indian companies raised a record $ 46.5 in debt and equity in 2017, the highest amount in the last decade. 64% of these funds are from the financial sector. What is interesting is that the energy and power sector was the second highest in raising funds. Also, amongst the financial sector companies, Power finance corp. Ltd. (PFC) which raised $ 3.5 billion was one of the largest fundraisers.

Budget reaction in the last 3 years

2017- The Union Budget 2017-18 provided the feel-good factor as the Sensex leaped close to 486 points to close at an over 3-month high of 28,142, with financial and realty stocks powering the momentum. Markets welcomed the budgetary proposals of infusing Rs 10,000 crore in public sector banks and keeping long-term capital gains tax (LTCG) and short-term tax rate (STCG) unchanged for the capital market.

Additionally, Finance Minister Arun Jaitley proposed that category I and II foreign portfolio investors (FPIs) should be exempted from taxation on indirect transfers, which made investors a happy lot. Both key indices Sensex and Nifty reclaimed their key levels of 28,000 and 8,700 for the first time, scoring their biggest single-day gain since October 2016.

Shares of companies related to the agriculture sector such as Dhanuka Agritech and Jain Irrigation Systems ended higher by up to 3.71% after Jaitley announced a whopping   Rs 1 lakh crore hike in credit target for the next fiscal to Rs 10 lakh crore as part of efforts to double farm income in the next five years.

2016- Union Budget 2016 failed to cheer Dalal Street as benchmark indices BSE Sensex and NSE Nifty skid 0.50% in a volatile trade.  In the Nifty pack, ICICI Bank, Kotak Mahindra Bank, IndusInd Bank, State Bank of India and ITC gained between 1.60% and 3.74%. On the other hand, ONGC, Cairn India, BHEL, Maruti Suzuki and Larsen & Toubro slid between 3.22% and 11.77%.

Among the sectoral indices on BSE, the BSE IT index dipped the most — 2.11%, followed by BSE TECk index (2%), BSE Capital Goods index (down 1.99%), BSE Consumer Durables index (down 1.75%). On the other hand, BSE Bankex and BSE Realty index gained 1.07% and 0.27%, respectively.

Market sentiments turned weak after the proposal for higher dividend distribution tax on those earning more, and a proposal to increase Securities Transaction Tax in some categories.

2015- By the time the Budget ended, the Sensex had briefly slipped into the red but managed to recover. The best performing sector of the day was S&P BSE Bankex, which gained 3.27%, followed by S&P BSE Healthcare at 2.03%. Meanwhile, the worst performing sector was S&P BSE FMCG which fell 4.09%, followed by S&P BSE Consumer Durables, which fell 2.05%.

Among the various other announcements, the Finance Minister announced that the Forwards Market Commission (FMC), the regulator for commodity futures markets, will be merged with Sebi, the regulator for securities market in India. The proposal was earlier recommended by B.N. Srikrishna, the head of Financial Sector Legislative Reforms Commission. The consolidation of market regulation and supervision of SEBI was also recommended by the Raghuram Rajan committee on financial sector reforms in 2009 itself.

How the stock market will react to Union Budget 2018

According to Livemint, if the last few years are taken as a precedent, it is likely that the Sensex would appreciate in the month after the budget. Since 2010, the Sensex has gone up six times out of nine in the month after the budget. But then, the benchmark index has also fallen eight out of nine times during the month prior to the budget. During this time, there was one interim budget as well.

The commentary on fiscal deficit will be an important thing to watch out for. As Morgan Stanley says, a higher fiscal deficit has multiple implications: a) it takes any case for a rate cut out of the picture as the risk of inflation rises, b) it supports growth and earnings in 2018, c) creates room for a further rise in long bond yields and d) it could eventually reduce the government’s ability to spend if oil prices spike and, thus, hurt growth. “We think the market is already pricing in some slippage on the fiscal front but the exact amount that is priced in is difficult to say,” it added.

Challenges for stock market

In the last Union budget, the Finance Minister Arun Jaitley identified three risks for the Indian economy: the Federal Reserve increasing interest rates, oil prices rising, and a retreat from globalisation. Most of these risks are playing out with slight variations. There are new faultlines developing now and it will be interesting to see whether the upcoming Union budget has a toolkit for these challenges.

Another emerging danger is the capital market’s decoupling from the real economy. Uday Kotak, executive vice-chairman and managing director of Kotak Mahindra Bank said that “Money is coming to a broad funnel and it’s going into a narrow pipe where massive amount of Indian savers’ money is now going into few hundred stocks. The amount of money that’s going into small and mid-cap stocks is something on which we have to ask tough questions. Is there a risk of a bubble?”

According to data from the Association of Mutual Funds in India, investment in mutual funds (net of redemptions) during April-December 2017 was up 28% over the previous year’s corresponding period. Much of this is flowing into stocks and influencing key indices: the 30-share S&P BSE Sensex has appreciated over 29% in the one-year period between January 18, 2017, and January 18, 2018. No other asset class can match these returns. State Bank of India’s fixed deposits for one year pay 6.25%, the government’s 364-day T-bills were recently auctioned at a cut-off rate of 6.52%, metals have ranged between 14-18%, gold yielded about 4%, crude oil is roughly 6% up and real estate continues to remain in the dog-house.

In an article published in Livemint, a larger section of Indians are now affected (directly or indirectly) by market movements and there’s no saying how additional taxes will have an impact on share values. Jaitley may want another Tobin-like tax to slow down runaway markets-investors already pay securities transaction tax, averaging around Rs 7,400 crore annually—but without rocking the boat. The market’s reception to government slashing its additional borrowing programme by Rs 30,000 crore was euphoric—the BSE Sensex rose over 300 points—ignoring that Rs 20,000 crore extra will still be borrowed. It is all down to managing the news cycle so that markets do not reverse course.