Market will be happy if FM keeps a fiscal target of 3.5% in FY18

Vinod Nair

It is a yearly agenda to be persuasive during the annual Budget time. A pre or post Budget rally may not completely sink with the Budget expectation or actual rewards. But, in spite of being a customary act, it brings volatility to the market. And this volatility depends on the domestic and global sentiment being building up before and after the Budget. Every year our pre- and post-Budget rally has been specific (one month before and after the Budget); hence, looking back at the historic performance of pre and post budget rally may not give a delta.

And this time it was really unlikely to experience a pre-Budget rally. But during the month of January, till date Sensex has given a return of 2.8 percent. This is in spite of India having a muted view in the global market and was expected to have a volatile start in 2017. This was due to global factors like aggressiveness of FED rate hike, continued boldness in international commodity prices, implication of Trump-economics and slowdown in China which are less attractiveness factor for emerging markets. Foreign flows were likely to be starched and INR to have a cautious stance. And this did actually happen, till the year net FIIs are negative at Rs 30 billion and INR has depreciated by 0.50 percent.

Apart from the global factors, domestic cautiousness was due to the likelihood of extended impact from demonetisation in FY18, reduced possibility of windfall, poor Q3 results, risk to GST, political-risk given crucial state elections and hazard over capital gain tax. It was mostly reasonable that volatility may vain on the Indian Market and we will return to course as clarity emerges.

But post December 26, 2016, the market has given a euphoric performance of 6 percent. This unforeseen pre-Budget rally has more to do with sector-specific performance. Sectors return range is zero to 19 percent. The top 5 sector-indexes were metal at 19 percent; Consumer durables at 14 percent; realty at 13 percent, infra at 12 percent and auto at 10 percent.

The international metal prices are zooming; the average increase in the essential four commodities like aluminium, copper, nickel and lead in the last year is at 27 percent. Additionally, steel prices are increasing due to better global demand and cut in Chinese production due to environmental needs and government agenda. Consumer-oriented sectors have benefited from bottom-fishing post the December economic data like auto volume, direct & indirect tax and corporate advance tax which indicated that economy is recovering well from cash crunch situation and Q3 results will not be a washout as expected earlier. The realty sector has benefited due to a sharp cut in marginal cost of funds based lending rate (MCLR). Banks have cut MCLR by upto 90 bps during the last 1 month. The home loan interest rate in India from banks have come down to as low as 8.35 percent which is much lower than one year earlier.

It is completely fair to believe that we are not under the assertive pre-Budget rally. Rather, the market is catching up from the fall of 7 percent post the announcement of demonetisation as per specific factors.

As far as going to the Budget expectations, it is limited, and there are so many factors which will be handled outside the Budget. For example, the most important reform undertaken by India which is GST will completely change indirect taxation. Hence, sector-specific wish-list is also limited since focus is on GST Council, to lower their effective sales tax.

Additionally, Budget expectations could have been higher if demonetisation had been very effective to give more resources in the hands of the government. This would have redirected government spending from windfall gains. Having said that, we have not completely seen the actual effect on the government coffer, since tax revenue (like IDS) and lock-in measure will improve government's fiscal. In spite of being given limited room, market expects a cut in corporate and personal tax as indicated 2 years ago. The extent of this benefit will depend on the government's math regarding the benefit from GST and demonetization. The market measures risk like populist reforms given the start of key state election post the Budget and possibility to spread some warmth post demonetization.

But we should not confuse popular with populist meauses as government undertake economic measures for the low-income session. The other culpable measures are increase in capital gain tax. But SEBI has submitted its recommendations to the government to lower securities transaction tax (STT) and rebates under section 88E for STT. Further, the SEBI has recommended to reduce the holding period for debt mutual funds to 12 months from the current 36 months for consideration of long-term capital gains.

The other two factors market is looking for are fiscal target and government spending. Market will be happy if FM maintains a fiscal target of not more than 3.5 percent in FY18 as in FY17. This is because infrastructure and rural spending will be an important arena to push for in the long-term. I will like to end with a notion that the Budget could have done much more than what we are anticipating today given the gap in demonetisation and GST. But these measures will depend on the government forecast regarding the unknown factors as discussed. We need to be more watchful with an optimistic mind since the intention of the long-term dreams are good.

 (Author is Vinod Nair, Head of Research, Geojit BNP Paribas Financial Services Ltd