Union Budgets and the equity market have a close-knit relationship. The market tracks the Budget sentiment, before and after—both positive and negative—and sways accordingly. However, in a recent report from Morgan Stanley India, equity strategists Ridham Desai and Sheela Rathi say that the impact of the Budget on the market has been on a secular decline.

Desai and Rathi point to the market’s performance history, suggesting that the Budget’s influence on short-term market performance is declining. “But expectations (as measured by pre-Budget performance) are still important in determining what the market does after the Budget,” the duo noted.

Budget day volatility has more than halved in the last 28
years
Budget day volatility has more than halved in the last 28 years
Image : Source: RIMES, Morgan Stanley Research

They backed their ‘zero-sum game’ claim with data. “The past 28 Budgets’ data show that when the market is up before the Budget, there is an 83% probability of the market falling 30 days after the Budget and a 75% probability of the market falling 15 days post the Budget,” they noted.

Long-term absolute performance around budget days
Long-term absolute performance around budget days
Image : Source: RIMES, Morgan Stanley Research

On a broader context, relative to emerging markets (EMs), if the market is up before the Budget, it underperforms four out of five times 30 days after the Budget, and it has a probability of 66.7% of underperforming 15 days after the Budget. Similarly, if the market underperforms EMs in the 30 days before the Budget, there is a more than 40% probability that it will outperform EMs after the Budget.

Looking at the past seven National Democratic Alliance (NDA) government Budgets (including the interim Budget of February 2019), Desai and Rathi highlighted that the market has been down in 30 days before the Budget on an absolute basis in four cases. And, it has been down on three of these four occasions 30 days after the Budget. “On a relative basis, India has underperformed in six of the seven cases 30 days before the Budget and in five out of seven cases 30 days after the Budget,” the duo wrote. “This year, India is tracking higher on an absolute basis and at par on a relative basis so far in January.”

Even while the Budget-market relationship is fading, as the volatility has been declining over the past 28 Budgets, Desai and Rathi said that market participants will have to deal with a fair amount of volatility on Budget day. The duo organised their expectations for policy action affecting equity markets into three categories: one, transferring resources from the public sector to the private sector; two, improving terms of trade; and three, fostering stability and growth of the financial system.

From the stock market perspective, the duo, in the coming Budget would keep a close watch on government spending on infrastructure, housing, water, and farmer cash transfers, apart from the fiscal deficit target.

Additionally, they would look for rationalisation of direct taxes, like a cut in personal tax, removal of long-term capital gains tax for all classes of investors, removal of dividend distribution tax, and extension of the low corporate tax rate for new investments in the services sector.

The scale of privatisation would be another area to look at, as this would demonstrate the government’s desire to undertake structural change as well as reduce supply in the market. And action on interest rates will be a welcome move, where linking small saving rates to repo rates should help bank deposit growth in the long run.

Consistent gainers and losers on budget day
Consistent gainers and losers on budget day
Image : Source: RIMES, Morgan Stanley Research

When it comes to stocks, both Desai and Rathi are positive on domestic cyclical mid-cap value stocks. The duo analysed the performance of the S&P BSE 100 constituents for the past seven Budgets and noted a group of stocks which appear to be consistent gainers or losers on the Budget day.

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