The BSE Sensex is down 7 per cent since January 29, its worst 30-day performance in the month prior to budget since 2009. The selloff in domestic markets has been led by foreign institutional investors, who after pumping in $3.2 billion in equities in last year, have dumped a net $2.4 billion in just two months of 2016. Domestic equities have been weighed down by global factors, but concerns about negative surprises in Finance Minister Arun Jaitley's third budget have also added to jitters.
Here are three major concerns that have weighed on markets ahead of budget:
1) Fiscal deficit: The government is on track to meet its FY16 fiscal deficit target of 3.9 per cent of GDP, helped by faster growth in indirect taxes (remember repeated hikes in excise duty on petrol and diesel?). But investors fear that the government may delay its medium-term fiscal consolidation path of controlling deficit to 3 per cent of GDP by FY18 because it needs funds to implement the 7th Pay Commission wage-hike proposal and recapitalise state-run banks struggling with mounting bad loans.
A breach of FY17 fiscal deficit target of 3.5 per cent of GDP may not go down well with investors. Bond yields (already on the rise) could shoot up causing more losses for foreign investors. Redemptions from bond markets (around $800 million in 2016) may pick up pace, leading to more pressure on the rupee, which is tottering around its record low of 68.85 per dollar. Higher yields will push up cost of funds for borrowers and will deter investment in the economy, creating more problems for the government.
2) Subsidies: Recent political reverses have led analysts to speculate that the government will increase spending to combat the rural distress in India's countryside. Mr Jaitley may provide more funds for Mahatma Gandhi National Rural Employment Guarantee Act (MGNREGA) - a programme that PM Narendra Modi had last year described as a "living monument of the Congress's failure to tackle poverty". Allocation for rural-focused infrastructure projects could go up. Morgan Stanley expects food subsidy spending to rise to 1 per cent of GDP in FY17 from 0.9 per cent in FY16 to provide for pan-India implementation of the Food Security Act, which aims to provide rice and wheat at highly subsidized rates to 67 per cent of the population.
A rural-focused budget will be investors' worst nightmare, even though it will be good for the economy, said market veteran Shankar Sharma. Such a budget will trigger a "big selloff" because anything done for the rural-economy is looked down upon by the financial markets, he added.
3) Taxes: Morgan Stanley's Ridham Desai says the government may contemplate changes to tax rates on saving, including dividend distribution tax and capital gains tax. Currently, dividends on stocks and mutual funds are not taxed in the hands of investors, while gains from stocks are also not taxed if the duration of investment is more than 12 months. Speculation that the government will increase the duration for applicability of long-term capital gains tax on equities from one year to three years has hit markets.
If the government changes long-term capital gains tax structure, there will be "immediate" repercussions, which could create "depression" in stock markets, said market expert Jyotivardhan Jaipuria.
Post Budget Rally?
The Sensex and Nifty could stage a big rally if the government does not disappoint on fiscal deficit, subsidies and taxes. Higher allocation for infrastructure development, rationalization of corporate taxes and a clear road map for reforms could also pave the way for sharp gains in beaten down stocks, traders say.
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