Tuesday, February 23, 2016

The Union Budget and the Stock Market reaction

This article was first published by www.yahoo.com on February 23, 2016; Co-author: Anisha Sircar (Student at the Flame University, Pune)

“…The President shall, in respect of every financial year, cause to be laid before both the Houses of Parliament a statement of the estimated receipts and expenditure of the Government of India for that year … referred to as the annual financial statement.”…(Article 112, Indian Constitution)

The Union Budget is the most watched, anticipated, debated and discussed politico-economic event in India. Reviewing what the government achieved in the last fiscal year and what it aims to do in the next fiscal year, the much awaited budget reflects the present economic conditions while forecasting future conditions, and is a key indicator of the financial health of the country. While core fiscal issues (such as taxation, expenditure, and fiscal deficits) are addressed in this session, the budget speech is also used by the Finance Minister to announce new schemes, reforms, policies and plans for the future.

This is why the run-up to the budget is often accompanied by considerable volatility in the stock market. The two are intimately related: how the Finance Minister spends and invests money affects the fiscal deficit, and the extent of this deficit influences the money supply and interest rates of the economy. Simplistically, for example, higher interest rates would mean higher industrial costs of production, lower profits and hence, lower stock prices. Similarly, the budget also deals with fiscal measures taken by the government which affect public expenditure. For example, a direct tax hike would reduce disposable income, which would, in turn, negatively impact consumption. This would affect production levels and cause a decline in economic growth. An indirect tax hike would have a similar effect: indirect taxes may be translated as higher prices onto the consumers, who are often made to bear the ‘incidence’ of the tax, so this would decrease demand for relatively elastic commodities and end up potentially slowing down production and growth.

Susan Thomas and Ajay Shah (Economic and Political Weekly, Vol. 37, No. 5, Money, Banking and Finance (Feb. 2-8, 2002), pp. 455-458) studies 26 Union Budgets to find out the “Stock Market Response to Union Budget” in India. They find that the budget session has on an average resulted in 10 percent higher stock index in the post-budget trading days (about 30 days). According to them, the reaction of a stock market is usually viewed as a measure of the ‘quality’ of a budget.

The announcements in the budget have an impact on the sectors with respect to which the announcement is made. For example, it is often seen that if the market expected a positive announcement regarding say the banking sector, in the pre-budget days, the banking stocks would rally. If the announcements on the budget day are in line with the expectations, there may be very little impact on the day itself. Whereas, if the announcement is better than expected, the banking stocks further rally on the day and may even continue to rally in the next few days. On the contrary, if the announcements are not as expected and are perceived as negative for the industry, the stock prices go down. After the 2005 and 2010 budget sessions, the stock price of almost every company in the banking sector went up. Whereas in 2004, 2007, 2009, 2012 and 2013 most of the banking stocks fell.

On the budget day, one invariably witnesses significant movements in the stock market, which depend on investors’ interpretations of economic activities. However, in an analysis of 31 budgets, done by Livemint (http://www.livemint.com/Opinion/LNs25k8uD6dZsi9Z10gLgK/The-budgets-declining-effect-on-the-stock-market.html) and published on February 17th 2016, it is seen that the impact of the budget on the stock market is going down. As per the analysis, from average gains in the upwards of 4% on the budget day in the 90s, to a gain of about 2.5% in 2015, the budget is no longer an ‘inflexion point’ for the market.

As expected, the forthcoming Union Budget, which is to be presented by the current Finance Minister Arun Jaitley before the Parliament at 11am on the last day of February, has been a subject of widespread discussion in the recent weeks. Key announcements with respect to the ‘Make in India’, ‘Digital India’, ‘Start up India’ and schemes such as the Pradhan Mantri Krishi Sinchai Yojana, etc. are expected. Goods and Services Tax (GST), Smart cities and Infrastructure reforms may also feature in the budget speech.

The speech will definitely act as a roadmap to the Indian economy in the coming fiscal year. However, with Oil prices, Chinese economy and global uncertainty already playing on the minds of the investors, impact of the forthcoming budget on the stock markets may be just another factor this year!
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