In the pre-budget sessions, Indian equity markets were falling like a house of cards. Foreign Institutional Investors (FIIs) were the net seller in the first 2 months of 2016. As per the data obtained from NSDL, FIIs pulled out US$ 2,396 million (Rs 16,251 crore) between January 01, 2016 and February 29, 2016. High valuation of Indian companies and their relatively flat performance made FIIs apprehensive of Indian equities. To add to their worries, the Government wasn’t successful in getting progressive bills sanctioned in the parliament. Global factors weren’t supportive either.

Global negatives...
China Worries continued to spook global markets. In February, Chinese manufacturing growth dropped below the expected level. Piling inventories of crude oil and falling commodity prices further dragged global stocks. China has been the topic of high-level economic discussions happing across the world.

Presenting semiannual monetary policy report to the Congress, Federal Reserve (Fed) Chair, Janet L. Yellen said, “As is always the case, the economic outlook is uncertain. Foreign economic developments, in particular, pose risks to U.S. economic growth. Most notably, although recent economic indicators do not suggest a sharp slowdown in Chinese growth, declines in the foreign exchange value of the renminbi have intensified uncertainty about China's exchange rate policy and the prospects for its economy. This uncertainty led to increased volatility in global financial markets and, against the background of persistent weakness abroad, exacerbated concerns about the outlook for global growth.” As a result, it is expected that the Fed may go slow on further interest rate hikes.

Budget 2016-17 was a big event
On this backdrop, fear of unknown (Union Budget 2016-17) made investors more bearish on Indian markets. Speculations reached new peaks and markets touched a new 2-year low. Some experts were expecting the Government to overshoot its fiscal deficit target while others were anticipating the reintroduction of long term capital gains tax on equity investments. The Government had a number of questions to answer which included its stance on fiscal discipline, plan for reviving the falling industrial growth and its approach to taking India to a new level of growth.

Markets breathe a sigh of relief
While the Finance Minister was announcing the Budget 2016-17 in the parliament, markets were depressed and were in the midst of panic selling. However, to everyone’s surprise markets recovered dramatically by the closing time on the very same day. There was an even bigger surprise the very next day. India’s bellwether Index S&P BSE Sensex rallied massive 777 points to record the biggest single-day rise in last 7 years. If you thought that was a knee-jerk reaction, the index shot up another 464 points for second day in a row, post budget. Third session post budget witnessed a jump of 364 points in Sensex. In short the Sensex has rallied over 1605 points (5.3%) in 3 trading sessions following the budget day.

Just a pullback or a new start?

(Source: ACE MF, BSE, PersonalFN Research)

Puzzled with the market reaction, investors have started wondering about the durability of the on-going rally. Although, there weren’t many industry-friendly announcements in the budget, the market seems to be rallying for some reasons overlooked by majority of the investors. We would discuss with you the reasons that might have made the markets enthused about the budget. Let’s check if this is just a pullback rally or has more legs to go farther.

Reasons to cheer...

• The Government has reaffirmed its commitment to maintain discipline in fiscal management. It remains confident about adhering to the fiscal deficit target of 3.9% for the Financial Year (FY) 2015-16. For the next fiscal, i.e. FY 2016-17, it has set a target of 3.5% which is largely in line with the market expectations and confirms with the commitment made by the Government in last budget. The markets seem to be impressed with this effort as it makes the fiscal policy a lot more predictable.
  
  
• The focus of the Government has been on the development of rural areas. Huge budgetary support of Rs 35,984 crore for the farmer’s welfare and the all-time high allocation to Mahatma Gandhi National Rural Employment Guarantee Scheme (MANREGA) of Rs 38,500 crore would place the rural economy on the strong footing. Weakening of rural demand has been a cause of concern for many Indian companies driving considerable portion of their revenues from rural areas.
  
  
• By providing in excess of Rs 2.21 lakh crore for the development of infrastructure, the finance minister has tried reviving the capex cycle. Over last few years, the private sector has stopped adding to its existing capacities on back of weaker demand. This has resulted in stagnation in India’s economic growth. Taking the challenge head on, the Government has set the ball rolling.
  
  
• Reiterating its support to infusing capital in public sector banks (PSB) that have been battling with the problem of poor asset quality for a while now the Government has made its intentions clear. Although the commitment to infuse Rs 25,000 crore might have fallen short of expectation of the market, what has put worries to rest has been clarity in the Government’s policy. The Government has made up its mind to act decisively on offloading its stake in IDBI bank below 50%. This hints at further actions by the Government in cutting its interference in the Governance issues of the functioning of PSBs. Easing of FDI policy to allow foreign players to invest in Asset Reconstruction Companies (ARCs). The relaxation in FDI policies allowing foreign investors to invest upto 49% in Central Public Sector Enterprises (CPSEs), other than banks, also suggests that the Government is planning to tap foreign money without losing its control. These efforts have gone down well with the markets.
  
  
• As we all know, expectations about food inflation have remained high over last few years. RBI has been insisting that, the Government needs to take steps to take out supply side constraints causing higher inflation. In the Budget 2016-17; the Government has announced a number of initiatives that are aimed at achieving higher food production and unaffected supply of food grains and other life essential agro commodities. The Government has taken a number of steps to improve the health of real estate sector which is expected to aid India in achieving its targets of building smart cities and providing affordable housing.
  
  

In a nutshell, the budget has provided a predictable path for achieving higher growth and containing fiscal deficit. This makes fiscal policy of the Government congruent with the monetary policy of RBI. Markets are going up on the expectation that, RBI will cut policy rates sooner rather than later. As the Marginal Cost of Funds based Lending Rate (MCLR) which will become applicable from the April 01, 2016, the cost of borrowing is expected to go down considerably. A rate cut at this time would be an icing on the cake. Although the Indian Meteorological Department (IMD) is yet to come out with the official statement, The Economic Times in its edition dated February 24, 2016, quoted a senior weather scientist who works with the IMD that Monsoon is likely to be normal this year. If this happens, it may augur well for India’s agriculture sector and bring down inflation.

Another reason for rally...
It is noteworthy that, FII’s participation has been missing for over 2 months now. They are still shying away from Indian markets. There were many short positions created in the derivatives segment in pre-budget sessions which are now getting covered. Short positions allow you to sell stocks / indices without possessing them. Now that the big event is out of its way and worries over slowdown in China are already in prices, equity markets are reacting positively to the budget and hoping a rate cut from RBI.

A word of caution...
While there’s a possibility that the current rally may continue if RBI accords a policy rate cut at this juncture, you should not overcommit to the market. In the whole budget speech, the Finance Minister didn’t make any reference to GST, which is a worrying factor. Execution of schemes remains important for achieving targets.

Strategy to follow
PersonalFN has always believed that you should refrain from timing the market and keep investing at regular intervals. Fluctuations based on events are often short-lived. It remains to be seen how the Government implements its own plan and whether that translates into higher growth indeed. Corporate profits and advance tax figures would start giving you hints soon. Avoid speculation. Investing in a Systematic Investment Plan (SIP) offered by an equity oriented mutual fund that has a proven long term record may help you generate long term wealth.

If you are not sure about which fund you should invest in; you may avail unbiased mutual fund research services provided by PersonalFN.

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