Every year, when the Finance Minister gets up to present the Union Budget, Dalal Street prepares for some amount of volatility. Headlines are quickly filled with announcements related to new welfare schemes, tweaking of taxes, and sector-specific sops. Yet, for seasoned market participants, all eyes are often elsewhere-on a single number that tends to shape market sentiment far more decisively than fresh policy promises: the fiscal deficit.
Why the Fiscal Deficit Matters to Markets
The fiscal deficit essentially represents the difference between the government’s total expenditure and its revenue receipts. For equity markets, this figure is a proxy for fiscal discipline, inflation risk, interest rate direction, and government borrowing requirements-all factors that have a direct bearing on corporate profitability and valuation.
If the deficit turns out to be higher than anticipated by the markets, that could indicate that the government might need to borrow more than expected during the year, and that might cause bond yields to rise in the future too. When the government has announced that it has plans for reducing the deficit over time, investors might take that as an indication that the macro situation is under control—the response might take the form of a stock market rally even if the Budget has no notable announcements per se.
REACTIONS FROM BUDGET DAY: LESSONS FROM THE PAST
History has witnessed how markets have responded to Budgets, reinforcing this preference. Every year, if Budgets have surprised positively in fiscal consolidation, markets have cheered even if new schemes were few. Again, if Budgets have been populist in their orientation with high expenditure plans without any indication of funding, they have been greeted with sharp sell-offs, sectoral or otherwise.
For example, there have been budget sessions when equity markets fell sharply not because of changes in tax policy or rollbacks, but because of what the math did to bond markets, which in turn affected equity markets, hence the importance of the deficit number.
More Than a Short-Term Market Trigger
“Significantly, the importance of the fiscal deficit far exceeds the market fluctuations on Budget day. This also influences the RBI’s monetary policy and the borrowing calendar of the Government. Importantly, the figure is a closely watched aspect of investment sentiments globally. Indeed, even globally, investors watching this figure far outnumber those interested in the Government’s welfare measures; not to mention the rhetoric produced on a daily scale.”
By contrast, new schemes can be seen as having little impact on earnings unless accompanied by large spend. Markets will quickly discount new schemes and put investors back to focusing on the fundamentals.
What Investors Watch on Budget Day
Generally, as the speech delivering the budget progresses, interested persons will keep track of:
Whether the fiscal deficit exceeds, meets, or beats expectations
The Credibility of the Assumed Revenue
The Balance between Capital Expenditure and Revenue Spending
Indicators of future borrowing trends and financial consolidation
These various factors collectively help to evaluate how the Budget benefits or hampers the overall framework of the economy.
The Bottom Line
Though it may be a slew of fresh schemes that capture the imagination of the media, on Budget Day, it is not the volume of the announcement that matters to Dalal Street. Rather, it is the figure; and on one Budget Day in particular, investors were told that it was in the small print of the Budget that lay the signal to move the markets.
