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Economy

At Yahoo: Budgets and Stock Markets

I write about Budgets and Stock Markets in my first piece on this Year’s budget, in Yahoo’s Special Budget Edition.

(Reproduced in Full)

The budget has traditionally been an important part of the financial year, with the government announcing exactly what it wants to do for the next year, and how it has succeeded grandly at what it said it wanted to do last year*.

Part of the budget is an economic survey that gives you lots of figures on government spending and income, and the remaining part is the budget speech which tells you what they intend to do in the coming year.

(* The failures are hardly given a mention.)

Stock markets tend to react violently the budget. Both directly and indirectly, listed companies benefit or get hurt by provisions in the budget. A look at stock markets on budget day itself – the change from the previous day to the next:

At Yahoo: Budgets and Stock Markets

(Note: Years are those in which the budget was presented, for the next financial year – so 2001 means the budget for 2001-02)

Before 2000, budgets were presented at 5PM – a hangover from the British days when the Indian budget was presented to coincide with the markets in England. Yashwant Sinha changed this and our markets have been blessed with massive budget moves ever since.

The average budget day move is -1.22% in the last 10 years,with the wildest swing being 5% either side. Only on two occasions have there been moves of less than 1%.

The swing from the budget day to one week after – an indication that people have finally digested information and there are clarifications issued – are interesting. While the average and median moves are small, that is because the swings are wild in either direction – in effect moves are more than 1% every single time, and bar 2004, more than 2%.

In 2002, when the swings were really wild, Yashwant Sinha had rolled back five proposals. The budget day saw a 4% fall, and the subsequent week, a 10% rise in the index.

Another way to look at markets are to see where markets go from one month before the budget to after.

At Yahoo: Budgets and Stock Markets

On the face of it, it seems like there isn’t a trade, that markets don’t trend or revert (around half of the graphs show a trend, the rest don’t). But an interesting play for options traders will be to take on a straddle or strangle (buying both put and call options). But you will note that these options get really expensive near the budget, because people like me have done the analysis of the past and pushed up options prices through buying; at some point, the odds go against you. You can make this out from the VIX – from a “normal” range of 18-22, the VIX tends to shoot up before important announcements such as the budget, or election results.

Stock markets react differently to budgets even on an individual sector basis. For instance, the budget is NEVER kind to cigarettes, so there is bound to be some underperformance in ITC. The Tech sector benefits from anything that involves lower direct taxes, and we saw a massive rise in these stocks through the early part of the last decade just after the budget, as taxes were slashed and flattened. Lately, though, there isn’t that much to cheer about, and the coming budget will be a very marginal player in the direct tax space (since most of that is being moved into the Direct Tax Code, applicable only from 2012 onwards) On indirect taxes – such as excise, customs and service tax – the idea is to move to GST, which is being discussed separately from the budget; again, expect no major fireworks here.

Government spending impacts infrastructure, so those stocks will react as the government tries to steady FDI in a year that it seems to have slows down. Better financial visibility – even from securitization or through impetus for the corporate bond market – will be a huge positive. Yet the government needs to balance between that and a reasonably large fiscal deficit next year – helping corporate bond means, to an extent, reducing demand for its own bonds, which must be sold to finance the deficit.

3G auctions gave a big fillip to revenues this year, and so did public sector IPOs. But the next year may not yield that much in terms of benefit – most of the IPOs sold are today quoting below their IPO prices, with the extreme example of NHPC being about 30% lesser. With no IPOs and no 3G, there must be either new ways for the government to make money (revenue) or curb spending (expenses); extreme measures to either goal are negative for stocks.

There must also be ways to incentivize investment in the country, be it FDI or private corporate investments. While some of this has to do with taxes, it’s more important to create policy that provides more visibility to investors; you can’t have a Jairam Ramesh scuttling projects after enormous sums have been invested. (I don’t disagree that the projects may be at fault, but there needs to be clarity right at the beginning of these projects)

Overall, this isn’t meant to be a great budget in terms of announcements: it’s mid-term, there aren’t too many elections, the main contenders of income and indirect taxes are being handled separately, and the budget is increasingly unimportant to even policy nowadays. Yet, there will be something or the other that will impact the stock you know, and with the recent drop in markets, it may be useful to position yourself in sectors that the government is likely to favour. For a long term value investor, the budget may throw up juicy opportunities to buy excellent stocks, especially if there is a negative bias. For the traders, the market volatility will go up even further, and if you can handle the butterflies in the stomach, there’s never been a better time to be in the markets.

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