Even if Budget 2015 is a good one, markets will struggle in the short term

Equity benchmarks have had a fantastic pre-Budget rally - nearly 3,000 points from the lows of mid-December - though the market knows the limitations of the Budget in fixing big problems of the economy. The Budget is usually seen as the centrepiece of the government’s vision for the economy and commitment to reforms. The market does not have much doubt on both counts. What it is now looking forward to is the government’s ability to execute its promises. Many brokerages are closely eyeing the Bills the government is able to pass in the Budget session, more than the Budget itself. [caption id=“attachment_2115529” align=“alignleft” width=“380”]  Reuters[/caption] Land acquisition, coal reforms, higher FDI in key sectors, mining rights and GST are the key areas where the market is watching for progress. And passing the Bills is just the first step; the results will show only with a lag of few quarters. The widely held view is that the government will just about meet the 4.1 percent fiscal deficit target for this fiscal and guide 3.6 percent for the coming fiscal. Most players also see Finance Minister Arun Jaitley making the right noises about fiscal consolidation. He may have little choice in this matter, given that future rate cuts by the RBI hinges on a credible road map for fiscal consolidation. The steep drop in crude prices will give some elbow room for the finance minister by way of a lower oil subsidy bill. But the savings will be far from enough to fund the massive investments required in infrastructure; the government needs to think of innovative ways to raise the funds. The industry and markets gripe about Jaitley’s first Budget was the absence of any radical tax reforms. When corporates and markets use the word tax reforms, it usually means tax breaks. Tax collections for this fiscal have fallen way short of estimates. So it remains to be seen if Jaitley would want to take a gamble by lowering taxes - corporate and personal - in the hope of spurring investment and consumption which in turn may generate higher revenues. Pre-Budget trial balloons being floated by Finance Ministry sources so far give a mixed picture. Some reports hint at tax cuts being unlikely because of strained finances, while other reports promise relief for corporates and individuals. This is not to say that the Budget will be a non-event for the market. Certain announcements can boost sentiment even if the eventual outcome will be known only by the next Budget. But there remains the problem of weak corporate earnings and consequently expensive valuations. December quarter earnings were dismal with many large cap companies disappointing missing estimates by a wide margin. In the case of many state-owned banks, the numbers were downright disastrous, highlighting the problem of bad loans which the government will have to fix at some point. Most companies have been able to cut costs and improve margins, but demand is showing no signs of picking up. The March quarter numbers are expected to be as mediocre. That has led many brokerages to downgrade their earnings estimates for FY16. Earnings growth in percentage terms may meet the 20-odd percent target that most analysts have been talking about. But that will come off a low base. In other words, the aggregate earnings per share of the Sensex and Nifty companies for FY16 is most likely to be lower than what the market was expecting a couple of quarters back. With the much anticipated recovery in economy and corporate earnings taking longer to materialise, investors have moved out of the so-called ’turnaround stories’ and once again sought refuge in stocks with sound earnings performance as well as with better earnings visibility. This had led to a sharp divide in the market where the good stocks have become way too expensive and, meanwhile, few investors are willing to bet on stocks where a recovery is still some time away. For the broader market, investors will have to be convinced by the Budget to bet on the turnaround candidates. A disappointing Budget will rattle investors for sure, but a good Budget is unlikely to lift the market beyond a point because of expensive valuations. Investors can take heart from the market’s resilience to dismal corporate earnings for the December quarter, and to despair of industry captains at the lack of any visible improvement on the ground. What the market seems to be indicating is that the medium term picture still looks good, despite the near term gloom.