Union budget 2021: All eyes on Nirmala Sitharaman

FM Sitharaman will have to strike a fine balance between prioritising growth and maintaining fiscal prudence.

Investors will keenly watch how Union finance minister Nirmala Sitharaman balances the need to spend big to spur a budding economic recovery amid limited fiscal room as she rises to present the Union budget on Monday.

How the government addresses the twin challenges of fuelling economic growth and maintaining fiscal prudence will define the trajectory markets take in the near term, analysts said. (HT Photo)

How the government addresses the twin challenges of fuelling economic growth and maintaining fiscal prudence will define the trajectory markets take in the near term, analysts said.

“We think higher fiscal support is necessary, along with a favourable monetary policy, to help develop confidence on growth beyond the current recovery,” analysts Saion Mukherjee and Neelotpal Sahu at Nomura said in a note on 28 January. “We expect higher allocation to segments impacted by the pandemic as the government aims to address the divergence caused by the K-shaped recovery.”

A K-shaped recovery happens when different parts of the economy recover at divergent rates after a recession.

Bulls have been on a rampage since the nationwide lockdown was gradually lifted last year, with the indices almost doubling from the March lows as foreign capital poured in amid ultra-loose monetary policies adopted by major central banks. Investors have, however, turned cautious ahead of the budget, with the benchmark BSE Sensex losing 7.8% in six straight sessions after hitting the record 50,184 level on January 21.

“The government’s fiscal response in 2020 indicates certain inflexibility and the lack of resources to stimulate the economy. While the expectation is that the government will substantially grow its spending to support economic activity, this does not seem likely at present,” said broking firm Motilal Oswal Financial Services Ltd in a note on January 23.

The Economic Survey, which was presented in Parliament on January 29, favoured a major expansion in government spending to avoid the risk of demand weakening, resulting in lower potential growth.

The Economic Survey projected a nominal gross domestic product (GDP) growth of 15.4% next fiscal and reiterated the government’s focus on healthcare, infrastructure, incentives for domestic manufacturing and supply-side reforms.

The surge in stock markets from the March low of last year has been built on expectations of a faster-than-expected economic recovery. However, the Sensex is in near-correction territory over the past few days.

Data trends show that the Sensex has given negative returns in the month prior to the budget in three out of five cases. Experts said that while long-term prospects are pegged to growth recovery, sudden surprises in the budget could dampen the mood significantly.

In a recent note to clients, brokerage Motilal Oswal said there is a distinct possibility that the government may levy a one-time “corona cess”, or a special surcharge, to shore up its finances.

While the move is positive for long-term prospects, the immediate impact of such a move on investor sentiment could be negative, it said. “Although economic activity has fared better than expectations in the past few months, it is prudent not to be complacent about the revival,” Motilal Oswal said. According to analysts at Emkay Global Financial Services, Sitharaman will need to introduce innovative financial sector reforms, allocate resources better, and fund spending by raising money through aggressive asset sales.

“Capex-led stimulus over a consumption-focused stimulus should be the key, especially amid the larger multiplier on employment and growth,” it said. Any unfavourable announcement in the budget such as higher taxation may puncture hopes of a market rally.

December quarter earnings so far have beaten analysts’ estimates. However, there is a growing worry that weak demand, expensive commodity prices and potentially higher-than-expected credit costs for banks may put the earnings revival at risk.

With a lack of participation by domestic institutional investors, consistency in foreign liquidity is critical to sustaining the markets rally. Foreign institutional investors (FIIs) bought $2.57 billion in equities since the start of this year, while domestic institutional investors sold ₹11,970 crore in stocks. However, FIIs have sold $684 million in the past three sessions.

“Even as past budgets have disappointed the equity markets more often, the finance minister has promised a landmark budget for FY22. Whether landmark or not, the FY22 budget will be historic in the face of an unprecedented pandemic, which has caused great economic loss…At this juncture, the budget appears to be quite constructive; however, the fiscal room afforded even after considering the improving economy and better-than-expected tax collections is not very significant,” said analysts at Axis Securities.