Budget 2018: Staring at a full-scale bear market

The market’s response to the last full Budget of this government was negative. The bond markets saw yields spiking on Thursday as Mr Jaitley made his speech. The stock market fell sharply on Friday after being shored up on Thursday. The Budget more or less coincided with a sharp sell-off in America, which could add another element of stress for investors. 

The 10-year US Treasury bond is the most popular global benchmark for the health of the world’s debt and forex markets. Similarly, the US stock market indices, such as the Dow Jones Industrial Averages (DJIA), are global benchmarks for the health of the world's equity markets. The signals from that quarter are poor. The US treasury yield spiked and the DJIA crashed on Friday. There are inflation worries and fears that the Federal Reserve may accelerate the pace of rate hikes.

The Budget includes a sequence of measures, which would have made different categories of investors nervous. First, the fiscal deficit expanded beyond targeted levels in 2017-18, and it might even exceed the revised estimates. It will be higher than hoped-for, in 2018-19, and cosmetics apart, it will be higher than the Budget itself claims.

Second, the Budget introduced a sequence of higher customs duties that reeks of the mindless protectionism that crippled the Indian economy back in the days of the Licence Raj. Third, personal income tax rates and slabs have not been revised in a manner that brings relief to average tax-payers.

Fourth, long term capital gains from equity will be taxed, without indexation, and without any relief in terms of Securities Transaction Tax or Dividend Distribution Tax. The cut in corporate tax rates to 25 per cent will only benefit relatively smaller companies since it only applies to companies with less than Rs 2.50 billion income.

Given the continuous changes to the GST rates and processes, it’s hard to tell if 2018-19 tax estimates are any more realistic than in 2017-18. The Budget assumes that monthly GST collections will rise by close to 30 per cent. There could also be tension on the fuel front because crude prices are up, and expected to rise further through the coming fiscal. 

NB FIIs bought net debt of Rs 85.2 bn (Jan1-31) & Rs 23.50 bn (Dec 1-31)

Lower tax collections and higher crude costs could both put pressure on the fiscal deficit, which was estimated at 3.5 per cent of GDP for 2017-18 in the Budget documents, well above the targeted 3.3 per cent. A day before the Budget however, the Central Statistics Office estimated the fisc at 3.7 per cent. The 2018-19 target is set 3.3 per cent of GDP. This accounting depends on ignoring the issue of Rs 800 billion worth of recapitalisation bonds for PSU banks. 

The bond market reacted negatively to the prospect of higher government borrowing, which is associated with a higher deficit. It was also unhappy at the thought that corporates were being “nudged” to raise a large proportion of their needs from bonds, coupled with the relaxation in the norms of investment grade ratings. 

India’s secondary bond market is not very liquid. But the benchmark 10-year bond saw yields shooting up as a sell-off drove prices down. The bond market has now been looking bearish for several months and higher yields generally indicate a potential bear market in equity. The announcement of higher MSP for food will also drive inflation expectations higher. 

Given the way the bond market is behaving, and prospects of higher food prices and more expensive fuel, it’s quite unlikely that the Reserve Bank of India will consider any further rate cuts in the upcoming review. The review is very likely to leave rates untouched and there is more chance of a rate hike than a cut. The RBI’s policy statement is likely to be read with great attention given that it is supposedly an independent institution and it would be seen as a sort of first response to the Budget. 

The rupee weakened considerably versus the USD over the last two trading sessions, after a bull run that had lasted for quite a while. The USD is very likely to continue strengthening after this trend reversal. This could be quite a big move, especially if foreign portfolio investors (FPI) start selling rupee assets. Traders also seem to be betting that the Euro and Yen will strengthen. 

In terms of market segments, it’s noteworthy that the PMS (portfolio management services) Division of ICICI Prudential is shutting down two of its schemes that operate in the small cap space. This decision to shut down and return investors’ corpus, came before the Budget, when the Nifty Smallcap 250 Index was running at a PE of 70-plus. Lack of institutional support could now cause a further dip in that segment.

Technically speaking, the dip on Wall Street is very likely to lead to poor sentiment elsewhere in the world including on Dalal Street. Interestingly, domestic institutions have sold since the Budget while FPIs held on. The fall in US equity values could trigger some selling by FPIs. 

The Nifty has already seen a 3-4 per cent pullback from its all-time highs of around 11,170. It could slide further to test support at 10,500, in the intermediate term. The 200-Day Moving Average, which is considered a benchmark for long-term health, is running at around 10,000 now. If that is tested and broken, we could be looking at a full-scale bear market.

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