The Brief: Decoding Market Volatility Before Budget

UNION BUDGET is perhaps the most anticipated financial event in India, followed by everyone in the stock market from doyens of trading to wizards of fund management to the enthusiast with a fresh demat account. The reaction of the market has always put an informal stamp of approval, or otherwise, on Budget proposals.

Interestingly, in past 29 years, the market has seldom been euphoric before and after the Budget. Since 2013, the VIX (Volatility Index) has been above 20 in three months prior to the Budget, before inching closer to 15. This indicates there is huge volatility before the Budget that starts normalising afterwards.

The year 2021 was the most volatile since 2013, with VIX remaining in the 23 range for six months at a stretch, three months before and three months after the Budget.

So, do current times justify the hype around the Budget?

At the end of FY23, India’s nominal GDP was ₹272 lakh crore while government of India’s receipts (excluding borrowings) were ₹24.31 lakh crore. This means the Centre’s earnings are less than 9% of India’s nominal GDP. To meet the total expenditure of ₹41.87 lakh crore, the government borrowed ₹17.55 lakh crore, or 42% of India’s budget. Thus, last fiscal balance sheet of ₹41.87 lakh crore was short by 16% of nominal GDP. In light of such data, the stock market should ideally be impervious to the Budget as government’s expenditure is not even 16% of our GDP, and its earnings even less. Moreover, in October 2023, the daily derivative trading volume of the stock market was about ₹342 lakh crore. It would seem out of place for a market that trades more than the country’s nominal GDP to react to the Budget, which is minuscule in comparison.

V.K. Vijayakumar, chief investment strategist at Geojit Financial Services, says in the developed world such as U.S., Europe and Japan, Budgets are not big events like in India. This is because developed countries have a long-term fiscal policy and don’t tinker with tax rates every Budget.

Pre-Budget rallies are based on expectations from government proposals and market movement depends on whether the expectations are met or unexpected advantages received. For instance, the 1996 Budget, known as the Dream Budget, presented by the then finance minister P Chidambaram introduced far-reaching tax reforms which turned out to be a big boost for the market. Similarly, in the 2004 Budget, long-term capital gains tax was abolished, boosting market sentiment.

Of late, in India, a large part of the indirect tax system has been replaced by GST. This means the country is moving towards uniformity of taxation. Apart from changes in direct taxes, which have been rationalised to a large extent, there is not much that is affected by the Budget. On the other hand, it is also a fact that the Budget not only lists government’s spending plans but also proposes policies and legislative changes.

So, how does the index move pre and post budget?

According to Geojit Financial Services, since 1995, in 18 out of 29 years, the Sensex fell on the 10th day before the Budget, and in 16, it fell a month prior to the Budget. In 18 of the 29 years, the Sensex dipped on the Budget day.

This indicates that for 2024, the probability of Sensex dipping a month before the Budget, and 10 days prior to the Budget, and on Budget day itself, is more than 50%. There is a 50-50 chance that the Sensex will rise again a month after the Budget.

Market participants say high volatility before the Budget is due to expectations around Budget proposals. If the Budget ignores these proposals, there is a sell-off.

Nevertheless, it has been observed that in pre and post-budget days, volatility in the Indian market changes dramatically. For instance, seven days prior to Budget 2023, VIX rose 14.5%, while seven days after, it fell 19%.

It seems the market is mostly driven by sentiments and noise of expectations in case of Budgets.