Budget Blues: Markets Cold to Middle-Class Bonanza

Modi 3.0 offers mother of all income tax breaks to the consuming classes but leaves the market underwhelmed.

Union Finance Minister Nirmala Sitharaman with Union Minister of State for Finance Pankaj Chaudhary.

(Photo: PTI)

Anyone who has ever tracked the markets on Budget Day knows that stock market investors don’t really care about the nitty-gritty of what the Finance Minister has to say. Their interests are both much bigger and much narrower.

The narrow part of it has to do with capital gains and Securities Transaction Taxes. Along with that, market players want to know how much Foreign Institutional Investors (FIIs) will be taxed.

This is usually what affects the markets most on Budget Day.

This time, there was a lot of anticipation that Nirmala Sitharaman would relent and reduce taxes that affect the stock market investors. Special trading sessions were slotted today in anticipation of big concessions to the capital markets. That is why both the Sensex and the Nifty were trading 1.5 percent higher when the FM began her speech.

But nothing happened. No changes in the Securities Transaction Tax, no cuts in capital gains tax, and nothing for FIIs. In fact, Sitharaman made it very clear that her income tax bonanza to the middle class does not extend to capital gains tax.

One would have imagined that the mega breaks to the middle class – the government says it will give up Rs 1 lakh crore in income taxes – should have enthused the markets.

By the time the FM ended her speech though, the markets had slipped marginally into the red, and the key indices – Sensex, Nifty, Bank Nifty, and the Nifty Midcap 100 – all ended flat or slightly down.

So, why didn’t the markets give a thumbs-up to a budget that is going to put a lot of money in the hands of the middle class, and hopefully boost consumption? This is where the big picture comes in.

The Big Picture

Stock market investors, indeed, the financial sector as a whole, look at government spending to see what kind of tax projections it is making, and how much it will borrow to finance its expenditure.

This is because, if the government borrows a lot, it increases the supply of government bonds. Bond prices fall, and yields rise, putting pressure on interest rates.

Now, we all know that money kept in a Fixed Deposit (FD), or invested in a bond, is less risky than investing in shares. If interest rates rise, we would need a higher return from the stock markets to justify our investments.

Higher interest rates make money flow from the share bazaar into debt instruments like bonds, debt mutual funds (MFs), and good-old term deposits. That is the reason why stock markets watch the ‘fiscal deficit’ number so closely.

The numbers should have made the markets very happy. The government has kept the fiscal deficit for 2024-25 below what it had budgeted for. And the FM has promised to bring it down to 4.4 percent of GDP next fiscal, from 4.8 percent this year.

But the fine-print makes this difficult to digest.

Read Between the Lines

For starters, the FM expects to keep total expenditure to just 5 percent more than what was budgeted last year. If you adjust for the expected GDP deflator of 3.5 percent, that’s a real increase of just 1.5 percent.

Compare this to the increase in spending in this fiscal. In nominal terms, total expenditure went up by 6.1 percent. Given that the GDP deflator was 2.8 percent in 2024-25, real, inflation-adjusted expenditure went up by 3.3 percent, more than twice what the government is projecting for next year.

The markets are taking this with a pinch of salt. And, perhaps, a bit of anxiety, but more on that later.

Then come the overly optimistic income tax projections. Despite the massive tax sops to the middle- and upper-middle classes, the government expects to raise an extra Rs 1.8 lakh crore in income taxes next year. That’s 14.4 percent more than what it actually raised, and 21.1 percent more than what it had budgeted for last year.

How is that supposed to happen? Will that come from the pay hikes that government employees will get from the 8th Pay Commission? 

In that case, the ‘Establishment Expenditure’ of the government should have shot up. But that is projected to increase by just 3 percent. Where will the extra income tax collections come from?

The markets would thus be justified in assuming that both the expenditure projections and the tax revenue estimates are a tad unrealistic. Stock market investors will, therefore, want to watch what happens to bond yields.

This is especially so because the US Federal Reserve System – America’s RBI (Reserve Bank of India) – has paused its plan to cut interest rates. In fact, if Donald Trump’s tariffs cause more inflation in the US, the Fed might be forced to raise rates.

If that happens, dollars will flow back to the home economy, expecting better returns. In response, the RBI will have to raise rates, here in India, to staunch the dollar bleed.

This is what brings us to the final point: the stock market’s anxiety over economic growth. 

Anxiety Pangs

Much of our GDP growth in the past few years has been driven by government spending. Now, the government is planning to take a back seat.

This is partly because it has realised that lofty plans of capital expenditure are very difficult to execute on the ground. Last year’s budget planned to spend Rs 15 lakh crore on building capital assets, either directly by the Centre or through grants to states. The actual spending is going to be just Rs 13 lakh crore, or 12 percent less than what was planned.

This time the budget for total capital expenditure has been increased by just 3 percent compared to the budget estimate last year. And most of the additional spending is expected to be done by states. That is an optimistic assumption, considering states failed to spend almost one-fourth of what they were given last year.

It is thus clear that the government is betting on the private sector to drive economic growth. That might be the reason why corporate taxes are expected to grow by 10.4 percent compared to what is likely to be collected this year, more or less, in line with the nominal GDP growth projection.

Ultimately, the Narendra Modi government seems to be hoping for a big recovery in middle-class consumption in 2025-26.

That is why it has given the mother of all income tax breaks to the consuming classes. Some of the extra money will also get saved and flow into investments. If that does pan out, the markets should gain as well.

You can’t, however, blame market players for wanting to wait and watch, especially on a Saturday.

(The author was Senior Managing Editor, NDTV India & NDTV Profit. He tweets @Aunindyo2023. This is an opinion piece. The views expressed above are the author’s own. The Quint neither endorses nor is responsible for them.)