Downside limited

The derivatives market, thanks to its higher volumes, gives a better idea of market direction than the cash segment. It's important, therefore, to see the impact of the Budget on the derivatives market in the previous two trading sessions.

The derivatives segment had a significant role to play in the rise in the markets on Budget day. Derivatives market players had built considerable hedge positions, largely by selling stock and index futures, in order to protect any downside risk on account of the Budget.

As a result of the selling in the futures market, the difference between cash and futures prices or the cost of carry had come down to just 2-3 per cent (annualised) and in some cases like the Nifty was even negative.

The buoyant mood on Budget day triggered short covering on these futures contracts, which was reflected in the jump in the cost of carry. The Nifty ended with a positive cost of carry, while in the case of most other stocks it jumped to around 8-9 per cent.

On Tuesday, when the markets corrected after reading the fine print on issues such as "fringe benefits tax", the cost of carry came down again. But what's more important is that the implied volatility on options contracts came down as well.

On the Nifty, the implied volatility was just about 17 per cent, much lower than 24-25 per cent level pre-Budget. The lower implied volatility is probably a sign of increased confidence in the markets. At the very least, the downside should be limited.

The bond market and bank stocks

A day after the Budget, the bond market continued to be jittery, and yields moved up further. That's not surprising""""the centre has Budgeted net market borrowing at 12.4 per cent higher than in the revised estimates for the current year.

The rise in the central government's borrowing is a huge 140 per cent , if the market stabilisation scheme is left out of the picture, although that doesn't really make a difference so far as market liquidity is concerned.

This fiscal, market borrowings have been much lower than Budgeted, thanks to the government mopping up funds directly from the retail investor through small savings and because of large cash draw downs. The fiscal deficit targets too are optimistic, which means that there could be further borrowing.

Further, the expenditure figures do not include the Rs 29,003 crore to be raised by the states in terms of the 12th Finance Commission recommendations.

That sum too is being looked at with trepidation by the markets. A particular concern is that some of the states are in bad shape and the market will demand a premium for subscribing to their paper.

In addition, there is not much demand for government securities. The combination of lower demand and higher supply will lead to higher yields. At the moment, however, liquidity is abundant, which accounts for the relatively muted reaction of the market to the higher-than-expected borrowing programme.

Much also depends on the small savings collected""""if the Rs 1 lakh deduction leads to more small savings collections there will be less need for the government to borrow from the market.

So far as the road map for banks is concerned, while it is true that some bank scrips have reacted negatively on the reduced prospects for immediate M&As, banks will be major beneficiaries of the lower corporate tax regime.

Further, the credit growth story remains intact. That is probably why, in spite of some selling on Tuesday, the BSE Bankex remains above its close before the Budget.

With contributions by Mobis Philipose