When FM Nirmala Sitharaman announced that she was raising the tax on short term capital gains from 15 per cent ot 20 per cent and long term capital gains from 10 per cent to 12.5 per cent, for while it appeared to would be a party pooper, as also the hike in Securities Transaction Tax for derivative trades.

While regulators Securities and Exchange Board of India and the Reserve Bank of India have expressed concern over the unbridled rise in derivative trading by retail investors, the government was quick to seize the opportunity to raise tax on these transactions. For perspective, the combined value of derivative trades on the BSE and National Stock Exchange of India in May 2024 was nearly Rs 10 lakh crore, SEBI data showed.

The market fell sharply following the announcement on tax on capital gains and security transactions for derivatives -- the benchmark Sensex , while Sensex plunged nearly 1,000 points, or 1.25 per cent and Nifty 50 index dropped more than 300 points, or 1.2 per cent -- but recovered in minutes to close marginally lower from Tuesday's opening.

One way to explain how the market responded is that equity investors view this as a six-month budget (with the next one expected in February) and are pinning hope on the so-called “next generation” reforms related to the factors of production and the comprehensive review of the Income Tax Act in six months, mentioned by the finance minister, Nirmala Sitharaman.

Tax measures and budgetary allocation aimed at improving consumer spending seem to be the bedrock on which the capital markets have based their faith on.

Fiscal Policies and Market Confidence

The budget’s aim to keep the fiscal deficit at 4.9 per cent of GDP, and a commitment to keep lowering it progressively has enthused the financial markets. This commitment to a fiscal consolidation path suggested that political expediency would not overwhelm economic prudence, a signal that comforted investors.

The budget introduces several tax reforms that can directly impact corporate profitability and investor sentiment. Notable among these is the reduction of the corporate tax rate for foreign companies from 40 per cent to 35 per cent, which is expected to attract more foreign investment and stimulate economic activity.

Additionally, the simplification of the capital gains tax regime and the introduction of measures to reduce litigation and disputes provide a clearer, more predictable tax environment for investors​​.

The abolition of the "angel tax" for all classes of investors is a significant tax designed to bolster the startup ecosystem. By removing this tax, the government aims to encourage more investments in startups, foster innovation and entrepreneurship, and boost the stock market as these companies mature and potentially go public.​

The changes in personal income tax rates, especially the increase in standard deductions, are expected to boost disposable income for individuals, potentially increasing consumer spending. Higher consumer spending can drive revenue growth for companies, positively impacting their stock prices.

Boost to Specific Industries

The budget is investing heavily in different sectors to drive growth, which will likely affect stocks in those areas. For example, the infrastructure sector is getting a huge boost with ₹11.11 lakh crore allocated for capital projects. This was already mentioned in the Interim Budget and has been baked into stock prices.

For agriculture and rural development, the budget sets aside ₹1.52 lakh crore to enhance productivity and resilience. Efforts like creating high-yield crop varieties and supporting natural farming could improve agricultural output, making food processing and agribusiness companies more prominent.

The manufacturing sector and MSMEs are getting support through various incentives, including credit guarantee schemes and easier access to term loans without collateral. This should help small and medium-sized businesses grow, create jobs, and increase economic activity, which can positively affect their stock prices.

Additionally, the budget focuses on energy security and renewable energy projects, such as the PM Surya Ghar Muft Bijli Yojana for rooftop solar installations. Investments in solar energy, nuclear power, and other green technologies are putting capital goods and renewable energy companies in the spotlight.

Consumer Spending

The budget’s focus on social welfare programmes, including significant allocations for rural development, employment, and skilling initiatives, is expected to enhance the overall economic. 

The stock market hopes that improving individuals' income and employment prospects will lead to increased consumer spending and drive revenue growth for companies across various sectors. 

This increase in consumer demand can positively impact the stock market as companies report higher earnings and improved financial performance​.

The emphasis on employment generation in the formal sector, particularly manufacturing, and enhancing farm prosperity are key drivers for boosting the long-term growth potential of the economy. 

A fund manager of a bank-sponsored mutual fund said, “Nothing has gone wrong, yet. We, as an industry, have 1.25 lakh crore (rupees) in hand.” Any fall in stock prices is an opportunity to buy, he said.

Seasoned investors, though, believe that prices could see a course change after July 25, when July derivative contracts get settled.

(Krishnadevan Vijayaraghan is a Mumbai-based financial journalist. Views expressed are personal)