Shares in India produced their biggest weekly rise in eight months, rallying on expectations the annual budget would have tax breaks for the middle class and companies as well as higher spending on infrastructure-related projects and for the farm sector, which provides livelihood to most people in the subcontinent.

Finance Minister Arun Jaitley is scheduled to present the budget in parliament on Wednesday, with his back to the wall after a shock government decision in early November to remove high-value bank notes — aimed to smoke out tax dodgers and counterfeiters — caused a severe cash crunch, dented consumer spending, triggered shift shutdowns at many factories and stalled the pace of economic expansion.

The invalidation of Rs1,000 and Rs500 notes, which together comprised 86 per cent of the currency in circulation, severely hurt business activity, incomes of workers and the poor. New Delhi is under pressure to soothe public anger ahead of elections to state assemblies in Uttar Pradesh, home to more than 200 million people, Punjab, Goa, Uttarakhand and Manipur over the next two months.

The budget, coming just past the midway stage of Prime Minister Narendra Modi’s five-year term, must not only ease the pain but should bolster investment, create jobs and accelerate growth. GDP expansion in the current financial year to end-March would likely drop one percentage point to 6.6 per cent, the International Monetary Fund said last week, citing the disruption caused by the demonetisation.

“We believe to strike a balance between economics and politics, the government may use half of the additional resources to provide relief to taxpayers and the other half for major pro-poor schemes,” brokerage Motilal Oswal Securities said in a note.

“The government will not want to breach its self-committed deficit target of 3 per cent of GDP for 2017-18 to uphold its credibility in the market and among the rating agencies.”

Still, Jaitley is likely to be tempted to ease the tap on spending, particularly to commit funds on roads, railways, ports, housing, power and for the farm sector — areas that have the potential to provide relief to semi-urban and rural distress. This was the main factor for shares of agro-chemicals, fertilisers, cement and banks to rally.

The top-30 Sensex rose 3.14 per cent over the week to 27,882.46 and the 50-share Nifty jumped 3.5 per cent to 8,641.25, both notching their best gains since the week ended May 27 last year. The indices, tracked closely by fund managers, were at their highest close in three months.

Lurking pitfalls

Economists at Deutsche Bank believe the budget would likely have a “sharp pro-poor, pro-rural” focus, while Bank of America Merrill Lynch said the government may step up support for affordable housing, raising demand for steel and cement.

“We do not expect major changes in the conduct of fiscal policy and hence view the budget as a market-neutral event,” Morgan Stanley said in a research note, adding that the pace of fiscal consolidation would be slower than planned earlier as the government would find it difficult to cut back aggressive spending post demonetisation.

The investment bank expects the budget to be positive for autos, cement and metals, consumer goods, internet and e-commerce, media and real estate; and neutral for financials, information technology, oil and gas and utilities.

While the main theme is expected to be for lower taxes, both for individuals and companies, and better tax compliance, the government must find ways to enhance revenue in an uncertain world besieged by the spectre of trade wars and rising prices of crude oil — the country’s single-biggest import item.

In this regard, Modi’s off-the-cuff remark in December that players who profit from the stock market needed to make a “fair contribution” to nation-building, could prove ominous. There is speculation the budget may lower the threshold for imposing long-term capital gains tax as well as roll out rules to bring foreign funds, operating from tax-havens, under the tax regime.

After pulling out about $4 billion over two months, overseas investors scooped up shares worth $101 million in the five days to January 20 in their first purchase in six weeks. The buying has continued this week, but any harsh moves in the budget could turn the tide again, especially as currency risks have risen with the rupee set to weaken against the dollar.

Earnings cheer

Another reason that underpinned the stocks rally was the better-than-expected corporate earnings, which indicated that the fallouts from the currency removal would wane without causing much problem.

Maruti Suzuki, the country’s biggest car maker, said its December quarter profit leapt 47.5 per cent over the same period a year earlier, as it reined in costs and stepped up sales of higher value vehicles to beat lower-than-expected sales rise.

“Increase in share of the company’s higher segment models, lower sales promotion and marketing expense, cost reduction efforts and higher non-operating income contributed to increase in profits,” Maruti, which is majority owned by Japan’s Suzuki Motor Corp, said in a statement.

On Friday, the company raised prices of its vehicles, suggesting improving confidence about the market.

Diversified ITC Ltd, India’s biggest tobacco company with interests in daily-use consumer goods, hotels, paperboards, software services and food items, beat market forecasts. HDFC Bank, the second-biggest private-sector lender, said its domestic loans grew 17.5 per cent at end-December from a year earlier, indicating robust credit demand for credit despite the notes ban. Its quarterly profit climbed 15 per cent, ahead of expectations.

Mahesh Nandurkar, India strategist at CLSA, believes that barring a few sectors like property and related housing finance and cement, most other sectors would see only a temporary slowdown due to demonetisation, a stance that is corroborated by the results of companies and management commentaries.

“So a couple of months down the line, we would probably have forgotten about the demonetisation or even the state election results,” he told ET Now television channel. “What ultimately matters is which way the corporate earnings are going to move and which way the economic growth is shaping up. On that front, we still believe that the corporate earnings growth will be looking much better in 2017-18 as compared to 2015-16 and 2016-17.”

He’s also upbeat about the stock market. “We do feel that over the next 12 months we should be seeing the markets delivering a double-digit return.”

The writer is a journalist based in India.