Feb 6, 2025
• Trade war begins, likely leading to global market volatility.
• India’s Union Budget shifts its focus to consumption, unlike previous budgets that emphasized capex.
• Personal income tax cut will leave more disposable income in the hands of the middle class, likely supporting the recovery of urban demand.
• The budget is neutral for equities, however we expect a sectoral rotation from the infrastructure theme to the consumption theme.
• The budget is also neutral for debt, with all eyes now on the RBI.
Consumption in Focus
As anticipated, the first month of this year was marked by heightened market volatility worldwide. President Trump announced a flurry of executive orders, including policy reversals, immigration, and pardons for individuals involved in the 06 January 2021 Capitol riot. He also announced tariffs on the U.S.’s largest trade partners, Canada, Mexico, and China, but later granted Mexico and Canada more time to negotiate. This move potentially signals the beginning of a tariff war. Meanwhile, a Chinese startup, Deepseek, disrupted the global AI landscape, unveiling open-source models that challenge the dominance of top U.S. tech giants, all at a fraction of the cost.
In India, the 2025 Union Budget marked a shift from the previous focus on capital expenditure to a more consumption-driven approach. By leaving more disposable income in the hands of salaried individuals, the budget is likely to support consumption. However, the reduction in personal income tax came at the expense of lower-than-expected government capital expenditure. Additionally, the government introduced incremental measures to support the rural economy, MSMEs, and improve the ease of doing business.
Global Macro Update
On his first day in office, President Trump signed over 200 executive orders, including reversing many previous policies. He withdrew from the Paris Climate Agreement and the WHO, declared a state of emergency at the southern border, halted refugee resettlement, and initiated the deportation of immigrants with criminal records. He also promoted fossil fuel production at Davos and moved to install loyalists in key bureaucratic positions. While some of these actions may face legal challenges, they set the administration’s course. Most of these actions align with the agenda established before the new administration took office.
President Trump also followed through on his tariff warnings by imposing a 25% tariff on Mexico and Canada and a 10% tariff on China. These three nations are the largest trading partners of the U.S., accounting for nearly 40% of its trade. At the time of writing this, the U.S. has granted Mexico and Canada an additional 30 days to negotiate, while the tariffs on China have already taken effect. A tariff war is expected to increase U.S. inflation and dampen global demand. While President Trump may intend to use tariffs as a negotiation strategy, an escalation in the trade war poses a significant risk to global markets and could contribute to ongoing market volatility.
Canada, Mexico and China make up nearly half of US Trade
Source: UN Contrade, Council of Foreign Relations
At its January monetary policy meeting, the Fed kept interest rates unchanged, in line with market expectations. It acknowledged that inflation “remains somewhat elevated” and removed previous references to “progress toward the 2% target.” While the FOMC statement had a relatively hawkish tone, Chair Powell struck a slightly more dovish note in the subsequent press conference. The Fed also emphasized a cautious stance amid uncertainties surrounding the new administration’s trade and immigration policies, signalling that it wants to keep its options open for now. Market continues to expect only a 50bps rate cut by the Fed this year.
The European Central Bank (ECB) reduced interest rates by 25bps in January, in line with expectations. Amid sluggish economic growth, the ECB remains focused on supporting the economy. However, inflation in the euro area rose to 2.4% in December 2024, potentially complicating its policy stance. Additionally, rising bond yields despite the rate cuts could undermine efforts to ease credit conditions. As a result, there are growing calls for fiscal policy support to complement the ECB’s actions.
The Bank of Japan (BOJ) raised interest rates to 0.5% from 0.25%, signalling confidence that wage growth and reflation in Japan will be sustained. This marks the highest interest rate since the 2008 financial crisis. The BOJ is expected to continue raising rates throughout the year, which could support the Japanese Yen against the U.S. dollar.
Global Market Update
Global markets rallied in the first week following the new administration’s inauguration, with U.S. bond yields falling, the dollar weakening, and equities rising, all amid the absence of tariff announcements. However, equity markets tumbled as investors grew concerned about Deepseek’s disruption of the global AI landscape. With the initiation of the tariff war, we will observe how markets respond in coming weeks.
Source: Bloomberg, Sanctum Wealth; Above returns are price returns in local currency terms
Deepseek, a Chinese startup backed by the hedge fund High-Flyer, launched foundational AI models nearly on par with those from U.S. giants like OpenAI, Meta, and Google, but at a fraction of the cost and without access to the latest Nvidia chips. Deepseek’s models triggered a sharp decline in key AI companies’ stock prices. Nvidia has dropped nearly 20% from its peak, while other companies, including Broadcom, Microsoft, and Micron, also saw significant losses.
While China may still face some challenges in keeping up with continuous AI innovation, it shifts the global focus toward cost efficiency and suggests that China may not be far behind the U.S. in the AI race, despite lacking access to the best chips. This also casts doubt on the “wide moat” of some U.S. AI giants and challenges their high valuations, which are based on expectations of very strong earnings growth in the coming years.
While more cost-effective models may pace of market growth for chips, power and data centres, they could drive higher AI adoption by businesses for end-use applications. This could expand the overall AI market. Thus, disruptions like Deepseek may reshape the AI industry, but the market itself may continue growing.
In the coming weeks, the focus on global markets is expected to shift toward tariffs. Investors should prepare for volatility, as escalating tit-for-tat measures could trigger sharp market reactions. A prudent global investment strategy may involve staying diversified across regions and sectors, increasing allocations to gold and bonds, and avoiding large, concentrated bets.
India Macro Update
In recent budgets, the government has prioritized infrastructure and manufacturing by significantly increasing capital expenditure. However, the FY2026 Union Budget shifted focus toward supporting consumption. The reduction in personal income tax benefits salaried urban taxpayers, with individuals earning INR 12 lakhs saving approximately INR 80,000—roughly 6.5% of their disposable income. The government estimates an additional INR 1 lakh crore in income for the Indian middle class, benefiting more than 2.5 to 3 crore people. This is expected to provide much-needed support for urban consumption. However, it is important to note that household leverage is at an all-time high of approximately 42% of GDP, and a portion of these savings may be used for deleveraging.
Source: Budget Documents
The government also provided incremental support to the rural economy and MSMEs. It expanded the coverage of Kisan Credit Cards and introduced measures to boost the production of key pulses, among other policies. These initiatives are expected to aid the recovery of rural demand. Additionally, the redefinition of MSMEs to include more companies and enhanced credit access further supports the MSME sector.
The government set a fiscal deficit target of 4.4% for FY2026, slightly lower than the expected 4.5% and the FY2025 revised estimate (RE) of 4.8%. This reduction primarily stems from a lower capital expenditure budget of INR 11.2 lakh crores. While this is a 10% increase over FY2025RE, the compound annual growth rate (CAGR) from FY2024 is only about 8.7%, which is below nominal GDP growth. Additionally, the figure fell short of the market expectation of around INR 12 lakh crores.
Source: Budget Documents
Figures in INR Crores
Nominal GDP growth for FY2026 is projected at 10.1%, higher than the FY2025 budget estimate (BE) of 9.6% and economist expectations of 9.3-9.5%. Corporate tax growth is estimated at 10.4% in FY2026, compared to 7.6% in FY2025RE, while personal income tax is expected to grow by 14.4%. These estimates are somewhat on the higher side, leaving room for potential disappointment.
The government also signalled steps to improve the ease of doing business. The finance minister announced the formation of a high-level expert committee to review regulations, certifications, licenses, and permissions in the non-financial sector. The economic survey underscored the urgent need for significant reforms, particularly to free the economy from the constraints of over-regulation.
Additionally, relaxations and extensions of tax concessions for the IFSC GIFT City were announced to promote it as a tax-friendly destination.
The budget outlines the government’s long-term plan rather than focusing solely on the next fiscal year. Overall, we believe the budget strikes a balance between ensuring macro stability and providing support for growth where possible and, more importantly, avoids any negative surprises. The focus will now shift to the RBI’s monetary policy on 07 February 2025, with most expecting a 25bps rate cut and continued liquidity support. The RBI has already been proactive in addressing the liquidity deficit seen earlier. The market will also closely watch the RBI’s stance on supporting the Indian rupee.
Equity Outlook
FIIs continued their selling spree in January, offloading approximately INR 86,000 crs of Indian equities. This marked the second-highest outflow ever, after October 2024. While the Nifty 50 remained relatively flat, mid and small-cap indices saw steeper declines. Pharma stocks were among the biggest losers, while banks, consumer stocks, and IT companies performed relatively better.
Source: Bloomberg, Sanctum Wealth
Above returns are price returns only
Budget day returns as returns for 1st February 2025
We believe the tax breaks outlined in the budget will directly support the recovery of consumption demand, particularly in entry-level and smaller-ticket categories. The automotive sector could benefit, especially two-wheelers, entry-level passenger vehicles, and tractors. Higher discretionary income may also boost consumption-driven industries such as clothing, quick-service restaurants (QSRs), and consumer staples.
Moreover, the extension of the UDAN initiative and additional funding for tourism infrastructure are expected to support the aviation and hospitality sectors.
The Electronics Manufacturing Services (EMS) industry stands to gain from policies supporting electronics and semiconductor production, with certain businesses benefiting from increased Production-Linked Incentive (PLI) funding and exemptions on component custom duties. Agrochemical companies may also benefit from initiatives aimed at boosting farm productivity and supporting the agricultural economy.
Although the capital expenditure budgeted was lower than anticipated, the government continues to focus on infrastructure development, with a particular emphasis on nuclear energy, metro projects, and irrigation. However, valuations of some capital goods and infrastructure companies had become stretched. With the budget signalling a shift away from these sectors, valuations may now normalize.
With the budget behind us, the focus will shift again to corporate earnings. We are more than halfway through the corporate earnings announcement for the quarter ended December 2024. Results so far have been largely in line with modest expectations. Nifty earnings are tracking a 4% y-o-y earnings growth compared to expectations of 5%. However, EPS downgrades continue to outpace upgrades. According to a report by Motilal Oswal Financial Services, EPS downgrades have outpaced upgrades by 4:1. The Nifty EPS for FY26 has seen another 1.2% cut since the start of the earnings season.
The FY2026 Union Budget’s focus on boosting consumption is expected to support a recovery in corporate earnings, but this will likely take time. We may see another one or two quarters of muted earnings. Overall, we view the budget as neutral for Indian equities. Given weak earnings and ongoing global uncertainty, particularly with the onset of a tariff war, we maintain an underweight position in equities for now. We intend to gradually increase our equity exposure in the coming weeks as the earnings outlook becomes clearer. Within equities, we prefer large-cap stocks, as valuations for mid and small-cap stocks, despite recent corrections, still remain high.
Fixed Income Outlook
The gross market borrowing for FY2026 is targeted at INR 14.82 lakh crores, up from INR 14.01 lakh crores in FY2025RE, while net borrowing is set at INR 11.54 lakh crores, compared to INR 11.75 lakh crores in FY2025RE. These borrowing figures are largely in line with expectations. While the GDP and tax growth projections are slightly aggressive, they remain reasonable. As a result, the budget has a neutral impact on Indian bonds. The bond market will now look for guidance from the RBI’s monetary policy. A 25bps rate cut and additional liquidity measures are already priced in, and the market will closely monitor the RBI’s commentary on future rate and liquidity trends.
Overall, we continue to recommend aligning investment horizon with duration. While we are not currently increasing our duration exposure, we also do not recommend exiting it.
Gold Outlook
We remain overweight on gold, as the upward momentum in prices continues. While President Trump is committed to de-escalating geopolitical tensions, the initial phase of the trade war is just beginning. In this environment, gold can serve as a safe haven and a hedge against these emerging risks.
