Budget 2026: Morgan Stanley says stock market sceptical, shares strategy

Morgan Stanley on Friday said the stock market appears to be approaching the Union Budget 2026 with scepticism and could be dealing with both volatility and upside risk post-budget, if history is a guide. It noted that the impact of the Budget on the market has been on a secular decline, albeit actual performance is a function of pre-budget expectations, as measured by market performance ahead of the Budget.

"For the market, the key things to watch are the extent of fiscal consolidation, capex, and sector-level actions. Of particular interest will be capital market reforms to encourage a revival in foreign portfolio flows. We are overweight on financials, consumer discretionary, and industrials," it said.

Morgan Stanley said the expenditure growth is likely to be tilted in favour of capex and social infrastructure related spending. It expects defence sector capex to show higher growth of 12-15 per cent, while core infrastructure capex could grow 8-10 per cent. Overall, the foreign brokerage said the capex may grow around nominal GDP growth of 11 per cent YoY.

"This will keep the productivity dynamics intact, as capex to GDP will likely remain steady at 3.1 per cent in FY27," it said.

Morgan Stanley expects the focus to also remain on social infrastructure such as drinking water, urban infrastructure, etc, along with affordable housing.

"This is imperative in fostering inclusive and sustainable development, through a confluence of social and economic measures, that brings about improved access, availability and affordability," it said.

The report was authored by Morgan Stanley equity strategists Ridham Desai and Nayant Parekh, along with Chief India Economist Upasana Chachra, among others.

Morgan Stanley said measures to deepen financial markets could be undertaken, via improved access to both bank and non-bank sources of funds, so as to improve accessibility and affordability. "Moreover, other banking sector reforms – such as privatising select public sector banks – remain fundamental. Simplification of IPO, FPO, and SME listing procedures and aligning taxation across debt and equity instruments are pivotal to ensure ease of raising capital," it said.

The foreign brokerage said the central government fiscal deficit likely to be set at 4.2 per cent of GDP in F27, corresponding to moderation in debt to 55.1 per cent of GDP.

A focus on capex to help create jobs, targeted social sector spending, and a step up in structural reform momentum are likely to be key themes, it said.

"We expect the government to target the fiscal deficit at 4.2 per cent of GDP in F2027 vs. the target of 4.4 per cent of GDP in F2026. This will likely be the shallowest pace of consolidation since F2023. The pace of consolidation will be consistent with central government debt reduction to 55.1 per cent of GDP from 56.1 per cent in F2026," it said.

Morgan Stanley said a pickup in nominal growth will help to lift tax buoyancy and improve tax collections in F2027, helping the government to prioritise capex and social infrastructure-related spending alongside gradual consolidation.

"As of now, the market appears to be approaching the Budget with scepticism and could be dealing with both volatility and upside risk post-budget, if history is a guide," it said.

On macro strategy, Morgan Stanley said consistent with the path of continued fiscal consolidation, net issuance of G-Secs may to remain broadly stable at Rs 11.6 lakh crore.

"Gross issuance may pick up to Rs 15.8 lakh crore (FY26: Rs 14.8 lakh crore) given the larger amount of redemptions. Our issuance projections are on the lower end of market expectations and could help G-secs rally temporarily if realised, providing an opportunity to pay rates," it said.