Indian equity markets are witnessing significant volatility ahead of the Union Budget 2026, as investor focus intensifies on sectors positioned to benefit from sustained government spending and policy continuity. Defence and infrastructure stocks have emerged as leading sectoral preferences, reflecting market expectations for continued public capital expenditure and strategic budget allocations.

Defence Sector Takes Lead in Pre-Budget Positioning

According to a pre-Budget survey of smallcase managers, defence has emerged as the top sectoral bet among market participants. The optimism stems from expectations of higher budget allocations driven by three key factors:

• Indigenisation initiatives promoting domestic manufacturing capabilities
• Military modernisation programs enhancing operational readiness
• Export-led growth strategies expanding India's defence manufacturing footprint

This positioning reflects confidence in the government's continued emphasis on strengthening domestic defence capabilities while reducing import dependence.

Infrastructure Maintains Strong Appeal

Infrastructure follows closely as the second-most favoured sector, underpinned by sustained confidence in the government's development agenda. Market participants expect continued momentum across multiple infrastructure verticals:

The sector's appeal stems from its role in supporting long-term economic growth through sustained capital deployment and job creation.

Capex Themes Dominate Portfolio Strategies

The survey highlighted that market participants continue to favour capital expenditure-led investment themes. Manufacturing has also attracted significant attention, with expectations of continued policy support through production-linked incentive schemes. This preference aligns with the government's focus on structural growth sectors over broad-based fiscal stimulus.

In contrast, consumption and agriculture sectors are expected to benefit from more targeted policy measures rather than comprehensive spending programs, consistent with the administration's emphasis on fiscal discipline.

Market Outlook and Volatility Expectations

While optimism for structural growth sectors remains intact, market participants anticipate short-term volatility around the Budget announcement. This expected turbulence is attributed to event-based positioning and potential policy surprises that typically accompany major fiscal announcements.

However, the consensus view suggests such volatility will likely prove temporary, with markets expected to revert to fundamental drivers including earnings growth, liquidity conditions, and macroeconomic stability in the weeks following the Budget.

Medium-Term Projections Show Confidence

Reflecting underlying confidence in India's equity markets, smallcase managers project the Nifty 50 to close FY26-27 above the 25,000 mark. A significant proportion of respondents forecast levels well beyond 27,500, underscoring a constructive outlook for Indian equities over the medium term.

Macro expectations also remain supportive, with a majority of managers forecasting inflation in the 4-5% range for FY27. This benign inflation outlook reinforces expectations for policy continuity and provides fiscal space for maintaining capital expenditure focus without compromising stability.

"As managers anticipate volatility around the Budget but remain confident about the medium-term trajectory, smallcase continues to offer a structured way for investors to participate in these themes with clarity and discipline," said Vasanth Kamath, Founder & CEO, smallcase.

The Indian financial markets faced significant pressure this week as the rupee touched a historic low and equity indices posted their steepest weekly decline in four months. The developments prompted intervention measures from the Reserve Bank of India to stabilize market conditions.

Rupee Touches All-Time Low

The Indian rupee fell to an all-time low of 91.93 against the US dollar on January 23, continuing its downward trajectory despite brief recovery attempts. Strong dollar demand from corporates and importers weighed heavily on the currency, pushing it dangerously close to the 92-mark even as global risk sentiment showed some improvement.

Equity Markets Post Worst Weekly Performance

BSE Sensex and NSE Nifty concluded their worst week in four months, with widespread selling pressure affecting investor sentiment. The benchmark indices experienced significant declines, with BSE-listed companies shedding an additional ₹16 lakh crore in market capitalization during the week. Overall market losses reached ₹15 lakh crore as Adani Group stocks led the decline, while the Nifty barely managed to stay above the 25,000 level.

RBI Announces Major Liquidity Support

Recognizing the market stress, the Reserve Bank of India stepped in with substantial liquidity measures. The central bank announced over ₹2 lakh crore of injections through bond auctions and scheduled a $10 billion forex swap for February 4 to provide market support.

Mixed Corporate Earnings Results

The third quarter earnings season presented contrasting performances across sectors:

Cipla reported disappointing results with EBITDA falling to ₹1,255 crore compared to ₹1,989 crore in the previous year, representing a 36.7% drop. The performance fell well below the CNBC-TV18 poll estimate of ₹1,696 crore, leading to a stock decline of over 4% as US sales narrowed and margins were impacted.

IndusInd Bank showed improved quarterly performance, posting a net profit of ₹128 crore, significantly higher than the CNBC-TV18 poll estimate of ₹42 crore. However, on a year-on-year basis, profit declined 90% from ₹1,402 crore due to elevated provisioning, though the bank's Net Interest Income topped estimates and NPAs remained stable.

International Developments

Several significant international developments impacted market sentiment during the week. A 90-member EU delegation arrived in India to advance long-pending Free Trade Agreement negotiations, even as the EU withdrew export benefits on a substantial portion of Indian shipments. Bank of America's CEO expressed bullish views on both Indian and US economic prospects, while TikTok finalized a joint venture agreement for its American operations to address regulatory concerns.