Defence and PSU Stocks Outperform Broader Market Ahead of Union Budget
Defence and public sector undertaking (PSU) stocks have surged significantly, outperforming the broader market as investor sentiment improves in anticipation of the upcoming Union Budget. On Wednesday, these sectors witnessed gains of 5-7%, driven by a combination of supportive triggers and renewed risk appetite.
Key Drivers Behind the Rally
Several factors have contributed to the recent upswing in defence and PSU stocks. Stronger-than-expected earnings from Bharat Electronics Ltd, optimism surrounding domestic defence manufacturing policies, and hopes for announcements on PSU divestment in the FY27 budget have collectively lifted investor confidence. Market experts highlight that sentiment had already improved following the latest EU-India free trade agreement announcement, with the recent market correction creating tactical pre-budget opportunities in select defence and public sector names.
Oil and gas stocks also gained momentum, supported by firmer crude prices and attractive valuations after a period of underperformance. This lent additional support to the broader PSU space, according to analysts.
Fiscal Relevance and Market Performance
Defence and PSU stocks have demonstrated remarkable resilience, outperforming the broader market on expectations of higher defence spending in FY27 and the growing fiscal importance of state-owned enterprises. PSUs play a central role in the government’s fiscal calculus, not only in executing infrastructure and energy investments but also as a key source of non-tax revenue through dividends and surplus transfers.
For FY26, the government projected a 25% year-on-year increase in dividends and profits from central public sector companies to ₹69,000 crore. This underscores their critical role in supporting the fiscal glide path, especially as the government continues to prioritize capital and defence spending while foregoing revenues through GST rationalization and income tax relief.
Between FY21 and FY26, India’s defence budget expanded at a compound annual growth rate of nearly 18%, rising from about ₹3 trillion to ₹6.8 trillion. This sustained ramp-up reflects the government’s post-pandemic push to strengthen domestic manufacturing and security spending amid a more fragile geopolitical environment. Recent tensions, such as last year’s India-Pakistan incidents, have only reinforced this priority.
Selective Rally and Valuation Concerns
Ahead of the Union budget presentation on 1 February, the Nifty 50 has fallen 3% over the past month. In contrast, the Nifty Defence index is up 5%, while the Nifty PSE index has gained 3% during the same period. However, the rally remains highly selective. Mint’s analysis reveals that about 45% of defence stocks and 60% of PSU stocks have lost value over the past month, with gains concentrated in a few large players like Oil India, ONGC, Bharat Electronics, and Coal India.
Valuations partly explain this restraint. The Nifty 50 currently trades at an 18% premium to its long-term average, while the Nifty Defence and Nifty PSE indices command a steeper 26% premium. Beneath the index level, the valuation stretch is widespread, with nearly 70% of defence stocks and around 80% of PSU stocks trading above their long-term averages. Despite improving risk appetite, experts caution that rich valuations and modest earnings growth may cap further budget-day upside in these sectors.
Budget Expectations and Historical Context
Historically, budget expectations have rarely translated into sustained price action. Over the past five years, defence and PSU stocks have delivered mixed returns in the month preceding the budget, with sentiment typically neutral to mildly cautious. Against this backdrop, defence stocks have rallied as markets price in a sharper step-up in defence spending. Brokerages are pencilling in around 13-15% year-on-year rise in defence allocations in FY27, though some economists remain more conservative, expecting a 10-10.5% increase broadly in line with nominal GDP growth.
Market participants are closely watching for measures to strengthen domestic defence manufacturing and exports, such as PLI support for drone manufacturing, smoother customs procedures, and tariff rationalization. Such initiatives could enhance Indian defence companies’ competitiveness and integrate them deeper into global supply chains, particularly as Europe steps up defence spending.
Execution Over Expectations
As budget expectations continue to support defence stocks, experts note that the trade has increasingly shifted towards execution. With most large defence companies already carrying order books stretching six to eight years, incremental budgetary increases are unlikely to materially alter earnings trajectories over the next two years. Instead, execution capacity, delivery timelines, working-capital discipline, and export volumes are becoming the key drivers of performance.
In contrast, PSUs face a more pronounced structural overhang. After a sustained re-rating, valuation headroom has narrowed as earnings momentum has slowed, partly due to a moderation in the government’s capital expenditure push. Budgetary capex grew at an average annual pace of 25% between FY21 and FY24 but slowed to roughly 11% across FY25 and FY26 as fiscal consolidation took priority. PSU capex, as a share of GDP, has fallen from about 2% in the pre-covid period to roughly 1% in recent years and is expected to remain broadly flat into FY27.
Large PSUs like the National Highways Authority of India, Indian Railways, Coal India, and NTPC retain strong balance sheets and enough headroom to step up capex. However, their focus on dividend payouts to the government over growth spending could hinder meaningful valuation upsides. The recent rally in PSU stocks is largely driven by expectations of asset monetization or privatization announcements in the budget, but this pre-budget build-up often fades once actual numbers are announced.
Looking ahead, without a visible improvement in execution, working-capital efficiency, and earnings quality, incremental policy support is unlikely to materially lift PSU valuations. As the budget approaches, investors are advised to balance optimism with caution, considering both the opportunities and constraints in these sectors.
