Till the second week of February, the Sensex looked all set to surge past 15,000 before the budget. But it has slumped more than 1000 points since then. Why?

The run-up to the budget is always a very exciting time for the stock markets. Expectations of tax rate changes and major policy announcements drive stock prices during this period. Even when expectations are not very high, traders wait for even marginal and inconsequential news flows and speculation to take positions.

The build-up normally starts by early February when the media gets into the pre-budget coverage overdrive. This year was no different and the indices started the month on a very strong note, with the Sensex seeking new record highs every other session. Most analysts and commentators had expected the Sensex to scale 15,000 before the budget.

All these pronouncements and expectations of a massive post-budget rally, like last year, encouraged traders to build up long positions. Just when everybody had bought into this story, the markets changed the script all of a sudden – as usually happens when traders and investors get complacent.

Suddenly, inflation flared up and touched a more than two-year high of 6.73 per cent. The government and the Reserve Bank donned their battle gear and announced a slew of measures to cool the tempos of creeping prices. Some of these measures, like import duty cuts were perceived as being negative for select sectors.

The RBI hiked the reserve ratios even further and most banks went in for interest rate increases. It is now universally accepted that the RBI would hike its key interest rates, maybe even before April when the next scheduled policy meeting takes place.

Cement stocks came in for some rough treatment on fears that the government would not allow further price increases. Cement stocks like Grasim, ACC and Gujarat Ambuja have been the worst affected in this fall, with Grasim losing around 20 per cent.

The rising cost of funds took its toll on banking stocks on fears that credit demand, especially for lucrative consumer loans, would slow down appreciably in the coming quarters. All the frontline banking stocks have lost substantial ground in recent sessions.

Property stocks, till recently the hot favourites, were hit badly. There are stray reports of the likelihood that property prices in some areas may decline this year. Any decline in property prices would significantly erode the valuations of these real estate companies, most of which received such high valuations on the basis of perceived values of land banks. Higher real estate prices and rising interest costs would affect housing demand.

Telecom stocks were the best performers in the market till recently. Bharti Airtel became the third-most valuable company early this year while Reliance Communications was the best performer among all index stocks. Part of this rally was in anticipation of the big-ticket stake sale in Hutch-Essar to Vodafone. Once the big event was over, profit booking set in all the telecom stocks.

Oil marketing stocks had done well in recent months on lower crude oil prices. They started to slip as international oil prices bounced back and the government's decision to cut retail fuel prices once again threatened their balance sheets.

Technology stocks were relatively better off as the outlook for these companies has not changed substantially. The only worry is that the RBI may allow the rupee to appreciate in its fight against inflation. A stronger rupee could affect the margins of technology companies.

Reliance Industries was surprisingly firm throughout this period and the company became the most valuable Indian company with its market capitalisation touching Rs2 lakh crore. The stock was held up by widespread rumours of major announcements from the company.

There is speculation in the markets that that Reliance Industries may hive off its retail division or its upstream oil and gas division as separate companies, which would come out with IPO's over the next year.

Metal stocks were also not much affected during this fall. Markets expect metal prices to firm up this year as raw material prices are showing no signs of a decline and have mostly increased over last year. Some of the metal stocks like Tata Steel were heavily beaten down anyway, even before the market decline started.

How long would this last? Would this fall be as steep as the one we saw during May-June last year?

It is reasonably safe to believe that much of the damage has already been done and the indices are close to their bottom. Much would depend on the budget proposals, and more pertinently, how the market perceives these proposals. Unless finance minister P Chidambaram can pull off another of his 'dream' budgets, the indices may face some more rough weather.

Most analysts and economists expect inflation to decline by April as the monetary and fiscal measures take effect and the rabi (winter) crops hit the market. If that doesn't happen, the interest rate outlook may worsen further and the current valuations of most frontline stocks could appear to begin to be perceived as being stretched.