Between the time the finance minister announced the fiscal deficit target of 5.5% for fiscal year 2010-11 and the time the budget speech ended, the Nifty index on the National Stock Exchange rose by about 2.3% and it looked like markets were pleased with the Budget.
But by the end of the day’s trading, the markets gave up nearly two-thirds of those gains and ended only about 1% higher. This is a rather subdued reaction, especially coming on the back of an 8% drop in the Nifty since mid-January.
The markets’ attention was almost entirely focused on the fiscal deficit target for 2010-11 and the estimate of the government’s borrowing. The fiscal deficit target was exactly in line with market expectations and matched the level of deficit indicated in the medium-term fiscal policy statement last year. Besides, the finance minister also laid a road map for further reductions in the fiscal deficit in the next two years. All this is encouraging, given the markets’ recent concern about India’s high deficit and borrowing programme. For 2010-11, the net borrowing is estimated to be Rs3.45 trillion, in line with market estimates.
What’s more, the government has targeted raising Rs40,000 crore from divesting stake in state-run firms next year, higher than the Rs25,000 crore it plans to raise this year. While it has initiated a withdrawal of its stimulus measures, it’s in a gradual manner and one that the markets were already expecting. A two percentage point increase in excise rates was already factored in share prices, and the decision to retain service tax rates at 10% is a marginally positive surprise. The relaxation in income-tax rates for individuals will push consumption demand and benefit sectors such as auto and consumer goods.
Infrastructure spend, too, is being increased by the government and this sector will also benefit from an additional tax exemption for infrastructure bonds. The financial services and banking sector will benefit from curtailment in the net borrowing programme, apart from the plan to allow more private competition in the sector. There was the usual farm spending push which would benefit companies catering to the rural segment. There were also specific sops for companies involved in clean energy such as Suzlon Energy Ltd.
One of the negatives in the Budget speech was the increase in the minimum alternate tax (MAT) rate from 15% to 18%. For MAT-paying companies such as Reliance Industries Ltd, this would result in a drop of about 3% in earnings after adjusting for the marginal reduction in corporate tax surcharge from 10% to 7.5%. Companies in the infrastructure space would be affected largely by the increase in the MAT rate. For companies that pay a full tax rate, there will be an increase of about 1% in earnings due to the reduction in corporate tax surcharge.
In this largely positive backdrop, the pertinent question is why the markets gave up most of the gains after the Budget speech ended. A reason, according to experts, is that the government’s expenditure targets are conservative. For instance, the government hasn’t budgeted for any subsidy share to be paid to oil companies for the next year, compared with a net outgo of Rs12,000 crore this year. This can’t happen unless the Kirit Parikh committee recommendations are implemented soon. But again, the fact that the finance minister has chosen to increase duties and excise rates on petroleum products suggests that it may be a while before the committee’s suggestions are implemented.
Retail boost: A good news for retailers is that the Budget will put more cash in the hands of individuals. Parth Sanyal/Reuters
Similarly, achieving the disinvestment target of Rs40,000 crore would depend on the state of the markets next year. Given some of these uncertainties, the concern is that government may overshoot the fiscal deficit target.
Of course, the markets’ reaction also needs to be seen in the light of the fact that the global markets have been subdued lately. While the Budget has taken away some of the concerns specific to India, global concerns remain and the market direction in the near term would depend on how these shape up.
Investors in auto stocks heaved a big sigh of relief after the finance minister announced that the increase in excise rates would be limited to 2%. This had already been factored into auto share prices. There was a concern that excise rates on diesel multi-utility vehicles will be raised even higher, based on a recommendation by the Parikh committee. This didn’t happen, leading to a rally in Mahindra and Mahindra Ltd’s shares. Auto makers will also benefit from the increase in disposable incomes.
Capital goods and engineering
Shares of Bharat Heavy Electricals Ltd fell despite the thrust on infrastructure spending and the broad rise in markets. It was because the markets’ expectation of a hike in customs duty to thwart Chinese competitors didn’t come through. Shares of Larsen and Toubro Ltd rose, thanks to the increase in infrastructure spend.
The hike in excise duty on cement from 8% to 10% was not a surprise for the sector and would mean an increase of around Rs4-5 per bag of cement. According to most analysts, companies will be able to pass on the hike. At worst, there will be a marginal impact on margins if the hike is not passed on entirely. The sector will also get affected by the introduction of a Rs50 a tonne cess on coal and an unanticipated hike in duties on diesel and petrol. This will increase freight costs.
Still, cement shares were either flat or rose marginally, indicating that the excise hike was largely expected. Besides, the sector should also benefit from the increased outlay for infrastructure spending.
ITC Ltd’s shares were among the worst hit after the Budget speech. But the market reaction seems overdone. For one, the Budget has actually reduced the excise duty on cigarettes up to 60mm length for both filter and non-filter cigarettes by 18%. A key demand of ITC for a special tax slab for smaller cigarettes has been met. But duties on cigarettes in the 60-70mm category have been hiked by 18% and for others by 11%. The quantum is not high. In the past, ITC has passed on excise hikes to customers with no real effect on demand, except when it coincided with a recessionary period.
Personal and home care products
While the 2 percentage point hike in excise duties was on expected lines, it comes in the backdrop of slowing demand in 2009-10. Companies have either cut prices or are offering volume discounts to spur demand. They would thus prefer to absorb higher excise duties in mass market categories such as soaps and detergents while hiking prices in less price-sensitive categories such as cosmetics. This will result in a marginal affect in profit margins of companies in this space. The hike in MAT will affect earnings of companies with manufacturing concentrated in tax-exempt locations.
The Budget will put more cash in the hands of individuals, inducing them to spend more. This is good news for retailers. But one amendment will sour the good feeling. Retail organizations had challenged the imposition of service tax on rentals in court and got a favourable judgement, which disallowed the tax. A retrospective amendment has been proposed, by which the activity of renting itself has been classified as a taxable service.
This will be with effect from 1 June 2007 and may involve retail companies having to pay back taxes. Also, the cost of doing business will increase for all retailers, as rentals contribute to a significant portion of costs.
Graphic: Ahmed Raza Khan/Mint
Pharmaceutical companies doing in-house research will benefit from the Budget proposal to increase weighted deduction on research and development expenditure increased from 150% to 200%. Indian pharma firms have become more conservative with their research budgets, especially on the new drug discovery front. That is driven more by business considerations and a higher deduction is unlikely to change that. However, research in other fields, including bulk and generic drugs, will benefit from this move. However, the hike in MAT will see the post-tax profits of companies such as Cipla Ltd getting affected.
Oil and gas
That government chose to increase customs duty on petroleum products and would charge an excise duty on petrol and diesel is being seen as an indication that the Parikh committee’s recommendations may be implemented with some delay. This is reflected in the share price of Bharat Petroleum Corp. Ltd, which fell by 1.3% on Friday.
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