>EQUITY STRATEGY (NOMURA)

Beware of slowdown in govt expenses

The strength of the fiscal stimulus in the second half of FY09 has been a key reason for demand in several sectors to move ahead of growth consistent with the current level of GDP growth and investment activity. While the fiscal stimulus should continue, the amount of expenditure is unsustainable in light of the elevated levels in 2H FY09. We believe demand in sectors such as cement, steel and twowheelers would have benefitted significantly from the stimulus and pre-election spending. Our economist, Sonal Varma, forecasts a slowdown in this spending and expects a 10.3% combined fiscal deficit in FY10. We believe that demand for cement, two-wheelers and steel could see some slowdown as expenditure growth cools off. We would advise investors to reduce weightings specifically in the cement and two-wheeler sectors.

■ We believe central government expenditure would have likely grown 35% y-y in FY09 and 42% y-y in the second half, as enhanced spending came into play. This is based on government numbers from April 2008 to February 2009 and our estimates for March 2009 We believe that demand strength in sectors such as two-wheelers, cement and steel, despite relatively weaker economic growth and investment cycle, is a direct result of this stimulus.

■ Given the weakness in revenues, we expect growth in government expenditure to start to fall. Our economist projects expenditure to grow 25% in 1H FY10 and then decline 2% in 2H FY10, bringing the full-year FY10 expenditure growth to 9.1% y-y, ahead of the government’s estimate of 5.8% y-y. We continue to assume large fiscal slippages and believe spending numbers are unlikely to be higher than our estimates, since a higher stimulus is likely to be harmful from a long-term fiscal perspective. Thus, there is little scope to be more positive than this on the government’s ability to stimulate the economy, in our view.

■ While there is likely to be a gradual pick-up in activity and demand from households and the private sector, this might not fully offset the slowdown in government expenditure. The impact of lower government expenditure should begin to be felt in the second half of FY10.

■ There has been a broad rally in the markets based on the green shoots of recovery. While not denying the structural growth resilience of economy, we note that expectations in some sectors have run ahead of fundamentals based on the demand pick-up. We advise caution in these sectors, the key ones being cement and two-wheelers.

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