>INDIA BUDGET (CITI)

5-year Government Agenda vs. 1-year Market Expectations?

■ Budget was expected to translate new government upsides into policy — But the market's 6% drop yesterday reflects a possible mix of: a) Expectations (and stocks) running well ahead of reality, b) A real problem on the fiscal deficit, c) Questions on the government's will to address head-on market friendly issues – divestment, FDI, broad-based reform, and d) Some sector policy and tax pain. In sum, the build-up was belied.

■ The real pain is the fiscal deficit – scale, scope and implications — This had always been an overhang. However, the government now expects it to rise to 6.8% (5.5% in Feb 2009); there is no roadmap to pull it back; it is driven by slack revenues rather than physical asset investments; and fundamentally stresses have already strained finances. This risks crowding out investments, higher interest rates and currency pressure, which do not bode well for investments, economic
growth or the equity markets.

■ And disappointment in text and tone — Market buzz words – divestment, FDI, deregulation, policy initiatives and reform roadmaps – were conspicuously absent. This does not mean that they are off the table. There is scope for policy action outside the budget (and near term), but near-silence on possibly contentious issues suggests caution and is disappointing.

■ Real gain too – rationalisation, direction and a clear agenda — The budget does have a clear and distinct agenda (consistent with its manifesto): sustain growth (continues stimuli) and make it equitable; simplify, rationalise and lower taxes (GST introduction); increase social investments; generate inclusive growth; and provide fiscal flexibility at least in the short term. This is probably the right (though risky) way to go with the government's five-year agenda. The market’s horizon looks clearly shorter than the government's. Should it risk looking farther
out?

■ Real economy should drive the market, stay defensive — We believe the Indian market will trade at a premium to its long-term average (15-16x 1yr fwd P/E) or 13500-14000 levels by December 2009. Sustainable growth provides downside support. Upsides lie in meaningful earnings (EPS growth should moderate 1-3% on budget) or macro upgrades, which we do not see in the near term. We would remain defensively positioned.

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