>INDIA STRATEGY (MERRILL LYNCH)

Growth stimulus vs fiscal deficit improvement

■ Expect 10-15% correction next quarter
Markets tend to correct post-budget with markets giving a positive return a month later in only 4 of the last 11 budgets. The good thing is that expectations of the market from the budget are low. We think the budget will carry forward the reform momentum. However, we believe market correction will be led by (a) expensive valuations at near 17x 1-year forward earnings (b) monsoon fears reversing the recent trend of earnings upgrades and (c) supply of paper.

■ Budget will try to accelerate growth momentum
We expect the Finance Minister to aim ensuring growth is on track with the fiscal deficit remaining at relatively high levels. The Government will direct its limited resources to the rural poor through continuation of measures like Rural Employment Guarantee Scheme and maybe increased subvention on agriculture loans. We expect the Finance Minister to target a fiscal deficit of 6.2-6.5% (actual may end up at 7.2%) for FY10 with $8bn receipts from PSU sale/3G auction.

■ Investment allowance for encouraging capital expenditure
For encouraging infra/capex spend the Government may introduce an “investment
allowance” that provides a 25% tax break on capital expenditure. This will be
financed by increase in tax rates marginally to 35% (from 34%). Gainers will be
high capex companies like Pantaloon, Tata Motors, SAIL, Tata Steel and Sterlite.

■ Tax holidays extended for infra projects/software
1. Extension of tax holiday for infra projects u/s 80IA – gainers Tata Power, Reliance Infra etc
2. Amend Sec 80 IB (9) to confirm tax holiday for gas – Reliance, ONGC
3. Extend tax holiday for software companies – HCL, Tech Mahindra
4. Tax exemption for interest/dividend of infra projects (Sec 10(23G): IDFC
5. Housing loan interest: raise tax exemption limit from Rs150K to Rs250K: HDFC, real estate companies

■ Excise duty – positive CVs; negative ITC, steel, cement
1. Increase excise duty on cement and steel by 400 bps – negative for steel/cement
2. Increase excise duty on cigarettes – negative ITC
3. Reduce excise duty on CVs by 400 bps – positive Tata Motors, Leyland

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