>Union budget FY11: Macro and sector impact (CLSA)

Well balanced
■ We went into the FY11 Budget looking for one key message – that fiscal consolidation would be a prime objective for the government. In that sense, the Finance Minister has done well; expenditure is being reined in and partial unwinding of the fiscal stimulus has happened, which will leading to a 1.4ppt reduction in the fiscal deficit targeted for FY11, at 5.5% of GDP. There is, no doubt, a greater reliance on non-tax revenues, including disinvestment/3G auction receipts, but we see other ‘politically difficult’ steps like the increase in fuel prices, following the hike in urea prices a week ago, as indications that the government will be serious about taking bolder moves on these fronts. There were positive signals on continuing with rationalisation of taxes as well.

■ The government is targeting a 20% rise in tax revenue, which we believe is fairly realistic, given the rebound in the economy (and consequently the visible buoyancy in consumer spending and corporate profits), the 2ppt hike in excise duties and the surprise moves to levy a 5ppt import tariff on crude oil and hikes excise duty on petrol/diesel. On expenditure, the government has, as we hoped, reined in subsidies and growth in non-plan spending, helped by the relief from one-offs like the Pay Commission related arrear payments and the fact that social development schemes like NREGA have achieved critical mass; on the other hand, outlays on key infrastructure sectors like roads have continued to go up. The Rs400bn budgeted from disinvestment is a stretch, but with +Rs250bn set to be achieved in FY10, we believe the risk of gross slippage is not high.

■ The changes in corporate tax/income tax and the fix on the service tax rate suggest that the FM is pushing for rollout of the GST regime and the new Direct tax Code by FY12, as indicated in his Budget speech. The announcements on establishing an apex regulator for financial sector, licences for new private banks, a regulator for the coal sector and the decision to restrict payment of oil subsidy to cash (rather than oil bonds) are all positive steps, in our view. Follow through will be important, though.

■ The moves towards fiscal consolidation will help sustain confidence in the Indian growth story, particularly because a pick-up in the investment cycle is critical for acceleration in GDP growth to c.8.5% and further earnings upgrade (from forecast +25% Sensex EPS growth) in FY11. We are positive on capital goods plays like BHEL, L&T, private Banks like ICICI and O-WT materials as well. However, 1H will be choppy for equity markets, given weak global markets, the large domestic equity pipeline and continued monetary tightening by the RBI; inflation pressures remain high and some of the Budget provisions (hikes in fuel prices, enhanced thresholds for income tax slabs, service tax on air/rail freight services) will further add to headline WPI inflation.

■ Sectors negatively impacted by the Budget are Oil & Gas (3ppt rise in MAT rate will see 2.5% EPS cut for Reliance, squeeze in margins for refiners IOC, BPCL, HPCL), Consumers, especially ITC (where excise duty was up by a higher than expected 15%), Telecoms (based on MAT rate increase). On the other hand, the Pharma sector will gain from higher tax incentives for R&D, Autos will benefit from the unexpected tax breaks on personal income.

What surprised … and what disappointed (see detail in report)

To read the full report: UNION BUDGET