>Tightening ties: Asian oil demand and pragmatism at crux of Saudi-Indian relations

■ Saudi exports to India rise seven-fold, imports jump six-fold between 2000 and 2008, with trade balance consistently favouring the kingdom

■ India’s geographic dependence on Saudi oil likely to grow in coming years as it seeks energy security to support economic growth plans

■ Prime Minister Manmohan Singh set to make first official visit by an Indian PM to Saudi Arabia in 28 years as two states strive to deepen economic and diplomatic ties

The trading relationship between Saudi Arabia and India is among the most-strategic bilateral

bonds for either country. As India’s largest supplier of crude oil, Saudi Arabia is favourably

positioned to benefit from burgeoning demand for energy in Asia’s third-largest economy, set

to experience annual economic growth rates of 7-8% for the foreseeable future. The balance

of trade between the two states has consistently swung in favour of kingdom, its trade surplus

standing at SR67.3 billion in 2008, up almost seven-fold from 2000 levels.

For India, Saudi Arabia comes fourth after China, the United States and the United Arab Emirates as its most-important trading partner. Saudi imports of Indian goods stood at SR18 billion in 2008, marking an almost six-fold rise from 2000, according to data of the Saudi Arabian Monetary Agency (SAMA). That positioned India as the sixth-largest source of Saudi imports, accounting for 12.4% of the kingdom’s total imports from Asia in 2008.

India’s geographic dependence on Gulf oil is likely to become amplified in the coming years due to limited prospects for enhancing domestic energy production. Common interests in supporting peace and promoting security in the region, as well as building counter-terrorism measures, form a pivotal part of the bilateral relationship, which has become strengthened in the recent past due to Iran’s nuclear ambitions. Indian interests in the Gulf Arab region are perceived as more important than its interests with Iran.

Aside from trade, Saudi Arabia is a major source of income for India as a result of workers remittances. Foreign workers accounted for 27% of Saudi Arabia’s population of 25 million in 2008 – and Indians form the kingdom’s largest expatriate workforce, working in fields from information technology to construction, with most employed as blue-collar workers. Given this varied web of economic and diplomatic interests, we regard Indian Prime Minister Manmohan Singh’s historic visit to Saudi Arabia this month as decisive to deepening ties between two countries poised to take a greater role in the world economy.

Revived relations

The importance of long-standing trading ties between Saudi Arabia and India has become pronounced this decade, with India’s share of total Saudi exports and imports gaining ground since 1990. In 2008, India accounted for 7.3% of total Saudi exports, compared with 2.5% in 1990, SAMA data show. Over the same period, the ratio of Saudi imports from India rose to 4.2% from 1.1%.

The two countries have worked to improve bilateral ties since the 1990s, prior to which time their relationship was constrained by Cold War politics and Saudi Arabia’s support for Pakistan. Saudi Arabia and India had established diplomatic ties shortly after the latter’s independence in 1947. But during the Cold War period, Indian-Saudi relations were confined to energy and labour as a result of India’s proximate ties with the Soviet Union and Saudi Arabia’s close links with the United States. Meanwhile, Saudi Arabia supported Pakistan during the Kashmir conflict and the

Indo-Pakistani War of 1971, further denting its relations with India.

To read the full report: TIGHTENING TIES

>Union Budget Analysis: 2010-11 (HDFC SECURITIES)

We had said in our Pre-Budget note dated February 23, 2010

“Knowing the way the Indian polity works (in a measured manner and if possible by consensus, unless the situation is catastrophic like in 1991), people on the street have little expectations from the Budget. This makes us believe that the initial market reaction to the Budget would be positive, though a few days later our markets could fall in line with the global markets in terms of direction …..

Critical issues like labor reforms, pension reforms, subsidies, etc may need broader political consensus. We expect material developments on the same, if any, to be outside the budget….

In our view, the significant reduction in deficit, if carried out, will be a positive for government bonds and for the equity market. A lower deficit will help the INR, which we expect will appreciate going forward…..

For the common man, we expect that Finance Minister may raise the exemption limit in personal income tax, or the investment limit Under Sec. 80C or reintroduce standard deduction for salaried people. “

Most of these have come true and the market reacted positively to the Budget. The FM has positively surprised the common man on the street by bringing down his personal tax outflow and providing one more avenue to him to save tax.

As far as the corporate sector is concerned, while the general excise duty rate has been rolled back from 8% to 10%, goods attracting tax at higher rates have escaped this rollback. Further service tax has also not been rolled back. These reliefs have been partly offset by a hike in the MAT rate from 15% to 18% (though surcharge has been cut from 10% to 7.5%).

On the macro front, the FM has impressed by bring down the FY10 fiscal deficit to 6.9% (from 7.8% in FY09) and has laid the roadmap to bring it down further to 4.1% over the next three years. (5.5% in FY11, 4.8% in FY12 and 4.1% in FY13). Even accounting for some possible slippages due to external factors, if these numbers are achieved, it would be a significant achievement. Raising Rs.36,000 cr by way of 3G Auction and spectrum usage charges and raising Rs. 40,000 cr (vs Rs.25,958 cr in FY10) by way of divestment in FY11 could be crucial to achieving this number in FY11.

The FM has assumed a nominal GDP growth of 11.3% in FY11 to Rs.69,12,800 cr (almost equal to 11.5% growth expected in FY10). This number seems achievable as things stand now. However his assumptions on growth in customs duty (up 36.1%) and in excise duty (up 29.4%) seem a little tough despite the fact that the increase in excise duty and customs duty on crude oil and petro products could bring in a big part of these incremental revenues. There is a lower allocation for the petroleum sector (from Rs.25,300 cr to Rs.3,217 cr) suggesting that the Govt is not expecting subsidy payments to be high based on assumptions of softer crude and downstream prices and/or implementation of Kirit Parikh committee report shifting the burden to consumers.

In terms of sectors, allocation to water supply and sanitation, agri research and education, agri financial institutions have been hiked. However allocation for social security and welfare and rural employment has either been flat or has fallen thereby suggesting that there is a churn in the schemes with some schemes seeing a rise in allocation while some others have seen a cut. A number of reliefs (excise, customs and service tax) have been provided on equipments used in agriculture use (including storage, preservation and transport of agri produce). Further central plan allocation has been hiked substantially for Coal, Steel, Power, School education and literacy and higher education.

Inflation could take time to come down in view of the rise in the excise duties on petro products, levying of clean energy cess on coal, lignite and peat, increase in excise duty on cement, rollback in excise duty from 8% to 10%, removing exemption of service tax on transport by rail, extending service tax to all domestic and international air passengers.

A lower projected fiscal deficit has an impact on reducing the net borrowings of the Govt from the market to Rs.345010 cr in FY11(E) vs Rs.398411 cr in FY10(E). Though more or less on expected lines, this is welcome as it could result in softening of interest rates and stop crowding out the private players from the debt market.

Overall we feel that the FM has done a decent job of consolidating social schemes, putting more money in the hands of consumers, refraining from tinkering too much with the direct and indirect taxes till the DTC and GST codes are implemented. Managing or bringing down inflation could continue to remain an issue due to the reasons mentioned above. A normal monsoon this year hence becomes even more important.

To read the full report: BUDGET ANALYSIS

>THERMAX: Settles pending legal dispute with Purolite (SHAREKHAN)

■ Thermax settles pending legal dispute

Thermax has entered into amicable settlement with Purolite International (Purolite) ending a five-year-long legal dispute regarding its ion exchange resin business in USA. The settlement is for a lawsuit filed by Purolite in the Eastern District Court of Pennsylvania, USA in 2005. Attached below is the series of events related to the litigation. As per the out-of-court settlement, Thermax will pay Purolite four installments of USD9.5 million each spread over calendar year 2010 to settle the litigation. The two parties will now be joint co-owners in perpetuity of the information and technology in dispute. The agreement permanently resolves all claims and counter claims.

■ One-time expense of Rs175.7 crore—a negative surprise

Though there will be one-time extraordinary expense of Rs43.9 crore in Q4FY2010 and Rs131.8 crore in FY2011 assuming an exchange rate of Rs46.23/USD, it is a long-term positive given the uncertainties associated with jury trials as well as cost and time. Now, the company will also be joint co-owners in perpetuity of the information and technology involved in ion exchange resin business, which is another positive. The management has also confirmed that there will be no further financial obligation on this account in the form of royalty.

■ Outlook remains intact, maintain Hold

We continue to remain positive on Thermax’ long-term business prospects and its possible entry into super critical boiler business in the near term. Nonetheless, the quantum of settlement charges has surprised us negatively. The management has however indicated that there are no more litigations of such nature in the offing. Hence, we maintain our adjusted earnings estimates at Rs22.7 for FY2010 and Rs29.7 for FY2011. At the current levels, the stock is trading at 21.3x FY2011 earnings per share (EPS) and 17.3x FY2012 EPS. We maintain our Hold recommendation on the stock with a price target of Rs662.

To read the full report: THERMAX

>CEMENT SECTOR: Demand strong but price headwinds imminent (RELIGARE SECURITIES)

Cement dispatches have been robust in H2FY10 on account of higher government expenditure on infrastructure and steady rural consumption. We expect demand to hold firm, particularly in India’s northern market, with a growth of over 10% in the next two years. On the flip side, our analysis suggests that cement overcapacity is imminent in the medium term. This together with rising coal and freight costs signals a challenging road ahead in FY11. With the southern market at greatest risk of a supply glut, we maintain our preference for north-based players like Grasim Industries, Jaiprakash Associates and Shree Cement.

Mid caps register strong volume growth in Jan: Mid cap companies in the RHH cement universe led the way in terms of dispatch growth for January ’10. While India Cements’ volumes grew 30% YoY, JK Lakshmi Cement registered an increase of 27%. Orient Paper, Shree Cement and Birla Corp also logged strong growth rates of 20%, 18%, and 16% YoY respectively. Mangalam Cement was the only player in our universe to witness a decline, with volumes slipping 16% YoY due to a five-day maintenance shutdown at its plant.

Amongst large caps, the Aditya Birla group (Grasim and UltraTech) continued to outpace Holcim (ACC and Ambuja Cement). YTD, Shree Cement and Grasim were in the lead with volumes rising 24% and 20% respectively.

Demand to grow at 10%+ for next two years: With cement dispatches picking up over the last three months, we expect to close FY10 with demand growth of over 11%. Further, with the sustained government thrust on infrastructure spending and a revival in the real estate sector, demand for cement could exceed the traditional correlation range of 1.2–1.3x GDP to touch 1.4–1.45x in FY11 and FY12.

Price recovery in Q4 may be short-lived: After declining by Rs 15–80/bag in Q3FY10, cement prices have partially recovered (in the range of Rs 10–40/bag) on account of buoyant demand and logistics-related supply shortages. The price hikes have been spread across regions, barring the south. However, with a large quantum of fresh capacities set to be commissioned in FY11 (30mn tonnes), we expect pricing power to deteriorate post May’10.

Likely rollback of excise cut: Budget 2010 is likely to see a rollback of the excise duty cut from 8% to 10%. Railway freight could also increase. We believe cement players will pass on the duty hike by raising prices in the near term. Over the longer term, however, cost rationalisation will be the key to preserving profitability.

FY11 a testing time – S. India most vulnerable: We believe FY11 will be a difficult year for the industry as the risk of oversupply looms large. The southern market would be the hardest hit as a bulk of the planned capacities will be commissioned here (53% and 23% of all-India fresh capacity in FY10 and FY11 respectively). This coupled with a demand slowdown due to political turmoil in Andhra Pradesh (AP) makes it the most vulnerable to pricing headwinds. While the northern, central and eastern markets will also face pressures brought on by capacity expansion, buoyant demand in these regions is likely to mitigate the supply glut.

All roads head north: For the next six months at least, cement will continue to be a regional play. While demand remains strong in the north, the central and eastern areas are seeing the highest price hikes. We remain bullish on select companies based in these regions, namely Grasim, Jaiprakash Associates and Shree Cement in the large cap space and Birla Corp, JK Lakshmi and Mangalam Cement in mid caps. On the other hand, as the south moves into an oversupply phase and the troubled state of AP continues to weigh down demand, we remain bearish on India Cements.

To read the full report: CEMENT SECTOR

>Uncertainty prevails - Budget reconciliation is the best way forward

President Obama's efforts to converge the Democrats and Republicans on a common plane with respect to Healthcare Reform through a televised healthcare summit held on February 25, 2010 have failed. The Senate Bill with amendments suggested by President Obama was discussed in detail for over seven hours. No headway was made; and it is now clear that the difference in views held by the Democrats and Republicans is too profound to be bridged. Presently, a great deal of uncertainty prevails on passage of the bill. Some major areas wherein Republicans do not appear to agree with Democrats:

■ Inclusion of new people: Republicans do not like the idea of forcefully inducting so many new people in insurance programs, as this would increase healthcare expenses and customers will not get the quality of healthcare they should

■ Increase in taxes: The healthcare spending increase would be funded through taxes at this point in time. Addition of more people could lead to newer taxes and surcharges and will result in increasing out-of-pocket expenses for the Americans

■ Reduction in Medicare spending: Any reduction in Medicare spend will lead to reduced quality of healthcare for the elderly and also result in doctors opting out of the programs, further impacting quality of healthcare

■ Overall increase in healthcare spend: Republicans strongly believe that the proposed healthcare bill will lead to a rise in overall healthcare spending for the US and not serve the primary objective of reducing healthcare expenses

■ Scrap, start all over: Republicans have been critical of the proposed bill and opine that the existing bill is scrapped and reforms are started all over.

Budget reconciliation is the best way forward

Debate over the reforms appears to be 'political posturing' by both parties and each side is firm about their respective ideology. Despite strong opposition from the Republicans, Democrats are not inclined to start the reforms all over. They have set a deadline for passing the reform bill in the next 4-6 weeks. This implies that the only way forward is to opt for the 'Budget Reconciliation' procedure whereby some changes to the already approved Senate Bill can be made and approved by the Senate through a simple majority (51 votes out of 100). The House would also pass the reconciled bill, along with the original Senate bill.

Impact on Indian Generics

Overall, the Senate bill with amendments suggested by President Obama is extremely positive for Indian companies. If President Obama is able to pass the Healthcare Reform Bill through the Reconciliation procedure, Indian generic drug makers could gain as we have discussed in our previous notes on US Healthcare Reforms.

To read the full report: BUDGET RECONCILIATION