Friday, March 2, 2012

>INDIA STRATEGY: Budget 2012 impact on sectors at a glance

Now for the hard work. The recent sharp rally in the Indian stock market largely factors expectations of improved governance (fiscal consolidation, structural reforms) but there is little concrete evidence so far. The FY2013 Union Budget will be the first test of the Government’s willingness and ability to meet the market’s lofty expectations. We expect the Government to set the FY2013 GFD/GDP target at 4.7% with underprovisioning for fuel subsidies; we estimate 5.4% under more realistic assumptions. We have increased the concentration of high-quality names in our Model Portfolio; we have very little exposure to high-beta names now.

■ Model Portfolio: High concentration of high-quality stocks notwithstanding global liquidity
We find most high quality large-cap stocks offering 8-15% potential upside to, or trading at, our
FY2013E fair valuations. We expect moderate improvement in India’s macro-environment over the next 12 months but higher-than-expected crude prices may derail the recovery. Very high global liquidity has already pushed crude oil prices beyond India’s comfort zone. High crude oil prices will result in (1) high subsidies and fiscal deficit, (2) large CAD and (3) high inflation, which may limit the RBI’s ability to reduce policy (interest) rates.

■ Fiscal consolidation, though positive, is unlikely to be painless
The rally in the Indian stock market derives its strength from expectations of improvement in governance, including fiscal consolidation. Fiscal consolidation would be positive indeed, but is also likely to be painful. Fiscal consolidation can take place either through (1) higher revenues (increase in excise and service tax rates) and/or (2) lower expenditure, primarily reduction in fuel subsidies (increase in fuel prices). The ongoing global liquidity-driven rally in commodities, notably crude oil, will further weaken India’s fiscal and BOP positions.

■ We expect the Government to target 4.7% GFD/GDP in FY2013
We expect the Government to target an ambitious 4.7% GFD/GDP in FY2013, backed by nominal GDP growth of 13% (real GDP growth of 7.5% and WPI inflation of 5.5%). However, as has been the case historically, expenditure is likely to be depressed with under-provisioning for subsidies (fertilizer, food and fuel). We believe 5.4% GFD/GDP may be more realistic. Robust tax collections (negative service tax list, economic buoyancy) and 2G spectrum and coal block auctions may surprise positively but higher subsidies on food and fuel may disappoint.

■ Painful or not, the Government may have to bite the fiscal prudence bullet
In our view, India needs to tackle the problems of weak governance, high fiscal deficit and a vulnerable BOP position. Specific to the FY2013 Union Budget, we believe the Government can send the right signals through (1) taxation reforms to improve the low tax-to-GDP ratio (negative service tax list in FY2013E; commitment to implement GST and DTC by FY2014E) and (2) subsidy reforms with an increase in fuel prices and a commitment to reduce subsidies in the medium term through better targeting and distribution of subsidies.

To read full report: MARKET STRATEGY