End of India premium story; more global now?

If the markets remain weak, the damage could extend beyond stocks to the corporate sector


In spite of faltering global markets, the Indian market had run up sharply in the last few days on hopes that the finance minister would, by some magical process, not only deliver higher spending that would lead to higher growth but would also somehow manage to keep the fiscal deficit in check. In fact, the bond markets too had been rallying on hopes that the fiscal deficit would be contained at around 6% of GDP.

What’s more, practically every analyst had said that valuations in the Indian market had gone too high, ignoring negatives such as the weak monsoon, the high fiscal deficit and persistently high food prices.

So while the 5.8% drop in the Sensex is the biggest ever on a budget day, in many ways the markets have themselves to blame for having heightened expectations. While the market expected announcements on all those issues that excite it, such as reforming subsidies, increasing foreign direct investment caps, abolishing the securities transaction tax and disinvestment, the fact of the matter is, as one equity strategist put it pithily, that the government figured it had managed to sustain growth by going in for a big fiscal push last year, so why not have more of the same.

The other factor was that there were very few Nifty short positions leading up to the Budget, as the bears had been badly hurt by the mauling they got after the elections. So when the markets fell, there was no short-covering and the fall was therefore very steep. Short positions must have been built up on Monday, though.

Of course, the Budget did disappoint in areas such as the plan for disinvestment and that of pricing of petroleum products. The target of Rs1,100 crore for disinvestment is woefully low considering the gravity of the fiscal situation. But as far as pricing of petroleum products go, the government already took the step of raising prices before the Budget and has now announced that a new viable and sustainable system of these products is being looked into.

The increase in the minimum alternate tax (MAT) rate is obviously a negative for companies such as Reliance Infrastructure Ltd and Reliance Industries Ltd. Thankfully, the proportion of companies that pay MAT is relatively less. Besides, tax paid under MAT can be used as a credit for ten years when these companies come out of the MAT regime and hence may not necessarily be a negative for all companies; by that logic, MAT is a kind of advance tax. But for some companies, the book profit (on which MAT is calculated) has been higher than the taxable profit for years on end and they haven’t availed of MAT credit. For such firms, the hike in the MAT rate is a definite negative. Analysts say much of the fall in the later half of the session was on a reading of the fine print of the MAT changes.

Interestingly, the BSE Capital Goods index was among the worst hit, falling by 7%, though there are ample outlays for both rural and urban infrastructure spending. But as Sandeep Sabharwal of Prabhudas Leeladhar Pvt. Ltd points out, valuations of large-cap capital goods companies had risen sharply in the run-up to the Budget and a correction was due. The BSE Bankex fell by at least 8%, as higher bond yields will lead to losses on treasury holdings. Bank stocks, too, had outperformed the broad market.

On the other end of the spectrum, FMCG (fast moving consumer goods) stocks gained by 1%, as the markets were enthused about the increased rural spend and the increase in incomes through the cut in personal tax surcharge and the removal of fringe benefit tax.

ITC Ltd gained at least 3% on relief that taxes on cigarettes were not raised in the Budget. Auto stocks fell by around 3% on an average, lower than the rate at which the broad market fell, for the same reasons. Besides, the stimulus package announced for the sector has been maintained, which is also a positive. IT stocks, too, were relatively better off thanks to the extension of the sunset clause on tax incentives for units that operate in software technology parks by one year. The removal of FBT (fringe benefit tax on perquisites) is also a large positive for the sector. Many companies in this sector, however, pay MAT and the increase in the MAT rate will result in higher tax outflow. But since MAT credits are available for 10 years, this is only a timing issue and there would be equivalent savings on taxes in future years, when these companies come out of MAT.

If the markets remain weak, the damage could extend beyond stocks to the corporate sector. Companies had started raising funds through QIPs (qualified institutional placements, or sales to certain categories of buyers, largey financial institutions) to repair their balance sheets and provide a cushion against the downturn. That option would no longer be open to them.

What of the future? The special India story triggered by the election results and sustained on hopes of a dream budget is now over for the time being. The hope was that India would continue to enjoy its premium over other markets in the region based on a reform agenda. That hope has now been dashed. The Indian market can now be expected to move more in sync with global markets.