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September 2010

The big event during the month was presentation of Union Budget. The finance minister had to walk a tightrope between containing the fiscal deficit while supporting the economic recovery.

The government stimulus which helped the economy in weathering the global downturn has partially been rolled back while paving the way towards fiscal consolidation.

India is clearly on a trajectory of improvement in government finances at a time when most of the other economies are facing challenges on the same front. Accepting the recommendations of Thirteenth Finance commission and reduction in the fiscal deficit will go a long way in enhancing macro-economic stability. Fiscal deficit at 5.5% of GDP and net market borrowing for the next year are in line with market expectations and will sooth fears of crowding out and sharp spike in interest rates. The Budget has made progress towards improving the transparency by consolidating off-balance sheet items like oil bonds in fiscal deficit itself. The budget also provided a roadmap towards fiscal consolidation with fiscal deficit forecast to come in lower at 4.8% in FY12 and 4.10% in FY13.

Government spending played a key role in sustaining the growth momentum last year, however, the private consumption and investment will gradually become the bigger drivers of growth going forward. Measures on the personal taxation and increased spending on key government programmes would keep the consumption story intact while some visible moves have been made to ensure increase in the pace of infrastructural build up. Increase in personal tax slabs would result in higher disposable income in the hands of the common man, providing another stimulus for consumption. For a person having taxable income in excess of Rs 800,000; tax savings would be around Rs 51,000. While service tax rate has been maintained at 10%, its scope has further been widened. Hike of 2% in excise duty is better than market expectations and should not impact the growth prospects.

Effective tax rate for corporates will come down due to reduction in surcharge, but MAT rate has been increased from 15% to 18%. Increase in MAT could impact several corporates in sectors like IT and infrastructure. This step is aimed at moving towards a more equitable and simple tax structure as envisaged in the new Direct tax code.

Measures like deduction for investment in long term infrastructure bonds and increased allocation towards infrastructure development that accounts for over 46% of the total plan allocation would fasten the pace of infrastructure build up. The long ranging reforms like roll out of GST, Direct tax code, further opening up of banking sector, and reforms on the subsidy front will assist in removing structural rigidities and increase the growth potential of Indian economy. While there are no big bang incentives for the industry, there are pockets of thrust areas in Research and development, renewable energy, health and education.

Bond yields have been inching up as market gears up for absorbing large amount of government borrowing next year. Last year, maturity and sequestering of MSS bonds, Open market operations of RBI and large demand from banks due to poor credit growth helped in smooth sailing of the government borrowing. This year, it would be challenging for the RBI to manage the borrowing program as the monetary policy bias would be towards tightening and bank credit growth is likely to pick up. There could be a brief spike in bond yields next quarter which should be used by investors to build duration. Yields at the very short end have shot up on expectation of RBI action, issuance pressure from Banks and impending change in mutual fund’s debt securities valuation guidelines. Some segments of the short term curve have become quite attractive and our money market and short term debt funds are positioned to capitalize on these opportunities.

We maintain our view on equity market that it is likely to consolidate the gains for some time and bigger driver of returns would mainly be earnings growth. The market would now focus on global cues, incremental economic data and corporate earnings for direction. We continue to focus on individual stock picking which we believe is the key to generate better returns on a consistent basis.

Navneet Munot