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Equity Research Asia/Pacific
India Budget F2004
India Research Team
March 3, 2003
Playing it Safe; Equities Look Elsewhere for Comfort
MSCI COUNTRY Asia Strategist Weight AC Asia MSCI (ex Japan) Weight INDIA 3.5% 3.8%
• Treading carefully
India’s Finance Minister Jaswant Singh, in his first budget, was careful not to upset the apple cart, by avoiding any tough reform measures.
• On balance, we rate budget measures as marginally positive
The government announced two pro-growth measures, including an increase in spending on infrastructure and a further cut in interest rates.
• Budget actions reflect little concern for rising fiscal burden
Finance Minster maintained the familiar trend of a lot of noise about the need for fiscal consolidation without reflecting it in the actions taken.
• Near-term growth concerns remain
The positive measures announced in the budget are unlikely to turn the decelerating growth cycle in the near term. We expect industrial growth to weaken further to 3-4% in F1Q04 from 5.1% in F3Q03 and 6.5% in F2Q03.
• Budget will have mixed impact on three key drivers of equities, in our view.
We estimate a small, 60 bps improvement in corporate earnings growth due to tax cuts. We also expect that an aggressive, 100 bps rate cut on small savings rates will cause a revival in otherwise contracting liquidity. However, reform initiatives, particularly in direct taxes, fall short of potential. The budget fails to create the tactical impetus for overall equity performance. Continue to focus on stock/sector picking. We are selling our high-beta picks – i.e., NIIT and Zee Telefilms – and adding to growth stocks trading at reasonable valuations – i.e., Infosys and Dr. Reddy’s
Please see the important disclosures at the end of this report.
JM MORGAN STANLEY
Morgan Stanley India Team
Director of Research Head of Indian Research
Robert Vaudry, Hong Kong
+852 2848 5939 Robert.Vaudry@morganstanley.com
Ridham Desai, Mumbai
+9122-2209-7790 Ridham.Desai @morganstanley.com
Cement Nonferrous Metals & Mining/Steel
Ridham Desai, Mumbai
+9122-2209-7790 Ridham.Desai @morganstanley.com
Sachin Sheth, Mumbai
+9122-2209-7915 Sachin.Sheth@morganstanley.com Commercial Vehicles /Two Wheeler/Engineering
Chetan Ahya, Mumbai
+9122-2209-7940 Chetan.Ahya@morganstanley.com Oil & Gas/Telecommunications
Chetan Ahya, Mumbai
Satish Jain, Mumbai
+9122-2209-7809 Satish.Jain@morganstanley.com Consumer/Media
Vinay Jaising, CFA, Mumbai
+9122-2209-7780 Vinay.Jaising @morganstanley.com Petrochemicals
Ben Godinho, Mumbai
Rajesh Mayani, Mumbai
+9122-2209-7925 Rajesh.Mayani@morganstanley.com Financial Services
Ridham Desai, Mumbai
+9122-2209-7790 Ridham.Desai @morganstanley.com Pharmaceuticals
Amit Rajpal, Hong Kong
Sameer Baisiwala, Mumbai
+9122-2209-7830 Sameer.Baisiwala@morganstanley.com Software
Sachin Sheth, Mumbai
Anantha Narayan, Mumbai
Akshay Soni, Mumbai
Amit Puri, Mumbai
Anil Agarwal, Mumbai
Anirudh Gangahar, Mumbai
Nimit Tanna, Mumbai
Vijay Chugh, Mumbai
India Budget F2004 – March 3, 2003 Please see the important disclosures at the end of this report.
India Budget F2004 – March 3. Treaty-Consensus. we rate the budget as marginally positive for the economy. equity – and treating all factors of production on a par. Nonetheless. Action) cycle. Savings rate cut: The thrust on cutting interest rates on government sponsored savings schemes continued in the budget.5%. What We Did Not Like About the Budget Much unlike the style of his predecessors. Migration to the new tax system may face many hitches. There was no reference to the status of the fiscal responsibility bill. he maintained the familiar trend: a lot of noise about the need for fiscal consolidation without taking any action that would impart confidence about the government’s seriousness in addressing this critical macro issue. Nevertheless. The rate on the small savings scheme (public provident funds scheme) was reduced by 100 basis points to 8. manufacturing productivity should increase significantly from economies of scale and the creation of a national market. once the national level VAT system is fully implemented. 10. It announced two pro-growth measures.e. . last Friday. has experienced.1% in the quarter ended in December 2002.0%. the budget has only added to the complexities by announcing more direct tax sops. The Finance Minister confirmed in the budget that the VAT system will be effective from April 1. Following the government’s cut in the small savings rate. we believe that it will take 9-12 months for the benefits of this spending to start flowing into the real economy. Therefore. which has been awaiting the approval of the Parliament for more than 2 years. Direct tax laws further entangled: The budget has gone against the grain of the recently released Kelkar committee recommendations. The most important of these is the new. lending some support to weakening household consumption. the central bank also reduced by 50 basis points each the repo rate to 5% and the savings bank deposit rate to No action on fiscal consolidation again: The budget reflects little government concern to reduce the fiscal deficit. Opposition. However. however. 2003 Please see the important disclosures at the end of this report. 2003.JM MORGAN STANLEY Page 3 Playing it Safe. Instead of simplifying the direct laws. seaports and a convention centre.. State Level VAT: The VAT (Value Added Tax) scheme is finally moving towards the action phase of the POTA (Proposition. which manages golden quadrilateral projects. finalizing the terms for awarding the contracts may be more complicated than the National Highway Development Authority. Equities Look Elsewhere for Comfort Economics Chetan Ahya Summary 3.000-km road project for US$8 billion. airports. the government plans to construct these roads by way of build/operate/transfer (BOT) with the participation of private players. We believe this would result in a delay in implementation. Finance Minister Jaswant Singh. Bottom Line: Near-term Growth Concerns Remain We believe the positive measures announced in the budget are unlikely to turn the decelerating economic growth cycle in the near term in any significant way.6 billion investment plan for roads. What We Liked About the Budget Construction spending on infrastructure: The government has announced a US$12. as suggested by Kelkar Committee. to 3-4% from 5. which aimed to reduce the cost of risk capital – i. The resultant downward bias in banks’ lending rates should help maintain momentum in retail loan growth. Over the next 2-3 years. including an increase in spending on infrastructure and a further cut in interest rates. We maintain our view that industrial growth will continue weaken through to F1Q04. presented an annual budget lacking the spice of poetic statements.
5% 13.6 4.5 5. P Chidambaram Mr.6% 25. This rise in revenue expenditure has been at the cost of capital outlays.1% in F1997.6 6. In a second revision after the completion of financial year.4 5.6% 7. expenditure management is still neglected. Revenue expenditure rose to 13.9 Source: Budget Documents. Exhibit 1 The central government’s internal debt burden has risen further to 58. Yashwant Sinha Mr. We believe that the government is too optimistic in its projections of indirect taxes for February-March 2003 (Exhibit 1). but the first revised forecast is already at 5. Morgan Stanley Research. We expect the F2003 deficit to be revised further to 6. from 11.3 5.5%.3% 13. We believe the exchange should have been allowed only on condition that the states agreed to initiate fiscal reforms. the estimated budget deficit (announced in February 2001) was 4. for F2002.7% in F2002 and 45.9% of GDP in F2003.4% in F1997.1 5. Bailouts for States Will Increase the Burden India’s Indirect Taxes: Ambitious Projections for F2003 Fiscal Year YoY Growth 1Q03 2Q03 3Q03 Jan-03 Feb-Mar Implied Est.1% Source: Budget Documents. The Finance Minister announced in the budget that 26 states have agreed to this swap.1% in F1997 (Exhibit 3). While the privatization of some of the large public-sector companies may help contain the deficit. defence and interest costs.6 4.5% 15.5% 14.8% 4. Jaswant Singh We are committed to bring the fiscal deficit below 4% of GDP Unwavering commitment to continue on the course of fiscal correction Given the state of the economy.8% 12. Debt Burden at New Peak Every year.3%. which was budgeted at 5.0 4. Maintaining the Ritual of Missing the Target subsidy. Morgan Stanley Research. India’s actual budget deficit is significantly higher than projected (Exhibit 2). to help reduce their interest burdens.1% 14. the estimate was raised further to 6. no further compression warranted Launching a medium-term strategy to reduce deficit We must squarely confront and overcome the critical challenge posed by a weakening fiscal situation Inadequate fiscal management has remained the most intractable problem over the past decade Expressed my deep concern at the poor fiscal situation of the central and state governments Fiscal consolidation through tax reforms 5.9% 34.5% of GDP in F2003 from 3.0 5.1 4.7%. The reduction in interest burdens may actually lessen the pressure on state governments to undertake fiscal reforms.9% (Exhibit 2). Yashwant Sinha Mr.1 5. The average growth in debt in the last three years has been 14. No Sign of Efforts to Correct the Problem Indirect Taxes Excise Customs 15. India Budget F2004 – March 3. 2003 Please see the important disclosures at the end of this report. Yashwant Sinha Mr.1% of GDP.7 5. Yashwant Sinha Mr.7% 21. as per budget estimates.3%.6% in F1997.8% 32. This is expected to save Rs810 billion in interest costs over the residual maturity of the loans. The fiscal deficit for F2003.1%. The new finance minister has been able to do little to address the issue. is now estimated to reach 5. the central government’s fiscal deficit has been on a consistent uptrend. Yashwant Sinha Mr.7% of GDP. the fiscal deficit for F2003 was budgeted to be 5. Revenue Expenditure Continues to Mount The F2004 budget showed little concern for addressing the problem of the fiscal deficit.8% of GDP in F2003. compared with 55. As an example. Similarly. Capital expenditure has fallen to 2. Actions Year Finance Minister Statement made during budget Deficit as % of GDP Budget Actual F1997 F1998 F1999 F2000 F2001 F2002 F2003 F2004 Mr.8 5. Later.2% 10. compared with nominal GDP growth of 8.1 4. The increase was due to higher Exhibit 2 India’s Fiscal Performance: Statement of Intent vs.JM MORGAN STANLEY Page 4 Fiscal Deficit: Customary Missing of Target Fiscal Deficit on Consistent Uptrend For the last five years.9%. this was revised (in February 2002) to 5. .9% of GDP compared with 4. P Chidambaram Mr.5% 14. The central government has offered state governments the opportunity to swap their high-cost debt with lower cost borrowings at current market rates.
642 6.9% 2.3% 968 3.0% 1.7% 4.3% 1.0% 3.2% 1.103 16.128 4.3% 561 2.355 5.968 11.7% 132 0. 1.4% 335 1.455 5.7% 1.3% This seems to be on the high side as the Finance minister has given some sops for direct taxes.532 6.135 4.329 5.3% 914 3.075 4.8% 653 2.4% 3. .5% 499 1.232 4.6% 728 2.0% 2.730 6. Deficit could again be slightly higher than budget estimates.7% 3.8% 721 2.002 4.4% 2.7% 698 2. BPCL and Maruti Udyog Ltd.337 5.8% 3.662 13.2% 403 1.7% 181 0.6% 2.141 4.6% 1.574 6.7% 1.012 4.210 4.899 11.5% 1.1% 1.6% 398 1. Morgan Stanley Research RE = Revised Estimates.5% 1.8% 911 3.6% 1.1% The actual figures are likely to be higher than budgeted especially for LPG and Kerosene.369 9.3% 954 3.717 6.5% 2.5% 1.461 5.5% 494 1. Billion F2002 F2003BE F2003RE F2004BE Gross Tax Revenue As % of GDP Indirect Taxes As % of GDP Excise As % of GDP Customs As % of GDP Direct Taxes As % of GDP Share of states As % of GDP Net As % of GDP Non Tax Revenues As % of GDP Total revenue receipts As % of GDP Capital Receipts As % of GDP --Privatization As % of GDP ---Others As % of GDP Expenditure Plan As % of GDP Non Plan As % of GDP Interest As % of GDP Subsidies As % of GDP Defense As % of GDP Others As % of GDP Total Expenditure As % of GDP Revenue Expenditure As % of GDP Capital Expenditure As % of GDP Fiscal Deficit As % of GDP Revenue Deficit As % of GDP Primary Deficit As % of GDP 1.405 13. Source: Budget Documents.8% 678 3.7% 34 0.4% 2.7% 1.4% 619 2.8% 956 3.219 9.1% 608 2.5% 1.9% 2.174 4.849 6.0% 3.0% 36 0.5% 120 0.2% 295 1.6% 4.416 13.842 6.0% 2.3% 726 2.4% 1. BE= Budget Estimates.536 5.366 5.7% 612 2.2% 1.6% 1.016 13.5% 1.014 8.388 16.6% 1.7% 446 1.0% 528 2.6% 650 2.JM MORGAN STANLEY Page 5 Exhibit 3 F2004 Budget: Central Government Finances Rs.5% 1.040 16.3% 1.5% 638 2. India Budget F2004 – March 3.8% 560 2.625 15.1% 1.3% 3.2% 1.871 8.047 4.6% 2.3% 1.178 11.3% 1.358 9.8% 688 3.9% 726 3.6% 1.515 9.9% 2.1% 304 1.539 9.7% 452 1.451 9.8% 624 2.8% 820 3.613 11.3% 698 2.3% 659 2.6% 1. 2003 Please see the important disclosures at the end of this report.637 6.8% 1.410 6.160 4.1% 1.610 7.123 4.652 6.7% 4.4% 543 2.5% 694 2. This target may be achieved only if the Government is able to privatize companies like HPCL.6% 1.7% 312 1.671 6.4% 703 2.5% 455 1.4% 874 3.9% 1.
0% 2.0% 6% 8.0% 2% 0. 2003 Please see the important disclosures at the end of this report.0% Tax Revenues (Direct and Indirect) (% of GDP) 7% 12.0% 5.JM MORGAN STANLEY Page 6 Exhibit 2 Central Government Finances Fiscal Deficit Trends (% of GDP) 20% 18% 15% 4% 13% 10% 8% F1992 F1993 F1994 F1995 F1996 F1997 F1998 F1999 F2002 F2003RE F2004BE F2000 F2001 3% 4.5% 3.4% 13. Billion) 140 120 100 80 60 40 20 0.0% 35% F2003RE F2003RE F2004BE Revenue Expenditure (LS) Capital Expenditure (RS) Non-Plan Expenditure (% of GDP) 12.0% 4. Morgan Stanley Research India Budget F2004 – March 3.0% 10.0% F1992 F1993 F1994 F1995 F1996 F1997 F1998 F1999 F2002 F2003RE F2004BE F2000 F2001 Fiscal Deficit Receipts (LS) Expenditure D irect Tax Indirect Tax Expenditure Trends (% of GDP) 14.0% 2.0% 2. F2004BE F1992 F1993 F1994 F1995 F1996 F1997 F1998 F1999 F2000 F2001 F2002 .0% Interest Cost as % of Revenue Receipts 55% 51% 47% 13.5% F1992 F1993 F1994 F1995 F1996 F1997 F1998 F1999 F2002 F2003RE F2004BE F2000 F2001 2.6% 39% 11. Economic Survey.2% 43% 12.0% 3.0% 10.0% Privatization Proceeds (Rs.0% 6.0% 8.0% F1992 F1993 F1994 F1995 F1996 F1997 F1998 F1999 F2002 F2003RE F2004BE F2000 F2001 0 F1993 F1994 F1995 F1996 F1997 F1998 F1999 F2000 F2001 F2002 Defense Expd Subsidies Interest payments Others Source: Budget Document.5% 4.8% 12.0% 6.
5% for corporates. Source: Budget Document. Rs. 2003 Please see the important disclosures at the end of this report. dividend distribution tax of 12. completely waived for individuals earning less than Rs. • Additional levy of 50 paise in diesel and motor spirit collecting. 150. Foreign Direct Investment • FDI in private banks increased from 49% to 74%. 500. Economic Survey. Interest Rates • Small saving rates was reduced by 1%. • Peak customs duty reduced by 5% • Services tax increased to 8% from 5% Government finances • Government proposes to buy back high-interest government bonds from banks who volunteer. However. voting right limitations to be amended.000 pa. • Increase in standard deductions for salaried individuals earning greater than Rs.000 pa • Government to maintain tax concessions on housing interest loans at Rs. the central bank reduced the repurchase and bank saving deposit rates by 50 basis points each.JM MORGAN STANLEY Page 7 Exhibit 4 Select Budget Measures Direct Taxes • 5% tax surcharge levied last year for country's security halved to 2. This amount will be used for road projects. 16% and 24% introduced. modernisation of airports and seaports. Infrastructure Spending • Government plans to invest around Rs 600 billion in 48 new road projects.000 per year and doubling it to 10% for individuals earning more than that amount. This is expected to lead to a saving of Rs 810 Biliion for the states over the residual maturity of the loan. . • Exemption on capital gains for 1 year on buybacks. • Tax free status of software export companies reinstated Indirect Taxes • Introduction of state level VAT system from 1st April 2003 • 3-tier excise structure 8%. • Premature repayment of loan of $3 billion from World Bank and Asian Development Bank. • Overseas investment limit for corporates hiked to 100% of net worth. • Government to introduce debt swap scheme with the states. 26 billion. 850. Following this announcement.5% imposed on corporates • Abolition of long term capital gains for all listed equity purchased after 1st April 2003. • Issue price of urea fertiliser to be raised by Rs 12 per 50 kilogram bag. Morgan Stanley Research India Budget F2004 – March 3. • Dividend tax at the hands of the shareholders removed.
impedes long-term growth recovery and thus caps the upside to equities (Exhibit 4). We think this defeats the purpose of removing the dividend tax. although tax administration was simplified. Market Continues to Appear Range-bound Indian Finance Minister Jaswant Singh’s systematic and detailed budget presentation for F2003-2004 recognizes the political limitations of a coalition government and an election year and thus avoids adventurous moves. and that seems to be missing in this budget.JM MORGAN STANLEY Page 8 Strategy Ridham Desai F2004 Budget: Equities Look Elsewhere for Sympathy Leaving the Glass Half Full.6% of GDP for F2004). The complicated tax exemption regime was left more or less intact. Singh did complete the annual ritual with the panache he is known for. this significant reduction in rates should abate the fall in liquidity. If anything. resulting in an equivalent improvement in earnings growth (in the ensuing 12 months). Financials gain from the budget. as in recent years. The focus on health.5% tax incidence on profits distributed by corporates. The budget seems to have disregarded the equitable tax regime philosophy and reduction in the cost of risk capital mooted by the Kelkar Committee. is fiscal consolidation. However. the numbers in the budget presentation look realistic and bear a higher probability of being achieved.5% and to the repo rate to 5%. the budget does not contain any big shock. However. While the tax on dividends has been abolished. Fiscal deficit remains alarmingly high: The biggest reform that needs to be pursued. Mr. with a 50 bps cut to the interest rate on bank savings accounts to 3. The removal of tax on long-term capital gains applies only to India Budget F2004 – March 3. with the benchmark 10-year bond yield falling by 47 bps to 5. We think the budget is unlikely to provide the macro environment for improved equity performance over the next six months. the reform initiatives seem to have fallen short of expectations and immediate growth outlook remains a question. in our view. This. Earnings for the software services sector may improve by a higher number (around 3%). a reduction of 5% in the peak customs tariff and the extension of service tax to more sectors (service tax was also increased from 5% to 8%). and we retain our large overweight position: The financial sector has received impetus from the budget in the form of both tax breaks for restructuring and acquisition and foreign direct investment. produce a limited earnings boost (arising from a slightly lower corporate tax rate) and a marginal increase in liquidity (due to lower interest rates). the budget influences three key drivers of equities: earnings. given the change in tax laws relating to software services companies. the budget has introduced a 12. This will likely reduce the average tax rate for corporates by around 60 bps. Change in corporate tax rates: The silver lining to direct taxes came in the form of a reduction in the corporate tax surcharge by 2.5%. unlike the slippage in recent years. A key rationale for the removal of the tax on dividends. This prompted the central bank to react immediately. That said. But the finance minister paid lip service to direct tax reforms.” dated January 27.) Capital (read profits) as a factor of production is still receiving stepmotherly treatment. Lip service to direct tax reform: In contrast. in our view. or Is it Half Empty? listed equities acquired over the next 12 months – which looks fairly inexplicable. That said. the effort on direct taxes was limited. was equitable tax regime for all factors of production. in our view. progression to value-added tax (VAT) including a cutback in the central sales tax rate to 2%. (See our note titled “Tax Reform and Dividend Debate – Anybody Listening. This budget will. We believe the budget impact is neutral for most other key sectors. 2003 Please see the important disclosures at the end of this report. the budget actually increases the list of exemptions. Aggressive rate cut: The finance minister boldly reduced interest rates on small savings by a whopping 100 bps. 2002. education and infrastructure (although the benefits will accrue only in the long term) are welcome moves. Thus. liquidity and macro (pace of reforms and growth). as suggested by the Kelkar Committee. we continue to look at range-bound . While central bank liquidity has been compressing over the past few weeks (not at all helped by rising crude oil prices). From the stock market’s perspective. Although the finance minister has made fiscal consolidation a focal point (the debt-swapping scheme for state governments and banks is an important step in that context). The bond market followed suit. the budget continues to target an unreasonably high level of fiscal deficit (5. Slew of indirect tax reform: The budget continued to pursue indirect tax reform. These reforms included rationalization of excise duties.85%.
BO.0% 50.808 1997 3.5 6M forward return on BSE Sensex (RS) Momentum Indicator in SD units (LS) -50.30% -11. policy reform (privatization).293 3. Rs876.0% 40. 6M-forward Returns 1.50% -16.274 2002 3.231 3.5%.900) and Dr. Overweight.0% 10.0 -1..487 1996 3.10% -1.45% 44. 2003 Please see the important disclosures at the end of this report.336 5. Overweight.284.BO.460 3.054 4.5 0.9.0% -10.0% 30.BO. 6M Fwd Returns 60% 40% 20% 0% -20% -40% -60% -80% Apr-96 Sep-96 Expected 6 month return based on composite valuation return indicator May-98 Mar-99 Oct-98 Apr-01 Jul-97 Jan-00 Nov-00 Feb-97 Sep-01 Dec-97 Aug-99 Feb-02 Jun-00 Jul-02 Jun-94 Jan-95 Aug-95 Mar-96 Oct-96 May-97 Dec-97 Jul-98 Feb-99 Sep-99 Apr-00 Nov-00 Jun-01 Jan-02 Aug-02 Mar-03 Actual 6 month return equities with a focus on stock or sector picking. Reddy’s it increases by 210 bps.652 1994 4.30% 1.831 1993 2. Rs4.70% 7.091 2.925 3.562 2003 3.04% 0.0% -30.0% -20.30% -7.007 3. Our valuation and momentum models are predicting a low return for the market (Exhibits 5 and 6).50% -3.526 3. NIIT (NIIT.40% -2.0% 0. Underweight.60% -3.286 1995 3.00% -1.0% BSE Sensex vs.10% 3. given its relatively low beta in a regional context. Price Target Rs118).250 3.149). Price Target Rs4. Exhibit 5 India: Composite Momentum Indicator vs.5 -1.447 2001 4. Exhibit 4 Source: Morgan Stanley Research Exhibit 6 India: Valuation Return Indicator vs.683 5.20% 2.20% Source: Morgan Stanley Research 1992 2.225 3.10% 5.80% -10. raising our position in pharmaceuticals to overweight.330 4.15. leaving our overweight in software services unchanged.40% -9. the Indian equity market will likely underperform. Overweight.406 3.30% 8. India’s Fiscal Deficit 120% 100% 80% 60% 40% 20% 0% -20% -40% -60% Aug-92 Aug-93 Aug-94 Aug-95 Aug-96 Aug-97 Aug-98 Aug-99 Aug-00 Aug-01 Aug-02 Aug-03 YoY Chg in BSE Sensex (LS) YoY Chg in Fiscal Deficit to GDP (RS) -25% -20% -15% -10% -5% 0% 5% 10% 15% 20% 25% Exhibit 7 Source: Morgan Stanley Research Indian Equities: Dealing with Budget Blues One Month Before Budget BSE Sensex Closing on One Month Budget Day After Budget 4. If geopolitical events turn favorable. Reddy’s (REDY.0 0.400 2000 5. Thus our position in Infosys rises by 1.BO.475 1998 4. Most of the triggers of better market performance – i.0 -0. polarized electorate verdict in the big state elections later in the year.JM MORGAN STANLEY Page 9 Model Portfolio: Naked Beta Extracted We have removed our key high-beta picks. The market also has to deal with a difficult post-budget trading history with an average return of -6. Price Target Rs145)and Zee Telefilms (ZEE.60% ? -6. For Dr.041 3.681 2. and have added to our positions in Infosys Technologies (INFY.27% 4.e. Rs135. Dec-02 . Growth stocks trading at reasonable valuations (GARP) are a strategic thrust in the model portfolio.30% 7. Price Target Rs1.7% and negative returns in 9/10 years in the month post the budget (Exhibit 7).5 1.506 3.788 3469 ? % Change Month Pre Month Post Budget Budget 23.10% -11.10% -1.284 Average since 1993 Standard deviation since 1993 Source: Morgan Stanley Research India Budget F2004 – March 3. improved global equity market performance and higher dividend payout – seem to have been pushed beyond the second quarter.643 1999 3.90% -0.70% -0.300 2.361 3.6.318 3.0% -40.776 3.0% 20. Rs84.50% -11.
Price Target Rs350) the foreign investment limit was unchanged. Rs285. especially for CVs and cars. Special National Calamity Duty: All two-wheeler and cars/SUV companies would be marginally affected by a 1% duty – called a national calamity contingency duty. Marginal gains from lower steel duties: The reduction in import duties on CR (cold rolled steel) from 30% to 25% should cause some relief to auto companies that are or would be affected by the rising price of steel. should be a long-term growth driver for the auto sector. Reduction in surcharge: The reduction in the tax surcharge from 10% to 5% benefits all auto companies as most now have high tax rates. from 32% to 24% is. the stock closed on February 28 at Rs285. positive for the car/SUV segment. given the paucity of “attractive” targets (implying banks without excess branches and employees) as well as the relative inflexibility in branch India Budget F2004 – March 3. Additional duties on chassis for body builders: To promote body-building by commercial vehicle (CV) companies as a measure of road safety. We believe that this is a good level to add to positions in the shares. Lower duties on tires: Excise duties on tires have also been reduced. to 24% from 32%. involving an expenditure of Rs400 billion. However. 2003 Please see the important disclosures at the end of this report.BO. . However. which was disappointing. The reduction is positive. We consider this a significant burden on freight operators. Morgan Stanley Research Banks and Financial Services: Positive Amit Rajpal / Sachin Sheth The budget. which are already reeling under the burden of rising fuel prices and low freight rates. most companies may have to absorb this cost. is largely neutral for the banking and finance sector. in our opinion.positive The limit on foreign direct investment in private banks has been raised from 49% to 74%. Road infrastructure to trigger growth: The auto sector is a direct beneficiary of road construction. with a positive bias. depending upon the type. the customers would have to bear the burden of the additional duties of Rs10. the additional duty has made bodybuilding for light commercial vehicles (LCVs) and smaller trucks unviable for the unorganized sector. the duty on the chassis has been increased to 16% +Rs10. Key measures include: Higher foreign direct investment in private banks . Lower duties on electric vehicles: Duties on electric vehicles are being reduced from 16% to 8%.000.75. for companies like Tata Engineering and Mahindra & Mahindra. As a result.JM MORGAN STANLEY Page 10 Automobiles Satish Jain Positive for cars/SUVs Neutral for two-wheelers Negative for commercial vehicles Lower duties for cars/SUVs: The proposed reduction in the excise duty.7% lower in a day. effectively providing an opportunity for foreign banks to acquire majority control. reeling under the burden of rising steel and fuel prices. currently capped at 10%.000. onto a level playing field with the organized sector. Exhibit 8 Automobiles: Key Excise Rates 2001-02 2002-03E Two Wheelers & Three Wheeler Tractors Commercial Vehicles Motorcars/ Utility Vehicles 16% 16% 16% 32% 16% 16% 16% 24% Source: Budget Documents. Considering the intense competition and pricing pressure they face. In addition. Overweight. Until the companies add capacity to build bodies. for the State Bank of India (SBI. which has shown sluggish growth for the past three years. It also reduces the pressure on companies. The proposal to undertake 48 new road projects. which we believe also acted as a stumbling block for mergers and acquisitions.75 – 5. While attempting to bring the unorganized sector. in our view. in our view. The average cost of vehicles would rise between 1% and 3%. the budget promises to consider raising the voting right limits. which does not pay any excise duties. This could serve as an incentive for some companies to introduce such vehicles. which should help all auto companies and the transport operators.
2003 Please see the important disclosures at the end of this report. UnderWeight. Even assuming that the entire 10. As mentioned in our recent note on rising rates. It is unlikely that SBI would voluntarily sell such securities. the 14% increase in excise duties India Budget F2004 – March 3.6 million tons. Price Target Rs445): • Tax exemptions on housing loans were retained in full. for which the impact would be approximately 5% added to F2004E earnings. on cement in a weak pricing environment is likely to have an immediate dampening effect on profits. as short end rates would decline along with the longer end. the central bank has taken the cue by cutting shorter-end savings bank rates from 4% to 3. and negligible for Gujarat Ambuja (GACM.BO. thus ruling out any potential decline in demand due to its withdrawal/reduction. we believe SBI will be a greater beneficiary of any steepening in the yield curve. We believe that. 3. However. Price Target Rs120). as highlighted below – especially for ACC – more than offsetting any potential benefits of the positive measures announced. Rs154.5% –.Positive With the government indicating a soft bias on rates by reducing rates on the longer-tenored small savings schemes.05.JM MORGAN STANLEY Page 11 restructuring and labour laws. more than offsetting any potential benefits. this has been recommended entirely on a voluntary basis.5%. as it has historically been conservative in booking treasury gains and has demonstrated a preference for playing the gain through its margins. The government plans to build another 10. which appears ambitious based on the progress of the Golden Quadrilateral program. in our view.000 kms would be completed in 3 years. it would be difficult for average company realizations to increase by the Rs2. to drive a secular increase in cement prices. Price Target Rs142). Impact on HDFC – Positive Two steps were announced in the budget that should be positive for HDFC (HDFC. in the current weak pricing environment. we expect limited M&A action. Underweight.5 per 50kg bag to Rs20 per bag. we believe that the impact on F2004E profits is significantly adverse. contrary to the Kelkar committee recommendations. While the intention is to start work on a quarter (or about 3.BO.BO. Rs375. Buyback of high-yield debt by the government – Neutral The government has indicated that it would encourage banks facing liquidity problems in their high-yield trading investment portfolios of government securities to sell these back to the government to reduce their debt servicing burden and to enable the banks to realize gains on their high-yield portfolios. the annual increment in demand would be on the order of 1.5% – not significant enough.000 kms) of this in the current year. including the recent rail freight rate reduction.15. Accordingly. or approximately 1.6% reduction in freight rates for cement is positive to the extent that companies rely on rail freight – mainly ACC (ACC. Rs161. This is likely to be positive for high-growth and reasonably high dividend yield companies like HDFC.5 per bag needed to pass this on to the customer. The recent. • • The main negative measure is the increase in excise duty from Rs17. .000 km of rural roads. Positive measures include the following: • The tax exemption on housing finance is retained. • The tax on dividends at the shareholder level is removed. This should help maintain the marginal steepness in the yield curve. Cement – Negative Sachin Sheth While the budget aims to boost medium term demand in core sectors like cement and steel through highway and housing-related measures. Central bank cuts savings deposit rates to 3. Overweight. a quarter of which would be concrete. the increment to demand is not likely to be significant. This benefits most banks with longer investment horizons and shorter funding duration.
the impact of the budget measures goes beyond the changes in the chemical sector. The surcharge on the corporate tax rate has been lowered from 5. The dividend tax on corporates has been reinstated at 12. While this hurts earnings.BO. partial effect will also be felt in a reduction of about 6% in 2003E earnings Source: Company Data. which would be eligible for a tax holiday for an additional year.6% reduction in the weighted average tariff protection for Reliance. Additional duty of Rs50/ton of crude oil levied for one year. in our view.5 billion in profits. Infocomm ACC GAC Grasim (F2002 data) 14. F2004E Local sales (mn tons) Impact on Op Profits Impact on Net Profits* polymers. The reduction in polyester duty augurs well for demand for polyester filament yarn. we have already assumed that the company shares about 2% of the sales tax benefit with its customers. from a reduction in the excise duty on biscuits from 16% to 8%. appears to be largely neutral for the Indian consumer sector. Morgan Stanley Research The cut-off for the eligibility of start-up telecom services (including broadband and Internet) for a 10-year tax holiday has been extended to March 31.5% and will reduce the effective tax rate for corporates to 35. The import tariff on paraxylene has been reduced from 10% to 5%. This is positive for the Infocomm part of Reliance’s operations. Over 70% of the sales tax benefit comes from sales within the state of Gujarat.JM MORGAN STANLEY Page 12 Exhibit 9 Indian Cement Sector: Impact of Higher Excise Duty. As a worst case. including routers. translating to a reduction of about Rs1.95. The imposition of an additional 3% tax on the service industry is likely to be a dampener for consumers. and this change will not result in incremental cash outflow.5% and will not be taxed in the hands of shareholders at the marginal tax rate. This would result in a 0. the only company in our coverage in the chemicals sector. Britannia Industries should be the biggest beneficiary in the sector. The latter will partly offset the increase in disposable incomes on account of a reduction in income tax. The companies may decide to adjust the payout. This should have a limited negative impact on Reliance’s earnings.2 9. Petrochemicals The Finance Bill. The biggest positive for consumers is the income tax reduction on individuals in lower income brackets. 2004. The decrease in peak customs duty from 30% to 25% implies a 5% cut in the import tariff on India Budget F2004 – March 3. including exemption of dividends in the hands of shareholders. However. it is already built in to our earnings model for Reliance. . We believe that the effect on disposable incomes and consumer sentiment across all income groups will be largely neutral: • Low-income groups will likely benefit from a lower income tax. The proposed reduction in customs duty for telecom equipment. the residual benefit could fall by Rs1. Chemicals Ridham Desai Chemicals – No Dramatic Change Consumers Rajesh Mayani Budget Impact – Neutral We discuss here the impact on Reliance Industries (RELI. Price Target Rs363). Rs293.5 8. 2003. Excise duty on polyester has been reduced from 32% to 24%. albeit partly hurt by higher prices for services. Given the diversity of the company’s businesses.0% to 2.5 billion.9%. This cut is slightly offset by the levy of an additional duty of 1% imposed on polyester filament yarn (PFY) to contribute to the National Calamity Contingency Fund. with the empowerment of state governments to impose up to a 4% sales tax on cigarettes.5 -22% -8% -5% -71% -16% -10% *Assumes no ability to pass on excise hike to customers *For GAC. optic fiber cables and other fixed wireless terminals would reduce the incremental capex for Reliance Infocomm. ITC will be the worst affected. 2003 Please see the important disclosures at the end of this report. Refining & Marketing Ceiling rate of central sales tax for interstate sales reduced to 2% from 4%. Overweight.
2) Excise duty on refined edible oil/vanaspati (branded and packed) increased from 0% to 8%. 5) Excise duty on hard-boiled sugar confectionery reduced from 16% to 8%. This implies that ITC will have to raise its prices an average of 4-5% to cover the additional excise burden. HLL’s earnings should benefit from the India Budget F2004 – March 3. We believe that. while price increases will hurt volumes in the near term. the government will amend the Additional Excise Duty Act to allow state governments to impose a maximum 4% sales tax on cigarettes. in our view. 3) significant material cost inflation. with 40% abatement. albeit marginally. with the abatement reduced from 40% to 35%. We assign a lower premium because of the company’s declining growth rate relative to the sector. 2) loss of market share in key product categories.0% 8. Key changes in the indirect tax proposals for the consumer sector are as follows: 1) Excise duty on biscuits reduced from 16% to 8%. the company will likely be hurt by the imposition of an 8% excise duty on refined edible oil/vanaspati. Morgan Stanley Research Estimates ITC (ITC. Excise comprises 60% of ITC’s total cigarette turnover and is the largest cost element. in our view. Also. 7) Excise duty on toilet preparations containing alcohol reduced from 50% to 16%. Equal-Weight.0% 8. Our price target of Rs180 is based on a 45% P/E premium to the sector multiple excluding HLL (10-year average) compared with HLL’s 5-year average of 64%. A specific excise duty has been retained. 8) Reduction in peak import duty from 30% to 25%. this group’s sensitivity to consumption is low. 6) Excise duty on aerated soft drinks reduced from 32% to 24%. ITC benefits from the reduction in excise duty from 16% to 8% on biscuits and sugar confectionery.50% 308 250 113 22 (253) (285) Neutral Neutral 155 22.7.BO. 2003 Please see the important disclosures at the end of this report. with the abatement reduced from 40% to 35%. The higher income group will be the most affected on account of the higher income tax as well as a higher service tax. Rs 650.BO. At the price target the stock would trade at a P/E of 21 based on our new 2003 earnings estimates. Equal-Weight. which would benefit ITC. hard-boiled sugar confectionery and biscuits and the cut in import duty on raw materials. the reduction in the small savings rate will reduce future income on savings.0% Excise Duty on Edible Oils Nil Tax on Tea Re 1 Dividend tax Nil Total Gain/Loss Profit before Tax 2002 % of PBT 16. Price Target Rs180) HLL: Budget Impact Existing Proposed Gain/(Loss) Rs m Excise Duty on toilet preparations containing alcohol 50. Exhibit 10 Higher-income households are likely to be affected by a higher tax surcharge. However.5% 8.0% Excise duty on biscuits and confectionery 16.0% Service tax on advertising 5.0% Re 1 12.0% Corporate tax surcharge 5. Rs168.JM MORGAN STANLEY Page 13 • The rural income group will gain from several new benefit schemes but will likely be hurt by a 4-5% reduction in fertilizer subsidy (urea and DAP). albeit marginally. 4) Excise duty on tea (Rs1/kg) converted to a cess of Rs1/kg.0% 25. Overall. the impact on HLL’s pretax profit from the key budget proposals will likely be around +0. The budget does not increase the excise duty on cigarettes. However.35. Implementation of the sales tax may take a few months. with abatement cut from 50% to 45%. However. Hindustan Lever (HLL.7% Source: Budget Documents. Price Target Rs700) HLL will benefit primarily from the reduction in excise duty on alcohol-based toilet preparations.357 0.7% (Exhibit 10). Key risks to our price target are: 1) a significant change in consumption demand growth. as its effective tax rate is 21% on account of backward-area benefits. We believe the lower duty on personal care products will be passed on to consumers to accelerate volume growth. profitability may not be significantly dampened on account of price hikes and an improvement in product mix. 3) No increase in excise duty on cigarettes.0% Custom duties (peak) 30.0% 2. and 4) any large acquisition. . • decrease in the surcharge on corporate tax.
While the gain appears to be huge. Instead of increasing the subsidy.5% would reduce their effective tax rate by around 1.3%.0% 30. The latter should also be helped by the reduction in the peak import duty on refined edible oil costs. Britannia Industries (BRIT. Increase in government subsidy on kerosene & LPG The government has increased the petroleum subsidy from Rs62.0% 2.BO.65 billion in F2003 to Rs81. The overall impact. any adverse outcome of pending litigation with government authorities. We believe this is primarily to compensate the R&M companies (IOCL. the stock would trade at a 15% discount to the sector earnings multiple. Advantage for LNG Regassification plants The government has reduced import duty on capital goods required for LNG regassification units. In our view. Our discussion with various industry officials and the Indian R&M companies lead us to believe that. 4) lack of success in the dairy business. Britannia should be the biggest gainer from the Finance Bill. a rise of 30%. According to our calculations.9. the government will have to issue oil bonds worth Rs82. India Budget F2004 – March 3. 2003 (Exhibit 11). the continued exemption on service tax and the benefit of setting-off unabsorbed losses and depreciation on amalgamation. which we believe is a fair valuation. is marginally positive.50% 514 43 13 Neutral 571 1362 42% Source: Budget Documents. and 5) utilization of surplus cash. We use EV/EBITDA as the valuation measure because it captures the earnings of the core cigarette business.16 billion for F2004. We arrive at our price target of Rs601 by applying a F2004E P/E of 14.6%. We believe that the company will decrease the price of its brands to pass on the lower excise duty to the consumer. This should accelerate its volume growth and ease pressure on operating margins.0% Nil 8. lowering the surcharge from 5% to 2.5 billion as compensation to the R&Ms for prior periods. the estimated subsidy on LPG has increased 77. Morgan Stanley Research Estimates.JM MORGAN STANLEY Page 14 The company’s hotel business should gain significantly from the withdrawal of the expenditure tax.1x EV/EBIDTA (12% premium to global average) on our F2004 estimates. Price Target Rs601) Exhibit 11 Britannia Industries: Budget Impact Existing Proposed Gain/(Loss) Rs m Excise duty on biscuits Custom duties (Peak) . 2003 Please see the important disclosures at the end of this report. ITC’s earnings will benefit from the decrease in the surcharge on corporate tax. The main risks we see to achievement of our price target for Britannia are: 1) a significant change in consumption demand growth. within this financial year. BPCL and HPCL) for existing subsidies on LPG and kerosene sales. The key risks we see to achievement of our price target for ITC are the operating fundamentals for domestic tobacco. Rs519. while the estimated subsidy on kerosene has been maintained at Rs3/liter.5% to Rs71/cylinder. and consequently lower their tax burdens. Energy Vinay Jaising F2004 Budget – Marginally Positive for Indian Oil & Gas The Union Budget for F2004 has five major proposals relevant to the Indian oil & gas industry. from 25% to 5%.5% As all the Indian oil & gas companies fall under the highest corporate tax slab.0% 25. this is positive for the Indian R&M companies. Based on our price target. We believe that a 15-20% premium to the global tobacco sector average multiple is justified by ITC’s higher forecast earnings growth rate and ROE. in our view. The excise reduction for biscuits from 16% to 8% should substantially boost its core bakery business. its key input. Surcharge on corporate tax reduced by 2. 3) substantial material cost inflation. Equal-Weight. 2) a meaningful shift in market shares in biscuits and major brands. the government could have increased LPG and kerosene prices to enable the R&Ms to realize prices close to the fair market value. among others. which is based on 7. and a significant change in investment in the company’s non-tobacco businesses.edible oils Corporate tax surcharge Dividend tax Total Gain/Loss Profit before Tax 2002 % of PBT 16.5% 12. as the company’s effective tax rate is 33.0% 5. We retain our price target of Rs700. . price decreases will likely be traded for volume increases.
In our view. This should give a boost to additions of larger power generation capacity. political considerations may delay passage of the bill. equipment manufacturers like BHEL may be negatively affected by the threat of imports or pricing parity with imports. translating to a reduction of about Rs5 billion in the cumulative profits of the industry Additional cess of Rs0. Additional duty on crude oil A Natural Calamity Contingency Duty of Rs50/ton has been imposed on crude oil – both indigenous and imported – for one year. While cable operators may be able to pass on the higher tax to consumer households. Also. the broadcasters may find it difficult to pass on the entire burden to advertisers. Customs duties on equipment for high-voltage transmission equipment have been reduced from 25% to 5%.BO. The proposal that we believe will affect the industry most is the increase in the service tax from 5% to 8%. which could also delay benefits to companies like BHEL in the form of lower receivables and greater demand for generation equipment after a lag of 1-2 years. . While this is obviously positive for the power sector. if we assume that Zee TV will have to bear the total incremental cost. seaports.5/liter.5% is positive for high marginal tax rate payers like Hindalco. Price Target Rs118). Advertising revenue comprises nearly 61% of total revenue for Zee TV (ZEE. Advertising revenue has been sluggish. albeit marginally.5 per liter on motor fuels Additional duty on motor spirit (petrol) and high-speed diesel oil has been increased from Rs1/liter to Rs1. In our view. the reduction in the corporate tax surcharge from 5% to 2. airports and power. or 7% of pre-tax profits. as customs tariffs for important nonferrous metals like aluminium and copper are unchanged in the budget. Infrastructure construction companies should benefit from more orders with the government’s proposed increase in investments in infrastructure projects like road construction. Media Rajesh Mayani Overall. Engineering Satish Jain Budget positive for power generation companies Negative for equipment manufacturers like BHEL Positive for infrastructure construction companies The budget mentioned that the Electricity Bill introduced in Parliament should be taken up for consideration at an early date. b) Customs duty on serially numbered gold bars has been reduced from Rs250 to Rs100 per 10 grammes. Overweight.5/liter. previously available only to “Mega power projects” (capacity above 1000MW) to all power projects. Excise duty on light diesel oil has also risen by Rs1. This will result in a 0. the company will be able to pass on at least 50% of the incremental cost to advertisers. Rs84. On the direct tax side. 2003 Please see the important disclosures at the end of this report. The following are some of the other changes that affect the industry: a) Gold arising from smelting copper and zinc has been exempted from excise duty. it will benefit from lower tax rate.JM MORGAN STANLEY Page 15 This will lower the capital expenditure to set up LNG projects. We estimate that the maximum impact on the company’s earnings will be Rs197 million. The government emphasized power generation and has decided allow benefits like 10-year tax holidays and a complete waiver of import duties. India Budget F2004 – March 3. We were expecting a 5% reduction in the copper tariff from 25% to 20%. Metals Chetan Ahya Non Ferrous and Precious Metals We view the budget as marginally positive for the nonferrous metal sector. the budget looks neutral to negative for the media sector.5% reduction in the weighted average tariff protection for the Indian refiners. and an incremental 3% service tax will likely hurt broadcasters.
Price Target Rs766) Budget proposals to retain the tariff on non-ferrous metals like copper. Overweight. (b) a longer-thanexpected weak cycle in copper treatment and refining charges. Several indirect tax/depreciation benefits (1) Increase in the depreciation rate by 15 percentage points to 40% for life-saving medical equipment. including Ranbaxy (RANB. the benefits of Section 10 (23G) of the Income Tax Act have been extended to financial institutions for providing capital to private hospitals with more than 100 beds. TISCO is highly leveraged to steel prices. as it is not influenced by the varying nature of capital intensity and the leverage cost of different players in the mining sector.05.BO. The rail budget announced earlier also had some benefits for the steel sector. Equal-Weight). 4) exempting all material/drugs used The budget proposals left the tariff on hot rolled coils intact at 25%. as it is not influenced by the varying capital intensity and leverage cost of the different players in the mining industry. We prefer to use EV/EBIDTA in setting the price target.000. To this end. • . The Finance Minister stressed the need to improve the country’s health care infrastructure. which had caused domestic prices to increase. and changes in those quotes affect EBIDTA and operating profits significantly. We believe risks to our price target include: (a) sharp declines in non-ferrous metal prices. Steel prices. This was a pleasant surprise. health care facilities and biotechnology industries. as we believe there would be little investor tolerance for a decline in steel prices. Overweight. however. (TISC. The key benefits we see for these companies are as follows: • Reduction in customs duty by 5 percentage points to 25% for pharmaceutical-related imports. Rs876. Dr Reddy’s (REDY. Rs587. Price Target Rs1. which attract nil/5% customs duty and exempting those drugs from excise duty. Rs453.BO. would prompt the government to cut the tariff by 5%. and (c) higher-than-expected cuts in tariff protection.5%. We retain our Overweight rating and our target price of Rs766 on the stock. The impact of this announcement is calculated in Exhibit 12. We believe that the budget is a mild positive for the pharmaceutical industry and may result in 2-3% higher profitability for the prominent pharmaceutical companies. 3) broadening of the list of life-saving drugs. in line with our expectation. Price Target Rs790). as we had expected that high international prices.BO. Tata Iron & Steel Co. Cipla (CIPL.4 times. Rs769. The 5% reduction in tariffs on cold rolled coils. accordingly. This would affect the companies across all sectors. Rs613. galvanized sheets and structurals was. Incorporating the budget measures outlined above. exempting gold arising from smelting copper from the excise duty and the reduction in the corporate tax surcharge are positive for Hindalco’s earnings. Target Rs154) • We maintain our Underweight rating on Tata Iron & Steel Co. 2) 20 percentage-point lower customs duty to 5% and CVD (countervailing duty) exemption specified for life-saving equipment.9.05. Our 12-month price target of Rs154 is based on a 12-month forward EV/EBITDA of 5. Pharmaceuticals Sameer Baisiwala The government has emphasized health care as one of its five priorities and.25.BO. The budget proposes a community-based universal health insurance scheme for the less advantaged citizens at a nominal premium of Rs1 per day for medical reimbursement up to Rs30. Overweight. Our price target is conservatively based on a 12-month forward EV/EBITDA multiple of 3. We prefer to use EV/EBIDTA in setting the price target.JM MORGAN STANLEY Page 16 Hindalco (HALC. (TISCO). we have raised our earnings forecast by 7% for F2004.5. Amongst the other positives for the sector were the government’s emphasis on infrastructure and housing and the reduction in excise duty for end-user segments like automobiles.3%.75. Rs280.050). Halving of the surcharge on corporate tax to 2. Sun (SUN.9. Overweight. announced several incentives for the pharmaceutical. Price Target Rs1.BO. with a reduction in freight on iron and steel of nearly 5. Price Target Rs420) and Wockhardt (WCKH. Rs149. Equal-Weight. 2003 Please see the important disclosures at the end of this report.BO.149). which is a 10% discount to the past five year’s average. Underweight. We have increased our earnings forecast by 4% for F2004 and F2005. The key risk we see to our price target is continued resilience of or an increase in steel India Budget F2004 – March 3.BO.
The proposed VAT rate (12.1% 2.8% 9. and 5) 20 percentage-point reduction in the Reference Standards to 5%. in our view. According to the companies.7% 6.1% 17.1% 1. we believe. including Bharti Tele- .75% to 35. assuming all imports qualify for lower customs duty **Impact is amplified for Ranbaxy since profits have risen disproportionate to imports over the last 15 months Technology Anantha Narayan Three proposals contained in the F2004 budget affect the software services sector.8% 3. We think companies may adjust their payouts to neutralize the tax – the shareholder should still be a net beneficiary.004 570 513 63 57 45 154 22 20 2.493 1.9% 42.7 17. Since we do not view the impact as significant. India Budget F2004 – March 3.3% 2.6% 3. 2003. As we have discussed before (see “Budget Possibilities” dated February 21. on routers. This would aid M&A and restructuring activity. the Income Tax Act inserted a proviso that restricted exemptions to 90% of profits.88%. This will have a negligible impact on the software services industry.5%) is likely to be higher than the present average rate of around 8%.2% 5. and 100% of profits are exempt once again. discussing the approximate likely effect of this change on various companies in our coverage. we are not changing our earnings estimates at this stage. and on certain specified equipment from 25% to 15%.4 193.5% on all companies in India but has made it exempt of tax in the hands of shareholders.1 17.5 199 17. All the telecom operators.8% 8.1 13. The marginal tax rate has gone down slightly from 36.7% 1.7 3. 2003). Changes in dividend distribution and marginal tax rate: The government has imposed a dividend distribution tax of 12.164 4. However. Exhibit 13 India Software Services: Approximate Impact of Reinstatement of 10% Tax Exemption Company F04E Tax Rate F04E EPS (Rs) F04E Likely Tax Rate F04E Likely EPS Likely EPS Change Digital HCLT Hughes i-flex Infosys Satyam 11% 11% 20% 12% 17% 10% 41. the market was expecting the status quo to be maintained.) In our view.9% 6. Thus.3% 1.1% 14. Telecom Vinay Jaising F2004 Budget Rings a Positive Tone Reduction in customs duty on certain telecom equipment should aid growth The India Union Budget F2004 reduced customs duty on optical fiber cables from 25% to 15%.6 17. even if majority ownership changes hands. Source: Morgan Stanley Research Estimates *Under the best-case scenario. income tax is the only significant budget variable that affects the sector.9% Clarification on change of ownership: The government has clarified that tax exemptions will continue.6 65. in our view. The budget also extended the low import duty rates of 5% for wireline and wireless customer premises equipment (CPE) for F2004.630 1. Income Tax Change: Last year. we regard this as marginally positive for the sector. note.6 14. the additional tax is likely to be passed on to the consumers. Exhibit 12 We reproduce in Exhibit 13 part of an exhibit from our February 21.JM MORGAN STANLEY Page 17 for clinical trials from customs and excise duty. Rs mn) Company Imports Impact (PBT)* Impact as a % of Profits Cipla Dr Reddy's Lab Glaxo Ranbaxy ** Sun Wockhardt 1. modems and fixed wireless terminals from 15% to 10%. (Previously 100% of profits were exempt.1 7.4% E = Morgan Stanley Research Estimates Source: Morgan Stanley Research Indian Prominent Pharmaceutical Companies: Effect of Lower Customs Duty (F2002 data. The probable enforcement of VAT (value added tax) is likely to benefit the organized pharmaceutical sector and facilitate supply chain efficiencies. it seems that the restriction has been lifted. However. The precise impact on individual companies can be assessed only once the fine-print is available.1 63.7% 3. 2003 Please see the important disclosures at the end of this report. that the above-mentioned benefits will result in 2-3% higher profitability for the prominent pharmaceutical companies. specifically for F2003. since there was no specific mention of this in the F2004 budget.
Increase in service tax from 5% to 8% is the sole negative The proposed increase in service tax in F2004 would increase the effective ARPU (and in turn.3% for of MTNL and 1% for VSNL due to reduction in the tax burden. Bottom lines could improve 1.JM MORGAN STANLEY Page 18 Ventures and Reliance Infocomm. 2003 Please see the important disclosures at the end of this report. . 30% exemption for the next five years) to those operators commencing operations up to March 31. Reliance Infocomm would be a direct beneficiary.8%. India Budget F2004 – March 3.5% reduction in corporate tax surcharge. MTNL and VSNL should benefit from 2. Eligibility of startup services for 10-year tax holiday extended for F2004 The government has decided to extend the eligibility of startup telecom services for a 10-year tax holiday (100% tax exemption for first five years. 2004. the cost to the consumer) of all wireline and wireless operators by 2. should benefit from the implied reduction in their overall capital expenditure.
The analyst views the performance of his or her industry coverage universe with caution vs. on a risk-adjusted basis. please go to www. More volatile (V). over the next 12-18 months.morganstanley. We estimate that this stock has more than a 25% chance of a price move (up or down) of more than 25% in a month. For definitions. Equal-weight. New York.com/companycharts. 2003 Please see the important disclosures at the end of this report. N=Neutral. The stock’s total return is expected to exceed the total return of the relevant country MSCI index. over the next 12-18 months. on a risk-adjusted basis. Underweight (U). we note that Overweight. or in the analyst’s view. most closely corresponds to a buy recommendation. respectively.com/companycharts. and sell but represent recommended relative weightings (see definitions below). India Budget F2004 – March 3. 2002: SB=Strong Buy. OP=Outperform. based on a quantitative assessment of historical data. Investment Banking Clients are companies from whom Morgan Stanley or an affiliate received investment banking compensation in the last 12 months. neutral. The stock’s total return is expected to be in line with the total return of the relevant country MSCI index. the relevant broad market benchmark over the next 12-18 months. The analyst expects the performance of his or her industry coverage universe to be in line with the relevant broad market benchmark over the next 12-18 months.889 632 Data include common stock and ADRs currently assigned ratings. Equal-weight (E). Ratings prior to March 18. An investor's decision to buy or sell a stock should depend on individual circumstances (such as the investor's existing holdings) and other considerations.JM MORGAN STANLEY Page 19 Global Stock Ratings Distribution (as of February 28. . Overweight. ANALYST STOCK RATINGS Overweight (O). For disclosure purposes (in accordance with NASD and NYSE requirements). Cautious (C). The stock’s total return is expected to be below the total return of the relevant country MSCI index.morganstanley. 10036 USA. We note that securities that we do not currently consider "more volatile" can still perform in that manner. 14th Floor (Attention: Research Disclosures). ANALYST INDUSTRY VIEWS Attractive (A). In-Line (I). Stock price charts and rating histories for companies discussed in this report are also available at www. You may also request this information by writing to Morgan Stanley at 1585 Broadway. and Underweight are not the equivalent of buy. UP=Underperform. our most positive stock rating. NY. the relevant broad market benchmark over the next 12-18 months. However. 2003) Coverage Universe Stock Rating Category Count % of Total Investment Banking Clients (IBC) Count % of Total IBC % of Rating Category Overweight 616 33% 239 38% 39% Equal-weight 883 47% 289 46% 33% Underweight 390 21% 104 16% 27% Total 1. it is likely to become materially more volatile over the next 112 months compared with the past three years. Stocks with less than one year of trading history are automatically rated as more volatile (unless otherwise noted). over the next 12-18 months. on a riskadjusted basis. Equal-weight and Underweight most closely correspond to neutral and sell recommendations. The analyst expects the performance of his or her industry coverage universe to be attractive vs.
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This report is not an offer to buy or sell any security or to participate in any trading strategy. a licensed dealer. and may trade them in ways different from those discussed in this report. (common stock). Morgan Stanley has no obligation to tell you when opinions or information in this report change. fund management. Ranbaxy Laboratories. Infosys Technologies. investment services and investment banking. Infosys Technologies. Mahanagar Telephone Nigam. or research associate (or a household member) owns securities in a company that he or she covers or recommends in this report: Ridham Desai . Tata Iron & Steel Co. risk arbitrage and other proprietary trading. Within the last 12 months. including investment banking personnel. Morgan Stanley DW Inc. Derivatives may be issued by Morgan Stanley or associated persons. Britannia Industries. Morgan Stanley DW Inc. Analysts may nevertheless own such securities to the extent acquired under a prior policy or in a merger. Sachin Sheth . 2003. comprehensive information. Sun Pharmaceutical Industries. Within the last 12 months. Videsh Sanchar Nigam.Infosys Technologies (common stock). stock picking. Infosys Technologies. Morgan Stanley DW Inc. and encourages investors to seek the advice of a financial adviser. HDFC. Ranbaxy Laboratories. or research associates principally responsible for the preparation of this research report have received compensation based upon various factors. Hindalco Industries.ICICI Bank (common stock). strategists and research associates from investing in securities in their MSCI sub industry.. which accepts responsibility for its contents). strategists. Morgan Stanley. operational or financial conditions of companies or other factors.. Facts and views presented in this report have not been reviewed by. ITC Ltd.morganstanley. Ranbaxy Laboratories. Hindalco Industries. please refer to the latest published research on these stocks. Britannia Industries. strategist.. Morgan Stanley makes every effort to use reliable. 2003 . An employee or director of Morgan Stanley. Seoul Branch. GlaxoSmithKline Pharma.ITC Ltd. but we make no representation that it is accurate or complete.. Morgan Stanley.. or an affiliate managed or co-managed a public offering of securities of i-flex Solutions Ltd. Morgan Stanley. State Bank of India. As of January 31. The securities discussed in this report may not be suitable for all investors.. and/or Morgan Stanley Dean Witter Australia Limited (A. and may not reflect information known to. professionals in other Morgan Stanley business areas. of the valuation methods used to determine the price targets included in this summary and the risks related to achieving these targets. Dr. These businesses include market making and specialized trading.N. or an affiliate has received compensation for investment banking services from Reliance Industries. Taipei Branch and/or Morgan Stanley & Co International Limited. investor client feedback. Morgan Stanley. Mahanagar Telephone Nigam. Cipla Ltd. competitive factors. Morgan Stanley DW Inc. ITC Ltd. There may be time limitations on the exercise of options or other rights in your securities transactions. The value of and income from your investments may vary because of changes in interest rates or foreign exchange rates. The appropriateness of a particular investment or strategy will depend on an investor's individual circumstances and objectives. Tata Iron & Steel Co. Bharti Tele-Ventures Ltd. In the next 3 months. This report does not provide individually tailored investment advice. Reddy's Lab. if applicable.com and other electronic systems. fund distribution or other involuntary acquisition.. Estimates of future performance are based on assumptions that may not be realized. Tata Iron & Steel Co. International Limited. and/or their affiliate companies beneficially owned 1% or more of a class of common equity securities of the following companies covered in this report: NIIT Limited. Wockhardt Limited. Research is available through your sales representative or on Client Link at www. Hindustan Lever (common stock). and/or their affiliate companies make a market in the securities of Reliance Industries. The information and opinions in this report were prepared or are disseminated by Morgan Stanley Dean Witter Asia Limited and/or Morgan Stanley Dean Witter Asia (Singapore) Pte. Reliance Industries. The research analysts. Morgan Stanley. The following analyst. Grasim Industries (common stock). Past performance is not necessarily a guide to future performance. as the case may be. affiliate companies and/or their employees may have investments in securities or derivatives of securities of companies mentioned in this report. Britannia Industries. firm revenues and investment banking revenues. State Bank of India.JM MORGAN STANLEY Page 20 For a discussion. HDFC. Morgan Stanley recommends that investors independently evaluate particular investments and strategies. securities prices or market indexes. It has been prepared without regard to the individual financial circumstances and objectives of persons who receive it. This report is based on public information. 67 003 734 576. Morgan Stanley DW Inc. Morgan Stanley policy prohibits research analysts. Videsh Sanchar Nigam.
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