Investment Strategy: Interim budget: Misplaced market expectations belied

Interim budget 09: No major changes : The interim budget presented by the Finance Minister did not announce any major tax changes. Market expectations, however, had been built up based we think on media reports of another fiscal stimulus package in the budget. The market’s budget expectations were belied leading to an over 3% correction in the markets today. With policy announcements likely to cease (except for a possible 50bp RBI cut by April 09) and political uncertainties of the elections, we expect markets to test the October lows.

High fiscal deficit continues to limit pump priming: The interim budget 09 expectedly supported our view of rising fiscal constraints to pump priming. Indeed, besides extending subsidizing of export credit, the government did not even meet our minimal expectations on incentives in autos and housing. We continue to estimate the FY10 Center’s conventional fiscal deficit at a higher 6.0% of GDP than the projected 5.5%. We understand the Finance Minister himself sounded the possibility of 0.5-1% of GDP slippage on account of higher plan expenditure. The FY09 fiscal deficit is pegged at 6% of GDP in line with our estimate of 6.1%, assuming all infrastructure and rural development spend materializes. If not, we think the fiscal deficit will likely end FY09 at 5.1%.

Rs3086bn borrowing to U yields 2Q09, near-term RBI driven The government’s Rs3086bn/US$68bn net market borrowing – higher than our above-consensus Rs2601bn/US$57.8bn (consensus, Rs2000-2500bn) - strengthens our view of a U in yields by 2Q09 as the RBI runs out of MSS sterilization bonds to fund a rising fiscal deficit (with the latest round of premature Rs450bn buyback). With higher-than-expected supply putting pressure on weak sentiment, gilts are now likely to be more dependent on RBI rate cuts/ OMO to provide respite and catalysts for a rally, in our view.

Spends hiked across Infra space; 9% target delayed to FY14: Hike in spends on Bharat Nirman +31%YoY to Rs409bn, JNNURM +74%YoY to Rs118bn, and NHAI +18%YoY to Rs110bn – we think are positive for all Infra contractors such as L&T, IVRC and NJCC. However, increased reliance on PPP model in roads, could delay spends / execution, given the lack of equity funding, in our view. Defense capex +13%YoY to Rs540bn – we think is positive for defense contractors such as Bharat Electronics, L&T and Tata Power. Government pushed back its targeted Infra spends of 9% as % of GDP, by two years to FY14E.

Sources: ML Research