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What to expect from the Dream Team
Shobhana Subramanian
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February 07, 2005

The curtain raiser to Budget 2005-06 has been quite something: upto 74 per cent foreign direct investment permitted in telecom, private pension funds given the go-ahead to invest in equities, the National Electricity Policy okayed by the Cabinet.

It is looking like banks too may get to invest 10 per cent of their deposits in stocks. To complete the picture, S&P has upped India's long-term foreign currency rating a notch to just a rung below investment grade.

All in all, not a bad setting for the Budget. The markets are loving the action -- the Sensex is now once again nudging its all time high of 6,651 and, despite the increase in the overnight Fed rate, there seems to be no let-up in buying by FIIs (foreign institutional investors). The pre-Budget rally seems to have begun in earnest.

Tax Reform. That's what everybody seems to be looking for in Palaniappan Chidambaram's next Budget. It's not going to be easy, since revenue collections have been way below targets, but that is unlikely to stop the original reformers from taking some major initiatives on this front.

To begin with, the finance minister should keep up the good work as far as bringing down excise and import tariffs is concerned. He is also reportedly a great believer in the Laffer Curve; so there could be some pleasant surprises in store for taxpayers - both corporate and individual. In short, he may gamble on continued growth in industry and services to bring home the bacon.

Here's a sampling of what you could look forward to:

It will be hard for the FM to do a repeat of what he did for the capital markets last July - there's little scope for capital gains tax to be reduced further but there's talk that dividend distribution tax could be lowered from the current 12.5 per cent.

On the other hand, reports have it that the securities transaction tax could be raised. The FM has already announced a divestment target of Rs 10,000 crore (Rs 100 billion) in FY06, which means a flood of government paper.

At a macroeconomic level, the FM has a big task on his hands since there is likely to be a serious shortfall in revenues this year.

Besides, there has been no major disbursal from the Rs 40,000 crore (Rs 400 billion) pool for infrastructure. Confederation of Indian Industry has suggested that an Infrastructure Development Board be set up to ensure development of the infrastructure sector.

The hike in FDI for the insurance sector to 49 per cent has not yet happened. Moreover, the trend towards assuring free power has to be reversed urgently and the previous understanding of a minimum power tariff in all states has to be re-established.

Direct taxes

According to the Kelkar Committee, the actual corporate tax rate of over 36 per cent should be brought down and the exemptions for EOUs, EPZs, FTZs done away with.

The committee also wants lower depreciation rates, down from the present 25 per cent, partly in tune with lower corporate rates and partly because  of lower inflation. The Shome Committee is also in favour of a lower corporate tax of 30 per cent.

Shome's suggestion

The effective corporate tax rate today is around 30 per cent, the rates being higher for capital-intensive companies. Industry would gain from a lower corporate tax but not if depreciation rates are lowered.

According to Ketan Dalal, senior partner, RSM & Co, this might not be the right time to lower depreciation rates since the capex cycle has just begun to turn. EOUs, EPZs and FTZs would be hurt if existing exemptions are prematurely withdrawn, which seems unlikely.

Industry has suggested that existing exemptions be 'grandfathered' and new ones not be added. If exemptions are withdrawn, minimum alternate tax under section 115JB may become irrelevant.

In the context of amalgamations, industry wants two existing conditions -- for holding 75 per cent of the book value of the assets of the amalgamating company for a period of five years, and continuance of the business of the amalgamating company for a minimum period of 5 years by the amalgamated company -- to be dropped. Service companies want a tax break when a loss-making service company merges into a profit-making one.

Personal income tax

The Kelkar Committee had recommended replacing the three slabs with two with the first slab of Rs 100,000-400,000 taxed at 20 per cent, while those in the above Rs 400,000 category being taxed at 30 per cent.

The Shome Committee has recommended that exemptions under section 80L and 88 should be gradually phased out. The maximum tax rate of 30 per cent is likely to stay. However, the FM could ease the burden on marginal taxpayers.

The following is the current personal tax structure:

Indirect taxes

Excise duties: The rate of excise duties for manufactured goods has generally been coming down and for most sectors the rate is 16 per cent though there are special excise duties on some goods.

The Kelkar Committee recommended that the general Cenvat rate should be brought down from 16 per cent to 14 per cent. More recently, a 12 per cent standard rate of excise has been recommended. While rates are more or less uniform, differential rates do exist for sectors such as textiles.

Kelkar's recommendations

Customs duties: The peak rate of 40 per cent in 1999 has been gradually brought down to 20 per cent in 2004-05. There is a good chance that duties will be further reduced from 20 per cent to 15 per cent. The Kelkar Committee has suggested that customs duty rates be brought down to 5 per cent, 8 per cent and 10 per cent.

Some products continue to attract higher duties ranging between 30 per cent to 150 per cent -- for instance, agricultural products, alcoholic beverages, automobiles for personal use, cigarettes, aerated soft drinks, sugar, edible oils and processed foods.

There are also products that attract a low duty of 5 per cent -- for example, capital goods for specified purposes, newsprint, non-alloy steel, steam-coal and metallurgical coke.

In a bid to keep in check prices of some key commodities, customs duty rates on certain products were reduced after the Budget 2004-05. These are iron and steel, motor spirit, HSD, LPG, polymers and various petrochemicals.

What Indian industry would like


Steel and other metals

Consumer goods

Capital Goods


Oil and petrochemicals


Research calls

ITC (outperformer): Considering the recent ordinance on excise definition of prices of cigarettes, SSKI hopes to see a 'fair' end to the legal issues involving excise definition soon. It expects the stock to remain flat in the near term.

Jain Irrigation (outperformer): SSKI sees upsides in the scrip from valuations of 8x FY06 earnings estimate as the company's business model is likely to help it capitalise on opportunities in the agri sector.

Dabur India [Get Quote] (outperformer): Dabur quotes at 15.9x FY06 earnings estimate. After acquiring Balsara and posting impressive Q3FY05 numbers, the company can now look forward to geographical expansion and its leadership in the existing categories for growth, feels SSKI.

Ashok Leyland [Get Quote] (buy): ASK Raymond James maintains its buy rating on Ashok Leyland with a target price of Rs 26. At a P/E of 10x for FY06, the downside is limited. The brokerage cites positives like increasing volumes, better product mix , e-sourcing and value engineering.

HCL Technologies [Get Quote] (downgrade): ASK RJ has reduced HCLT's EPS estimates for FY05 and FY06 by 12 per cent and 13.2 per cent respectively due to a weaker growth outlook and lower treasury income. It has reduced its price target to Rs 355 in 12 months.

Sun Pharma [Get Quote] (outperformer): Prabhudas Lillader feels that the company is in a transformation phase, and expects its initiatives in the US markets to fructify soon. At a price-earnings ration of 20.2x FY05E and 15.1x FY06E, it feels that Sun is trading at attractive valuations in view of the strong growth prospects ahead.

Gujarat State Fertilizers & Chemicals (outperformer): Considering GSFC's strong financial performance, Prabhudas feels that growth will be aided by higher prices for the chemicals business, increased usage of natural gas and higher capacity utilisation. It feels that the stock trades at inexpensive valuations of a price-earnings ratio of 4.8x for FY06E.

Oriental Bank of Commerce [Get Quote] (market underperformer): Refco has downgraded OBC to market underperformer with a target price of Rs 290 after which it will trade at 8.4x FY06 earnings. OBC has accumulated losses of Rs 1225 crore, which would reduce its net worth. Refco feels that OBC trades at rich valuations. However, it expects positive surprises like reduction of OBC's net NPAs and possible income tax benefits.

Bharti Shipyard (buy): Prabhudas initiated coverage on Bharati Shipyard [Get Quote] with a buy rating. It feels that BSL is experiencing strong growth in the offshore vessel- and anchor-handling-tug segments as high oil prices have made offshore drilling more viable. BSL also has a strong order-book which is constrained only by its installed capacity. Prabhudas feels that the stock is attractively valued at 11.1x FY2005 and 8.0x FY06E earnings and has set a price target of Rs.235.


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