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India Equity Research Reports, IPO and Stock News
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Strategy
Indian Economy
GST may get going finally. A recent consensus among state finance ministers for a
negative list approach to service tax may (1) increase the number of services to be taxed
in FY2013 and more important, (2) have finally set the stage for GST implementation.
This may also drive investor confidence in India given perceived ‘policy inaction’ at a
time of a deteriorating fiscal situation, weak BOP and an economic slowdown. We
expect the Indian market to return 15-20% in CY2012 if governance and macroeconomic
factors improve; valuations are supportive and earnings appear reasonably
resilient. However, the market may languish without improvement in governance.
Challenges abound in CY2012: As many opportunities as there are risks
As highlighted in our November 24, 2011 report titled Governance: The missing link, we believe
CY2012 could either be the start of a multi-year bull market in India or a repeat of CY2011,
another wasted year. The difference between the two scenarios is the response of the
Government in the form of improved governance (which will also improve macro-economic
factors) versus the current state of policy drift. The former is likely to drive 15-20% returns for the
Indian equity market in CY2012 and the latter may result in a static -5-+5% return. We find
comfort in (1) relatively depressed valuations (see Exhibit 1) and (2) earnings resilience (see Exhibit
2; we model 13.7% and 17.1% earnings growth for the BSE-30 Index in FY2012 and FY2013
respectively). The composition of India’s earnings (see Exhibit 3)—(1) global nature of earnings of
the energy, metals & mining and technology sectors and (2) a large share of earnings of
companies such as Coal India and ONGC, whose earnings do not depend on domestic economic
factors, provides some degree of resilience to earnings.
GST implementation seeing some momentum; likely in FY2014
We note two challenges to the introduction of GST: (1) political consensus and (2) overhaul of IT
infrastructure. The recent agreement among state finance ministers (part of the Empowered
Committee of State Finance Ministers on GST) probably points to political consensus. However, the
Chairman of the same Committee stated that the creation of infrastructure (computerization of
records of state governments) may push implementation to April 1, 2013.
Service tax key driver of taxation reform in FY2013E; expect higher excise duties as well
Notwithstanding the delay in GST implementation, the FY2013 Union Budget provides the
Government with another avenue for fiscal consolidation. India applies service tax on125 services
currently. In the negative list approach, all services will be taxed by the Government barring those
specified in the list. This proposed change has the potential to widen the Indian service tax net
significantly. Services tax constitutes a small portion of the Government’s overall taxes (see Exhibit
4) despite the service sector’s large share of India’s GDP. We do not rule out higher excise duty in
FY2013 as the Government grapples with high fiscal deficit in FY2012E and FY2013E (see Exhibit
5).
Portfolio changes: MSIL replaces HUL; no other major changes
We have replaced HUL wi th Maruti in our Top-10 list (our Consumers team recently downgraded
HUL on valuation), reduced HUL’s weight to a neutral position (100 bps overweight previously) and
compensated this through MSIL (100 bps overweight versus neutral previously) (See Exhibits 6-7).
We had added a little bit of risk to our Model Portofolio in December 2011 through ICICI Bank
and Sterlite. We retain our hedged investment strategy--a combination of (1) high-quality stocks
(retail-focused private banks, consumer, pharma and technology stocks account for about 50% of
the Model Portfolio) and (2) solid companies with inexpensive valuations and favorable reward-risk
balance from improvement in macro factors (interest rate cycle), government policies (pricing in
the case of Coal India and ONGC) and company-specific factors (STLT).
The Government could do a lot more
We believe the Government can do a lot more to demonstrate its commitment to tackle
major challenges being faced by India. India may have little choice but to improve
governance and reform dramatically, given the high cost of ‘policy inaction’ in terms of time
and opportunity. Some progress has been made on subsidy reforms (increase in domestic
selling price of fuels and power tariffs) though it is quite inadequate in the context of large
subsidies on fuels and losses of state electricity boards.
We see taxation reforms being led by the introduction of a negative list for service tax in
FY2013 and GST in FY2014 (DTC may be implemented in FY2013) as only one of the several
reforms required to achieve higher, sustainable and more inclusive growth. We have
highlighted the potential for further reforms in our November 24, 2011 strategy report titled
Governance: The missing link. A dynamic response from the Government to current
challenges is required to increase India’s potential GDP growth—(1) mindset reforms
(acknowledge the challenges and react with well-articulated policies), (2) execution reforms
(step up investment in infrastructure and remove policy impediments to pending projects)
and (3) fiscal reforms (fiscal consolidation through taxation and subsidy reforms).
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Strategy
Indian Economy
GST may get going finally. A recent consensus among state finance ministers for a
negative list approach to service tax may (1) increase the number of services to be taxed
in FY2013 and more important, (2) have finally set the stage for GST implementation.
This may also drive investor confidence in India given perceived ‘policy inaction’ at a
time of a deteriorating fiscal situation, weak BOP and an economic slowdown. We
expect the Indian market to return 15-20% in CY2012 if governance and macroeconomic
factors improve; valuations are supportive and earnings appear reasonably
resilient. However, the market may languish without improvement in governance.
Challenges abound in CY2012: As many opportunities as there are risks
As highlighted in our November 24, 2011 report titled Governance: The missing link, we believe
CY2012 could either be the start of a multi-year bull market in India or a repeat of CY2011,
another wasted year. The difference between the two scenarios is the response of the
Government in the form of improved governance (which will also improve macro-economic
factors) versus the current state of policy drift. The former is likely to drive 15-20% returns for the
Indian equity market in CY2012 and the latter may result in a static -5-+5% return. We find
comfort in (1) relatively depressed valuations (see Exhibit 1) and (2) earnings resilience (see Exhibit
2; we model 13.7% and 17.1% earnings growth for the BSE-30 Index in FY2012 and FY2013
respectively). The composition of India’s earnings (see Exhibit 3)—(1) global nature of earnings of
the energy, metals & mining and technology sectors and (2) a large share of earnings of
companies such as Coal India and ONGC, whose earnings do not depend on domestic economic
factors, provides some degree of resilience to earnings.
GST implementation seeing some momentum; likely in FY2014
We note two challenges to the introduction of GST: (1) political consensus and (2) overhaul of IT
infrastructure. The recent agreement among state finance ministers (part of the Empowered
Committee of State Finance Ministers on GST) probably points to political consensus. However, the
Chairman of the same Committee stated that the creation of infrastructure (computerization of
records of state governments) may push implementation to April 1, 2013.
Service tax key driver of taxation reform in FY2013E; expect higher excise duties as well
Notwithstanding the delay in GST implementation, the FY2013 Union Budget provides the
Government with another avenue for fiscal consolidation. India applies service tax on125 services
currently. In the negative list approach, all services will be taxed by the Government barring those
specified in the list. This proposed change has the potential to widen the Indian service tax net
significantly. Services tax constitutes a small portion of the Government’s overall taxes (see Exhibit
4) despite the service sector’s large share of India’s GDP. We do not rule out higher excise duty in
FY2013 as the Government grapples with high fiscal deficit in FY2012E and FY2013E (see Exhibit
5).
Portfolio changes: MSIL replaces HUL; no other major changes
We have replaced HUL wi th Maruti in our Top-10 list (our Consumers team recently downgraded
HUL on valuation), reduced HUL’s weight to a neutral position (100 bps overweight previously) and
compensated this through MSIL (100 bps overweight versus neutral previously) (See Exhibits 6-7).
We had added a little bit of risk to our Model Portofolio in December 2011 through ICICI Bank
and Sterlite. We retain our hedged investment strategy--a combination of (1) high-quality stocks
(retail-focused private banks, consumer, pharma and technology stocks account for about 50% of
the Model Portfolio) and (2) solid companies with inexpensive valuations and favorable reward-risk
balance from improvement in macro factors (interest rate cycle), government policies (pricing in
the case of Coal India and ONGC) and company-specific factors (STLT).
The Government could do a lot more
We believe the Government can do a lot more to demonstrate its commitment to tackle
major challenges being faced by India. India may have little choice but to improve
governance and reform dramatically, given the high cost of ‘policy inaction’ in terms of time
and opportunity. Some progress has been made on subsidy reforms (increase in domestic
selling price of fuels and power tariffs) though it is quite inadequate in the context of large
subsidies on fuels and losses of state electricity boards.
We see taxation reforms being led by the introduction of a negative list for service tax in
FY2013 and GST in FY2014 (DTC may be implemented in FY2013) as only one of the several
reforms required to achieve higher, sustainable and more inclusive growth. We have
highlighted the potential for further reforms in our November 24, 2011 strategy report titled
Governance: The missing link. A dynamic response from the Government to current
challenges is required to increase India’s potential GDP growth—(1) mindset reforms
(acknowledge the challenges and react with well-articulated policies), (2) execution reforms
(step up investment in infrastructure and remove policy impediments to pending projects)
and (3) fiscal reforms (fiscal consolidation through taxation and subsidy reforms).
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