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Sunday, March 04, 2007

Anagram - Mutual Fund Fortnightly

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Which market will blow up next? - Jim Jubak

Who's next?

It's only logical to wonder after the 9% plunge in China's Shanghai stock market led to a global sell-off on Feb. 27. That ended with the Dow Jones Industrial Average down 416 points on the day.

There are the usual suspects, of course:

  • The U.S. markets, if the crisis in the submortgage market spreads to the rest of the debt market.
  • Japan, if investors panic at signs that the economy might be slipping back toward recession after the latest interest rate increase.
  • Russia, if investors decide that the country's booming stock market -- up 51% in 2006 -- and state-controlled economy too closely resemble the Chinese market that just blew up.
  • The $345 trillion derivative market, if some of the math whizzes that carve up risk sent too much risk to the wrong investors.

But I've got another candidate: India.

It's as big as China. It's growing just about as fast. Its economy is in more danger of overheating. And it's more dependent on speculative hot money. The Indian stock market suffered through a 30% drop in May and June of 2006, so similar volatility in the days ahead is certainly a possibility. And the country looks like it's on the road to a genuine economic and political crisis.

And, of course, with the global financial markets as spooked as they are after the Feb. 27 meltdown in Shanghai and the subsequent global sell-off, any short-term blip in a major developing market such as India could set off big ripples across the globe.

In the long term, however, I think India might be the most attractive of all global stock markets: Its population is younger than China, its educational system is expanding and improving, and its companies are more focused on creating wealth for shareholders.

Do the long-term rewards outweigh the short-term risks? Should you buy in now, determined to weather any storm, or wait for the rain to fall and the clouds to clear? Let me lay out the short-term risks and the long-term potential.

First, the short-term risks

  • Asset prices are high, so high that they show all the signs of a classic asset bubble. The market valuation of the main Indian stock market in Mumbai, despite that 30% downturn in 2006, had climbed to $836 billion in mid-February from $121 billion in April 2003, an increase of 591%. Property values have soared, with the value of prime office space in Mumbai up 70% in the last year.
  • Those high asset prices depend on a flood of easily withdrawn overseas hot money. Flows of capital into the Indian stock market climbed to $12.5 billion in fiscal 2006, up from $2 billion in fiscal 2002.
  • India is very dependent on global cash flows. Unlike China, India runs a trade deficit and only showed a total capital account surplus in fiscal 2006 because of that $12.5 billion from overseas investors in stocks, foreign direct investment of $6 billion in 2006 and rising corporate borrowing on international capital markets (about $6 billion in fiscal 2005). India was relatively untouched by the Asian financial crisis of 1997, but it is much more vulnerable to changes in external cash flows today.
  • Bank lending is out of control. Over the past three and a half years, bank credit outstanding has jumped by 76%, according to Morgan Stanley.
  • Inflation is out of control. Nationally, inflation recently hit a two-year high of 6.7% and is running even higher -- about 9% -- in the rural areas where two-thirds of Indians live. Inflation at the wholesale level has increased to 6% from 4% last spring.
  • The Reserve Bank of India, the country's central bank, raised its benchmark interest rate to 7.5% at the end of January without noticeably slowing either inflation or the lending boom. Finance Minister Palaniappan Chidambaram has thoroughly undercut the central banks efforts by urging banks not to pass on interest rate increases to lenders.

My short-term prognosis: A big domestic credit crunch -- caused when lenders stop lending and borrowers can't get the cash they need to run their businesses -- causes India to fall far short of current forecasts of 9% to 10% annual growth. Foreign investors begin to withdraw money from the Mumbai stock exchange, producing another 30% "correction." The current Congress Party government loses power. After stumbling with politically motivated attempts to reduce food and fuel prices in rural areas, a new government bites the bullet, raises interest rates and cuts bank lending enough to slow inflation and the economy. Overseas cash begins to return.

It won't play out exactly like that, of course. I don't know how deep any credit crunch might be or how much the Reserve Bank of India might have to slow the economy to reduce inflation to its 5% to 5.5% comfort zone. I don't know how long the Congress Party government might be able to cling to power. I don't know how other global markets would react to a big drop in Indian stocks.

Most of all, I don't know when all of this might happen. This mess took a while to create, and my suspicion is that it will take a while to correct. The core of the problem -- the imbalance between urban areas quickly growing wealthy (in Indian terms) and rural areas left behind in the boom -- isn't unique to India, and it won't be solved by just one crisis. And subduing inflation in India will require big increases in supply, since Indian companies are now operating at full capacity, and improvements in infrastructure that reduce the costs of moving food and fuel. A recent study by the Reserve Bank of India says that it will take 18 months to two years to add significant supply. I think it's reasonable to look for an Indian crisis within that 18- to 24-month parameter.

Second, the case for long-term rewards

  • There's no going back to the highly regulated economy of the past. Even the Congress Party, no friend of an open economy, wasn't able to resist the momentum. And with Indian companies increasingly making big bucks from the global economy, there's no reason to put the genie back in the bottle. That means future growth should be in the range of 7% to 10%, not the anemic rates of the 1980s, when growth was just a third of that.
  • The Indian middle class numbers 200 to 300 million, enough to make them the driver of a domestic consumer economy. With Indian per capita GDP of $3,460 in 2005 (adjusted for purchasing-power parity because money goes further in a poorer country), India is still poorer than China at $6,660 per capita in 2005, but the country has crossed the economic threshold where growth in consumption takes off. Only 10% of Indians have life insurance now, only 2% have credit cards and less than 15% have refrigerators.
  • Even some of India's problems have major economic upside. India's investment in infrastructure has lagged China's. In 2002, for example, the country spent only $31 billion, or 6% of GDP, on building the roads, ports, railroads and airports necessary for competing as a global economy. China in that year spent $210 billion, or 20% of GDP. But the Indian government recognizes its need to catch up.
  • Education is getting the attention -- and rupees -- it needs. Indian society has been soundly shaken over the last two years by studies that show that the country spends too little (just 3.8% of GDP), educates too few (only 8% of 18- to 24-year-olds go on to higher education, about half the Asian average), and teaches too poorly (although 95% of 5- to 10-year-olds go to school, 40% drop out by age 10). The government's next budget, though, is expected to show an increase in education spending to 6% of GDP.
  • Demographics work in India's favor. Half of India's 1.1 billion people are under 25 today, and the country is among the least rapidly aging in the world. In 2002, according to the United Nations, in the developed world 20% of the population was 60 or over. In China, the figure was just 10%, and in India, 8%. By 2050, according to projections, the percentage will have climbed to 33% in the developed world and to 30% in China, but to just 21% in India. That means that India has time to fix its problems before the needs of a huge cohort aged 60 and older begin to dip into national savings. India can take comfort in research that shows younger economies grow faster, too.
  • India's companies have a culture of creating value for shareholders. I know this is subjective, but it is important. If you're going to be a passive shareholder in a company, you'd better hope that the goal of the company is growing the value of all shareholders' stakes. Many Indian companies -- and some of the biggest -- have that culture, maybe because so many started life as businesses run by extended families. I think that culture takes much better care of shareholders than that of corporate China, where companies are often run to enrich local officials, managers and party elites.
  • India's companies show above-average profitability. Here's something much more concrete: The average return on equity for Indian companies on the Mumbai stock exchange is 21%. That's significantly above the 18.7% average return on equity for the U.S. members of the Standard & Poor's 500 Index
  • In addition, Indian companies are comparatively underleveraged, with an average debt-to-equity ratio of just 70% compared with a ratio of 123% for the S&P 500 companies. That means they're got plenty of room to add debt, which will in turn increase leverage, return on equity and profitability for investors.

My long-term prognosis: India is the most attractive stock market in the world for the long haul. By that I mean over the next decade or so.

Adding it all up: After weighing the long-term pluses and short-term minuses, I'd wait for another 30% correction in the Indian stock market. The risks in the Indian economy and the global financial markets are just too great in the short run at current prices in Mumbai. And as the panic on global markets that followed the 9% drop on the Shanghai stock market on Feb. 27 indicates, there are just too many hot-money investors around the world, all hoping to be the first out the door at any sign of trouble.

If I didn't get my correction in Indian stocks by early 2008, I'd re-evaluate my calculations of risk and reward to see if the global risk picture had changed.

Emkay - Automobile Sales

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Prabhudas Lilladher - Budget Analysis

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Money Times

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IVRCL: Buy Nagarjuna Construction: Buy

Investors looking for exposure in the infrastructure space can consider the stocks of IVRCL Infrastructures and Projects, and Nagarjuna Construction. The thrust on irrigation and water management in the recent Budget augurs well for the companies, as both are strong in this space.

Buy with a two/three-year perspective. While stocks in the sector have returned manifold gains over the past few years, the re-rating story is unlikely to repeat itself in the near future. Hence, investors need to moderate their returns expectations.

Complementing strategies

Although both the companies operate in similar business segments, we believe they can complement each other well. While IVRCL continues its thrust on water projects and is likely to emerge a key beneficiary, Nagarjuna's relatively more diversified portfolio is likely to offer cushion against slowdown in any one segment.

Further, any risks from IVRCL's more aggressive alliance and acquisition-led strategy is likely to be offset by Nagarjuna's organic growth approach.

At the current market price, IVRCL and Nagarjuna trade at 17 times and 13 times respectively, their expected earnings for FY-08. This is after adjusting for tax implications consequent to the withdrawal of Section 80 IA benefits for infrastructure cash contracts. The premium for IVRCL appears justified, given the possible unlocking of value on the listing of its real-estate subsidiary and the potential in the power transmission segment.

A high growth story

IVRCL's net profits have grown at about 50 per cent over the past five years on an annualised basis. This high growth has been achieved by the company's ability to quickly ramp up its business in roads, power and recently real-estate without losing focus on its core strength — water-based projects. Its controlling stake in Hindustan Dorr Oliver has not only turned around the latter's business, but also strengthened IVRCL's own water and environment solutions division. Further, IVRCL's tie-up with Nefasa of Spain for the Chennai water desalination plant (commencement of which has been delayed) is likely to give it technical qualification, once completed, for industrial and urban waste treatment projects.

The water and irrigation segment generated 52 per cent of IVRCL's total revenues in FY-06. With the added impetus to irrigation projects and the Urban Renewal Mission (86 per cent of the spending related to water infrastructure) in the latest Budget, IVRCL, armed with the requisite technology, is likely to emerge a prime beneficiary.

New businesses hold potential

Spotting opportunity in the power space, IVRCL has forayed into the transmission business. This nascent division has grown six times in the past two years, although from a low base.

A rural electrification project and a sub-station for Alstom Projects are being executed. The company's plans to set up a manufacturing facility in Nagpur to achieve backward integration may improve operating profit margins in the long run.

The listing of the company's real-estate subsidiary, IVR Prime Urban, may see some unlocking of value, given that the company is quickly ramping up activity in the realty space.

With an order-book of Rs 7,800 crore (five times the FY-06 revenue), the earnings visibility remains high for IVRCL, given that it has demonstrated strong execution capabilities in the past.

A well-laid road

Nagarjuna Construction, while diversifying its business segments, has spread its wings to the overseas markets. An office in Dubai and a subsidiary in Muscat have led to the company bagging over Rs 800 crore worth of water and road projects in Oman. Unlike IVRCL, which has used the acquisition strategy, Nagarjuna has so far set up its own subsidiaries to foray into new areas. NCC Infra Holdings and NCC Urban Infrastructure, which undertake public-private partnership projects and real-estate development respectively, have emerged an effective de-risking strategy.

While Nagarjuna's stronghold is water projects, only about 20 per cent of the current order book of Rs 7,000 crore constitutes such schemes with about 40 per cent in transportation. We believe the increased activity in the road segment is a conscious attempt by the company to ramp up volumes. A 50 per cent compounded annual growth in revenue over the last three years appears to have come about through increased proportion of road projects. Given the company's strength in water projects, it can always bid for more such projects in future.


Both IVRCL and Nagarjuna's management have come out with numbers on the impact of the withdrawal of Section 80 IA tax benefits on their bottomline. The impact appears insignificant given the companies' strong fundamentals and business potential in the infrastructure space.

Further, both the companies are moving away from being cash contractors, toward build-own-operate transfer (BOT and BOOT) players. While this model is successful in the road sector, it is being now taken forward to hydro-related projects and power sector. The SPVs operating such projects will continue to enjoy the tax incentives. However, there are other risks. The increase in the excise duty on cement, will affect construction players. Price escalation clauses wherever available are likely to offer some protection. Given this situation, we do not expect the current OPM (between 9-10 per cent) to improve.

With increasing activity by both the companies in the realty space, the risks related to price fluctuations in land and buildings will have to be factored in. Further, equity expansion, if any, especially for Nagarjuna, can cause earnings dilution in the short term. We, however, maintain that equity expansion is a necessary evil for construction companies to bid for projects and maintain growth.

Cummins India: Buy

Exposure can be considered in the stock of Cummins India with an investment horizon of about one-two years. At current market price, the stock trades at about 17 times the likely FY-08 earnings per share.

Buoyant demand from user industries, planned addition the capacities and strong growth prospects on both the domestic and export fronts underscore our recommendation.

Also, the company's efforts to improve efficiency with the help of cost-reduction initiatives are a positive.

Power generation to drive growth

The contribution from the power generation business in the domestic market is likely to drive Cummins India's growth.

For the nine months ended December 2006, there was a 40 per cent increase in the revenue contribution.

Further, on the back of frequent power deficits and increasing demand, the need for alternative sources of power such as DG sets, would continue to propel the segment's growth.

While we expect Cummins to sustain its market share in the high horsepower range, it could face stiff competition from such players as Kirloskar Oil Engines and Greaves Cotton in the lower horsepower range.

Growth in the industrial business unit, however, has been mixed. While it can be attributed mainly to increased sale of engines, which find application in various equipment used in road construction, and mining, the water well compressor business remained a laggard.

However, with the increase in outlay towards the NHDP (National Highway Development Project), increase in the capex of user industries and the Government's thrust on infrastructure development, the company's revenue visibility is likely to strengthen.

The automotive segment, which has more than doubled its revenue contribution, is likely to fortify future growth.

Our optimism stems from the positive demand environment for high horsepower trucks and engines, which will witness a growth in demand given the Supreme Court directive for enforcement against overloading.

Cummins' partnership with Tata Motors for providing engines for the latter's heavy trucks is likely to remain the growth driver for this segment.

In addition to this, the company's effort to consolidate its position in the CNG (compressed natural gas) bus market is also encouraging.

On the export front, revenues are likely to sustain given the increased outsourcing from the parent company.

Nevertheless, any further appreciation of the rupee could exert more pressure on the export earnings. Besides this, any slowdown in the US economy could affect the earnings.


A rise in crude oil prices is likely to affect Cummins negatively as that would put pressure on the profitability of the user industries, leading to a fall in demand for Cummins' products.

Cummins also faces the risk of increased competition from global players, given the low import duty on engines.

The delay in the capex plan of user industries or an unprecedented rise in raw material cost is a downside risk to our recommendation.

Gokaldas Exports: Buy

An investment can be considered in the stock of Gokaldas Exports, India's largest garment exporter. The extension of TUFS is likely to benefit companies such as Gokaldas, which are on an ongoing expansion drive. Import of fabrics is likely to be cheaper with the cut in Customs duty. The inclusion of income from its export-oriented units under the Minimum Alternate Tax may not have too adverse an impact on net margins, considering that the company already bears an effective tax rate of more than 10 per cent.

From a long-term perspective, the stock valuations are reasonably attractive. The stock trades at 10-11 times its likely FY-08 per-share earnings, assuming its expansion programme remains on track. Fresh capacities, a diversifying product and client mix and the identification of the domestic retail market as a new revenue stream would ensure that revenue growth remains in strong double-digit. Gokaldas has been fairly conservative both in its expansion strategy and growth targets. We are inclined to view this positively, however, as it limits the downside. The stock may be suitable for investors with modest return expectations of 15-20 per cent.

Capex plans

In the first nine months of this fiscal, Gokaldas invested about Rs 65 crore in expanding its facilities. Four factories came up in the third quarter in Chennai and in and around Bangalore; utilisation is likely to be ramped up over the next couple of quarters.

A plant in Mysore and a bottoms facility near Bangalore are likely to become operational in April 2007, while a unit in Hyderabad is likely to come up later this year. By the end of FY-08, Gokaldas' annual garment capacity would go up by about 25 per cent to 30 million pieces.

As Gokaldas is operating at optimum capacities, there is room for volume growth once these capacities come on stream.

Domestic retail, a new avenue

Ramping up production to full utilisation levels should not be much of a problem for Gokaldas, which recently set its eyes on the rapidly-growing domestic market as well. Gokaldas' retail initiative,

The Wearhouse, has not made much of an impact beyond the South Indian market.

Given its reputation as a quality garment exporter, the company, however, appears well-placed to capitalise on the demand from domestic retailers such as Reliance and Bharti that will be sourcing locally for their labels.

Diversifying product mix

Gokaldas has a product portfolio that is fairly untapped by other organised players, with jackets, coats, windcheaters, ski wear, sportswear forming a significant portion of its exports.

Given the fashion edge these products tend to have, Gokaldas is less vulnerable to severe price undercutting that takes place in volume-based segments such as cotton knitwear. It has, however, been diversifying its product portfolio and ramped up the contribution of trousers, chinos and other bottomwear and casual wear and babywear.

A new suits facility is likely to go on stream this quarter. Gokaldas is also in talks with an international player for a joint venture to start a apparel line. It has also diversified its customer base and appears to have made greater inroads into Europe since its public offer.

With an expanding number of customers, including those of repute, there is likely to be demand for its new products as well.

Polaris Software: Buy

Investors with a high-risk appetite can consider an exposure in the Polaris Software stock taking advantage of the recent weakness. At the current market price, the stock trades at a price-earnings multiple of 16 times its likely per share earnings for 2006-07. We have a buy recommendation outstanding on the stock, made in end-November at Rs 123.

Given its good order pipeline and overall improvement in the execution, the robust growth momentum of the past three quarters is likely to be sustained over the next year or so. Its growth engines, particularly an increased contribution from the IP-led intellect product, may add to the operating profit margin in the coming quarters.

On the downside, however, Polaris will have to contend with stiff competition across the banking products space and efficacy of cross-selling its testing/ERP solutions to the existing product clients. Any scaling down of revenues from Citibank, its key client (accounting for 44 per cent of revenues), or a slowdown in order flows from the US or Europe, poses additional risks. The impact of the introduction of the Minimum Alternate Tax and Fringe Benefit Tax in the latest Budget may not materially alter the per share earnings projections for 2007-08. sConsidering the sharp run-up in the stock since our earlier recommendation, investors need to moderate their return expectations to 15-20 per cent. But the returns are likely to be steady and linked to financial performance in the coming quarters.

Improving fundamentals

At the broad level, the six sub-verticals created within the BFSI space — retail banking and credit cards; consumer finance and mortgages; insurance; capital market and wealth; corporate banking and cash and enterprise solutions; and mainframe — will be Polaris' engines of growth. The three variables that inspire confidence in its fundamentals over the next year are:

Order pipeline: The traction on the order front has been encouraging. As of the third quarter ended December 31, 2006, Polaris had 55 strategic accounts, with 13 AAA (potential to generate revenues of $ 10 million), 15 AA ($5-10 million) and 27 A ($1-5 million). The Polaris management has also indicated that of the top 25 financial institutions, 11 are their customers and 11 are prospects. In the latest conference call, the company stated that it has nine $5-million accounts (compared to seven in 2005-06), six have moved in the $3-5 million basket (from four last year) and 16 are in the $ 1-3 million bracket (from eight last year).

Contribution of intellect: The contribution from the high-margin IP-led intellect core suite has been rising steadily. In the latest quarter, it accounted for 18.5 per cent of revenues, up from 16.6 per cent and 14.9 per cent in the two previous quarters. As the contribution from this stream increases, it is likely to impact positively the overall margins and create good scope for downstream revenues from services. The sustained investment in sales and marketing is likely to yield good results.

Balanced geographic mix: The fairly balanced geographic mix among North America, Europe and Asia-Pacific is a positive. In the latest quarter, North America accounted for 35 per cent of revenues, with Europe and Asia Pacific accounting for 31.6 per cent and 21.6 per cent respectively. The successful penetration of Europe is likely to work to its advantage in the next few quarters.

It is a combination of these variables that have helped the Polaris management talk in terms of a 5-7 per cent sequential growth over the next few quarters.

Riding the equity turbulence

The storm clouds of inflation, higher interest rates and global jitters had been hovering over the stock market much before the Budget, which, given that it was long on populism and short on reforms, took a further toll on equity values.

The Sensex cracked 540 points on Wednesday, making it a 1,200-point fall in a fortnight. As the dust settles after the Budget, there is a key question: Is the market poised for a spirited pull-back and how can investors play the volatile equity theme over the next few months?

Investors need to take stock of three key variables:

Global nervousness and portfolio flows: The fear of a crackdown on speculation in China (which was the best performing market in 2006) has triggered massive concerns across the globe.

The prospect of tighter monetary conditions across Asia (including Japan) may stem the flow of easy money away from the fancied emerging markets.

There is a possibility that funds may flow away from the BRIC countries towards Malaysia, Indonesia or the Philippines in the short run. This trend may be aggravated if the threat of a slowdown in US growth intensifies.

The latest figures suggest that the US economy grew by an annual pace of 2.2 per cent compared to 3.5 per cent earlier.

Since FII flows are directly linked to these factors, any sluggishness in liquidity will have a direct impact on market movements in India.

Overhang of interest rates: The domestic interest rate cycle has been on an upturn for the past few months (see related story). Despite recent policy moves on this front by the Reserve Bank of India, some economic commentators and analysts feel that the central bank may be behind the curve in increasing interest rates.

Taming inflation may not be easy for the government, if one goes by the hike in cement and steel prices, post-Budget.

If inflation hardens over the next quarter, the Government may be left with no choice but to increase interest rates further.

From an investment valuation standpoint, rising interest rates are usually a negative for the stock market as they are negative for corporate earnings and increase the risk-free rate used to calculate cost of capital. And the impact of this will catch up with the markets.

No sectoral favourites: For the first time over the past year, investors may be running out of sector favourites. Heavyweight sectors such as oil and gas, automobiles and pharma have been out of favour the past quarter.

And post-Budget, it appears that investors need to be selective in stock-picking, even in such fancied sectors as construction, capital goods, software and cement.

Among the index heavyweights, barring a couple of telecom stocks, the market is running out of investment ideas.

Despite attractive valuations, in the absence of investment triggers, the mid-cap and small-cap stocks continue to languish.

In the backdrop of these factors, investors may be better off:

Staying on the sidelines in the near term, without taking fresh exposures. Inflationary pressures may worsen in the near term, as the supply side may not be able catch up with demand quickly.

If it persists, manufacturing companies may face margin pressures. On the contrary, from these levels, even if the market were to rally, it may offer only a 10 per cent return, which may not adequately compensate the risks involved.

Consider booking partial profits in some of their deep in-the-money positions.

As a measure to reduce risk through diversification, you could move some of those profits into mutual funds with multi-cap portfolios that straddle large-, mid- and small-cap stocks.

Funds such as HDFC Equity and Franklin Prima Plus may be ideal investments, apart from a dose of short-term debt.

As the long-term India story remains intact, investors with a long-term perspective can stay invested for now.

However, more attractive opportunities may open up later for taking fresh exposures at lower levels.

Five points someone overlooked

We have been short-changed in the Budget, says India Inc. The corporate sector is like a strong oak tree while the agriculture sector is like a plant which has to be nursed, said Mr P. Chidambaram in defence, implying that the former does not need support any longer. "We have done nothing to hurt the growth story," he says.

Corporate India's grouse is that most of its suggestions have not been considered by Mr Chidambaram even as he proposed such not-so-friendly measures as higher education cess, application of the Minimum Alternate Tax on IT companies, extension of the Fringe Benefit Tax on employee stock options and increase in the dividend distribution tax to 15 per cent.

Focus on agriculture is fine, and with two-thirds of the population depending on it for their livelihood it is also probably necessary. But tending to the plant does not necessarily exclude caring for the oak because it is the latter that is generating the resources to help the former.

Here are five proposals which, had they been considered by the Finance Minister, might have balanced the Budget better between industry and agriculture. They would have certainly pleased India Inc. and the best part is that these measures are either revenue neutral or would have had but a minor impact on revenue. So, here are those proposals that were not to be:

excise duty on cars

The passenger car industry had suggested a reduction in the excise duty on all categories of cars and utility vehicles to 16 per cent. At present, except small cars conforming to a specified definition on size and engine capacity, all other vehicles suffer 24 per cent excise. Paan masala is the only other product to suffer a similar excise duty!

Mr Chidambaram could have considered the suggestion favourably given last year's experience, when sales of small cars shot up following the reduction in their excise duty.

Small-car sales zoomed 31 per cent when the overall car industry grew 23 per cent in April-January this fiscal. Incidentally, the growth rate for small cars for the whole of 2005-06 was half that.

The beneficial effect is clearly visible here with the increase in sales compensating for the revenue loss from duty reduction. Who knows, a reduction in duty on all cars this year could have stimulated sales in a similar manner. The auto industry is a major employer and contributes 5 per cent to GDP now. The trickle-down effect to the component sector in terms of investment and employment would have been tremendous. Did Mr Chidambaram miss something here?

Focus on tourism infrastructure

Tourism is an industry that is largely neglected especially given the potential in the country. As anyone who has travelled to any of the major cities recently would tell you, it is just impossible to get good hotel rooms for even a night's stay. Occupancy levels are at 100 per cent and most good hotels boast of a waiting list of guests.

How can tourism prosper in such conditions? While the hotel industry had asked for infrastructure status, Mr Chidambaram could have at least considered extending the five-year tax holiday that he has granted to new hotels coming up in the Capital and surrounding areas, to all over the country. Tourism is probably the next big thing waiting to happen and a couple of concessions to the sector would have gone a long way in promoting its growth.

Duty structure for petroleum products

The petroleum industry is riddled with tax conundrums and Mr Chidambaram has just made a peripheral attempt at solving them by reducing excise duty on petrol and diesel to 6 per cent.

He could have tried his hand at reforms by shifting to specific duties and abolishing the ad valorem component on the two products. This would have been an equitable measure as in the ad valorem mechanism the consumer pays more as duty when oil prices move up.

Customs duty on petrol and diesel, currently at 7.5 per cent, could also have been reduced to the same level as that of crude oil at 5 per cent.

There are no imports of petrol and diesel whatsoever and there are no revenue implications for the Government by reducing the duty. There is also no strong argument for extending protection to domestic refiners who are anyway efficient.

A dual-pricing system for cooking gas and kerosene could also have been attempted, as there is no reason why the thriving middle-class ought to enjoy subsidy on the two products.

Such a measure proposing subsidised prices only for the poor and deserving would have sent out a very strong signal on the Government's commitment to reform even as it would have reduced the subsidy burden significantly. But it was not to be.

Promoting savings

Last year, Mr Chidambaram had included bank deposits with a five-year term under Section 80C of the Income-Tax Act subject to the overall limit of Rs 1,00,000. Given the backdrop of rising inflation and the need to promote savings, he could have considered reducing the term for such deposits to three years.

As a further aggressive measure to promote savings, the Finance Minister could have considered re-introduction of Section 80 L, which used to offer a deduction of up to Rs 10,000 on interest from deposits.

Abolishing DDT for holding companies

This was a strong demand from India Inc. and in the interests of equity ought to have been considered by Mr Chidambaram.

At present, dividends suffer tax twice when they emanate from a holding company and pass on eventually to shareholders of the subsidiary or vice versa.

The holding company has to pay tax on dividend distributed by it to its shareholders, though such dividend is being paid out of its own dividend earnings from its subsidiaries which have already paid the tax.

The increase in DDT to 15 per cent would have gone down better if Mr Chidambaram had fine-tuned this aspect of holding-subsidiary company dividends.

Shareholders of a number of companies, particularly in sectors such as power where it is required to float independent subsidiaries for every project, would have benefited from this move.

Taking the sop out of ESOPs

Those of you waiting to make a quick buck on exercising your ESOPs (employee stock option plans) may have to share some of your profits with the taxman. Under the new rules proposed in the Budget, ESOPs will now be treated as fringe benefit and taxed accordingly. However, more clarity on such aspects as determination of the value of ESOPs, the rate for FBT etc. is awaited.

PAN made THE sole identification number

Be ready also with your PAN (permanent account number) card every time you invest, as the Budget proposes to make this the sole number for financial market transactions. Though various broking houses had already made PAN mandatory for trading in stocks, you can now use it for investing in mutual funds too! This essentially means that the previously proposed MIN (mutual fund identification number) is no more a must for mutual fund investments. Making PAN the sole identification number not only saves you from a lot of paper work, but would also help the government keep a close watch on your investments. With PAN becoming the most important number ever, those of you who have still not applied for a PAN, get cracking.

Tax deductions on education loans

Thanks to the new amendment introduced in the Budget, you can now get a tax deduction for educating your spouse or children! The proposed amendment allows you to deduct the amount that you pay as interest for the education loan (for your spouse or children) from your gross total income.

The facility was hitherto available only for the individual who applied for the loan. It is to be noted that the deduction would be available for eight assessment years beginning from the year in which the payment of interest on the loan begins. However, since the amendment would be effective from April 2008, you can avail yourself of the facility from the assessment year 2008-09 only.

Market View

Our view on the Indian equity market is that after the pre and post Budget fall, the market can be expected to consolidate for some time. With respect to the budget provisions, some of the affected sectors have reacted sharply to discount the implications for them. While, the near term impact of introduction of marginal taxation across the sectors could impact the short term earnings of some corporates, however, the proposed investments in the infrastructure, power and irrigation etc. should continue to buoy the economy and corporate profits in the long term. In the long term, we believe that the focus on inclusive, broad based growth touching every segment of the society is extremely important, because only this can provide a sustainable growth over an extended period of time.

Tata Mutual

The reduction in the indirect tax rates across a host of products, including the key reductions in excise for petrol & diesel, are aimed at controlling the inflation rate, which is currently ruling at multi-year highs.

The markets reacted negatively to the budget proposals, in a weak environment triggered by a global equity meltdown. The key negatives for the markets were the increase in DDT, removal of tax sops for construction companies, inclusion of IT companies under the MAT umbrella and disappointment over lack of any reduction in direct tax rates. The cement sector was impacted from the increased excise rates. The Rs.190 per bag price was considered unrealistic and a possible negative impact was expected on demand from higher prices due to higher excise duty.


The markets have been under pressure in recent times due various factors and the weakness in the global markets had a greater impact on sentiment rather than the budgetary proposals. Indices have fallen across the board due to selling in certain sectors after the Union budget.

The technology sector has been under pressure due to move to include income under MAT and bringing ESOPs under Fringe Benefit Tax. Other sectors to come under pressure after the budget include cement, iron ore exporters and construction. The permission to allow mutual funds to launch dedicated infrastructure funds should help in directing more flows into the crucial sector.

The recent fall in the Indian markets has come about after a strong rally, and in that sense, it was to be expected. The sector-specific measures in the budget could result in downgrading of earnings for those sectors and near term sentiment is likely to remain bearish. Given the strong economic fundamentals, we believe that the medium to long- term outlook remains positive and investors can consider these levels as an entry point into the markets.

Trader's Corner

Many of us would be familiar to the situation in which a stock that has been pushed to the back of our minds and it starts zooming up suddenly. We do not want to see all the profit whittle away again. At the same time, we want to avoid the ignominy of an early exit.

The way to solve this quandary is by using trailing stop losses. Trailing stop loss is nothing but another form of a stop loss order. Assuming that a share has been bought and the trade has moved in to profit, the trailing stop loss order is calculated using a certain percentage from the most recent high. As the price moves up, the trailing stop loss too moves higher. But when the price moves lower, the trailing stop does not move lower and so gets triggered when the trend reverses.

The reverse is true in a short selling. The trailing stop loss would be a fixed percentage from the most recent low. It will move lower as the price moves lower. But if the trend reverses and the price moves higher, the trailing stop would not move and so the trade would get stopped out.

Let us explain this concept with an example. If 100 shares of Reliance were purchased at Rs 1,000 and a 2 per cent trailing stop loss is decided upon. If the price moves to Rs 1,050, the trailing stop would be at Rs 1,029. If the price moves to Rs 1,075, the trailing stop would be at Rs 1,053. If the price moves to Rs 1,200, the trailing stop would be shifted to Rs 1,176. If the price reverses from Rs 1,200 and falls to Rs 1,070, the trailing stop at Rs 1,076 would get triggered and a profit of Rs 76 would be booked.

The moot question is what the trailing stop loss percentage should be. It would depend upon, the trading style adopted. Day traders would keep a trailing stop of half a per cent or 1 per cent. While a swing traders might keep a 2 per cent trailing stop. Investors with a shorter time frame can ideally keep a 5 to 7 per cent trailing stop if their stock starts zooming up in an unexpected fashion.

The second factor that would determine the percentage of the trailing stop loss limit would be the volatility of the stock that has been purchased. A sedate stock that does not see too great an intra day movement would require a lower trailing stop whereas a volatile stock would require a larger trailing stop percentage

Finance Bill 2007 and personal taxation

What changes are proposed relating to the rates of taxation?

While the rates of income-tax are not proposed to be changed, there is a new levy, the secondary and higher education cess, which would be 1 per cent of the tax and surcharge.

This cess will be computed only on the tax and surcharge and will not include the additional surcharge, which 2 per cent now. This will apply to all assessees. In the case of individuals and HUFs (Hindu undivided family) the basic exemption has been raised by Rs10,000. The tax rates for various slabs will be as in the table.

It is also proposed to amend the provisions of Section 115O to provide for a tax on distributed profits at 15 per cent against 12.5 per cent now. It is proposed to amend Section 115R to provide for tax on distributed income on mutual funds to be computed as follows:

25 per cent on income distributed by a money market mutual fund or liquid fund

12.5 per cent on income distributed by a fund other than a money market mutual fund or liquid fund if the distribution is to an individual or HUF.

20 per cent on income distributed by a fund other than a money market mutual fund or liquid fund if the distribution is to any other person.

The term money market mutual fund is proposed to be defined to mean a money market mutual fund as defined in Section 2(p) of the Securities and Exchange Board of India (Mutual Funds) Regulations, 1996 and a liquid fund is proposed to be defined to mean a scheme or plan of a mutual fund which is classified by SEBI as a liquid fund in accordance by the guidelines issued by it in this behalf under the SEBI Act, 1992 or the regulations made there under.

Are there any new assets which will be charged to capital gains on transfer?

To bring within the ambit of capital gains certain personal effects, an amendment is proposed to Section 2(47) to exclude from the definition of the term personal assets, archaeological collections, drawings, paintings, sculptures or any work of art, which would mean that the transfer of these assets would be chargeable to capital gains.

What are the changes proposed with regard to making investments in bonds for claiming exemption in respect of long-term capital gains?

Section 54EC of the Income-Tax Act, 1961 provides tax exemption on capital gains arising from the transfer of a long-term capital asset to the extent such capital gains are invested in `long-term specified assets' within six months from the date of such transfer. The Finance Act, 2006 amended the definition of long-term specified assets so as to mean any bond redeemable after three years and issued on or after April 1, 2006 by the National Highways Authority of India and Rural Electrification Corporation Limited. Such bonds had to be notified by the Central Government in the Official Gazette.

It is proposed to amend the said Section, by substituting the existing clause (b) of explanation, so as to provide that the Central Government, while notifying such bonds in the Official Gazette may lay down in the notification such conditions, including for providing a limit on the amount of investment by an assessee in such bonds, as it thinks fit. This amendment will take effect retrospectively from April 1, 2006. The proposed amendment seeks to regularise the condition stipulated in Notification S.O.2146(E) December 22, 2006, where it was provided that the investment cannot exceed a sum of Rs50 lakh.

It is also proposed to amend the section so as to provide for a ceiling on investment by an assessee in such long-term specified assets.

Investments in such specified assets to get exemption under Section 54EC, on or after April 1, 2007 cannot exceed Rs 50 lakh in a financial year.

What are the changes proposed on allowing deduction for health insurance premium? Will the deduction be allowed if the payment is made by credit card?

Section 80D provides that in computing the total income of an assessee, being an individual or a HUF, the sum paid by cheque to effect or to keep in force an insurance on the health of the assessee or on the health of any member of the family shall be allowed as a deduction.

The maximum amount allowed as deduction is Rs 10,000. In the case of senior citizens, the deduction allowed is Rs 15,000. Similarly, Section 36(1)(ib) provides for a deduction of the amount of any premium paid by cheque by the assessee, as an employer, to effect or to keep in force an insurance on the health of his employees under a scheme framed by General Insurance Corporation formed under Section 9 of the General Insurance Business (Nationalisation) Act, 1972 and approved by the Central Government or by any other insurer and approved by the Insurance Regulatory and Development Authority established under Section 3(1) of the Insurance Regulatory and Development Authority Act, 1999.

To allow deduction for payments made through electronic mode, credit card, etc., it is proposed to amend the provisions of Section 80D and Section 36(1)(ib) so as to provide that the payment of premium made by any mode other than cash, shall be eligible for deduction under these sections. It is also proposed to increase the maximum amount allowable under Section 80D, from Rs 10,000 to Rs 15,000. In the case of senior citizens, it is proposed to increase the limit from Rs 15,000 to Rs 20,000.

Can interest on loan taken for the benefit of relatives education be claimed as deduction?

Section 80E provides for a deduction, from the gross total income of an individual, of the amount paid by him by way of interest on loan taken from any financial institution or approved charitable institution for the purpose of pursuing higher education.

The deduction is available for eight assessment years beginning from the assessment year in which the payment of interest on the loan begins and is available only when the loan is taken for the higher education of the individual.

It is proposed to amend Section 80E so as to allow the deduction of interest on loan taken by an individual for higher education of the individual, the spouse and children.

Is there a proposal to increase the threshold limit for tax deduction at source in respect of interest?

The existing Section 194A(3)(i) provides that deduction of income-tax at source shall not be made in a case where the amount of income by way of interest other than "Interest on securities" does not exceed Rs 5,000.

The amendment proposes that the limit for deduction of tax at source under the aforesaid Section shall be Rs 10,000 where the payer is a banking company or a co-operative society engaged in carrying on the business of banking or a post-office in respect of notified schemes. In other cases, the threshold limit is to be retained at Rs 5,000.

These amendments are proposed to be effective from June 1, 2007.