A fine balance

SMARTSHARE

Given the exigencies of coalitions and impending state elections, the FM was walking a thin line when he put the 2006-07 Budget together. He had to give the Left enough sops to keep the inevitable whining muted.

He had to balance government finances in circumstances where high crude prices and high credit demand have started to distort interest rates and yield curves. He had to keep economic momentum going.

He's done a fair job. The Left can cheer the retention of a (modified) FBT and the discriminatory excise cut, which favours small cars. The conservatives will hail the paring down of the fiscal deficit and the improved ratio of planned to unplanned expenditure. The business environment should improve incrementally unless something unforeseen goes badly wrong.

There are some sins of omission. It would have been more sensible to eliminate FBT rather than modify it. Domestic LPG has been pulled out of the ambit of state sales tax but Aviation Turbine Fuel has not. Life would be a lot easier for airlines if ATF was uniformly priced across India.

There's been no attempt to ease the subsidy burden on oil companies; in fact, cess on crude has been raised and the service tax hike will also affect surveys and exploration activities.

The Securities Transaction Tax hike was expected but it would have been pragmatic to chuck short-term capital gains tax out along with the hike. STT is difficult to evade; STCG is reasonably easy to avoid. An abolition of STCG would have led to a jump in trading volumes leading to higher STT collections.

But the Budget does not undermine the stability of the economic environment, such as it is. Nor does the tax incidence rise very significantly. For this relief, much thanks!

Given policy direction, the beneficiaries of growth will generally be players with a direct or indirect connection to infrastructure development. Cement, steel, construction and engineering contractors should gain.

Contrarians will focus on the power industry "" it's in terrible shape and it's the sector where reform is most critically urgent. Players across the entire value-chain could see relief if the announced combination of incentives and reforms works.

The initiative to tie up guaranteed coal sources for power producers could alleviate the supply shortages that crippled generation in 2005-06. Additional capacity will create opportunities for equipment manufacturers and financial players. If the empowered group of chief ministers and state power ministers does get cracking on reform, losses could reduce. Transmission and distribution players would gain once more capacity is onstream.

The new power trading tariff system needs review. It has weird provisions "" low entry-level net worth considerations (just Rs 2.5 crore), commissions fixed at 4 paisa/unit rather than as a percentage of unit costs, no margining system.

There are a lot of experienced players in the sector. The laundry list of available stocks across the value-chain would include PFC (due for an IPO), NTPC, Suzlon, BHEL, ABB, Siemens, CESC, Tata Power and Reliance Energy. Don't forget the EPC contractors like HCC and L&T who could also be beneficiaries. And there are the transmission guys, like KEC and there's PTC.

Profit-making power sector companies are all rather richly-valued "" especially equipment producers. If the industry does take off, we could see a phenomenon of rising stock prices combined to dropping PE ratios as earnings jump. Any investments here would be long-gestation, however.