Double whammy

BUDGET 2007-08

The global market meltdown and the dividend distribution tax increase pulled down the Sensex

The stock market was hit by a double whammy on Wednesday "" the global market meltdown and the Budget that didn't meet market expectations.

The Chinese stock markets decline of nearly 9 per cent on Tuesday and fears that global growth is slowing down, which will have a negative impact on corporate profitability and shareholder returns, led to stock prices declining globally.

Back home, the 2007-08 Budget failed to cheer investors, and the Sensex which opened weak, stayed low through the day except briefly in intra-day trades when it was slightly higher than before the Finance Minister began reading the Budget speech.

The Sensex ended 4 per cent lower to close at 12,938 points, off 12 per cent from its all-time high made in early February. For the past two weeks, investors have been worried at rising inflation and concerns over valuation, which would have been additional factors contributing to the broad sell-off.

On the macro front, the Budget reiterates that the economy is on a strong wicket with an estimated growth of 9.2 per cent in 2006-07. The finance minister has put special thrust on agriculture, as its growth is lagging than industry and services. The thrust on infrastructure too continues.

For investors, the Budget has largely maintained status quo. There is no increase in short-term capital gains tax or an increase in securities transaction tax. The dividend tax has gone up, but its impact is not going to be very significant for shareholders.

And if company boards scale down their dividend policies, it will mean less cash for promoters, as other investors can sell some shares to raise cash, which promoters can't do at the risk of reducing their stake in companies. The increase in education cess by one per cent will also have a marginal impact on profitability.

In terms of industry, the Budget has imposed minimum alternate tax on exporters, including software companies, which were out of the tax net. This will hurt software companies to an extent. For example, Infosys estimates that its net profit margin will decline by 150 basis points.

However, the industry will need to pay higher tax in order to retain employees as ESOPs come under the fringe benefit tax. No wonder, among the BSE sector indices, the IT index declined the most""nearly 6 per cent.

The finance minister has clearly signalled that he wants cement companies to take a re-look at their pricing structure, given his move to hike excise duty by about 50 per cent on cement sold at more than Rs 190 per bag.

Analysts highlight that cement players may need to hike prices by Rs 10 per bag, to offset this higher tax structure. Power and construction companies will continue to do well with the thrust on infrastructure being maintained.

Ironically, one of the gainers on Budget Day was ITC, up 4 per cent, as the excise duty rate of 5 per cent was at the lower end of market expectations.

As a result, the BSE FMCG index was the only sectoral index to have gained .5 per cent. There were some other positive measures that helped FMCG companies""reduction in import duty on edible oils and exemption of duties on packaged foods.

The reduction in duties on seconds and defectives of steel from 20 per cent to 10 per cent will help smaller companies but there will not be any impact on integrated players like Tisco and Sail.

Oil marketing companies like IOC and HPCL are expected to see their petrol marketing margins turning positive to the extent of Rs 0.35 per litre, while for diesel the under-recovery will reduce to Rs 1.8 per litre, as ad valorem component of excise duty on auto-fuels has been cut.

The Budget is balanced and wouldn't have led to such a stock market fall if it weren't aided with global pessimism. The bull may have exited the China shop, but in India, life will get back to normal once the valuations get tempting.