Don’t bet your shirt on the Budget

If you are a stock market investor all primed up for the action on Budget day, here’s a quick question. Do you remember the sectors that were touted to be the big gainers in last year’s Budget? Can you at least recall the sectors that were plunged into despair because the Finance Minister didn’t grant their wish list? If you don’t, here’s a refresher.

Realty companies offering affordable homes were said to be the big gainers of the last Budget, after the Finance Minister granted an additional ₹1 lakh tax break to first-time home buyers. Automobile companies, particularly SUV makers, were predicting gloom and doom after the Finance Minister raised the excise duty on SUVs in Budget 2013.

Yet, taking stock a year later, it is clear that the Budget proposals have had no lasting impact on the fortunes of these players. The stock of the SUV-making M&M has vroomed 32 per cent since the last Budget.

But affordable-home developer Puravankara Projects is up a mere 9 per cent.

As we head into the 2014 Budget and market experts get busy drawing up lists of sectors and companies that could be ‘winners’ and ‘losers’ from this exercise, it would pay to remember what happened in the previous Budget. Yes, if you’re a trader hoping to make some intra-day gains on July 10, you can have some fun and join in this game of ‘second-guessing the FM’.

But if you’re a long-term investor looking for good bets, the tax tweaks announced in the Budget should play a very limited role in the sectors or stocks you pick up for your portfolio.

Though industry associations do their best to convince you that the annual Budget can make or break their fortunes, the truth is that the sector-wise proposals in the eagerly awaited Part B of the Budget speech now have very limited impact on companies’ earnings trajectory over the long term.

For one, the rationalisation and simplification of excise duties in recent years has left the Finance Minister with limited room to hand out big concessions or levy exceptional duties on any one sector, just on a whim. Nor does he have much elbow room to impose protectionist customs duties, as these are subject to international trade agreements. The annual Budget, therefore, has ceased to spring big surprises for individual industries or companies, on tax breaks or duty cuts.

Tax reforms undertaken over the last decade or so have also rationalised the multiple rates of excise and customs duties and transitioned them to a unified rate that now applies across sectors and products.

With the playing field more or less levelled by these changes, the annual Budget has come to exercise limited influence over a sector’s profitability or fortunes.

Thanks to the sharp pruning of indirect levies, they also make up a far lower proportion of corporate profits than they did a decade ago. While peak customs duty rates have plummeted from over 120 per cent in the ’90s to 10-12 per cent levels now, excise duty rates have declined from as much as 40 per cent to a standard rate of 10-12 per cent now. With both excise and customs duties falling sharply over the years, indirect taxes are no longer a significant differentiator deciding corporate fortunes.

Today, sectors riding an upturn in their business cycles or companies which have inherently strong businesses have managed to take excise or import duty tweaks in their stride, passing them on through price hikes. Those which are in the grip of a downturn or those with weak pricing power have been laid low by market conditions or competition, irrespective of the sops they win in the annual Budget.

There can be no better illustration of this than ITC, the quintessential “short-it-on-Budget-day” stock. With successive finance ministers always looking to cigarettes to buttress their coffers, ITC has usually been at the receiving end of most Budgets with sharp excise duty hikes battering the stock on Budget day.

Yet, the company has usually been able to pass on excise duty hikes through price hikes on its cigarettes, without making much of a dent on its volumes.

Therefore, despite not being Budget winner by a long chalk, ITC’s stock has been one of the top wealth creators of the last decade, delivering a 25 per cent annual return over this period.

Software companies make another good example. After enjoying a raft of tax concessions in the nineties, these companies have seen the government pull the carpet from under their feet in recent years, withdrawing SEZ benefits and raising the Minimum Alternate Tax, sharply increasing the tax incidence on these companies.

Yet, both leading and mid-sized companies in the sector have successfully weathered this challenge, by cutting back on costs and improving their revenue mix. IT companies figure next only to FMCG companies in the list of the top wealth creators over a decade.

Therefore, as you tune into the budget on July 10, don’t worry too much if the Finance Minister passes by the companies in your portfolio for stimulus measures or tax breaks. And don’t jump into a new stock or sector just because it won a fleeting mention in the speech.

Instead, pay close attention to Part A of the Budget speech which deals with the big picture on the economy, tax revenues, subsidies and the Centre’s plans for containing the fiscal and revenue deficits.

Whether the Centre is able to exercise control over these variables will have a big impact on foreign investment flows, inflation, interest rates, growth and your own career prospects over the next one year.

Plodding through this section of the Budget may be less exciting than watching the ticker tape flash red and green as stocks respond to ‘surprises’ or ‘disappointments’ in Part B of the Finance Minister’s speech.

But make no mistake, it will prove far more useful for your portfolio over the long term than betting on the Budget winners or losers.

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