Budget 2004-05

July 8, 2004
FOR PRIVATE CIRCULATION

THE RESEARCH TEAM

Union Budget Analysis FY2004-05

Budget juggles political priorities
Honouring people's verdict, Mr Palaniappan Chidambaram, in his first budget speech as the finance minister in the UPA government, concentrated mainly on rural sector reforms. His was a great trapeze artist's act, trying to balance between the onerous task of implementing the national common minimum program and finding ways to fund those objectives. In our opinion, the direction of the budget is towards growth, stability and equality. The aim is to achieve a sustainable 7-8% GDP growth over the next 5 years and containment of the fiscal deficit at 4.4% in FY2005.

Politically mature budget

We believe the FM has presented a politically mature budget, which meets the need of the hour. Since the UPA government was formed, with the critical support from the Left, fears and concerns were raised that these politically diverse interests might derail the reform process for short-term political gain. There were doubts whether the reform process would be allowed to continue, given the coalition politics compulsions. The FM has exploited this overhang of negative expectations. Broadly there are no surprises in the budget and that was expected. In the event, the budget did nothing to indicate that the reform agenda was being derailed. On issues that might have been touchy to the coalition partners including foreign investments and privatization, there has been no visible rollback. FDI limits in telecom and airlines have been increased and the FM has surprised the market raising FDI limit in the insurance sector to 49%. The FM has also taken Rs.40 bn credit as the 'touchy' disinvestment proceeds. These steps indicate the FM's firm resolve to draw a line, as far as rollbacks and reversals in the reform process are concerned. The main positive, in our opinion, is that there are no sign of policy reversal. We believe the budget has played safe, as the macroeconomic situation did not warrant any dramatics. There are only seven months left until the next budget. We see signs of more substantial changes to come in February 2005, not just for agriculture but across all fronts. Our optimism stems from the number of task forces/committees/commissions that the FM has announced. We cannot wish away these committees, as the issues covered -subsidies, investment and competitiveness are fundamental to growth and fiscal management. With Mr Montek Singh Aluwahalia as the chairman of the planning commission, one can expect these bodies to provide the government with a set of feasible recommendations, which will form the core of the Budget speech next February 2005.

Reform agenda continues

No sign of policy reversal

We remain optimist for a possible big bang budget in February 2005

A sustainable growth of 7-8%

In order to have a sustainable growth of 7-8% of GDP, the FM has focused on agriculture and rural sector growth by providing easy and enhanced credit, creating an environment for healthy growth of micro-financing and rural infrastructure. Reduction in import duties, moderation and stability in the tax structure, introduction of VAT, creating irrigation facilities and generation of employment opportunities gives us reason to believe that such a growth of 7-8% is achievable in the longer term.

Fiscal Discipline

Despite maintaining the commitment of investments across the various programs, the government is hopeful to contain the fiscal deficit at 4.4% of GDP. Revenue deficit is estimated to be at 2.5%, which is to be eliminated by FY 2008-09 under the FRBM Act. The elimination of revenue deficit will open up fiscal space up to 3% of GDP for enhanced public investment without undermining fiscal prudence.

Registered Office: Kotak Securities Limited, Bakhtawar, 1st floor, 229 Nariman Point, Mumbai 400021 India.

July 8, 2004

Kotak Securities

Turnover Tax: Party dampener

The finance minister has imposed a hefty transaction tax of 0.15% on all buy side transactions in securities on the stock exchanges. The transaction tax has come in lieu of long-term capital gains tax and the reduction of short-term capital gains tax to 10%. Such a blanket tax on all equity and bond market transactions, including futures and options is going to throw a spanner in the works. The turnover tax would reduce the participation of arbitrageurs and speculators who not only provide liquidity to the market but also help the price discovery mechanism.

Mighty Agriculture

Agriculture has got a never-before thrust in the budget. Excise duty has been waived on farm inputs like tractors, farm-machinery, dairy-machinery, farm-tools etc. Focus on micro-financing, doubling the agri-credit in the next 3 years, accelerated irrigation benefit program and promotion of agro-processing industries set up to process, preserve and package fruits and vegetables would boost the rural sector income.

Dividend Distribution Tax

The finance minister has withdrawn the concession given to the mutual fund industry in terms of dividend distribution tax. Now mutual funds would require to withhold tax on dividends on their debt-schemes at the rate of 12.5% for individuals & HUF and 20% for corporates. Also, benefits on bonus stripping and dividend stripping would be plugged by suitable changes in the IT Act.

FDI cap released

Raising the foreign direct investment (FDI) cap on telecom, civil aviation and insurance have come as a pleasant surprise to the industry. It would boost the confidence of various multinational investors and MNCs who were waiting for a clear signal from the UPA government to gauge its friendliness to FIIs and FDIs. FDI cap
Sector Telecom Civil Aviation Insurance FDI Limit Increased from 49% to 74% Increased from 40% to 49% Increased from 26% to 49%

Raising Income Tax Limit

The finance minister has given great relief to the common man by raising the taxable limit to Rs. 1 lakh. This would relieve 1.4 crores of taxpayers, who have a taxable income of less than Rs.1 lakh.

n
Trading volume will drop substantially...

Short to medium term impact of the budget on the stock market

... impacting price discovery

The imposition of turnover tax at a substantially higher rate of 0.15% on all kinds of transactions (to the buyer) is a major dampener for the stock market. Though this has come in place of longterm capital gains tax and by reducing short-term gain to 10%, it is going to have a very negative impact on day-traders, arbitrageurs and speculators. This would not only reduce the liquidity in the market, but also works against the fair price discovery mechanism besides increasing the cost of capital. The quest to raise Rs.4-5,000 crores from the capital market would negate the benefits of a level-playing field created for domestic players, who will have a disadvantage over FIIs as FIIs use the double taxation treaty route to avoid any long-term or short-term gains. Increased expenditure on infrastructure investments, lowering of import duties and taking measures to boost rural income would benefit the market marginally. Excise duty hike on steel from 8 to 12%, imposition of cess across taxes at the rate of 2% and increasing service tax from 8% to 10% would make stocks dearer against their earnings. The imposition of dividend distribution tax puts the mutual fund industry at a disadvantageous position; this would put pressure on the bond market as well. For the equity market, we rate the budget as disadvantageous in the short-to-medium term, however, in the long-term we believe the budget has a neutral to positive impact as the market assimilates the positives of the budget recommendations. Our top picks are Mahindra & Mahindra, Punjab Tractor (excise duty exemption), Bharti Televenture (FDI limit increased to 74%), ITC (no increase in excise), Biocon (exemption to bio-tech research), Indian Rayon (FDI in insurance increased to 49%), BEL (increased defence spending), Vardhaman/Mahavir Spinning, Super Spinning (new excise structures).

Positive: multiplier from infrastructure spending Negative: Cost of production of manufacturing goods to increase

Our picks

Budget 2004-05

Please see the disclaimer on the last page

For Private Circulation

July 8, 2004

Kotak Securities

BUDGET HIGHLIGHTS
"Tax rates will be stable and conducive to growth, compliance and investment."- FM during his speech during presenting the budget FY04-05.

Objectives of the taxation policy

q To keep tax rates moderate and stable. q To increase revenue from direct taxes and excise duty. q To expand the service tax net.

Changes in direct taxes

q Turnover tax of 0.15% introduced. Long-term capital gains tax abolished. Shortterm capital gains tax to be at 10%. q Personal taxable income raised to Rs.1,00,000. q Withdrawal of tax exemption on foreign currency NRE and NRO accounts. q Gifts from unrelated persons above Rs.25,000 will be taxed as income. q New agro-processing industries set up to process, preserve and package fruits and vegetables will be tax exempted for 5 years. q R&D in automobiles to fetch deductions up to 150%. q Shipping companies will now have an option to pay either tonnage tax or normal corporate tax on profits. q Mutual funds to withhold dividend tax of 12.5% and 20% for individuals and corporates respectively, on debt schemes; equity schemes continue to remain under exemptions q Stripping of bonus or dividends will be taxed after amendment in the act

Changes in indirect taxes

q Service tax increased from 8% to 10%. q Levy of 2% cess for education on all direct and indirect taxes. q Excise on steel increased from 8% to 16%. q Customs duty on non-alloy steel reduced from 15% to 10%. q Reduction of peak duty on alloy steel, copper, lead, zinc and base metals to 15%. q Excise duty on tractors and dairy machinery reduced from 16% to 0%. q Excise duty on computers reduced from 8% to 0%. q The mandatory cenvat duty on handloom and power loom sector has been withdrawn.

Seven economic objectives of the budget

q Maintaining a growth rate of 7-8% per year for a sustainable period, q Providing universal access to quality basic education and health, q Generating gainful employment in agriculture, manufacturing and services and promoting investment, q Assuring 100 days' employment to the breadwinner in each family at the minimum wage, q Focusing on agriculture and infrastructure, q Accelerating fiscal consolidation and reform, and q Ensuring higher and more efficient fiscal devolution.

Budget 2004-05

Please see the disclaimer on the last page

For Private Circulation

July 8, 2004

Kotak Securities

ECONOMIC DATA
REVENUE Tax revenue Corporation tax Income tax Excise duty Import duty Service tax Other taxes Gross tax revenue Less: States share Net tax revenue Net non-tax revenue Total revenue receipts Recovery of loans Privatisation Non debt capital receipts Gross receipts EXPENDITURE Revenue expenditure Interest Defense Subsidies Admn & sockal services Plan expenditure Total revenue expenditure

CHARTS

Central Government Finances (Rupess in billions)

FY2001 FY2002 FY2003 FY2004RE FY2005BE

357.0 317.6 685.3 475.4 26.1 24.6 1,886.0 519.5 1,366.6 559.5 1,926.1 120.5 21.3 141.7 2,067.8

366.1 320.0 725.6 402.7 33.0 23.2 1,870.6 535.3 1,335.3 677.7 2,013.1 164.0 36.5 200.5 2,213.6

461.7 368.6 823.1 448.5 41.2 19.5 2,162.7 568.4 1,594.3 723.2 2,317.5 341.9 31.5 373.4 2,690.9

629.9 402.7 923.8 493.5 83.0 16.4 2,549.2 673.8 1,875.4 754.9 2,630.3 646.3 145.0 791.3 3,421.5

884.4 509.3 1,092.0 542.5 141.5 7.7 3,177.3 838.3 2,339.1 754.2 3,093.2 271.0 40.0 311.0 3,404.2

993.1 372.2 268.4 633.7 511.0 2,778.4

1,074.6 380.7 312.1 630.3 617.0 3,014.7

1,178.0 407.1 435.2 660.0 716.0 3,396.3

1,245.6 433.9 447.1 721.3 781.0 3,628.9

1,295.0 435.2 435.2 771.2 918.4 3,854.9

Capital expenditure Defense Plan expenditure Loans Total capital expenditure Plan expenditure on rev & cap a/c Non-plan expenditure on rev & cap a/c Total expenditure DEFICITS Fiscal deficit % of GDP Revenue deficit % of GDP Primary deficit % of GDP

124.0 316.0 37.5 477.5 826.7 2,429.2 3,255.9

162.0 395.0 51.4 608.4 1,011.9 2,611.2 3,623.1

149.5 399.0 59.2 607.7 1,114.6 2,889.4 4,004.0

169.1 434.0 510.6 1,113.7 1,215.1 3,527.5 4,742.6

334.8 537.5 51.1 923.4 1,455.9 3,322.4 4,778.3

1,188.2 5.6 852.3 4.0 195.0 0.9

1,409.6 6.1 1,001.6 4.3 335.0 1.4

1,313.1 5.3 1,078.8 4.4 135.0 0.5

1,321.0 4.8 998.6 3.6 75.5 0.3

1,374.1 4.4 761.7 2.5 79.1 0.3

Sectoral real growth rates in GDP (at factor cost)

1997-98 Agriculture Industry Services Total GDP at factor cost (2.4) 4.3 9.8 4.8 1998-99 6.2 3.7 8.4 6.5 1999-00 0.3 4.8 10.1 6.1 2000-01 (0.1) 6.5 5.5 4.4 2001-02 6.5 3.4 6.8 5.8 2002-03 (5.2) 6.4 7.1 4 2003-04 9.1 6.5 8.4 8.1

Budget 2004-05

Please see the disclaimer on the last page

For Private Circulation

July 8, 2004

Kotak Securities

ECONOMIC DATA
Where the rupee comes from
Borrowings 24% Non Debt Capital Receipts 6%

CHARTS

Where the rupee goes

Corporation Tax 16% State share of tax & duties 15%

Interest 23%

Income Tax 9%

Plan Expenditure 25% Defence 14%

Net Non-tax Revenue 13% Other Taxes 0% Service Tax 3%

Excise Duty 19% Customs Duty 10% Loans 1 % Admn & social Services 14%

Subsidies 8%

Fiscal deficit
Fiscal Deficit (Rs bn) 1600 % of GDP 7

Subsidies
500.0 435.2 400.0 447.1 435.2

1400

312.1 300.0 244.9 268.4

1200

200.0
1000 4

100.0

800 FY2000 FY2001 FY2002 FY2003 FY2004RE FY2005 BE

FY2000 FY2001 FY2002 FY2003 FY2004RE FY2005 BE

Capital expenditure on defence

400.0 334.8 300.0

Market borrowing
1000.0 975.9

900.0 877.2 858.0

903.7

200.0 162.0 124.0 100.0 100.0 149.5 169.1

800.0 729.3 700.0 702.8

FY 00 FY 01 FY 02 FY 03 FY 04RE FY 05 BE

600.0 FY 00 FY 01 FY 02 FY 03 FY 04RE FY 05 BE

Budget 2004-05

Please see the disclaimer on the last page

For Private Circulation

July 8, 2004

Kotak Securities

INTRA
Gainers

DAY PRICE MOVEMENT (ON THE BUDGET DAY)

Losers
ONGC

Bharti Televentures

HCL Technologies

SAIL

ITC

Wipro

Source: moneycontrol.com

Budget 2004-05

Please see the disclaimer on the last page

For Private Circulation

July 8, 2004

Kotak Securities

SECTORAL
Sector
Automobiles

ANALYSIS SNAPSHOT

Budget impact
Positive Impact analysis: q Reduction in custom duty on steel will benefit the industry to some extent. It will also benefit from the reduction in excise duty on various metals through the auto ancillary route. q Exempting the entire tractor industry from excise duty has come as a major booster. q Again, the non-inclusion of transport industry under service tax will have a positive impact on commercial vehicle sales.

Our top pick

Mahindra & Mahindra Impact on companies: q Very positive for Mahindra and Mahindra as it gets the benefit of excise and also lower raw material cost due to reduction in excise/ customs duty on base metals. q Tata Motors would benefit from the R&D expenditure benefit and also lower raw material cost.

Changes made in the budget q Reduction of the peak rate on alloy steel, copper, lead, zinc and base metals to 15% and increase in excise duty on steel from 7% to 12% q Tractors are fully exempt from excise duty q Increase in tax benefit on R&D expenditure to 150%

Sector
Banking Changes made in the budget q Thrust on agriculture, micro-credit and infrastructure financing. q Interest rate likely to go up due to the inflationary pressure. q Securitisation act to be amended in favour of banks and financial institutions.

Budget impact
Negative Impact analysis: q Speedy recovery of NPA. q Turnover tax to reduce the investment portfolio profitability. q Hike in insurance FDI to boost valuations. q Fiscal deficit target is aggressive at 4.4%, which appears to be on the higher side. q Higher interest rates would leave a hole in the investment portfolio.

Our top pick

State Bank of India Impact on companies: q Banks with insurance arms are to be highly benefited e.g. HDFC, SBI, ICICI Bank, ING Vysya. q NPA recovery will speed up due to amendment in Securitisation Act q High duration investment portfolio banks would feel the heat most: PNB, BoI, Union Bank, BoB

Sector
Capital goods Changes made in the budget q A inter institutional group has been constituted to garner Rs400 bn. This would ensure speedy conclusion of loan agreements and implementation of infrastructure projects. Electricity for all, re-emphasized. Accelerated completion of irrigation projects and investing in rural infrastructure. q Launching a nationwide water-harvesting scheme covering 1-lakh irrigation units at a cost of Rs200 bn. q Sectoral cap for FDI to be raised from 40% to 49% in civil aviation. q Increased allocation towards Defense modernization to Rs7700 bn from Rs6530 bn in BE2003-04. q Deduction of 100%of profit for 5 years and 25% of profit for the next five years for facilities set up to process, preserve and package fruits and vegetables. q Dairy machinery, which attracts a 16% excise duty to be fully exempt.

Budget impact
Positive Impact analysis: q Thrust on infrastructure will result in increased order inflows for the capital goods sector. q Electricity for all and tax exemptions under Sec 80IA would be positive for the power equipment manufacturers. q Emphasis on completing irrigation projects would augur well for pump manufacturers and engine manufacturers catering to the agri requirement. q Increased defense modernization allocation, positive for players supplying equipment for defense needs. q Special benefits announced for the agroprocessing industry and dairy industry, positive for companies involved in manufacturing and installing specialized machinery for these sectors.

Our top pick

Siemens, ABB, L&T, BEL and Alfa Laval Impact on companies: Positive q Larsen & Toubro. Thrust on infrastructure. q Siemens, ABB, BHEL, Thermax and Jyoti Structures. Emphasis on building capacities and extension of the Sec80IA benefit for the T&D segment. q BEL. Increased allocation towards defense modernization fund. q Alfa Laval. Benefits given to the agro processing and diary sector would result in increased orders.

Budget 2004-05

Please see the disclaimer on the last page

For Private Circulation

July 8, 2004

Kotak Securities

Sector
Cement & Construction Changes made in the budget q The cement sector has remained un affected by the current budget. The excise duty and the import duty were un changed.

Budget impact
Neutral to positive Impact analysis: q The impact of this budget is Neutral to Positive for the cement industry. The thrust of this budget in creating agricultural infrastructure such as dams, roads, irrigation projects, water management, coupled with thrust on education and health infrastructure along with emphasis on capital formation augers well for the cement and construction industry.We expect the cement industry to grow by 6.5% to 7% during the year.

Our top pick

Birla Corp, ACC, Guj. Ambuja, Nagarjuna Construction Impact on companies: q Major cement companies such as ACC, Birla Corp, Gujarat Ambuja Cements will benefit from the increased demand for cement, as they will be able to command better prices due to demand growth. q Construction companies such as Nagarjuna Construction, JP Associates, and Larsen & Toubro will benefit due to increased spending on infrastructure.

Sector
Fertilizers Changes made in the budget q No direct remarks for the fertilizer sector q Budget is farm sector friendly

Budget impact
Positive Impact analysis: q Increased farm credit would spill over towards fertilizer q Better irrigation facilities would increase consumption of fertilizers q Balanced consumption towards NPK usage would boost complex fertilizers sale

Our top pick

Indo Gulf Fertilisers Impact on companies: q Overall fertilizer consumption level to go up and help the industry but to benefit efficient players like Indo Gulf, Tata Chemicals and Coromandel Fertilisers more q Complex fertilizers would benefit more than urea producers due to the balanced usage of NPK

Sector
FMCG Changes made in the budget q Nothing directly impacting FMCG q Budget is rural sector friendly and increases disposable income of common man

Budget impact
Positive Impact analysis: q Sparing excise hike on tobacco has enthused the general sentiment in FMCG q Thrust on rural sector credit, increasing the disposable income and supporting microfinancing & SHGs would benefit the sector q Implementation of VAT would make the supply chain management more efficient

Our top pick

ITC Impact on companies: q ITC would be benefited most due to its reach, network and rural focus. Sparing the excise hike on tobacco is the icing on the cake for ITC

Sector
Information Technology Changes made in the budget q No mention of abolition of tax break under Section 10 A/B q Computers are fully exempt from excise duty.

Budget impact
Neutral Impact analysis: q The impact is neutral on the sector. The relief of non-abolition of tax-break under Section 10 A/B would again make IT a formidable bet.

Our top pick

Infosys Technologies Impact on companies: q No direct impact on software companies. q Hardware companies such as HCL Infosystem would be benefited the most.

Sector
Metals Changes made in the budget q Excise duty on steel increased from 8% to 12%. Import duty on steel reduced to 10% from 15%. q Import duty on copper, zinc, alloy steel and lead reduced by 5% to 15%.

Budget impact
Neutral Impact analysis: q The impact of this budget is neutral for the metals sector. q The rise in excise duty coupled with a reduction in the import duty will marginally impact steel companies. The difference between the landed price and the domestic price of steel, which till yesterday was Rs.2,500 per ton, will now stand reduced to Rs.2,000 per ton. This will not impact steel companies in any negative manner as they have a cushion of Rs. 2,000 per ton. q We do not expect any reduction in the price of steel. q The 5% reduction in import duty on copper will marginally impact Hindalco's profits.

Our top pick

TISCO, JISCO, Hindalco, Sesa Goa Impact on companies: q Steel companies such as TISCO, SAIL and JISCO are not expected to be impacted in any manner. q Hindalco will be marginally impacted due to reduction of 5% in import duty on copper.

Budget 2004-05

Please see the disclaimer on the last page

For Private Circulation

July 8, 2004

Kotak Securities

Sector
Oil & Gas Changes made in the budget q No changes in the excise duty and the import duty structure for the oil and gas sector.

Budget impact
Neutral Impact analysis: q The excise duty was maintained at the same level of 26% for motor spirit, 11% for highspeed diesel and 8% for LPG. q The customs duties are being maintained at the levels of the previous year. q This measure will be neutral for the oil and gas industry. q It will be positive, to some extent, for standalone refineries such as Kochi Refineries, Chennai Petroleum and Bongaigaon Refineries, as it was widely expected that the customs duty would be lowered thereby negatively impacting their margins.

Our top pick

ONGC, GAIL, IOC, Kochi Refineries, Chennai Refineries, Reliance, Finolex Ind Impact on companies: q Stand alone refineries such as Kochi Refineries and Chennai Refineries will stand to benefit as the customs duty has not been reduced, contrary to expectations. IOC, due to its diverse operations, will continue to perform well. q GAIL and ONGC will continue to perform well due to no change in the duty structure.

Sector
Pharmaceuticals Changes made in the budget q R&D expenditure gets exemption

Budget impact
Neutral to positive Impact analysis: q Positive on the bio-technology and research companies

Our top pick

Biocon, Wockhardt Impact on companies: q Positive

Sector
Power Utilities Changes made in the budget q Electricity for all, re-emphasized. q Sec80IA benefit to be extended to renovation and modernization projects in the T&D segment, undertaken during the period April 1, 2004 to March 31, 2006. q The EA2003 envisages unbundling of generation, transmission and distribution.

Budget impact
Neutral Impact analysis: q Infrastructure building in the power sector would get an impetus. q The T&D segment would benefit due to the extension of tax exemption. q No specific direction has been given in terms of revising the EA2003 as expressed earlier.

Our top pick

Tata Power & Power Trading Corporation Impact on companies: Neutral q Tata Power, Reliance Energy and Jaiprakash Associates. Extension of the 80IA benefit would be marginally positive, however, lesser clarity on the EA2003 front would result in an overall neutral impact on these companies. Positive q Power Trading Corporation. Capacity enhancement in the sector would result in higher surplus availability for trading of power.

Sector
Shipping Changes made in the budget q Tonnage tax introduced to bring Indian shipping at par with the world shipping industry as far as direct taxation is concerned.The deduction U/S 33 AC of the income tax act has been withdrawn and all shipping companies will have to decide whether they want to follow the tonnage tax system or the corporate tax system.

Budget impact
Positive Impact analysis: q The introduction of tonnage tax system will have a positive impact on the Indian shipping industry. It was a long-term demand of the shipping industry and has been finally heard by the finance minister. q The impact of introduction of tonnage tax system is explained in our note "Tonnage tax: Implications for the Indian shipping industry" which was released by us on July 6, 2004. The same is attached along with this document for your ready reference.

Our top pick

GE Shipping, Shipping Corporation Impact on companies: q Shipping Corporation of India (SCI) and Great Eastern Shipping are expected to be positively impacted from this new tonnage based taxation system.

Sector
Sugar & Tea Changes made in the budget q No specific mention about the sugar or tea industry. q Tea industry is more insulated than sugar, as it does not have any excise and hence no cess.

Budget impact
Neutral Impact analysis: q The impact is neutral on the sector. However, we believe that thrust on agriculture, farm credit, micro finance and self-help groups would benefit the sector marginally.

Our top pick

Balrampur Chini Mills Impact on companies: q No direct impact other than the cess on the industry.

Budget 2004-05

Please see the disclaimer on the last page

For Private Circulation

July 8, 2004

Kotak Securities

Sector
Telecom Changes made in the budget q FDI limit increased to 74%

Budget impact
Positive Impact analysis: q This will facilitate Cellular companies need of investment to the tune of Rs.700 bn in next 5 years to reach the penetration level of 10%

Our top pick

Bharti Televentures Impact on companies: q Positive

Sector
Textiles Changes made in the budget q The cenvat chain as projected by us has been broken. The mandatory cenvat duty on handloom and power loom sector has been withdrawn. q No mandatory excise duty on pure cotton, wool and silk in any form be it fibre, yarn, fabric or garments.Blended textiles and noncotton textiles such as polyester, viscose, acrylic and nylon will have a different tax regime. q New system of excise duty calculation introduced for power loom, handloom and composite textile mills.

Budget impact
Positive Impact analysis: q The budget is Positive for cotton spinning and cotton textiles companies.

Our top pick

Arvind, Indian Rayon, Vardhman Spinning, Mahavir Spinning. Impact on companies: q Vardhman Spinning, Mahavir Spinning and super spinning are expected to benefit positively.Integrated textile companies such as Arvind Mills stand to benefit positively.

Budget 2004-05

Please see the disclaimer on the last page

For Private Circulation

10

July 8, 2004

Kotak Securities

DETAILED IMPACT
AUTOMOBILES
Rating: Overweight

ANALYSIS

Budget Impact: Positive

B UDGET

HIGHLIGHTS

n Reduction of the peak rate on alloy steel, copper, lead, zinc and base metals to 15% and
increase in excise duty on steel from 7% to 12%

n Tractors are fully exempt from excise duty n Increase in tax benefit on R&D expenditure to 150%

I M PA C T

ON THE SECTOR

n Reduction in customs duty on steel will benefit the industry to some extent and will also
benefit from the reduction in excise duty on various metals through the auto ancillary route. Exempting the entire tractor industry from excise duty has come as a major booster for the industry. Again, the non-inclusion of transport industry under service tax will have a positive impact on commercial vehicle sales.

T OP

PICKS

n Our top pick remains Mahindra & Mahindra & Tata Motors.
Impact on EPS
Company Mahindra & Mahindra Tata Motors FY2004 30.0 21.9 FY2005 Pre Budget Post Budget 39.8 31.4 43.0 31.4 Recommendation Very positive as tractor goes ex excise - BUY Will benefit from the lower cost of raw materials and higher R&D benefit - BUY

Budget 2004-05

Please see the disclaimer on the last page

For Private Circulation

11

July 8, 2004

Kotak Securities

BANKING
Rating: Underweight Budget Impact: Negative

B UDGET
Agriculture credit boost may impact the profitability and return on average assets

HIGHLIGHTS

n Thrust on agriculture credit, to double it in the next 3 years. n Micro-financing and self help groups to get a boost. Indicative target of credit linking 5.85
lakh SHGs during the period up to March 31, 2007 has been set for NABARD, SIDBI, banks and other agencies.

Withdrawal of tax exemption on NRE/NRO

n Withdrawal of tax exemption on foreign currency Non-Resident External/ Non-Resident

Ordinary Account.

n Fiscal deficit to remain at 4.4% of GDP. n Formation of Inter-Institutional Group (IIG) for accelerated investment in infrastructure. n Raising FDI in insurance from 26% to 49%. n SSIs to be encouraged for credit rating and will receive higher benefits under capital subsidy
scheme. Securitisation act amendment would boost NPA recovery

n Securitisation Act to be amended in favour of banks and financial institutions for speedy
recovery.

n Turnover tax on bonds trading.

I M PA C T

ON THE SECTOR

n The Securitisation Act amendment would help banks control their NPAs. n Turnover tax on bonds trading would reduce trading profits on the back of diminution of
values due to increasing interest rates.

n Raising FDI in insurance from 26% to 49%, will boost the valuation of banks/ companies
having an insurance arm. Insurance to set a big boost. Favorites: max India, Indian Rayon, HDFC, ICICI Bank

n Fiscal deficit target is very aggressive at 4.4% and appears to be difficult to meet, which
would raise the general interest level in the economy. This would widen the hole in the investment portfolio.

T OP

PICKS

n Our top picks are State Bank of India, Oriental Bank of Commerce and HDFC Bank for
their robust financials, manageable investment portfolio and better risk-management processes. Impact on EPS
Company State Bank of India Oriental Bank of Commerce FY2004 68.5 32.0 FY2005 Pre Budget Post Budget 80.0 40.0 78.5 39.0 Recommendation SBI is our top pick based on valuations - Buy OBC is highly insulated in terms of investment portfolio and business risks - Buy Likely to be least impacted of the entire banking sector - Buy. Likely to be worst impacted both on agriculture credit and investment portfolio losses - Sell Middle path bank and profits sustainable in the worst of times - Sell

HDFC Bank

17.4

21.5

21.5

Punjab National Bank

41.8

46.5

40.0

Corporation Bank

35.2

40.0

38.0

Budget 2004-05

Please see the disclaimer on the last page

For Private Circulation

12

July 8, 2004

Kotak Securities

CAPITAL GOODS
Rating: Overweight Budget Impact: Positive

B UDGET
IIG to garner Rs.40,000 crore

HIGHLIGHTS

n An inter institutional group (IIG) has been constituted involving IDBI, IDFC, ICICI Bank,
SBI, LIC, Bank of Baroda and Punjab National Bank to garner Rs40,000 crore. This is to ensure speedy conclusion of loan agreements and implementation of infrastructure projects.

n The finance minister has reiterated "Electricity for all" programme announced by the NDA
government.

n Doubling agricultural credit in three years, accelerating the completion of irrigation projects
and investing in rural infrastructure.

n Launching a nationwide water harvesting scheme to cover 1 lakh irrigation units at a cost
of Rs.20,00crore.

n Sectoral cap for FDI to be raised from 40% to 49% in civil aviation. n Increase in allocation towards Defense modernization to Rs.77,000crore from
Rs.65,300crore in BE2003-04.

n Deduction of 100% of profits for 5 years and 25% of profits for the next five years to be
allowed in the case of new agro-processing industries set up to process, preserve and package fruits and vegetables.

n Dairy machinery, which attract a 16% excise duty, to be fully exempt.

I M PA C T
Thruston infrastructure positive for capital goods

ON THE SECTOR

n Considering thrust on infrastructure be it road, irrigation projects, ports, airports, power,

etc, we believe the overall impact of the budget on the capital goods sector is positive.

n Electricity for all and tax exemptions under Sec 80IA would be positive for the power
equipment manufacturers.

n Emphasis on completing irrigation projects would augur well for pump manufacturers and
engine manufacturers catering to agri requirement.

n Increased allocation towards defense modernization will result in higher orders for companies
involved in supplying equipment for defense needs.

n Special benefits announced for the agro-processing industry and dairy industry would
translate into higher revenue for companies involved in manufacturing and installing specialized machinery for these sectors.

T OP

PICKS

n Siemens, ABB, L&T, BEL and Alfa Laval

Impact on EPS
Company FY2004 FY2005 Pre Budget Post Budget 44.5 54.0 44.2 60 34.5 38.0 36.7 14.0 44.5 54.0 44.2 60 34.5 38.0 36.7 14.0 Recommendation BUY BUY BUY BUY BUY HOLD BUY HOLD

BEL 39.5 Larsen & Toubro 42.7 Alfa Laval^ 35.8 Siemens* 50 ABB^ 29.3 BHEL 30.0 Thermax 30.1 Jyoti Structure 4.6 * September ending; ^ December ending

Budget 2004-05

Please see the disclaimer on the last page

For Private Circulation

13

July 8, 2004

Kotak Securities

CEMENT & CONSTRUCTION

Rating: Overweight Budget Impact: Neutral to Positive

B UDGET
No change in excise

HIGHLIGHTS

n No changes in the excise duty and import duty structure for the cement industry.

I M PA C T

ON THE SECTOR

n The impact of this budget is Neutral to Positive for the cement industry. n We had anticipated a rise in excise duty of Rs.50 to Rs. 100 per ton of cement. No increase
in the excise duty is welcome relief to the cement industry.

n The thrust of this budget in creating agricultural infrastructure such as dams, roads, irrigation
projects, water management, coupled with thrust on education and health infrastructure along with emphasis on capital formation augers well for the cement and construction industry.

n We expect the cement industry to grow by 6.5% to 7% during the year.

T OP
Thrust on infrastructure will increase demand for cement and construction companies

PICKS

n Birla Corporation, ACC, Gujarat Ambuja Cements and Nagarjuna Construction.

Impact on EPS
Company ACC Gujarat Ambuja Cements* Birla Corp Shree Cement Grasim Nagarjuna Construction FY2004 11.7 14 5.6 3.75 83.2 26.4 FY2005 Pre Budget Post Budget 15.0 19.5 18.5 18.4 90 38.8 15.0 19.5 18.5 18.4 90 38.8 Recommendation Buy Buy Buy Not rated Not rated Buy

* June ending data for year ended June '03 & estimates for June '04.

Budget 2004-05

Please see the disclaimer on the last page

For Private Circulation

14

July 8, 2004

Kotak Securities

FERTILISER
Rating: Overweight Budget Impact: Positive

B UDGET

HIGHLIGHTS

n Though there is no direct hint of any benefit given to the fertilizer industry and the overall
subsidy has also not been increased, we believe that the thrust on agriculture and irrigational facilities would benefit fertilizer companies in the long run. The sell-off of loss making fertilizer companies is not ruled out, which would facilitate efficient companies to capture control. The easy access of agricultural credit will make fertilizers more affordable to farmers, who balance consumption of NPK.

I M PA C T

ON THE SECTOR

n Overall impact on the sector is positive due to higher allocation towards agriculture and
farm credit. We believe that to increase yield, fertilizer consumption would increase. Increase in irrigation facilities would further augment the consumption of fertilizers.

T OP

PICKS

n Our top picks within the sector remains Indo Gulf Fertilisers, Tata Chemicals and Coromandel
Fertilisers. Chambal Fertilisers is a good play on dividend rather than growth within the sector. Impact on EPS
Company Indo Gulf Fertilisers Tata Chemicals Coromandel Fertilisers FY2004 20.0 11.8 17.0 FY2005 Pre Budget Post Budget 13.1 13.4 18.4 13.1 13.4 19.2 Recommendation Outlook remains positive for the company- BUY Will benefit from the sell-off of PSUs - BUY Consolidation and balanced usage of NPK would boost sales for the company- BUY To benefit from the boost in sales due to better farm creditNot Rated Needs capital infusion Not Rated

RCF

3.04

3.67

3.67

GNFC

7.98

9.5

9.5

Budget 2004-05

Please see the disclaimer on the last page

For Private Circulation

15

July 8, 2004

Kotak Securities

FMCG
Rating: Overweight Budget Impact: Positive

B UDGET

HIGHLIGHTS

n The absence of a much awaited excise hike in tobacco products has made the FMCG
sector jubilant. Thrust on rural credit, infrastructure in the hinterlands and gainful employment in agriculture and the rural economy, besides boosting micro-finance, would revive growth in the sector. Though there was no direct mention relating to FMCG, the undertone would put FMCG on a fast track.

I M PA C T

ON THE SECTOR

n We believe that the focus of the budget would set a northward pace in the rural economy.
Growth in the rural economy, along with the higher disposable income due to lowering of income taxes, would make FMCG again a sector to depend on. Companies with strong network and deeper reach in rural and semi urban areas would get an immediate benefit.

T OP

PICKS

n Our top pick in the sector remains ITC, due to its strong network, reach and growing product
portfolio. The reality of non-hike in excise duty on tobacco relieved ITC and increased its earnings visibility. Impact on EPS
Company ITC FY2004 61.8 FY2005 Pre Budget Post Budget 73.4 75.0 Recommendation Higher disposable income in the hands of rural and semi urban population would be beneficial for the company- BUY Will be impacted positively due to better affordability- Not Rated

HLL

8.0

6.8

7.0

Budget 2004-05

Please see the disclaimer on the last page

For Private Circulation

16

July 8, 2004

Kotak Securities

INFORMATION TECHNOLOGY
Rating: Overweight Budget Impact: Neutral

B UDGET

HIGHLIGHTS

n No mention of abolition of tax break under Section 10 A/B. n Computers are fully exempted from excise duty.

I M PA C T

ON THE SECTOR

n The impact is neutral on the sector. The relief of non-abolition of tax-break under Section
10 A/B would again make IT a formidable bet.

T OP

PICKS

n Our top pick is Infosys Technologies

Impact on EPS
Company Infosys Technologies Wipro FY2004 42.5 35.6 FY2005 Pre Budget Post Budget 61.2 60.4 61.2 60.4 Recommendation Budget neutral- BUY Budget neutral- BUY

Budget 2004-05

Please see the disclaimer on the last page

For Private Circulation

17

July 8, 2004

Kotak Securities

METALS
Rating: Overweight Budget Impact: Neutral

B UDGET

HIGHLIGHTS

n Excise duty on steel increased from 8% to 12%. Import duty on steel was reduced to 10%
from 15%.

n Import duty on copper, zinc, alloy steel and lead was reduced by 5% to 15%.

I M PA C T

ON THE SECTOR

n The impact of this budget is neutral for the Metals sector. n The rise in excise duty coupled with a reduction in the import duty will marginally impact
steel companies. The difference between the landed price and the domestic price of steel, which till yesterday was Rs.2,500 per ton, will now stand reduced to Rs.2,000 per ton. This will not impact steel companies in a negative manner as they have a cushion of Rs. 2,000 per ton.

n We do not expect any reduction in the price of steel. n The 5% reduction in import duty on copper will marginally impact Hindalco's profits.

T OP

PICKS

n Our top picks in the steel industry are Tata Iron and Steel (TISCO) Jindal Iron & Steel
Company (JISCO), Hindalco and Sesa Goa.

Impact on EPS
Company TISCO SAIL Jindal Iron and Steel Jindal Steel and Power Sesa Goa Hindalco FY2004 47.3 6.1 35 104 66 110 FY2005 Pre Budget Post Budget 55 4.5 54 113 114 126 55 4.3 54 113 114 122 Recommendation Buy Not Rated Buy Buy Buy Buy

Budget 2004-05

Please see the disclaimer on the last page

For Private Circulation

18

July 8, 2004

Kotak Securities

OIL & PETROCHEMICALS

Rating: Overweight Budget Impact: Neutral

B UDGET

HIGHLIGHTS

n No changes in the excise duty and the import duty structure for the oil and gas sector. n The excise duty was maintained at the same level of 26% for motor spirit, 11% for highspeed diesel and 8% for LPG. Customs duties are being maintained at previous year's levels.

I M PA C T

ON THE SECTOR

n The announcement that petroleum companies will not be given pricing freedom is a
dampener, as it probably indicates that the government will continue to shift the subsidy burden to the petroleum companies and ONGC.

n This measure will be neutral to the oil and gas industry. n It will be positive, to some extent, for stand-alone refineries such as Kochi Refineries,
Chennai Petroleum and Bongaigaon Refineries, as it was widely expected that the customs duty was expected to be lowered thereby negatively impacting their margins.

n Positive for Reliance, IPCL, Finolex Industries, Indorama as price protection continues
and PVC users increases with government thrust in irrigation and water management.

T OP

PICKS

n Our top picks in the oil industry are ONGC, GAIL, Kochi Refineries, Indian Oil Corporation
(IOC), and Chennai Petroleum.

Impact on EPS
Company ONGC Chennai Petroleum Kochi Refineries Indian Oil Corp GAIL HPCL BPCL FY2004 60.8 26.9 40.1 60.0 22.2 56.2 56.5 FY2005 Pre Budget Post Budget 73.5 29.0 37.4 55.0 22.7 50.0 48.5 73.5 29.0 37.4 55.0 22.7 50.0 48.5 Recommendation Buy Buy Buy Buy Buy Not rated Not rated

Budget 2004-05

Please see the disclaimer on the last page

For Private Circulation

19

July 8, 2004

Kotak Securities

PHARMACEUTICALS
Rating: Overweight Budget Impact: Neutral to Positive

B UDGET

HIGHLIGHTS

n Increased focus on health insurance and extention of the terminal date to avail of 100 per
cent tax deductions for research companies till March 2005.

I M PA C T

ON THE SECTOR

n Positive

T OP

PICKS

n Biocon, Wockhardt
Impact on EPS
Company Ranb axy Dr. Reddys Lab Cipla Sun Pharma Biocon Glaxo Novartis Aventis Wockhardt Cadila Nicholas Piramal Divis Lab FY2004 38.7 37.7 9.3 19.2 13.9 25.0 21.5 32.2 12.5 22.7 50.1 56.8 FY2005 Pre Budget Post Budget 45.3 41.6 11.0 21.2 18.9 29.7 23.2 35.0 17.6 29.3 59.8 88.1 45.3 41.6 11.0 21.2 18.9 29.7 23.3 35.0 17.6 29.3 59.8 88.1 Recommendation Buy Buy Buy Sell Buy Buy Buy Buy Buy Buy Buy Buy

Budget 2004-05

Please see the disclaimer on the last page

For Private Circulation

20

July 8, 2004

Kotak Securities

POWER UTILITIES
Rating: Overweight Budget Impact: Neutral

B UDGET
Electricity for all

HIGHLIGHTS

n The finance minister has reiterated "Electricity for all" programme announced by the NDA
government.

n In order to promote renovation and modernization of the existing Transmission and

Distribution (T&D) lines, benefit under 80IA would be extended to the projects undertaken during the period April 1, 2004 to March 31, 2006.

n The Electricity Act 2003 (EA) envisages unbundling of generation, transmission and
distribution.

I M PA C T
No mention of revision in the EA 2003

ON THE SECTOR

n The overall impact on the sector on account of these announcements would be neutral.
All the announcements like emphasis on electricity for all and extension of a tax holiday under Section 80IA would ensure continued investment in capacity expansion in the power sector. The government appears committed towards building power infrastructure, however, there was no specific mention of the revision proposed in the EA 2003 earlier.

T OP

PICKS

n Tata Power and Power Trading Corporation

Impact on EPS
Company Tata Power Reliance Energy JaiPrakash Associates Power Trading FY2004 23.6 24.2 9.9 2.3 FY2005 Pre Budget Post Budget 24.5 28.0 13.8 3.5 24.5 28.0 13.8 3.5 Recommendation BUY HOLD HOLD BUY

Budget 2004-05

Please see the disclaimer on the last page

For Private Circulation

21

July 8, 2004

Kotak Securities

SHIPPING
Rating: Overweight Budget Impact: Positive

B UDGET

HIGHLIGHTS

n Tonnage tax introduced to bring the Indian shipping industry at par with the world shipping
industry, as far as direct taxation is concerned.

n The deduction U/S 33 AC of the income tax act has been withdrawn and all shipping
companies will have to decide whether they want to follow the tonnage tax system or the corporate tax system.

I M PA C T

ON THE SECTOR

n The introduction of tonnage tax will have a positive impact on the Indian shipping industry.
It was a long-term demand of the shipping industry and has been heard by the finance minister.

n The impact of introduction of the tonnage tax system is explained in our note "Tonnage tax:
Implications for the Indian shipping industry" which was released by us on July 6, 2004. The same is attached, along with this document, for your quick reference.

T OP

PICKS

n Our top picks are Shipping Corporation of India (SCI) and Great Eastern Shipping.
Impact on EPS
Company Shipping Corp Great Eastern Shipping Essar Shipping FY2004 22.2 26.4 4.3 FY2005 Pre Budget Post Budget 30.0 29.4 5.3 32.5 30.5 5.8 Recommendation Buy Buy Not rated

Budget 2004-05

Please see the disclaimer on the last page

For Private Circulation

22

July 8, 2004

Kotak Securities

SUGAR & T EA
Rating: Overweight Budget Impact: Neutral

B UDGET

HIGHLIGHTS

n No specific mention about the sugar or tea industry. n Tea industry is more insulated than sugar, as it does not have any excise and hence no
cess.

I M PA C T

ON THE SECTOR

n The impact is neutral on the sector. However, we believe that thrust on agriculture, farm
credit, micro finance and self-help groups would benefit the sector marginally.

T OP

PICKS

n Our top pick remains Balrampur Chini Mills, Bajaj Hindustan and Tata Tea
Impact on EPS
Company Balrampur Chini Bajaj Hindustan Bannari Amman EID Parry Tata Tea FY2004 31.9 5.3 28.9 24.2 39.3 FY2005 Pre Budget Post Budget 40.3 7.5 48.7 38.3 40.5 40.3 7.5 48.7 38.3 40.5 Recommendation No impact of budget, we continue to recommend BUY No impact of budget, we continue to recommend BUY No impact of budget, we continue to recommend BUY No impact of budget, SELL No direct budget impact. We continue to maintain BUY

Budget 2004-05

Please see the disclaimer on the last page

For Private Circulation

23

July 8, 2004

Kotak Securities

TELECOM
Rating: Neutral Budget Impact: Positive

B UDGET

HIGHLIGHTS

n Increase in foreign direct investment limit from 49 percent to 74 percent. n Tax holiday under section 80-IA extended for one more year. n Mobile switching centre import duty waived. n Special package for ITI

I M PA C T

ON THE SECTOR

n The increase in the foreign direct investment (FDI) limit from 49 per cent to 74 per cent is
a positive for the sector, which is expected to require investments to the tune of Rs 700900 billion over the next 5 years. Bharti Tele-Ventures, Hutchison-Essar and Idea Cellular are expected to be the major beneficiaries of the decision.

n The extension of the tax holiday under section 80-IA for 1 more year, up to March 31, 2005,
is positive for investments in the sector.

n The customs duty exemption given on imports of mobile switching centres imports by
universal access service providers is expected to result in lower capital costs for Reliance Infocomm, Tata Teleservices and BSNL

n The Rs 5.08 billion package for Indian Telephone Industries (ITI) will help the company
restructure its operations and strengthen its technological capabilities.

T OP

PICKS

n Bharti Televentures
Impact on EPS
Company Bharti Televentures MTNL VSNL FY2004 3.1 19.3 11.0 FY2005 Pre Budget Post Budget 4.6 20.0 4.6 20.0 Recommendation Buy Trading Buy Sell

Budget 2004-05

Please see the disclaimer on the last page

For Private Circulation

24

July 8, 2004

Kotak Securities

TEXTILES
Rating: Overweight Budget Impact: Positive

B UDGET
Cenvat chain broken

HIGHLIGHTS

n The cenvat chain, as projected by us, has been broken. The mandatory cenvat duty on
handloom and power loom sector has been withdrawn.

n No mandatory excise duty on pure cotton, wool and silk in any form be it fibre, yarn, fabric
or garments.

n Blended textiles and non-cotton such as polyester, viscose, acrylic and nylon will have a
different tax regime.

n Rates For Excise Duty On Man Made Fibres. Mandatory excise duty on manmade fibre
at 16% (increased from 12%), on polyester filament yarn at 24% (no change), other man made filament yarn at 16% (increased from 12%). New system for excise calculation introduced

n New System Introduced For Excise Calculations. New system of excise duty calculation
introduced for power loom, handloom and composite textile mills. Under this new system, the players will have to choose between two routes of excise taxation: l Exemption route or l Cenvat route When the player chooses the exemption route, no excise duty will have to be paid at any stage except on man made fibre and filament yarn. or When the player chooses the cenvat route then the player can take credit for all the excise duty paid at the earlier stages. For the purpose of optional excise duty the rates of excise are: l 4% for pure cotton sector be it yarn, fabrics, garments or made ups l 8% for blended textiles sector and all non-cotton sectors. The garment exporters concerns if any will be addressed through the DEPB mechanism.

I M PA C T

ON THE SECTOR

n The budget is Positive for cotton spinning and cotton textiles companies.

T OP

PICKS

n Arvind Mills, Mahavir Spinning, Vardhman Spinning n Indian Rayon (likely to be benefited due to increase in the FDI limit in insurance business
from 26% to 49% as Indian Rayon holds 74% stake in Birla Sun Life Insurance, but negative to some extent as excise duty on viscose yarn increased from 12% to 16%). Impact on EPS
Company Arvind Mills Raymonds Indian Rayon Bombay Dyeing Mahavir Spinning Vardhman Spinning Super Spinning FY2004 4.8 21.6 18.6 13.9 22.9 20.7 18.9 FY2005 Pre Budget Post Budget 6.0 18.5 19.5 15.0 24.0 22.0 20.0 6.0 18.5 19.5 15.0 24.0 22.0 20.0 Recommendation Buy Not rated Buy Not rated Buy Buy Buy

Budget 2004-05

Please see the disclaimer on the last page

For Private Circulation

25

July 8, 2004

Kotak Securities

ANNEXURE
Tonnage tax: Implications for the shipping industry
A corporate entity in the shipping industry in India is taxed at the maximum rate applicable under the Income Tax Act. The shipping industry, however, enjoys a special deduction U/S 33 AC of the Income Tax Act. The Act allows a 100% deduction of profits derived from the shipping business, provided that the amount is transferred to a reserve account. The amount transferred to this reserve under section 33AC is to be utilised by the shipping company for acquisition of new ships only. Tonnage tax: the preferred option
A shift to tonnage tax will reduce taxes of Indian shipping companies and bring it on par with its international counterparts World over, and particularly in the major shipping nations, there has been a shift from the corporate tax regime to the tonnage based tax system. Under the tonnage-based system, shipping companies have to make a choice whether they want to be taxed as per the corporate tax system or the new system of tonnage based tax. Once a company makes its choice, it has to adhere to it for 10 years. This system helps reduce the incidence of taxation on shipping companies and brings taxation at par with other countries that have already adopted this duel system. Shipping companies also derive income from chartering of ships. The general law in all the shipping nations is that: if the total gross tonnage moved by chartered ships exceeds the total gross tonnage moved by the company's own ships with more than a 4:1 ratio, this income from chartering will be taxed as ordinary income.

Obligation to train new cadets

This tonnage based tax system comes with one rider: a training commitment. Worldover (except in the UK where it can be waived off by paying a lumpsum amount in lieu of its training obligations) a company adapting to the tonnage tax regime has an obligation to train new cadet officers. This is a primary requirement and any company failing to do this automatically forgos all the benefits derived from having adopted the new tonnage tax system.

Benefits of tonnage tax

Listed companies will derive more advantages as deferred tax liability will be phased out, resulting in higher earnings q Tonnage tax offers a new, simple, fixed rate, low tax regime for shipping. q Companies opting into the regime will enjoy a certainty on the level of taxes that will be imposed on their shipping activities. q In case of pure shipping companies, it will reduce the amount of effort required to compute annual tax returns and result in cost savings. q Listed companies will derive more advantages from this regime in that the deferred tax liability in respect of shipping will be phased out. This will result in higher earnings per share and at the same time strengthen the balance sheet. The new tax regime will allow shipping companies to sell ships anytime and tax only the capital gains accruing out of the sale q Tonnage tax system will lead to ending of the benefit U/S 33 AC of the Income Tax Act 1961. This will greatly benefit shipping companies as they will be able to sell ships as and when they want and not get constrained by the provisions of the said section wherein it is stated that if any ship acquired is sold within eight years of purchase, the entire revenue will be added back as profits in the year of sale. As a result of the tonnage tax regime only capital gains will get taxed. q The tonnage tax-training requirement will increase the availability of trained seafarers to the shipping industry.

Budget 2004-05

Please see the disclaimer on the last page

For Private Circulation

26

July 8, 2004

Kotak Securities

How taxes are calculated in Europe

Moreover, the law in EU stipulates that all expenses related to the shipping business concerning tonnage income will be non-deductible and assets included in the calculation of tonnage tax cannot be depreciated. q Capital gains on sale of ships will continue to be taxed at corporate tax rates. q Income from non-shipping business will be taxed at the applicable corporate tax rate. q The deferred tax liability of the company will stand abolished. q The tonnage tax is based on the tonnage of a ship and also on the age of the ship. The older the ship, the higher is the incidence of tonnage tax. q Among the main aims of tonnage tax is to encourage shipping companies to acquire new ships to replace older ones as also to provide better training to cadets and officers in the shipping industry. Tax structure in different countries is as follows: Comparative tax structure (Net ton per day)
Ship Size Denmark Germany Finland Ireland Netherlands 0.91 0.67 0.46 0.23 Spain 0.90 0.70 0.40 0.20 UK 0.97 0.73 0.48 0.24 India (Rs)* 50.0 35.0 30.0 20.0 < 1000 DWT 0.94 0.92 1.38 1.00 1000 DWT > 10000 DWT 0.67 0.69 1.03 0.75 10000 DWT > 25000 DWT 0.40 0.46 0.69 0.50 25000 DWT > 0.27 0.23 0.57 0.25 Note: * estimated; Currency Euro except for India; Euro: Rs.56.28; Source: Kotak Securities

The rates given above are per day rates. The shipping company will be taxed per ship and for the days the ship was in operation only. If the ship is not operating due to repairs or otherwise it will not be taxed for that period. Moreover, the age of the ship can also be a deciding factor and an index can be used to determine the taxation level. Older ships will be taxed more than new ships.

Implication of tonnage tax on shipping companies

The implications of tonnage tax on Indian shipping companies will have to be understood in the light of the deduction U/S 33AC and the compulsion on shipping companies to get 100% deduction by transferring profits to the reserve created under the said section. At present, shipping companies, after availing deduction U/S 33 AC, are paying 5 % to 7% tax on their reported profits. Also, there is a rider that any ships acquired from this reserve, if sold within eight years will be taxed for the total revenue. The introduction of tonnage tax will see shipping companies paying only 1.5 % to 2% of their net profits as tax. Under the new tonnage tax system, the constraint on sale of ships will go and shipping companies will be taxed only for the capital gains, if any, on sale of ships.

Impact of tonnage tax on valuations

PBT FY04 (Rs mn) Shipping Corporation GE Shipping Essar Shipping Source: Kotak Securities 7135 4918 1510 865 270 220 12.1 5.5 14.6 Taxation % of PBT Tonnage tax @ 2% of PBT 143 98 30 % Impact on EPS 2.60 0.90 0.60 Recommendation BUY BUY NOT RATED

Budget 2004-05

Please see the disclaimer on the last page

For Private Circulation

27

July 8, 2004

Kotak Securities

Research Team
Name
Amitabh Chakraborty, CFA, FRM Jay Prakash Sinha Ketan Karani Mayuri Yadav Mitesh Thacker Shrikant Chouhan Nilay Dani Shankri Basu K. Kathirvelu

Sector
Head of Research Agro-Industry, Banking Cement, Construction, Shipping, Textiles, Mid Cap Capital Good, Engineering, Power Technical analyst Technical analyst Derivatives Editor Production

Tel No
+91 22 5634 1509 +91 22 5634 1207 +91 22 5634 1209 +91 22 5634 1522 +91 22 5634 1417 +91 22 5634 1439 +91 22 5634 1428 +91 22 5634 1535 +91 22 5634 1567

E-mail id
amitabh.chakraborty@kotak.com jay.sinha@kotak.com ketan.karani@kotak.com mayuri.yadav@kotak.com mitesh.thacker@kotak.com shrikant.chouhan@kotak.com nilay.dani@kotak.com shankri.basu@kotak.com k.kathirvelu@kotak.com

Disclaimer
This material has been prepared by Kotak Securities Limited. This document is not for public distribution and has been furnished to you solely for your information and may not be reproduced or redistributed to any other person. Persons into whose possession this document may come are required to inform themselves of, and to observe such restrictions. This material is for the personal information of the authorized recipient, and we are not soliciting any action based upon it. This report is not to be construed as an offer to sell or the solicitation of an offer to buy any security in any jurisdiction where such an offer or solicitation would be illegal. No person associated with Kotak Securities Limited is authorised to call or initiate contact with you for the purposes of elaborating or following up on the information contained in this document. The material is based upon information that we consider reliable, but we do not represent that it is accurate or complete, and it should not be relied upon as such. Neither Kotak Securities Limited, nor any person connected with it, accepts any liability arising from the use of this document. The recipient of this material should rely on their own investigations and take their own professional advice. Opinions expressed are our current opinions as of the date appearing on this material only. While we endeavor to update on a reasonable basis the information discussed in this material, there may be regulatory, compliance, or other reasons that prevent us from doing so. Prospective investors and others are cautioned that any forward-looking statements are not predictions and may be subject to change without notice. We and our affiliates, officers, directors, and employees world wide, including persons involved in the preparation or issuance of this material may: (a) from time to time, have long or short positions in, and buy or sell the securities thereof, of company(ies) mentioned herein or (b) be engaged in any other transaction involving such securities and earn brokerage or other compensation or act as a market maker in the financial instruments of the company(ies) discussed herein or act as advisor or lender I borrower to such company(ies) or have other potential conflict of interest with respect to any recommendation and related information and opinions. The same persons may have acted upon the information contained here. No part of this material may be duplicated in any form and/or redistributed without Kotak Securities prior written consent. Budget 2004-05 Registered Office:

Kotak Securities Limited, Bakhtawar, 1st floor, 229last page Point, Mumbai 400021 India. Please see the disclaimer on the Nariman

For Private Circulation

28