Sunday, June 21, 2009


A tightrope walk

The government will present the Union Budget in the Parliament for the balance months (August-March) of FY10 on July 6. The budget is set to be presented against a backdrop of the government grappling with conflicting objectives of supporting growth and containing fiscal deficit. Given the fiscal constraints the government faces at the moment, any significant tax concessions or large direct government stimulus expenditure seem unlikely. However, programmes targetting rural employment generation, low cost housing, weaker sections of the society are likely to continue. The budget’s focus is likely to be on inclulsive growth, infrastructure, small and medium enterprises (SMEs), and labour-intensive and export-oriented industries (textiles, leather, gems and jewellery, etc). Agriculture will continue to be favoured. The UPA, both in its manifesto and the interim budget, had emphasised on divestment. Hence, one can expect the same to be on for discussion in the current budget.

Apart from the duty and tax cuts on budget wish lists, companies expect the government to promote investment. Construction companies expect an increase in funding for roads, irrigation, and in both rural and urban infra schemes. FMCG companies expect the government to boost the rural economy by increasing allocation for various agriculture-centric and employment generating schemes. In the metals sector, companies expect the government to help PSU steel companies to increase capacity and grant of infrastructure status for steel sector. The 3G auction issue for telecos is also expected to be touched upon in the budget, as it may generate additional funds of INR 250-400 bn. The wish list of oil & gas companies includes deregulation of auto fuel prices making domestic auto fuel pricing linked to international crude oil prices up a level (e.g, below USD 75/bbl). However, it is uncertain to what extent this proposal will go through, since an alignment to international prices will imply significant fluctuations in gasoline and diesel retail prices.

However, in case of most reforms (including 3G auction and oil price deregulation), only general directions and broad guiding criteria are expected in the upcoming budget. Detailed announcements and quantitative specifications are likely to follow in a staggered manner, in consultation with the specific ministries.

Inclusive growth, infrastructure to be key focus areas
Supporting growth will be the foremost objective of the upcoming budget. The government has repeatedly emphasized that its focus is “the common man” and, hence, it prefers the growth process to be as “inclusive” as possible. Amidst subdued job scenario across the economy, the government is likely to demonstrate its commitment to generating employment. There are also talks of sector-specific stimulus measures, particularly labour-intensive, export-oriented industries and SMEs. The government has also stated that concerns raised in the interim budget, especially with regard to sectors hit badly by the global financial crisis—textiles, leather, and gems and jewellery—will be addressed in the budget. The measures may include interest rate subsidies and tax subsides. Representatives of the export sector are also seeking a market development fund to support the sector.

Agriculture will continue to be favoured. The government is likely to introduce new initiatives
in rural infrastructure, such as, widen the irrigation cover, apart from increasing the corpus of
the Rural Infrastructure Development Fund (RIDF) to ensure greater availability of funds.
Government initiatives are expected to ensure better credit disbursements to agriculture, and
increase agriculture input subsidies.

The budget may include some announcements on public sector-led infrastructure spending,
including new initiatives in power sector development, improvement of railway infrastructure,
upgradation of port infrastructure and capacity building in airlines and airports. The
reintroduction of infrastructure bonds and investment allowance is on the wish list of corporates.

High fiscal deficit a concern; but small scale projects to continue
The government has expressed the need to contain the fiscal deficit within reasonable limits. Certain government sources have indicated that they will attempt to contain the combined (Centre and States) fiscal deficits within 11% of GDP. However, given the sharp revenue slowdown the government is currently facing, this target appears ambitious unless there is a significant turnaround in the economy.

Accordingly, the government’s ability to provide any further dose of large and generalized stimulus for the economy will be limited in the current budget. However, the government will continue with small scale projects such as providing land at zero pricing for the economically weaker sections (EWS) and lower income groups (LIG) under the Model Real Estate Regulation Bill, increasing the minimum wages under the NREGA scheme to INR 100/day, and providing food security.

Can there be any significant tax reductions?
Given the difficult business environment, demands from industry have been strong to reduce corporate tax rates or remove the surcharge on corporate income tax. Wish lists also include maintaining the reduced indirect tax rate and increasing tax free thresholds on income tax so as to not depress consumption.

However, the government is currently facing sharp revenue slowdown and there is no immediate need to be populist. Hence, there is no realistic expectation of a significant reduction in taxes. Tax concessions, if any, will only be token and largely for uplifting sentiments.

There is a possibility of rationalisation of income tax slabs yielding benefits to tax payers particularly at the lower end of the pyramid. The existing limit of INR 0.10 mn of tax exemption under Section 80C could be revised upwards.

On the other hand, to help interest rates to soften further, the government may consider reducing administered interest rates for small saving schemes like postal deposits. This will help banks reduce deposit rates and, in turn, lending rates.

Goods and services tax (GST)
The government is keen on speeding up the streamlining of the tax system with the introduction of the Goods and Services Tax (GST). The finance minister has proposed to set April 1, 2010, as the date for introducing GST. Currently, there are parallel systems of indirect taxation at the central and state levels. Each of the systems needs to be reformed to eventually harmonize them.

Some of the steps the government needs to take with regard to GST are: (1) harmonize central excise and service tax rates; (2) eliminate end use/region based exemptions; (3) set up a body to recommend constitutional amendments, if any, needed to implement a uniform GST; and (4) give clarity on how import duties will be merged with GST. It remains to be seen how many of the above-mentioned issues will be addressed by the finance minister in the budget.

The GST rate may be pegged at 10-12% against the current 8-12% Cenvat rate, 10% service
tax rate, and 12.5% VAT rate. There is also a possibility of introducing GST with differential
rates for different goods and services with gradual unification of the rates over time.

Fringe Benefits Tax (FBT)
Another long-standing demand from corporates is the removal of the Fringe Benefits Tax (FBT). Corporates have been opposed to FBT, not just on account of the added tax burden, but also because of the huge additional paperwork and accounting complications involved. Given the miniscule FBT collections (~2% of the total direct tax collection), there is a view that FBT may be removed in the budget for certain sectors. However, removal of FBT does not gel with UPA’s focus on “the common man”.

Securities Transaction Tax (STT)
The wish list of the capital market includes abolishing Securities Transaction Tax (STT). Several market participants, however, feel that abolishing STT will be low in the priorities of the government as such a move will not offer any significant help for “the common man”. Another option for the government can be to reduce the STT (from the current 0.125%) instead of abolishing it altogether. There is also a possibility that if the STT is abolished, it will be replaced by another tax, such as long-term capital gains tax.

Expectations high on a roadmap for divestment …
With the economic slowdown impacting the government’s revenue receipts, divestment is one route to raise funds to improve the fiscal scenario. IPOs from unlisted government owned companies could help revive the primary capital market. Indian National Congress’ (INC) manifesto and the interim budget both emphasized the need for divestment.

PSUs in which government’s stake is significantly higher than 51% may be the ones where stake sales will be pushed through first. Thus far, a majority of the amounts raised from divestment have come in from sale of minority stakes in companies, rather than strategic sale and residual sale. This suggests that the government is likely to lean towards divestment of minority stakes in PSUs through the IPO route. However, strategic sales in loss-making companies too may be considered.

Given that government holding in many public sector banks (PSBs) is near 51% and statute prohibits further dilution. The government will have to resolve this issue to ensure that PSBs are able to raise funds by diluting their equity base. Divestment may not occur in PSBs or at the most it could be restricted to non-strategic banks. However, the government may relax the 51% statute, thereby keeping the control in its hands and at the same time garnering the much-needed capital. The governement is not likely to be aggressive on divestment in the infrastructure sector, as it will be sensitive to opposition from employees and other stakeholders.

Potential listing candidates include Oil India, NHPC, Coal India, RINL, Manganese Ore, Cochin
Shipyard, and Air India. The government may also look at follow-on public offers in BPCL, HPCL, IOC, and ONGC, and stake sales in BSNL and LIC.

… and for increasing FDI cap
The proposal for increasing the FDI cap in retail and insurance was raised by the United Progressive Alliance (UPA) government in the 2004-05 Budget. However, opposition from Left parties eluded consensus on the issue.

FDI is not currently allowed in multi-brand retail, thus curbing mega-international stores like Walmart, Tesco, and IKEA from entering Indian markets. Although allowing FDI in retail is on the wish list of the middle and upper classes, as it will boost the service quality, available choice as well as pricing, we doubt if such a proposal will find a berth in the forthcoming budget, as introduction of such norms will adversely affect employment generated by local

Currently, 26% foreign equity is allowed in insurance companies. Expectations are that over the next two-three years, this will be raised to 49%, as it will help bring in more resources and experience to Indian insurance companies. This may not happen in the forthcoming budget itself. However, the government may take an initial step in this direction and chart out a future roadmap for the same.