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"One-off performance" or "One of performance"?
Low expectations amidst macroeconomic headwinds
Union Budget 2011-12 comes against the backdrop of high inflation, tight liquidity, high interest
rate, industrial slowdown, delayed reforms and negative market sentiment. Thus, expectations
from the budget are, in general, muted. The positive is that FY11 fiscal deficit target of 5.5% of
GDP will be over-achieved. But without one-off revenue sources like 3G, meeting the FY12
fiscal deficit target of 4.8% is a challenge [our estimate 5%; gross (net) market borrowing of
Rs4.7t (Rs4t)]. Clarity on reforms such as DTC, GST and oil/fertilizer subsidy is the key watchout.
Backdrop: Union Budget 2011-12 comes amidst macroeconomic headwinds
Union Budget 2011-12 comes at a time when the Indian markets and economy are facing
critical headwinds on multiple issues, both domestic and global:
1. Inflation at decadal high; no signs of meaningful moderation yet
2. Tight liquidity and rising interest rate environment
3. Few early signs of industrial slowdown
4. Stalling of reforms process
5. Persistently high global oil and other commodity prices
6. ~14% correction in equity markets; India has been the top underperforming market in
2011 amongst top-10 global markets.
Repeating FY11 fiscal performance will be a challenge in FY12
We expect FY11 fiscal deficit to be significantly lower than the 5.5% budget estimate
(BE). Absolute fiscal deficit will be somewhat lower than BE as gains of (1) 3G/BWA
bonanza, (2) tax buoyancy, (3) stimulus withdrawal and (4) lower Plan expenditure were
substantially eaten up by bloating oil and fertilizer subsidies. However, second highest
nominal GDP growth of 20.3% helped in a sharp drop in fiscal deficit/GDP ratio.
Repeating FY11 performance in FY12 will pose a serious challenge in view of (1) ballooning
subsidy bill on the back of rising international oil prices, and (2) no 3G-like bounty. We
expect FY12 fiscal deficit/GDP ratio at 5%, translating into gross (net) market borrowing
of Rs4.7t (Rs4t)
What to watch out for
Rationalization of oil pricing/subsidy structure by a combination of (1) customs/excise
duty cuts, and/or (2) measured price hikes
Any steps to reduce the fertilizer subsidy
Aligning direct and indirect tax rates with eventual DTC and GST framework
Kickstarting the reform engine with implementation clarity on GST and DTC, etc.
Any specific measure to boost revenues (divestment target, one-time revenue generators
similar to 3G in FY11)
Backdrop
Union Budget 2011-12 comes amidst macroeconomic headwinds
Union Budget 2011-12 assumes significance on many counts. First, inflation is at its decadal
peak and has remained high despite a series of monetary/fiscal policy actions. The prospect
of drought in China could mean higher cereal prices and uncertainties in the Middle-East
could lead to further increases in oil prices. A gradual move towards re-aligning to
international oil prices appears more certain in FY12, which would lead to one-time release
of suppressed inflation, preventing dramatic decline in inflation in FY12 on high base.
Second, as a response to emerging inflationary risks, RBI has successively hiked policy
rates effectively by 300bp since the exit of stimulus measures in October 2009. This was
accompanied by a quantitative tightening by restricting money supply far lower than the
credit demanded by the government and the private sector. As a result, interest rates
hardened fairly quickly. Further, as liquidity remained severely stretched for an extended
period of time, the interest rate pressures acted more on the shorter end first by flattening
the yield curve and second by inverting the private sector yield curve (with the one-year
CD rates ruling ahead of 3-year AAA and in turn over 5-year AAA, and so on).
Third, with heightened inflation and interest rates, the capacity to live with macroeconomic
risks appears stressed, with definite signs of slowdown in industrial production. A variety
of factors has contributed to this, including higher international commodity prices, higher
interest rates, a spate of corruption issues creating a circumspect atmosphere, environmental
clampdown, and issues of land acquisition and water availability.
The above uncertainties reflected on the equity markets, which corrected by ~14% from
the recent highs. FII withdrawal from the equity market and rebalancing of portfolio towards
debt during the current calendar year too adversely impacted sentiment. Adverse market
sentiment seriously dented the IPO pipeline, further weakening industrial prospects.
The compulsions of coalition politics, differences within the government and political
opposition have stalled the progress of various key reforms that have serious implications
for India's ability to push the growth bar back to the potential 9-10%. Many reforms in key
sectors such as oil, fertilizers, banking, FDI in retail/insurance/defense, and significant tax
reforms are on suspended animation.
Under the prevailing circumstances, Union Budget 2011-12 assumes significance that
goes far beyond the government's normal income-expenditure statement. Over the years,
the budget has become a key policy tool to rejig growth, enhance macroeconomic stability,
address sectoral imbalances, ensure inclusive growth and in general articulate the mediumterm
development strategy for the government. Union Budget 2011-12 would therefore
carry great expectations of addressing the current exigencies as highlighted above. The
budget also comes on the heels of a spate of corruption issues that have been highlighted
in the media and currently being redressed through various executive, legal and
parliamentary mechanisms. Hence, the issue of governance that has been mentioned as
the third pillar of strategy by the government along with growth and inclusive growth in
the recent years comes in sharp limelight. Needless to add, rolling of the reform engine
is an absolute must for India at this juncture.
Key expectations
Repeating FY11 fiscal performance will be a challenge in FY12
(i) FY11: Expect Fiscal deficit/GDP at 4.6%
Post the crisis phase of the fiscal stimulus, the government has moved back to consolidation
mode. The trend during the current financial year up to 3QFY11, for which data has been
made available, shows robust revenue growth helping the government to keep the deficit
within target. The revenue target has been achieved mainly on three counts (1) high real
and nominal GDP growth has increased direct tax revenue even after announcing tax
benefits, (2) indirect tax collection has grown very significantly on rollback of tax
concessions from the stimulus levels, (3) 3G/BWA bonanza of Rs1t as against budgeted
Rs350b. Thus, overall revenue receipts are likely to reach Rs8t v/s the budgeted Rs6.8t
(see Annexure I on page 6).
Non-plan expenditure growth has largely been on track while some softness is visible on
planned expenditure. As planned expenditure usually rises in 4Q and a major subsidy
overhang (estimated at Rs600b) looms on account of oil and fertilizer bill, overall expenditure
is estimated higher at Rs12t v/s the budgeted Rs11t.
This leaves us with a somewhat lower fiscal deficit of Rs3.6t v/s Rs3.8t budgeted. While
the market borrowing program has largely proceeded on course, improved revenue position
has resulted in significant cash balances of ~Rs1t with the government in recent months.
The nominal GDP has grown by a record 20.3% as against 12.5% assumed by the budget.
The combined impact of higher revenue, slower planned expenditure and higher GDP
base is likely to take fiscal deficit/GDP ratio to as low as 4.6% during FY11.
(ii) FY12: Clarity on reforms is a key watch-out
We have placed our FY12 real and nominal GDP growth at 8.3% and 14%, respectively.
As the direct tax is very highly related with nominal GDP growth, we have assumed 15%
growth in personal tax and 18% growth in corporate tax. Major concessions in direct tax
have already been advanced in FY11 and we are near the revised direct tax code (DTC)
threshold. Also, various concessions given in the final DTC draft placed in the Parliament
have restricted fiscal space for the government to reduce tax rates dramatically as
envisaged in the original DTC draft. We expect only marginal enhancement in personal
tax slabs (Rs175k from current Rs160k of minimum threshold). Stricter enforcement may
result in enhancement in tax revenue.
On the indirect tax front, the government has serious intentions to introduce goods and
services tax (GST), which is set to replace the complicated indirect tax structure currently
in place at the central and the state level (see Annexure III). While no agreement has still
been reached between the center and key states opposing it, it is hoped that an agreement
can be reached with suitable modifications of the existing proposals. Though GST is not
expected to follow the ideal course in its final form, most sources place the revenue
neutral GST rate of 8% at the central level if a unified rate is implemented (unlikely) and
5% and 10% under a dual rate structure for merit goods and general goods, respectively.
The tax net for services sector is expected to be widened to cover all services and service
tax per se is envisaged to be brought under GST. However, it needs to be emphasized that
many matters of principle (like autonomy of states) as well as detail (like tax rates, exemption
list, rules for inter-state tax credit and transfer, compensation for revenue loss of states,
etc) are still being evolved. While the ideal GST structure would elude us given the
complexity of issues, an agreement between a compromise formula and a complete letdown
would be a highly reasonable starting point. Somewhat unexpected inclusion of GST in the
bills to be introduced in the parliament in the budget session itself indicates, however, the
government's resolve in this regard.
There would however, be no one-time accretion of 3G/BWA revenue in FY12. The financial
position of the telecom companies also indicates rather limited possibility of incremental
revenue from the auction of additional 2G spectrum with the existing players. Hence, we
expect FY12 non-tax revenue to be sharply lower than FY11 and fall back to its trend.
Taking all into consideration, our revenue receipts estimate for FY12 stands at Rs8.4t.
On the expenditure front, the demand for subsidies and welfare-based programs such as
MNREGA is on the rise. However, we also feel that the government would be encouraged
to implement the key subsidy reforms already announced in the nature of diesel price
deregulation and nutrient-based subsidy (NBS) regime for fertilizers once there is some
visibility of moderation of inflation in 1QFY12. This is likely to leave the subsidy burden
relatively unchanged after accounting for nearly Rs600b enhanced subsidy bill in FY11.
On the other hand, being the last year of the 11th five year plan, Union Budget 2011-12 is
set to witness ~18% increase in planned expenditure to meet the plan targets. Thus, scope
for fair amount of expenditure cuts is rather limited. It would be rather difficult to restrict
overall expenditure below Rs13.4t.
This leaves us with significantly higher fiscal deficit of Rs4.5t in FY12 vis-à-vis Rs3.7t
expected in FY11. Despite an enhanced nominal GDP, this would translate into a fiscal
deficit of 5%, still higher than the 4.8% target set as per the medium-term fiscal strategy
statement. Without any source of one-off revenues, it would be difficult for the government
to achieve the target of 4.8%. One such one-off source highlighted in the press is the tax
amnesty scheme (last introduced in 1997). This is a distinct possibility and given the
environment of governance issues coming to the fore at present, this would be a definite
incentive to regularize unaccounted income as one last opportunity to come clean.
The consequence of a Rs4.5t fiscal deficit is an additional gross borrowing requirement of
Rs4.7t and a net borrowing market requirement of Rs4t. We believe this in itself is high,
and any higher figure would be viewed negatively by the bond market. However, the Rs1t
cash balance of the government, even if partially carried forward and used in FY12, can
substantially reduce the borrowing requirement.
(iii) Medium-term fiscal consolidation plan looks promising
We expect the government to largely remain within the fiscal corrective course set by it.
While FY11 fiscal deficit target of 5.5% is likely to be over-achieved, the FY12 target
looks a bit challenging at the outset. However, the overall direction of the second phase of
fiscal consolidation including a reduction in public debt is unmistakable. Notably, India's
achievement in this regard stands out vis-à-vis various advanced countries that have
stretched the fisc to enable recovery, triggering a sovereign debt crisis.
Economic legislation roadmap: Scope to turnaround business climate
After the loss of the winter session, the government is on overdrive to move key economic
legislation during the budget session. It has acceded to the opposition demand for a joint
parliamentary committee (JPC) probe to ensure smooth conduct of business. It is hoped
that this would assuage the opposition to cooperate on key economic legislation that are
imperative at this juncture.
The most significant of these is the GST Bill (as mentioned earlier, the government has
somewhat hurried up in its introduction). Four other contentious bills that the government
plans to introduce relate to the mining sector and in the area of land acquisition and
rehabilitation (see Annexure III). Besides, various other bills slated to be taken up for
consideration and passing include Companies Amendment Bill, SBI Amendment Bill to
pave the way for merger with subsidiaries, right to education and permission to accounts
and related professionals for limited liability partnerships, etc. Most of these bills can
usher important changes enabling turnaround in the business and investment climate.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
"One-off performance" or "One of performance"?
Low expectations amidst macroeconomic headwinds
Union Budget 2011-12 comes against the backdrop of high inflation, tight liquidity, high interest
rate, industrial slowdown, delayed reforms and negative market sentiment. Thus, expectations
from the budget are, in general, muted. The positive is that FY11 fiscal deficit target of 5.5% of
GDP will be over-achieved. But without one-off revenue sources like 3G, meeting the FY12
fiscal deficit target of 4.8% is a challenge [our estimate 5%; gross (net) market borrowing of
Rs4.7t (Rs4t)]. Clarity on reforms such as DTC, GST and oil/fertilizer subsidy is the key watchout.
Backdrop: Union Budget 2011-12 comes amidst macroeconomic headwinds
Union Budget 2011-12 comes at a time when the Indian markets and economy are facing
critical headwinds on multiple issues, both domestic and global:
1. Inflation at decadal high; no signs of meaningful moderation yet
2. Tight liquidity and rising interest rate environment
3. Few early signs of industrial slowdown
4. Stalling of reforms process
5. Persistently high global oil and other commodity prices
6. ~14% correction in equity markets; India has been the top underperforming market in
2011 amongst top-10 global markets.
Repeating FY11 fiscal performance will be a challenge in FY12
We expect FY11 fiscal deficit to be significantly lower than the 5.5% budget estimate
(BE). Absolute fiscal deficit will be somewhat lower than BE as gains of (1) 3G/BWA
bonanza, (2) tax buoyancy, (3) stimulus withdrawal and (4) lower Plan expenditure were
substantially eaten up by bloating oil and fertilizer subsidies. However, second highest
nominal GDP growth of 20.3% helped in a sharp drop in fiscal deficit/GDP ratio.
Repeating FY11 performance in FY12 will pose a serious challenge in view of (1) ballooning
subsidy bill on the back of rising international oil prices, and (2) no 3G-like bounty. We
expect FY12 fiscal deficit/GDP ratio at 5%, translating into gross (net) market borrowing
of Rs4.7t (Rs4t)
What to watch out for
Rationalization of oil pricing/subsidy structure by a combination of (1) customs/excise
duty cuts, and/or (2) measured price hikes
Any steps to reduce the fertilizer subsidy
Aligning direct and indirect tax rates with eventual DTC and GST framework
Kickstarting the reform engine with implementation clarity on GST and DTC, etc.
Any specific measure to boost revenues (divestment target, one-time revenue generators
similar to 3G in FY11)
Backdrop
Union Budget 2011-12 comes amidst macroeconomic headwinds
Union Budget 2011-12 assumes significance on many counts. First, inflation is at its decadal
peak and has remained high despite a series of monetary/fiscal policy actions. The prospect
of drought in China could mean higher cereal prices and uncertainties in the Middle-East
could lead to further increases in oil prices. A gradual move towards re-aligning to
international oil prices appears more certain in FY12, which would lead to one-time release
of suppressed inflation, preventing dramatic decline in inflation in FY12 on high base.
Second, as a response to emerging inflationary risks, RBI has successively hiked policy
rates effectively by 300bp since the exit of stimulus measures in October 2009. This was
accompanied by a quantitative tightening by restricting money supply far lower than the
credit demanded by the government and the private sector. As a result, interest rates
hardened fairly quickly. Further, as liquidity remained severely stretched for an extended
period of time, the interest rate pressures acted more on the shorter end first by flattening
the yield curve and second by inverting the private sector yield curve (with the one-year
CD rates ruling ahead of 3-year AAA and in turn over 5-year AAA, and so on).
Third, with heightened inflation and interest rates, the capacity to live with macroeconomic
risks appears stressed, with definite signs of slowdown in industrial production. A variety
of factors has contributed to this, including higher international commodity prices, higher
interest rates, a spate of corruption issues creating a circumspect atmosphere, environmental
clampdown, and issues of land acquisition and water availability.
The above uncertainties reflected on the equity markets, which corrected by ~14% from
the recent highs. FII withdrawal from the equity market and rebalancing of portfolio towards
debt during the current calendar year too adversely impacted sentiment. Adverse market
sentiment seriously dented the IPO pipeline, further weakening industrial prospects.
The compulsions of coalition politics, differences within the government and political
opposition have stalled the progress of various key reforms that have serious implications
for India's ability to push the growth bar back to the potential 9-10%. Many reforms in key
sectors such as oil, fertilizers, banking, FDI in retail/insurance/defense, and significant tax
reforms are on suspended animation.
Under the prevailing circumstances, Union Budget 2011-12 assumes significance that
goes far beyond the government's normal income-expenditure statement. Over the years,
the budget has become a key policy tool to rejig growth, enhance macroeconomic stability,
address sectoral imbalances, ensure inclusive growth and in general articulate the mediumterm
development strategy for the government. Union Budget 2011-12 would therefore
carry great expectations of addressing the current exigencies as highlighted above. The
budget also comes on the heels of a spate of corruption issues that have been highlighted
in the media and currently being redressed through various executive, legal and
parliamentary mechanisms. Hence, the issue of governance that has been mentioned as
the third pillar of strategy by the government along with growth and inclusive growth in
the recent years comes in sharp limelight. Needless to add, rolling of the reform engine
is an absolute must for India at this juncture.
Key expectations
Repeating FY11 fiscal performance will be a challenge in FY12
(i) FY11: Expect Fiscal deficit/GDP at 4.6%
Post the crisis phase of the fiscal stimulus, the government has moved back to consolidation
mode. The trend during the current financial year up to 3QFY11, for which data has been
made available, shows robust revenue growth helping the government to keep the deficit
within target. The revenue target has been achieved mainly on three counts (1) high real
and nominal GDP growth has increased direct tax revenue even after announcing tax
benefits, (2) indirect tax collection has grown very significantly on rollback of tax
concessions from the stimulus levels, (3) 3G/BWA bonanza of Rs1t as against budgeted
Rs350b. Thus, overall revenue receipts are likely to reach Rs8t v/s the budgeted Rs6.8t
(see Annexure I on page 6).
Non-plan expenditure growth has largely been on track while some softness is visible on
planned expenditure. As planned expenditure usually rises in 4Q and a major subsidy
overhang (estimated at Rs600b) looms on account of oil and fertilizer bill, overall expenditure
is estimated higher at Rs12t v/s the budgeted Rs11t.
This leaves us with a somewhat lower fiscal deficit of Rs3.6t v/s Rs3.8t budgeted. While
the market borrowing program has largely proceeded on course, improved revenue position
has resulted in significant cash balances of ~Rs1t with the government in recent months.
The nominal GDP has grown by a record 20.3% as against 12.5% assumed by the budget.
The combined impact of higher revenue, slower planned expenditure and higher GDP
base is likely to take fiscal deficit/GDP ratio to as low as 4.6% during FY11.
(ii) FY12: Clarity on reforms is a key watch-out
We have placed our FY12 real and nominal GDP growth at 8.3% and 14%, respectively.
As the direct tax is very highly related with nominal GDP growth, we have assumed 15%
growth in personal tax and 18% growth in corporate tax. Major concessions in direct tax
have already been advanced in FY11 and we are near the revised direct tax code (DTC)
threshold. Also, various concessions given in the final DTC draft placed in the Parliament
have restricted fiscal space for the government to reduce tax rates dramatically as
envisaged in the original DTC draft. We expect only marginal enhancement in personal
tax slabs (Rs175k from current Rs160k of minimum threshold). Stricter enforcement may
result in enhancement in tax revenue.
On the indirect tax front, the government has serious intentions to introduce goods and
services tax (GST), which is set to replace the complicated indirect tax structure currently
in place at the central and the state level (see Annexure III). While no agreement has still
been reached between the center and key states opposing it, it is hoped that an agreement
can be reached with suitable modifications of the existing proposals. Though GST is not
expected to follow the ideal course in its final form, most sources place the revenue
neutral GST rate of 8% at the central level if a unified rate is implemented (unlikely) and
5% and 10% under a dual rate structure for merit goods and general goods, respectively.
The tax net for services sector is expected to be widened to cover all services and service
tax per se is envisaged to be brought under GST. However, it needs to be emphasized that
many matters of principle (like autonomy of states) as well as detail (like tax rates, exemption
list, rules for inter-state tax credit and transfer, compensation for revenue loss of states,
etc) are still being evolved. While the ideal GST structure would elude us given the
complexity of issues, an agreement between a compromise formula and a complete letdown
would be a highly reasonable starting point. Somewhat unexpected inclusion of GST in the
bills to be introduced in the parliament in the budget session itself indicates, however, the
government's resolve in this regard.
There would however, be no one-time accretion of 3G/BWA revenue in FY12. The financial
position of the telecom companies also indicates rather limited possibility of incremental
revenue from the auction of additional 2G spectrum with the existing players. Hence, we
expect FY12 non-tax revenue to be sharply lower than FY11 and fall back to its trend.
Taking all into consideration, our revenue receipts estimate for FY12 stands at Rs8.4t.
On the expenditure front, the demand for subsidies and welfare-based programs such as
MNREGA is on the rise. However, we also feel that the government would be encouraged
to implement the key subsidy reforms already announced in the nature of diesel price
deregulation and nutrient-based subsidy (NBS) regime for fertilizers once there is some
visibility of moderation of inflation in 1QFY12. This is likely to leave the subsidy burden
relatively unchanged after accounting for nearly Rs600b enhanced subsidy bill in FY11.
On the other hand, being the last year of the 11th five year plan, Union Budget 2011-12 is
set to witness ~18% increase in planned expenditure to meet the plan targets. Thus, scope
for fair amount of expenditure cuts is rather limited. It would be rather difficult to restrict
overall expenditure below Rs13.4t.
This leaves us with significantly higher fiscal deficit of Rs4.5t in FY12 vis-à-vis Rs3.7t
expected in FY11. Despite an enhanced nominal GDP, this would translate into a fiscal
deficit of 5%, still higher than the 4.8% target set as per the medium-term fiscal strategy
statement. Without any source of one-off revenues, it would be difficult for the government
to achieve the target of 4.8%. One such one-off source highlighted in the press is the tax
amnesty scheme (last introduced in 1997). This is a distinct possibility and given the
environment of governance issues coming to the fore at present, this would be a definite
incentive to regularize unaccounted income as one last opportunity to come clean.
The consequence of a Rs4.5t fiscal deficit is an additional gross borrowing requirement of
Rs4.7t and a net borrowing market requirement of Rs4t. We believe this in itself is high,
and any higher figure would be viewed negatively by the bond market. However, the Rs1t
cash balance of the government, even if partially carried forward and used in FY12, can
substantially reduce the borrowing requirement.
(iii) Medium-term fiscal consolidation plan looks promising
We expect the government to largely remain within the fiscal corrective course set by it.
While FY11 fiscal deficit target of 5.5% is likely to be over-achieved, the FY12 target
looks a bit challenging at the outset. However, the overall direction of the second phase of
fiscal consolidation including a reduction in public debt is unmistakable. Notably, India's
achievement in this regard stands out vis-à-vis various advanced countries that have
stretched the fisc to enable recovery, triggering a sovereign debt crisis.
Economic legislation roadmap: Scope to turnaround business climate
After the loss of the winter session, the government is on overdrive to move key economic
legislation during the budget session. It has acceded to the opposition demand for a joint
parliamentary committee (JPC) probe to ensure smooth conduct of business. It is hoped
that this would assuage the opposition to cooperate on key economic legislation that are
imperative at this juncture.
The most significant of these is the GST Bill (as mentioned earlier, the government has
somewhat hurried up in its introduction). Four other contentious bills that the government
plans to introduce relate to the mining sector and in the area of land acquisition and
rehabilitation (see Annexure III). Besides, various other bills slated to be taken up for
consideration and passing include Companies Amendment Bill, SBI Amendment Bill to
pave the way for merger with subsidiaries, right to education and permission to accounts
and related professionals for limited liability partnerships, etc. Most of these bills can
usher important changes enabling turnaround in the business and investment climate.
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