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India Strategy FY11 Pre-budget: Fiscal Consolidation is key
„Budget – low expectations but surprises unlikely
The good news is that market expectations from the budget (on Feb 28
th
) seem to
be low. However, given the need for fiscal consolidation, we think any tax sops
that surprise the market are unlikely. The surprise could be reform legislation
(insurance, banking reforms etc) being passed in the budget session. We
continue to believe the market near term remains vulnerable to (a) high inflation
and rising interest rates (b) slowing economy and (c) earnings downgrades.
Fiscal Deficit forecast at 5.3%; including oil subsidy at 5.7%
We expect the fiscal deficit in FY12 to be 5.7% including oil subsidy (5.3%
excluding oil subsidy) higher than our forecast 5.2% for FY11 including oil
subsidy. We believe the Finance Minister will have to juggle between conflicting
objectives of fiscal consolidation, inflation control and maintaining growth
momentum.
What do we expect?
1. An increase in excise duty and service tax by 2% to complete reversal of the
stimulus given 2 years ago.
2. Reduction in import duty and excise duty on crude and oil products.
3. Some sops to agriculture and infra sectors.
Key Sector/Stock Impact
1. Autos, cement and consumers – negative: excise duty to be increased by
2%. We believe this is partially reflected in stock prices of auto and cement
stocks.
2. Metals – Sesa Goa Negative: increase in export tax on iron ore.
3. Banks – positive: Tax breaks on NPLs to be increased.
4. Jain Irrigation – positive: hike in subsidy from 40% to 50%.
5. Fertilizers (Chambal, Nagarjuna, Tata Chem) – positive: urea firms get
import parity based pricing.
6. Software – positive: Potential extension of STPI tax holiday by 1 year to
March, 2012. TCS, Wipro & smaller companies like Hexaware, Persistent
gain.
7. Upstream Oil companies – positive: Reduction in subsidy burden due to
lower custom/excise duties on oil and oil products.
Top Buys: HCL Tech, SBI, Maruti, Reliance, BHEL, Lupin
Fiscal risks overdone
We continue to believe fiscal risks are overdone, like in 2010. Budget 2011
should persist with slow fiscal consolidation. The Center’s fiscal deficit (inclusive
of oil subsidy) will likely come off to 5.7% of GDP from 6.5% (ex 3G auction
proceeds) in FY11 and in FY10. Yes, this will exceed the Finance Minister’s 4.8%
FY12 fiscal deficit target, but we have always found that unrealistic. Against this
backdrop, we continue to expect a 75bp increase in lending rates in 2HFY12 with
loan demand likely to persist at 20% levels. The 10-y yield should continue to
trade in a mid-cycle range around 8%, with the RBI likely to support the net
borrowing program of Rs4000bn through OMO. Do read our 2011 views here.
Swing factors: Disinvestment, 2G money
Focus on rural development, infrastructure… and reforms
We expect the thrust of Budget 2011 to continue to focus on rural development -
especially given state polls - and infrastructure. Although the Food Security Bill
could be enacted in 2011, we do not see a major fiscal impact in FY12. Finally,
Budget 2011 could reiterate a commitment to reforms. Officials at our macro tour
said that some bills - like hiking FDI in insurance or removing the 10% voting cap
in banks were good to go if the Parliament functions during the Budget session.
Doable 5.3% of GDP Center’s fiscal deficit …
We have projected the Center's fiscal deficit at 5.3% of GDP (ex oil subsidy) in
FY12 (Table 4). This would be deterioration from FY11’s 4.7%, inclusive of 3G.
Excluding the one-off 3G impact, the FY11 fiscal deficit would be higher at 6%
(exclusive of oil subsidy). Disinvestment is pegged at Rs400bn - the same as in
FY11. Yes, fiscal improvement is slower than the previous cycle, but this is true
for other BRICs as well
We have forecast FY12 oil subsidy at 0.4% of GDP. This assumes: our in-house
US$89/bbl Dated Brent 2011 forecast, 10% hike in prices of diesel, kerosene and
cooking gas after the summer 11 polls and the INR at Rs45/USD. Our estimates
suggest that the oil subsidy would climb to 1.0% of GDP at US$100/bbl.
… 2% excise duty hike (although tax buoyancy’s back)
We continue to expect the Finance Minister to roll back the remaining 200bp
excise duty cut of end-2008 to contain the fiscal deficit (Table 5). Our March 2011
inflation forecast of 7.6% factors in a likely inflation impact of 50bp. Cant higher
tax buoyancy from growth alleviate the need for an excise duty hike at a time of
high inflation? Not really. It is true that the tax-to-GDP ratio is also beginning to
recover with higher growth (Chart 1). At the same time, rising fuel subsidies will
still require a hike either in excise duty or customs duty (as was hinted by some
finance ministry officials earlier). This could be counterbalanced by a 2% cut in
import duty on crude, a 5% cut in import duty on oil products and a Re 1/liter cut
in excise duty on petrol and diesel offset by lower subsidies .
Can the FM do 4.8% of GDP fiscal deficit? Not really
Can Finance Minister Pranab Mukherjee do the FY12 fiscal deficit of 4.8% of
GDP laid out in the government’s medium-term fiscal policy statement? We
doubt, given that the one-off US$22bn bonanza will not be repeated this year.
Our estimates suggest that the Finance Minister will be able to make up for 3G
inflows only partially by not offering any further concessions on direct taxes
(unlike last year) and raising money from the telecom industry (Table 5). Second,
oil subsidies remain substantial. Finally, any major expenditure compression
looks difficult in view of summer state polls.
Our telecom analyst, Reena Verma, points out TRAI recommendations on 2Gspectrum valuation could result in a potential cash collection of$7.6bn by the fisc,
if the recommendations are accepted. These include: payment of US$3.6bn for
excess spectrum beyond 6.2MHz by incumbent operators and possible payment
of US$4bn for spectrum enhancement from 4.4MHz to 6.2MHz for new licenses
issued in 2008. We have factored in an inflow of US$4bn in our estimates.
Tax amnesty unlikely in current political scenario
We do not think that the political risk-reward today favors a tax amnesty scheme.
The government did announce such tax amnesty schemes - voluntary disclosure
of income scheme - where "black" money could be "whitened" at some lower than
prevailing income tax rate. In FY99, this had actually raised a pretty useful 0.6%
of GDP of tax revenues as well
Rs4000bn net borrowing, 10y to trade ~8% on RBI OMO
We expect the Center to borrow a net Rs4000bn somewhat higher than last
year’s levels given our fiscal deficit projections (Table 8). We assume that the
government carry-forward surplus balance of Rs850bn which will be utilized to
pay for the fiscal slippage due to the oil subsidy.
Our estimates suggest that this will generate an excess gilt supply of 20% of
deposit mobilization like last year. The saving grace is that the RBI will likely still
need to OMO Rs1500-2000bn to generate liquidity as a large-scale current
account deficit will limit fx intervention (Table 9). The 10-year should thus
continue to trade in the current mid-cycle 8% range through FY11. Do read our
latest rates report (with Ashok Bhundia) here .
… 20% loan growth to push up lending rates 75bp in 2H
We grow more confident of our call of lending rates going up 75bp in 2HFY12
(Table 10). After all, our estimates suggest that banks will face an excess loan
demand of 8.9% of deposits if they invest Rs1700bn in gilts as we have assumed
(Chart 2). This assumes: deposit growth of 17.5% and loan demand of 20%.
When will growth hurt? Mid-2012 after lending rates rise by another 100bp.
Experience suggests that cycles usually turn down (up) when the real lending
rate, now 7. 5%, pierces (slips below) the ‘neutral’ 7.5-8% potential growth rate.
This margin of comfort will likely be exhausted by end-2012.
Autos
„ Overall Expected Budget Impact: Negative
„ Budget Winners: NA
„ Budget Losers: All auto companies
Key Expected Measure
„ We expect 2% roll-back in excise rates, except high end cars and Utility
vehicles which could be maintained at existing rates of 20%.
„ We think auto majors will attempt to pass on excise hikes to consumers.
However, the industry also has to compensate for commodity related
increase in input costs.
Impact of Measure
„ Overall impact on demand will be negative if industry partially absorbs the
higher excise rates and upgradation costs. In the likely scenario of 50%
absorption of rollback, we estimate 8% impact on next fiscal EBITDA for
Maruti, 7% on Tata Motors and 6% on two wheeler companies.
„ M&M will be least impacted due to high dependence on Utility vehicles
(~50% of sales).
„ Auto stocks have already underperformed YTD in anticipation of exciserollbacks, so may not react sharply post-event. Also, possible volume
surprises imply stocks are trading at reasonable valuations..
Agriculture
„ Overall Expected Budget Impact: Positive
„ Budget Winners: Fertilizer companies, Jain Irrigation
„ We expect Budget to link urea capacities that work on regulated 12% RoE to
import parity price based realisations. This will be significant positive for urea
companies like Chambal, Nagarjuna and Tata Chemicals increasing their
earnings from fertilizer by ~50%.
„ Expect a positive announcement on micro irrigation subsidy in the budget by
way of a) increase in the total quantum of subsidy and b) hike in central
subsidy to 50% from current 40% of the purchase price. This will benefit Jain
Irrigation.
„ We expect govt to focus on modernisation of farming and supply chain. This
can include additional incentives for a) use of solar power in farming which
will benefit Jain Irrigation and b) for development of cold chains which we
believe will benefit Sintex Industries that offers products in this area as part
of its prefabs business
Banking and Financials
„ Overall Expected Budget Impact: Neutral
„ Budget Winners: All banks
„ Budget Losers: None
Key Expected Measure
Expected Measures and Impact
Tax exemption on infrastructure financing: Reintroduce Section 10 (23G) of
the Income tax Act, 1961 leading to tax breaks and possibly some expansion in
the scope of priority sector lending to include infrastructure-related projects.
Full tax breaks on NPL provisions: Banks looking for full tax breaks on NPL
provisions given that bank’s now have to maintain at least 70% provision cover.
Long-term fund raising options to banks for infra. financing: Banks await
cues from the budget to assess fund raising needs and have been looking to float
long-term infrastructure bonds with tax breaks.
Reduce deposit tenor for tax exemption: Currently, interest from deposits is
taxed at the rate of 33% + applicable surcharges; except for deposits >5 years.
The govt. may lower the maximum tenor to 3 years. This should be a key positive
for banks.
Other possible measures
Increasing tax deduction limits: The limit for tax exempt investments under
Section 80C is continuing at the archaic Rs1 lakh. Increasing the limit will help
those who have the potential to invest. This will also help the housing industry as
currently people are not able to derive the full benefits for the principal portion of
the housing loan repayment.
Consumers
„ Overall Expected Budget Impact: Negative
„ Budget Winners:
„ Budget Losers: ITC, Asian Paints, HUL, Godrej Consumers
Key Expected Measure
Within the consumer sector, the Budget is most relevant primarily for ITC. Post
the steep hike in excise duty by 15% in 2010 Union Budget, the probability of a
benign excise duty hike in budget this year is higher. However, with government
requiring funds to curtail fiscal deficit, sharp tax hike on cigarettes cannot be ruled
out.
We also expect excise duty slabs to be moved upwards by 2% for most consumer
goods. Most of this duty hike is likely to be passed on to the consumers with no
major impact on overall volume growth for the sector.
Impact of Measure
ITC: Our earnings forecast for ITC currently built in an average 5% excise duty
hike for cigarettes with a volume growth assumption of 6-7%. A tax increase of
>10% could result in downside to our estimates. However, over last few years we
have observed that ITC’s cigarettes business has developed enough resilience
where a steep tax hike does not impact growth as ITC compensates for weaker
volume growth with higher price hike.
Asian Paints, Godrej Consumers, HUL: Rise in excise duty should hurt Paints
and Soaps companies the most. The increase in excise duty combined with input
cost pressure could trigger retail price hikes. This is likely to have some impact on
the volume growth especially in the current high food inflation scenario.
Infrastructure
„ Overall Expected Budget Impact: Positive
„ Budget Winners: All E&C cos., Adani Power on cut in imported coal duty,
Entire power sector if National Electricity Fund is indeed set-up.
„ Budget Losers: State utilities as supply of paper increase in case of higher
divestment in cos. such as Neyveli Lignite, PGCIL & NTPC etc. Power
utilities / Infra developers if 10 year tax IT holiday u/s 80 IA is not extended.
Key Expected Measure
Utility Sector
„ In order to accelerate the pace of distribution reforms in power sector,
Finance Ministry has approved creation of Rs500bn National Electricity Fund
including an interest subsidy for lending under the fund. The loans provided
to the state discoms under the scheme will have tenure of 14 years.
„ Industry is seeking extension of 10 year tax holiday benefit u/s 80 IA of
Income Tax Act for the undertakings commencing generation and
distribution, which expires on 31st March, 2011 to FY15.
„ Power ministry has demanded to abolish 5% custom duty on imports of coal
as acute shortage of domestic coal threatening to destabilise its power
generation plans. As per CIL in a meeting with Plan Panel, it can only supply
319mnT of the total demand of 480mnT in FY12.
„ Power ministry to seek cabinet approval for foreign borrowings of US$2bn by
state run firms PFC and REC and tax breaks for ECBs. Currently, they can
raise ECBs to upto 50% of their net worth with a limit of US$500mn per year
and attract a withholding tax on interest on ECBs.
„ Higher exposure limits for banks for financing UMPPs. Presently, the
exposure limit of a bank to a single private company and a group is 20% and
30% of net worth respectively.
„ Exemption of customs duty on construction equipment used in hydropower
projects. Also, excise and customs duties on energy-efficient equipment
should be reduced.
„ Removal of applicability of MAT during 10 year tax holidays u/s 80 IA or
Gross Assets Tax (GAT) under new Direct Tax Code.
„ Reduce MAT rate to not more than one third of the regular rate tax, or at
least, kept stable at the present levels.
„ Increase the carry-forward time limit of MAT credit from 10 years to 15 years
to prevent any lapse of unutilized credit.
„ Coal Regulator Bill will be introduced in Budget to ensure level playing field
to all the stake holders. It would also make recommendations for reforms in
coal sector and about coal pricing.
„ Domestic Capital goods manufacturers are seeking for import duties on
power equipment for mega-projects. However, since it also escalates the
costs of projects, it may not be implemented.
„ Extension of concessions or exemptions under custom & excise laws to civil
materials like cement and steel, just as other raw materials and components,
required for the manufacturing of ‘machinery and equipment’ of power
projects.
„ End the step treatment of the captive power plants; they are neither covered
under any of the existing exemptions or concessions under customs and
central excise laws for power projects nor are they eligible for benefits under
the project import scheme.
Infrastructure
„ Govt. plans to use pension and insurance funds to provide long-term finance
for infrastructure projects and ease pressure on banks.
„ Restoration of tax exemption of income from investment in infrastructure and
other projects under section 10(23G) (removed in 2007) to ensure low cost of
raising capital.
„ Extend tax holiday to the newly introduced Limited Liability Partnership LLP
form of business setup which are engaged in the development of
infrastructure projects.
„ Raise deduction u/s 80CCF available to individual / HUF to Rs1lakh from
Rs20k for investment in long-term notified infrastructure bonds.
„ Exemption from service tax and works contract tax for Metro Rail and Mono
rail construction projects.
E&C
„ Domestic Capital goods manufacturers are seeking for import duties on
power equipment for mega-projects. However, since it also escalates the
costs of projects, it may not be implemented.
„ Proposal of hike in budgetary support for Road Infra projects by the Road
Transport & Highway ministry.
„ Construction Federation of India (CFI) sought capital gains tax exemption
for`Special Purpose Vehicle’ (SPV) on the lines of exemptions to listed
companies u/s 10(38) of Income-Tax Act. It has also sought 20% additional
depreciation to construction industry u/s 32(iia).
„ In roads sector, industry is seeking:
o exemption of toll revenue from service tax which is contended as taxable
by the Department of Revenue,
o amend dividend distribution tax (DDT) rules to prevent cascading effect,
o extension of 10 years tax holiday u/s 80IA to widening of roads which, at
present, is available for developing ‘new’ infrastructure facility, and
o allow usage of duty-free imported capital goods for road construction
business rather than to road project.
„ Real estate industry is seeking from finance minister:
o to hike income tax exemption for interest on home loans to at least
Rs2.5lakhs (vs Rs1.5lakh),
o to increase exemption on principal repayments of home loans to
Rs3lakhs (vs Rs1lakh) and make this benefit a separate category,
instead of making it a part of Section 80C.
o accord infrastructure industry status to real estate to allow easier access
to loans for its activities and
o Re-introduce tax exemption u/s 80IB (10) to promote affordable housing
currently allowed to project sanctioned before March 31, 2008.
„ Steel industry has demanded to raise import duty on HR coils to 10% from
5% and increase export duty on iron ores to 20% from 15%. Whereas Small
scale industries are seeking to cut import duty to nil from 5% in wake of over
30% jump in steel prices in last two months, on possible increase in coal
prices from Australia.
Impact of Measure
„ Creation of National Electricity fund for distribution reforms to strengthen
State Electricity Boards financial position shall support re-rating of power cos.
„ The extension of tax exemption u/s 80 IA till FY15 would benefit power
utilities companies setting up generation, transmission and distribution
capacity, including the proposed Ultra Mega Power Projects.
„ Cut in import duty of non-coking (thermal) coal would also cut imported coal
costs for all captive and utility plants.
„ Removal of MAT during tax holiday would benefit the utilities claiming
exemption u/s 80 IA.
„ Hike budgetary support to roads infra developments would benefit the
construction companies such as IVRC, JPA, L&T, NJCC, R- Infra etc.
„ Investment by pension and insurance funds of their investible resources into
Infra projects and re-financing of existing rupee loans through ECBs would
benefit the infrastructure companies such as GMR, GVK, IVRC, JPA, L&T,
NJCC, R – Infra.
„ Increase in import duty on steel would impact equipment manufacturing
companies like BHEL, L&T & Suzlon.
„ Exemption of service tax / works contract tax for construction of metro /
monorail project would benefit the project developers such as L&T and
Reliance Infra.
IT Services
„ Overall Expected Budget Impact: Positive
„ Budget Winners: TCS, MphasiS, Persistent, Hexaware
„ Budget Losers: None
Key Expected Measure
„ Potential extension of STPI tax holiday: The key hope of IT services
companies from the budget is around the extension of deadline for STPI
(software technology parks of India) tax holiday. As per the current scheme,
STPI tax holiday benefits (Section 10A/B) are expected to expire after 10
years of set-up or by March 2011, which-ever is earlier. We expect the expiry
date to be extended by a year to March 31, 2012 as it provides the much
needed impetus to small and mid sized companies in the sector and can be
followed-up with a smooth switch over to DTC (direct tax code) from FY13.
Large companies benefit to a lower extent as majority of their STPI units
have completed the 10-year window.
„ Expect status quo around SEZ policy i.e units set up until Mar31, 2014 will
run their course of tax benefits even if DTC is introduced.
„ IT industry also seeks clarification on taxation of revenues generated by
employees who work out of client's location abroad (onsite revenues). This
had been classified as not taxable in 2000 but the industry seeks a
reassurance in light of a couple of legal cases that sprung last year.
Impact of Measure
„ Amongst the mid-tier vendors - Persistent, Hexaware, Patni and MphasiS
are expected to pose the steepest increase in effective tax rates for FY12 in
case STPI tax holiday were to expire on March 2011. Hence these should be
biggest beneficiaries in case the deadline is extended by a year.
„ TCS is expected to be the key beneficiary amongst the large-tier vendors.
Metals
„ Overall Expected Budget Impact: Neutral
„ Budget Winners: none
„ Budget Losers: Sesa Goa.
Key Expected Measure
Potential increase in excise duty on steel:
„ Increase in excise duty on steel by 2%. Excise duty on steel products is
currently 10% and may be increased to 12% post budget.
„ If imposed, we believe realizations of domestic steel mills are unlikely to be
affected as steel companies should be able to pass on the excise duty
increase to consumers. However, this will increase costs for end users
further thus could marginally impact demand.
Increase in export tax on iron ore
„ Government may increase export duty on iron ore by 5%. Export duty on iron
ore lumps is 15% and export duty on iron ore fines is 5%. We
„ This is possible as iron ore spot prices are strong and Indian steelmakers are
lobbying for a higher iron ore export duty. Also Government is likely to be
concerned about inflationary impact of rising steel prices led by higher input
costs
„ If imposed this will be negative for Indian iron ore miners like Sesa Goa as it
will hurt their export realizations. 1% increase in export duty reduces FY12e
EPS by 1.5%. We note that miners may be able to pass through part of
export tariff increase initially as iron ore markets are tight due to Karnataka
ban. However this could reverse due to incremental improvement in supply if
Karnataka export ban is lifted.
„ Higher export duty on iron ore is a positive for non integrated domestic steel
companies like JSW Steel which source iron ore from domestic mines.
Oil & gas
Budget expectations
The following proposals may be implemented in the budget:
„ Cut in import duty on petrol and diesel from 7.5% to 2.5%
„ Cut in excise duty on petrol and diesel by Rs1/litre
„ Cut in import duty on crude oil from 5% to 0-3%
„ Income tax Act being amended to confirm 7-year income tax holiday on gas
produced from all NELP blocks. RIL would be biggest and immediate
beneficiary if it is done
Import and excise duty cut to cut subsidy
Duty hike made in Feb 2010 budget may be reversed
In the February 2010 budget
„ Import duty on petrol and diesel was raised from 2.5% to 7.5%
„ Excise duty on petrol and diesel was raised by Rs1/litre
„ Import duty on crude oil raised from 0% to 5%
Finance minister said in his Feb 2010 budget speech that the import duty on
petrol, diesel and crude oil had been cut when oil price was over US$100/bbl in
June 2010. With oil price is at US$75/bbl, the import duty was again being raised
Now with Brent at over US$100/bbl again, there is an expectation that import and
excise duty hike made in February 2010 budget may be reversed.
Duty cuts to prune government revenue by US$7.4-8.1bn
The hit to government’s FY12E revenue would be US$7.4-8.1bn if import duty on
crude is cut to 0% and excise duty on petrol and diesel cut by Rs1/litre.
US$5.3-6bn hit to government revenue if crude duty cut to 0%
If import duty on crude oil is cut from 5% to 0% hit to FY12E government revenue
would be
„ US$5.3bn if Brent is at US$89/bbl (BofA ML forecast)
„ US$6.0bn if Brent is at US$100/bbl
US$2.1bn hit to government revenue if excise duty cut by Rs1/litre
The cut in excise duty on petrol and diesel by Rs1/litre would cut government’s
revenue by Rs94bn (US$2.1bn)
Duty cuts on products to prune subsidy by US$4.4bn
Subsidy would decline by
„ US$2.3bn if import duty on petrol and diesel is cut from 7.5% to 2.5%
„ US$2.1bn if excise duty on petrol and diesel is cut by Rs1/litre
Thus the reduction in subsidy would be US$4.4bn.
33% of gain from subsidy cut to upstream companies
Any rise or decline in subsidy at the margin is shared by upstream players and
government in ratio of 33:67. Thus upstream players’ subsidy would be cut by
„ US$766m if import duty on petrol and diesel is cut from 7.5% to 2.5%
„ US$710 if excise duty on petrol and diesel is cut by Rs1/litre
Thus upstream companies’ subsidy would decline by US$1.5bn if both steps are
taken. See Oil India Ltd, 12 January 2011 (see table 8) for impact on earnings of
upstream companies.
Government subsidy cut by US$3bn; revenue rise US$0.7bn
Half of gain to oil companies back to government as tax and dividend
Government’s share of subsidy would decline by
„ US$1.5bn due to cut in import duty on petrol and diesel from 7.5% to 2.5%
„ US$1.4bn due to cut in excise duty on petrol and diesel by Rs1/litre
The balance gain from subsidy reduction of US$1.4bn would go to the stateowned oil companies. Typically half of this gain would come back to the
government in the form of higher income tax and dividend. Government’s gain on
this account would be US$700m.
Government revenue loss more than cut in subsidy
Revenue loss of US$7.4-8.1bn vis-à-vis gain of US$3.7bn
The hit to government revenue from cut in import duty on crude and excise duty
on petrol and diesel would be US$7.4-8.1bn. On the other hand its gain from
subsidy reduction (including tax and dividend rise) would be just US$3.7bn
Government net loser as loss on crude import duty high
The government is a net loser due to the following reasons
„ Loss from crude import duty cut at US$5.3-6bn is much higher than gain from
cut in import duty on petrol and diesel of US$1.9bn
„ Govt gain is only 67% of subsidy reduction with balance gain going to oil cos.
Crude import duty may be cut to 2-3% instead of 0%
Government revenue loss US$2.1-3.6bn if crude duty cut to 2-3%
Import duty on crude needs to be cut along with cut in import duty on petrol and
diesel to ensure refining profitability of R&M companies is unaffected. However,
to ensure that import duty on crude need not be cut by 5%. A 2-3% cut in import
duty on crude to 2-3% from 5% would be enough to sustain refining profit of R&M
companies.
Government revenue loss would be
„ US$2.1-2.4bn (Brent at US$89-100/bbl) if crude import duty is cut to 3% from
5%
„ US$3.2-3.6bn if crude import duty is cut to 2% from 5%
Government loss US$4.2-5.7bn if crude duty cut to 2-3%
Thus if import duty on crude is cut to 2-3% and not 0% the government revenue
loss would be US$4.2-5.7bn as against gain from subsidy cut of US$3.7bn.
Tax holiday on gas production
Amend the law to confirm tax holiday for gas production
Probability low but cannot be ruled out
In the July 2009 budget the law was amended to allow tax holiday for gas
production only from exploration blocks allotted under NELP VIII. Whether there
is tax holiday on gas produced from blocks allotted under NELP I-VII is being
litigated. The government had thus left it to the courts to decide the matter.
Amending the law in the Feb 2011 budget can ensure tax holiday for gas
produced from all NELP blocks. Otherwise courts will decide the matter.
The probability of this change in the budget is low.
RIL main beneficiary if tax holiday confirmed
RIL producing from KG D6 block since April 2009
Reliance Industries (RIL) has started gas production from KG D6, a block allotted
to it under NELP I. Thus RIL will be the immediate and biggest beneficiary if the
law is amended to allow tax holiday for gas produced even from NELP I-VII
blocks.
RIL’s PO & EPS unchanged if tax holiday for gas allowed
Earnings and PO assume RIL gets tax holiday
Our earnings forecast and PO for RIL assumes that it will get tax holiday for gas
production. Thus its earnings and PO will remain unchanged even if tax holiday
for gas production is confirmed.
Pharmaceuticals
„ Overall expected budget impact: Neutral
Expected Measures & Impact
„ Higher weighted deductions for in-house R&D spend to persist: The
weighted deduction slab of 200% for in-house R&D spends is likely to persist
to encourage R&D spends by pharmaceutical companies. Most of the large
companies would stand to benefit from this. Key names being Sun Pharma,
Cadila, Lupin, Ranbaxy, Dr Reddys.
„ Excise duty rate to remain unchanged at 4% on domestic formulations.
Anyways, pharma companies typically pass on any benefit due to such
reduction or reduce impact of excise duty increase by suitable price increase,
nullifying impact on earnings. We believe that increasing penetration of
affordable medicines to rural/tier 2/3 towns would remain government’s focus
and an increase in excise duty would be counter-productive.
„ Expect no changes to import duty structure. We do not expect a
reduction in the peak rate of customs duty on bulk drugs, drug intermediates
and formulations currently at 10% (except certain life saving drugs). In line
with interim budget, we expect no significant changes.
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India Strategy FY11 Pre-budget: Fiscal Consolidation is key
„Budget – low expectations but surprises unlikely
The good news is that market expectations from the budget (on Feb 28
th
) seem to
be low. However, given the need for fiscal consolidation, we think any tax sops
that surprise the market are unlikely. The surprise could be reform legislation
(insurance, banking reforms etc) being passed in the budget session. We
continue to believe the market near term remains vulnerable to (a) high inflation
and rising interest rates (b) slowing economy and (c) earnings downgrades.
Fiscal Deficit forecast at 5.3%; including oil subsidy at 5.7%
We expect the fiscal deficit in FY12 to be 5.7% including oil subsidy (5.3%
excluding oil subsidy) higher than our forecast 5.2% for FY11 including oil
subsidy. We believe the Finance Minister will have to juggle between conflicting
objectives of fiscal consolidation, inflation control and maintaining growth
momentum.
What do we expect?
1. An increase in excise duty and service tax by 2% to complete reversal of the
stimulus given 2 years ago.
2. Reduction in import duty and excise duty on crude and oil products.
3. Some sops to agriculture and infra sectors.
Key Sector/Stock Impact
1. Autos, cement and consumers – negative: excise duty to be increased by
2%. We believe this is partially reflected in stock prices of auto and cement
stocks.
2. Metals – Sesa Goa Negative: increase in export tax on iron ore.
3. Banks – positive: Tax breaks on NPLs to be increased.
4. Jain Irrigation – positive: hike in subsidy from 40% to 50%.
5. Fertilizers (Chambal, Nagarjuna, Tata Chem) – positive: urea firms get
import parity based pricing.
6. Software – positive: Potential extension of STPI tax holiday by 1 year to
March, 2012. TCS, Wipro & smaller companies like Hexaware, Persistent
gain.
7. Upstream Oil companies – positive: Reduction in subsidy burden due to
lower custom/excise duties on oil and oil products.
Top Buys: HCL Tech, SBI, Maruti, Reliance, BHEL, Lupin
Fiscal risks overdone
We continue to believe fiscal risks are overdone, like in 2010. Budget 2011
should persist with slow fiscal consolidation. The Center’s fiscal deficit (inclusive
of oil subsidy) will likely come off to 5.7% of GDP from 6.5% (ex 3G auction
proceeds) in FY11 and in FY10. Yes, this will exceed the Finance Minister’s 4.8%
FY12 fiscal deficit target, but we have always found that unrealistic. Against this
backdrop, we continue to expect a 75bp increase in lending rates in 2HFY12 with
loan demand likely to persist at 20% levels. The 10-y yield should continue to
trade in a mid-cycle range around 8%, with the RBI likely to support the net
borrowing program of Rs4000bn through OMO. Do read our 2011 views here.
Swing factors: Disinvestment, 2G money
Focus on rural development, infrastructure… and reforms
We expect the thrust of Budget 2011 to continue to focus on rural development -
especially given state polls - and infrastructure. Although the Food Security Bill
could be enacted in 2011, we do not see a major fiscal impact in FY12. Finally,
Budget 2011 could reiterate a commitment to reforms. Officials at our macro tour
said that some bills - like hiking FDI in insurance or removing the 10% voting cap
in banks were good to go if the Parliament functions during the Budget session.
Doable 5.3% of GDP Center’s fiscal deficit …
We have projected the Center's fiscal deficit at 5.3% of GDP (ex oil subsidy) in
FY12 (Table 4). This would be deterioration from FY11’s 4.7%, inclusive of 3G.
Excluding the one-off 3G impact, the FY11 fiscal deficit would be higher at 6%
(exclusive of oil subsidy). Disinvestment is pegged at Rs400bn - the same as in
FY11. Yes, fiscal improvement is slower than the previous cycle, but this is true
for other BRICs as well
We have forecast FY12 oil subsidy at 0.4% of GDP. This assumes: our in-house
US$89/bbl Dated Brent 2011 forecast, 10% hike in prices of diesel, kerosene and
cooking gas after the summer 11 polls and the INR at Rs45/USD. Our estimates
suggest that the oil subsidy would climb to 1.0% of GDP at US$100/bbl.
… 2% excise duty hike (although tax buoyancy’s back)
We continue to expect the Finance Minister to roll back the remaining 200bp
excise duty cut of end-2008 to contain the fiscal deficit (Table 5). Our March 2011
inflation forecast of 7.6% factors in a likely inflation impact of 50bp. Cant higher
tax buoyancy from growth alleviate the need for an excise duty hike at a time of
high inflation? Not really. It is true that the tax-to-GDP ratio is also beginning to
recover with higher growth (Chart 1). At the same time, rising fuel subsidies will
still require a hike either in excise duty or customs duty (as was hinted by some
finance ministry officials earlier). This could be counterbalanced by a 2% cut in
import duty on crude, a 5% cut in import duty on oil products and a Re 1/liter cut
in excise duty on petrol and diesel offset by lower subsidies .
Can the FM do 4.8% of GDP fiscal deficit? Not really
Can Finance Minister Pranab Mukherjee do the FY12 fiscal deficit of 4.8% of
GDP laid out in the government’s medium-term fiscal policy statement? We
doubt, given that the one-off US$22bn bonanza will not be repeated this year.
Our estimates suggest that the Finance Minister will be able to make up for 3G
inflows only partially by not offering any further concessions on direct taxes
(unlike last year) and raising money from the telecom industry (Table 5). Second,
oil subsidies remain substantial. Finally, any major expenditure compression
looks difficult in view of summer state polls.
Our telecom analyst, Reena Verma, points out TRAI recommendations on 2Gspectrum valuation could result in a potential cash collection of$7.6bn by the fisc,
if the recommendations are accepted. These include: payment of US$3.6bn for
excess spectrum beyond 6.2MHz by incumbent operators and possible payment
of US$4bn for spectrum enhancement from 4.4MHz to 6.2MHz for new licenses
issued in 2008. We have factored in an inflow of US$4bn in our estimates.
Tax amnesty unlikely in current political scenario
We do not think that the political risk-reward today favors a tax amnesty scheme.
The government did announce such tax amnesty schemes - voluntary disclosure
of income scheme - where "black" money could be "whitened" at some lower than
prevailing income tax rate. In FY99, this had actually raised a pretty useful 0.6%
of GDP of tax revenues as well
Rs4000bn net borrowing, 10y to trade ~8% on RBI OMO
We expect the Center to borrow a net Rs4000bn somewhat higher than last
year’s levels given our fiscal deficit projections (Table 8). We assume that the
government carry-forward surplus balance of Rs850bn which will be utilized to
pay for the fiscal slippage due to the oil subsidy.
Our estimates suggest that this will generate an excess gilt supply of 20% of
deposit mobilization like last year. The saving grace is that the RBI will likely still
need to OMO Rs1500-2000bn to generate liquidity as a large-scale current
account deficit will limit fx intervention (Table 9). The 10-year should thus
continue to trade in the current mid-cycle 8% range through FY11. Do read our
latest rates report (with Ashok Bhundia) here .
… 20% loan growth to push up lending rates 75bp in 2H
We grow more confident of our call of lending rates going up 75bp in 2HFY12
(Table 10). After all, our estimates suggest that banks will face an excess loan
demand of 8.9% of deposits if they invest Rs1700bn in gilts as we have assumed
(Chart 2). This assumes: deposit growth of 17.5% and loan demand of 20%.
When will growth hurt? Mid-2012 after lending rates rise by another 100bp.
Experience suggests that cycles usually turn down (up) when the real lending
rate, now 7. 5%, pierces (slips below) the ‘neutral’ 7.5-8% potential growth rate.
This margin of comfort will likely be exhausted by end-2012.
Autos
„ Overall Expected Budget Impact: Negative
„ Budget Winners: NA
„ Budget Losers: All auto companies
Key Expected Measure
„ We expect 2% roll-back in excise rates, except high end cars and Utility
vehicles which could be maintained at existing rates of 20%.
„ We think auto majors will attempt to pass on excise hikes to consumers.
However, the industry also has to compensate for commodity related
increase in input costs.
Impact of Measure
„ Overall impact on demand will be negative if industry partially absorbs the
higher excise rates and upgradation costs. In the likely scenario of 50%
absorption of rollback, we estimate 8% impact on next fiscal EBITDA for
Maruti, 7% on Tata Motors and 6% on two wheeler companies.
„ M&M will be least impacted due to high dependence on Utility vehicles
(~50% of sales).
„ Auto stocks have already underperformed YTD in anticipation of exciserollbacks, so may not react sharply post-event. Also, possible volume
surprises imply stocks are trading at reasonable valuations..
Agriculture
„ Overall Expected Budget Impact: Positive
„ Budget Winners: Fertilizer companies, Jain Irrigation
„ We expect Budget to link urea capacities that work on regulated 12% RoE to
import parity price based realisations. This will be significant positive for urea
companies like Chambal, Nagarjuna and Tata Chemicals increasing their
earnings from fertilizer by ~50%.
„ Expect a positive announcement on micro irrigation subsidy in the budget by
way of a) increase in the total quantum of subsidy and b) hike in central
subsidy to 50% from current 40% of the purchase price. This will benefit Jain
Irrigation.
„ We expect govt to focus on modernisation of farming and supply chain. This
can include additional incentives for a) use of solar power in farming which
will benefit Jain Irrigation and b) for development of cold chains which we
believe will benefit Sintex Industries that offers products in this area as part
of its prefabs business
Banking and Financials
„ Overall Expected Budget Impact: Neutral
„ Budget Winners: All banks
„ Budget Losers: None
Key Expected Measure
Expected Measures and Impact
Tax exemption on infrastructure financing: Reintroduce Section 10 (23G) of
the Income tax Act, 1961 leading to tax breaks and possibly some expansion in
the scope of priority sector lending to include infrastructure-related projects.
Full tax breaks on NPL provisions: Banks looking for full tax breaks on NPL
provisions given that bank’s now have to maintain at least 70% provision cover.
Long-term fund raising options to banks for infra. financing: Banks await
cues from the budget to assess fund raising needs and have been looking to float
long-term infrastructure bonds with tax breaks.
Reduce deposit tenor for tax exemption: Currently, interest from deposits is
taxed at the rate of 33% + applicable surcharges; except for deposits >5 years.
The govt. may lower the maximum tenor to 3 years. This should be a key positive
for banks.
Other possible measures
Increasing tax deduction limits: The limit for tax exempt investments under
Section 80C is continuing at the archaic Rs1 lakh. Increasing the limit will help
those who have the potential to invest. This will also help the housing industry as
currently people are not able to derive the full benefits for the principal portion of
the housing loan repayment.
Consumers
„ Overall Expected Budget Impact: Negative
„ Budget Winners:
„ Budget Losers: ITC, Asian Paints, HUL, Godrej Consumers
Key Expected Measure
Within the consumer sector, the Budget is most relevant primarily for ITC. Post
the steep hike in excise duty by 15% in 2010 Union Budget, the probability of a
benign excise duty hike in budget this year is higher. However, with government
requiring funds to curtail fiscal deficit, sharp tax hike on cigarettes cannot be ruled
out.
We also expect excise duty slabs to be moved upwards by 2% for most consumer
goods. Most of this duty hike is likely to be passed on to the consumers with no
major impact on overall volume growth for the sector.
Impact of Measure
ITC: Our earnings forecast for ITC currently built in an average 5% excise duty
hike for cigarettes with a volume growth assumption of 6-7%. A tax increase of
>10% could result in downside to our estimates. However, over last few years we
have observed that ITC’s cigarettes business has developed enough resilience
where a steep tax hike does not impact growth as ITC compensates for weaker
volume growth with higher price hike.
Asian Paints, Godrej Consumers, HUL: Rise in excise duty should hurt Paints
and Soaps companies the most. The increase in excise duty combined with input
cost pressure could trigger retail price hikes. This is likely to have some impact on
the volume growth especially in the current high food inflation scenario.
Infrastructure
„ Overall Expected Budget Impact: Positive
„ Budget Winners: All E&C cos., Adani Power on cut in imported coal duty,
Entire power sector if National Electricity Fund is indeed set-up.
„ Budget Losers: State utilities as supply of paper increase in case of higher
divestment in cos. such as Neyveli Lignite, PGCIL & NTPC etc. Power
utilities / Infra developers if 10 year tax IT holiday u/s 80 IA is not extended.
Key Expected Measure
Utility Sector
„ In order to accelerate the pace of distribution reforms in power sector,
Finance Ministry has approved creation of Rs500bn National Electricity Fund
including an interest subsidy for lending under the fund. The loans provided
to the state discoms under the scheme will have tenure of 14 years.
„ Industry is seeking extension of 10 year tax holiday benefit u/s 80 IA of
Income Tax Act for the undertakings commencing generation and
distribution, which expires on 31st March, 2011 to FY15.
„ Power ministry has demanded to abolish 5% custom duty on imports of coal
as acute shortage of domestic coal threatening to destabilise its power
generation plans. As per CIL in a meeting with Plan Panel, it can only supply
319mnT of the total demand of 480mnT in FY12.
„ Power ministry to seek cabinet approval for foreign borrowings of US$2bn by
state run firms PFC and REC and tax breaks for ECBs. Currently, they can
raise ECBs to upto 50% of their net worth with a limit of US$500mn per year
and attract a withholding tax on interest on ECBs.
„ Higher exposure limits for banks for financing UMPPs. Presently, the
exposure limit of a bank to a single private company and a group is 20% and
30% of net worth respectively.
„ Exemption of customs duty on construction equipment used in hydropower
projects. Also, excise and customs duties on energy-efficient equipment
should be reduced.
„ Removal of applicability of MAT during 10 year tax holidays u/s 80 IA or
Gross Assets Tax (GAT) under new Direct Tax Code.
„ Reduce MAT rate to not more than one third of the regular rate tax, or at
least, kept stable at the present levels.
„ Increase the carry-forward time limit of MAT credit from 10 years to 15 years
to prevent any lapse of unutilized credit.
„ Coal Regulator Bill will be introduced in Budget to ensure level playing field
to all the stake holders. It would also make recommendations for reforms in
coal sector and about coal pricing.
„ Domestic Capital goods manufacturers are seeking for import duties on
power equipment for mega-projects. However, since it also escalates the
costs of projects, it may not be implemented.
„ Extension of concessions or exemptions under custom & excise laws to civil
materials like cement and steel, just as other raw materials and components,
required for the manufacturing of ‘machinery and equipment’ of power
projects.
„ End the step treatment of the captive power plants; they are neither covered
under any of the existing exemptions or concessions under customs and
central excise laws for power projects nor are they eligible for benefits under
the project import scheme.
Infrastructure
„ Govt. plans to use pension and insurance funds to provide long-term finance
for infrastructure projects and ease pressure on banks.
„ Restoration of tax exemption of income from investment in infrastructure and
other projects under section 10(23G) (removed in 2007) to ensure low cost of
raising capital.
„ Extend tax holiday to the newly introduced Limited Liability Partnership LLP
form of business setup which are engaged in the development of
infrastructure projects.
„ Raise deduction u/s 80CCF available to individual / HUF to Rs1lakh from
Rs20k for investment in long-term notified infrastructure bonds.
„ Exemption from service tax and works contract tax for Metro Rail and Mono
rail construction projects.
E&C
„ Domestic Capital goods manufacturers are seeking for import duties on
power equipment for mega-projects. However, since it also escalates the
costs of projects, it may not be implemented.
„ Proposal of hike in budgetary support for Road Infra projects by the Road
Transport & Highway ministry.
„ Construction Federation of India (CFI) sought capital gains tax exemption
for`Special Purpose Vehicle’ (SPV) on the lines of exemptions to listed
companies u/s 10(38) of Income-Tax Act. It has also sought 20% additional
depreciation to construction industry u/s 32(iia).
„ In roads sector, industry is seeking:
o exemption of toll revenue from service tax which is contended as taxable
by the Department of Revenue,
o amend dividend distribution tax (DDT) rules to prevent cascading effect,
o extension of 10 years tax holiday u/s 80IA to widening of roads which, at
present, is available for developing ‘new’ infrastructure facility, and
o allow usage of duty-free imported capital goods for road construction
business rather than to road project.
„ Real estate industry is seeking from finance minister:
o to hike income tax exemption for interest on home loans to at least
Rs2.5lakhs (vs Rs1.5lakh),
o to increase exemption on principal repayments of home loans to
Rs3lakhs (vs Rs1lakh) and make this benefit a separate category,
instead of making it a part of Section 80C.
o accord infrastructure industry status to real estate to allow easier access
to loans for its activities and
o Re-introduce tax exemption u/s 80IB (10) to promote affordable housing
currently allowed to project sanctioned before March 31, 2008.
„ Steel industry has demanded to raise import duty on HR coils to 10% from
5% and increase export duty on iron ores to 20% from 15%. Whereas Small
scale industries are seeking to cut import duty to nil from 5% in wake of over
30% jump in steel prices in last two months, on possible increase in coal
prices from Australia.
Impact of Measure
„ Creation of National Electricity fund for distribution reforms to strengthen
State Electricity Boards financial position shall support re-rating of power cos.
„ The extension of tax exemption u/s 80 IA till FY15 would benefit power
utilities companies setting up generation, transmission and distribution
capacity, including the proposed Ultra Mega Power Projects.
„ Cut in import duty of non-coking (thermal) coal would also cut imported coal
costs for all captive and utility plants.
„ Removal of MAT during tax holiday would benefit the utilities claiming
exemption u/s 80 IA.
„ Hike budgetary support to roads infra developments would benefit the
construction companies such as IVRC, JPA, L&T, NJCC, R- Infra etc.
„ Investment by pension and insurance funds of their investible resources into
Infra projects and re-financing of existing rupee loans through ECBs would
benefit the infrastructure companies such as GMR, GVK, IVRC, JPA, L&T,
NJCC, R – Infra.
„ Increase in import duty on steel would impact equipment manufacturing
companies like BHEL, L&T & Suzlon.
„ Exemption of service tax / works contract tax for construction of metro /
monorail project would benefit the project developers such as L&T and
Reliance Infra.
IT Services
„ Overall Expected Budget Impact: Positive
„ Budget Winners: TCS, MphasiS, Persistent, Hexaware
„ Budget Losers: None
Key Expected Measure
„ Potential extension of STPI tax holiday: The key hope of IT services
companies from the budget is around the extension of deadline for STPI
(software technology parks of India) tax holiday. As per the current scheme,
STPI tax holiday benefits (Section 10A/B) are expected to expire after 10
years of set-up or by March 2011, which-ever is earlier. We expect the expiry
date to be extended by a year to March 31, 2012 as it provides the much
needed impetus to small and mid sized companies in the sector and can be
followed-up with a smooth switch over to DTC (direct tax code) from FY13.
Large companies benefit to a lower extent as majority of their STPI units
have completed the 10-year window.
„ Expect status quo around SEZ policy i.e units set up until Mar31, 2014 will
run their course of tax benefits even if DTC is introduced.
„ IT industry also seeks clarification on taxation of revenues generated by
employees who work out of client's location abroad (onsite revenues). This
had been classified as not taxable in 2000 but the industry seeks a
reassurance in light of a couple of legal cases that sprung last year.
Impact of Measure
„ Amongst the mid-tier vendors - Persistent, Hexaware, Patni and MphasiS
are expected to pose the steepest increase in effective tax rates for FY12 in
case STPI tax holiday were to expire on March 2011. Hence these should be
biggest beneficiaries in case the deadline is extended by a year.
„ TCS is expected to be the key beneficiary amongst the large-tier vendors.
Metals
„ Overall Expected Budget Impact: Neutral
„ Budget Winners: none
„ Budget Losers: Sesa Goa.
Key Expected Measure
Potential increase in excise duty on steel:
„ Increase in excise duty on steel by 2%. Excise duty on steel products is
currently 10% and may be increased to 12% post budget.
„ If imposed, we believe realizations of domestic steel mills are unlikely to be
affected as steel companies should be able to pass on the excise duty
increase to consumers. However, this will increase costs for end users
further thus could marginally impact demand.
Increase in export tax on iron ore
„ Government may increase export duty on iron ore by 5%. Export duty on iron
ore lumps is 15% and export duty on iron ore fines is 5%. We
„ This is possible as iron ore spot prices are strong and Indian steelmakers are
lobbying for a higher iron ore export duty. Also Government is likely to be
concerned about inflationary impact of rising steel prices led by higher input
costs
„ If imposed this will be negative for Indian iron ore miners like Sesa Goa as it
will hurt their export realizations. 1% increase in export duty reduces FY12e
EPS by 1.5%. We note that miners may be able to pass through part of
export tariff increase initially as iron ore markets are tight due to Karnataka
ban. However this could reverse due to incremental improvement in supply if
Karnataka export ban is lifted.
„ Higher export duty on iron ore is a positive for non integrated domestic steel
companies like JSW Steel which source iron ore from domestic mines.
Oil & gas
Budget expectations
The following proposals may be implemented in the budget:
„ Cut in import duty on petrol and diesel from 7.5% to 2.5%
„ Cut in excise duty on petrol and diesel by Rs1/litre
„ Cut in import duty on crude oil from 5% to 0-3%
„ Income tax Act being amended to confirm 7-year income tax holiday on gas
produced from all NELP blocks. RIL would be biggest and immediate
beneficiary if it is done
Import and excise duty cut to cut subsidy
Duty hike made in Feb 2010 budget may be reversed
In the February 2010 budget
„ Import duty on petrol and diesel was raised from 2.5% to 7.5%
„ Excise duty on petrol and diesel was raised by Rs1/litre
„ Import duty on crude oil raised from 0% to 5%
Finance minister said in his Feb 2010 budget speech that the import duty on
petrol, diesel and crude oil had been cut when oil price was over US$100/bbl in
June 2010. With oil price is at US$75/bbl, the import duty was again being raised
Now with Brent at over US$100/bbl again, there is an expectation that import and
excise duty hike made in February 2010 budget may be reversed.
Duty cuts to prune government revenue by US$7.4-8.1bn
The hit to government’s FY12E revenue would be US$7.4-8.1bn if import duty on
crude is cut to 0% and excise duty on petrol and diesel cut by Rs1/litre.
US$5.3-6bn hit to government revenue if crude duty cut to 0%
If import duty on crude oil is cut from 5% to 0% hit to FY12E government revenue
would be
„ US$5.3bn if Brent is at US$89/bbl (BofA ML forecast)
„ US$6.0bn if Brent is at US$100/bbl
US$2.1bn hit to government revenue if excise duty cut by Rs1/litre
The cut in excise duty on petrol and diesel by Rs1/litre would cut government’s
revenue by Rs94bn (US$2.1bn)
Duty cuts on products to prune subsidy by US$4.4bn
Subsidy would decline by
„ US$2.3bn if import duty on petrol and diesel is cut from 7.5% to 2.5%
„ US$2.1bn if excise duty on petrol and diesel is cut by Rs1/litre
Thus the reduction in subsidy would be US$4.4bn.
33% of gain from subsidy cut to upstream companies
Any rise or decline in subsidy at the margin is shared by upstream players and
government in ratio of 33:67. Thus upstream players’ subsidy would be cut by
„ US$766m if import duty on petrol and diesel is cut from 7.5% to 2.5%
„ US$710 if excise duty on petrol and diesel is cut by Rs1/litre
Thus upstream companies’ subsidy would decline by US$1.5bn if both steps are
taken. See Oil India Ltd, 12 January 2011 (see table 8) for impact on earnings of
upstream companies.
Government subsidy cut by US$3bn; revenue rise US$0.7bn
Half of gain to oil companies back to government as tax and dividend
Government’s share of subsidy would decline by
„ US$1.5bn due to cut in import duty on petrol and diesel from 7.5% to 2.5%
„ US$1.4bn due to cut in excise duty on petrol and diesel by Rs1/litre
The balance gain from subsidy reduction of US$1.4bn would go to the stateowned oil companies. Typically half of this gain would come back to the
government in the form of higher income tax and dividend. Government’s gain on
this account would be US$700m.
Government revenue loss more than cut in subsidy
Revenue loss of US$7.4-8.1bn vis-à-vis gain of US$3.7bn
The hit to government revenue from cut in import duty on crude and excise duty
on petrol and diesel would be US$7.4-8.1bn. On the other hand its gain from
subsidy reduction (including tax and dividend rise) would be just US$3.7bn
Government net loser as loss on crude import duty high
The government is a net loser due to the following reasons
„ Loss from crude import duty cut at US$5.3-6bn is much higher than gain from
cut in import duty on petrol and diesel of US$1.9bn
„ Govt gain is only 67% of subsidy reduction with balance gain going to oil cos.
Crude import duty may be cut to 2-3% instead of 0%
Government revenue loss US$2.1-3.6bn if crude duty cut to 2-3%
Import duty on crude needs to be cut along with cut in import duty on petrol and
diesel to ensure refining profitability of R&M companies is unaffected. However,
to ensure that import duty on crude need not be cut by 5%. A 2-3% cut in import
duty on crude to 2-3% from 5% would be enough to sustain refining profit of R&M
companies.
Government revenue loss would be
„ US$2.1-2.4bn (Brent at US$89-100/bbl) if crude import duty is cut to 3% from
5%
„ US$3.2-3.6bn if crude import duty is cut to 2% from 5%
Government loss US$4.2-5.7bn if crude duty cut to 2-3%
Thus if import duty on crude is cut to 2-3% and not 0% the government revenue
loss would be US$4.2-5.7bn as against gain from subsidy cut of US$3.7bn.
Tax holiday on gas production
Amend the law to confirm tax holiday for gas production
Probability low but cannot be ruled out
In the July 2009 budget the law was amended to allow tax holiday for gas
production only from exploration blocks allotted under NELP VIII. Whether there
is tax holiday on gas produced from blocks allotted under NELP I-VII is being
litigated. The government had thus left it to the courts to decide the matter.
Amending the law in the Feb 2011 budget can ensure tax holiday for gas
produced from all NELP blocks. Otherwise courts will decide the matter.
The probability of this change in the budget is low.
RIL main beneficiary if tax holiday confirmed
RIL producing from KG D6 block since April 2009
Reliance Industries (RIL) has started gas production from KG D6, a block allotted
to it under NELP I. Thus RIL will be the immediate and biggest beneficiary if the
law is amended to allow tax holiday for gas produced even from NELP I-VII
blocks.
RIL’s PO & EPS unchanged if tax holiday for gas allowed
Earnings and PO assume RIL gets tax holiday
Our earnings forecast and PO for RIL assumes that it will get tax holiday for gas
production. Thus its earnings and PO will remain unchanged even if tax holiday
for gas production is confirmed.
Pharmaceuticals
„ Overall expected budget impact: Neutral
Expected Measures & Impact
„ Higher weighted deductions for in-house R&D spend to persist: The
weighted deduction slab of 200% for in-house R&D spends is likely to persist
to encourage R&D spends by pharmaceutical companies. Most of the large
companies would stand to benefit from this. Key names being Sun Pharma,
Cadila, Lupin, Ranbaxy, Dr Reddys.
„ Excise duty rate to remain unchanged at 4% on domestic formulations.
Anyways, pharma companies typically pass on any benefit due to such
reduction or reduce impact of excise duty increase by suitable price increase,
nullifying impact on earnings. We believe that increasing penetration of
affordable medicines to rural/tier 2/3 towns would remain government’s focus
and an increase in excise duty would be counter-productive.
„ Expect no changes to import duty structure. We do not expect a
reduction in the peak rate of customs duty on bulk drugs, drug intermediates
and formulations currently at 10% (except certain life saving drugs). In line
with interim budget, we expect no significant changes.
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