Union Budget Preview - Budget to address multiple macro headwinds:: Edelweiss

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n  Macroeconomic backdrop tough for Union Budget 2011-12

The Union Budget will be set against a very challenging macroeconomic backdrop: Crude prices are hovering around ~USD 90 per barrel, domestic inflation is ruling at elevated levels and current account deficit is at historically high levels. These challenges are supplemented by continuous expansionary fiscal policy. 

n  Key focus: Fiscal consolidation, tacking inflation and sustianing growth

Fiscal consolidation: Indian economy has regained its high growth momentum and now expansionary fiscal policy (largely consumption oriented) is putting upward pressure on inflation and interest rates, leading to crowding out of the private sector. Accordingly, fiscal consolidation has become necessary.

Tackling structural inflation: In the past two years, addressing persistently high inflation has been largely left to the monetary policy. However, since a large part of current high inflation is due to supply-side constraints, the government is likely to undertake measures to ease such constraints, e.g., encouraging investment in agriculture, cold storage chains and reduction in mandi tax.

Undertaking policy reforms to support growth: To sustain the growth momentum and expand manufacturing base of the economy over medium term, the government is likely to look at addressing the challenges of land acquisition, infrastructure bottlenecks and infrastructure financing, among others. 

Inclusive agenda: After years of substantial expansion in the social sector spending, the government is likely to go relatively slower on its inclusive growth agenda, given limited fiscal headroom. 

n  FY12 fiscal deficit to be at 5% of GDP; quality of govt.  finance a concern

In FY12, the government is likely to boost revenues through cutting exemptions on excise duty and bringing more services under the preview of service tax. On the expenditure side, government is unlikely to undertake any meaningful cut in subsidy bill, given high energy prices. Against this, we foresee fiscal deficit to reach 5% of GDP in FY12 compared to expectation of 4.9% in FY11, necessitating net market borrowing of ~INR 4 tn in FY12. However, the quality of public finances remains a concern. The meaningful fiscal consolidation would require reducing revenue expenditure, particularly on subsidies, by improving delivery mechanism and boosting tax revenues (by introducing GST, reducing tax evasion and supporting economic growth) rather than relying on gains from disinvestment.

n  Impact on industries; a few to come under purview of taxation

While expectation is benign for most sectors, the government could try to increase tax avenues. For one, we expect many services, currently tax exempt, to come under the purview of taxation. Second, the government may not extend the exemptions granted to various sectors. The biggest impact could be in IT, wherein we do not expect any extension of sunset clause on tax exemptions for STP.  Third, there could be an increase in excise duty within FMCG (especially cigarettes) and auto sectors (additional excise on diesel cars). On the positive side, we see increased allocation in infra and continued social spending benefitting construction and consumer sectors, respectively.