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Union Budget 2011-12 - Preview
Union Budget 2011-2012 – Addressing supply constraints is critical
The Indian economy has the potential to grow by 10% but has got chained to a moderate 8% GDP growth rate on
account of supply constraints, and no doubt a lot can be done on the policy reform front. The country is currently
grappling with several headwinds that can be effectively addressed through policy reforms and fiscal action rather
than monetary action alone. For instance, our savings rate is low, current account deficit is high and headline
inflation is also high, mainly on account of supply constraints. Demand, on the other hand, is showing signs of
moderating, reflected in the perceptible moderation in IIP growth even after eliminating the base effects as well as
the low level of manufacturing price increases that is leading to margin compression for a number of companies.
Mining, infrastructure and agriculture are amongst the key affected sectors and positive measures in the budget for
these sectors would be more than welcome.
Increasing agri-production is critical
Looking at the anatomy of our high inflation problem, there appear three drivers for the same. First is domestic
supply-side inflation (this is mainly crop-related inflation) that stands at 15.6% yoy. The second is global commodity
inflation (mainly crude and metals), which is also at elevated levels of 17.5%. Put together, these articles have 29%
weightage in the WPI and are contributing 61% to the current 8.4% headline inflation number. Inflation in
manufactured products is the third driver (that can be seen as a proxy to demand-driven inflation), which stands at
just ~4.4%. Looking at the second driver of inflation first, in our view, policy makers need to find ways of meeting
the economy’s global resource requirements more sustainably and, beyond that, remain policy-neutral to global
commodity inflation.
As far as domestic supply-side food inflation is concerned, India is clearly at a critical juncture where strong
government focus on agriculture is needed. In the current year, India has grown by 7–8%; while at the same time,
agriculture output has grown at less than 1%. India has around 146mn hectares (ha) of land under agriculture,
which yields 188mn tonnes of food grain; while in case of China, it has 100mn ha of land, which yields 412mn
tonnes of food grain. India produces around 600mn tonnes of food products (fruits + vegetables), of which 25–
30% is wasted due to lack of adequate logistical support. Hence, the need to raise production along with
productivity of land and developing cohesive logistical support is of utmost importance and the best way to
manage the long-term food security issue. In case of fertilisers, the country has not seen new plants being set up in
the last two decades, while 25% of the total consumption is still imported. Urea continues to be the most consumed
fertiliser, as its prices are the lowest. Thus, a new fertiliser policy is an immediate requirement, wherein the private
sector is encouraged to expand fertiliser capacity.
Mining activity needs further boost
Moreover, in a resource-rich country like India, it is unfortunate that we are ending up importing gigantic 35mn
tonnes of thermal coal, even though we have the world’s fourth-largest reserves. Sufficient coal availability is likely
to be a key constraint for the power sector as coal-based power plants have been facing fuel shortage on account
of various reasons such as delay in procuring coal linkages, issues in obtaining environment clearances and other
regulatory approvals for developing coal blocks, hurdles in expansion of coal blocks, and logistical and
infrastructural issues. To a smaller extent, we are also importing steel, while exporting 100mn tonnes of iron ore
per annum, even though we have the world’s fifth-largest iron ore reserves and should ideally be a major steelexporting
country. Therefore, the government needs to take urgent action to reverse this situation by fast-tracking
policy reforms and incentives as well as speeding up coal and iron ore mine auctions, allocations and clearances,
if we are to sustainably grow at a higher GDP rate.
Infrastructure spending must be ramped up
Moreover, it goes with saying that no country can grow without ramping up infrastructure investments. Our current
i f t t i t t infrastructure investments of 5-7% of GDP need to increase to 9-10%, if our growth trajectory is to go up. Given
that the sector plays a vital role in achieving the desired run rate of economic growth, we expect some
announcements to come through, viz. higher allocation to flagship programs of Bharat Nirman, JNNURM, APDRP,
AIBP and NHDP. Land acquisition and environment clearance are the two major bottlenecks hampering the timely
execution of projects. Hence, roll out of policies to expedite these procedures would lend a fillip to the sector.
Welcoming FDI and incentivising exports also required
Opening up of sectors that can attract foreign investments, such as retail and insurance, needs to be hastened,
especially as we have not added to our forex reserves of late. The industry has constantly advocated that 100%
foreign direct investment (FDI) should be allowed in single-brand retailing. Currently, FDI of up to 51% under
single-brand retail trading and 100% in the cash-and-carry wholesale format is allowed under the automatic route.
Additionally, FDI may be allowed in diluted form in multi-brand retailing. If this happens, it would expedite growth
of the organised format in the country, leading to lower prices, improved product quality and a wider choice of
products available to consumers. Moreover, other emerging markets have been growing on the steam of higher
contribution of exports to their GDP. The government also cannot afford to ignore this lever of growth, considering
our vast, expanding, low-cost workforce. So, more momentum is required to incentivise manufacturing exports
through SEZs, especially when our closest competitor’s currency is pegged.
All this, without hampering fiscal consolidation – A key challenge
As far as fiscal deficit is concerned, in the last budget, the government had committed to a sustained path of fiscal
lid ti L ki consolidation. Looking at the already rising interest rates, it is important that the government delivers on this front.
Unlike last year, when the government received ~`1,00,000cr from auctions of 3G and BWA spectrum, there are
no such benefits expected in the short term. Any further increase in fiscal deficit would further harden interest rates,
eventually hitting credit demand in the economy. In this regard, we expect fund-raising plans by the government
through disinvestment will continue in FY2012. We believe the FY2012 budget is likely to expedite the
disinvestment process for SAIL and Hindustan Copper, among others.
On a related front, it will also be important to see if there are any measures to address the mismatch in creditdeposit
growth prevailing in the economy. The gap between savings and investments is being plugged by the high
current account deficit at present. With higher deposit mobilisation being the need of the hour, measures to
encourage savings, such as reducing lock-in period on tax-saving FDs, may become a reality in the coming budget
session.
As far as ensuring healthy availability and flow of credit to various sections of the economy is concerned, the
government has already been quite pro-active in the last few budgets. For instance, the `65,000cr farm waiver
increased the ability of banks to channel more funds to the agriculture sector, where investments to alleviate supply
constraints are the need of the hour. Similarly, the `16,500cr capital infusion in PSU banks should alleviate
constraints to their credit growth and the granting of IFC status to infrastructure lending companies should increase
the availability of much-needed long-term funds for the sector. With credit growth already quite strong, we would
not expect any major moves on this front in the upcoming budget, though more avenues of long-term financing for
the infrastructure sector, including creation of corporate debt market, dedicated infrastructure debt fund and
attracting foreign investment, would be welcome.
Conclusion – Policy reforms hold the key to higher GDP growth rate
Looking ahead, we believe an increase in policy reforms and faster project clearances would hold the key for
t ki th taking the GDP growth rate beyond the 8-8.5% expectations. Clearly, in case of most of the economy’s current
woes, growth is being held back due to supply-side constraints and lack of execution, whether it comes to
agriculture, mining or infrastructure. It is important that the budget shows decisive commitment and clear action on
the government’s part to fast-track the removal of all these shackles to our growth so that the private sector can
achieve its maximum potential. At the same time, gradual monetary tightening, coupled with rupee depreciation, is
also expected to help restore equilibrium to the current imbalances such as low domestic savings, high current
account deficit and high inflation.
The Sensex is available at a much more reasonable 15x P/E now. Moreover, the Indian markets have
underperformed other emerging markets recently and the Sensex is now trading at lower valuations than the
Shanghai Composite, in spite of enjoying stronger structural tailwinds. In fact, Dow Jones in the last six months has
appreciated by 20-25%, Chinese markets have appreciated by 10%, while Indian markets have come down by 10-
12%. From a sectoral standpoint, post the correction, banking and infrastructure sectors are looking especially
cheaply valued. Also, we continue to find huge value in some of the bottom-up picks in the mid-cap space, which
are either high-quality entry-barrier businesses or are available at dirt cheap valuations. All in all, even with our
GDP growth rate at 8-8.5%, the Sensex is looking reasonably valued at 15x P/E, and we maintain our positive
outlook, with a March 2012 Sensex target of 21,845.
