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At first glance, Budget 2012 has delivered on the low expectations: 7.6% real GDP growth
with less than 6% inflation, fiscal deficit of 5.1% of GDP, inclusive growth, etc
These headline numbers, however, build in stretch assumptions which imply taking stiff
policy measures such as lower fuel and fertilizer subsidy.
There are some major negative earnings implication for Oil & Gas and select companies in
Healthcare.
Foreign investors will likely be jolted by a proposed retrospective change in tax laws.
There are also a few positives as well such as marginal relief in personal taxes and incentives
for investment in some key sectors like fertilizers, power and roads.
Overall, the Budget does not strengthen market's conviction of a meaningful rate cut
cycle on the back of easing inflation. With valuations at LPA of 14x one-year forward
P/E, expect markets to remain range-bound for the next few months.
Backdrop: Delivering on low expectations
The Union Budget 2012 has been presented in a backdrop of slowing GDP growth
(6.1% in 3QFY12), high oil prices (under-recoveries of INR2t at current prices), fickle
political allies (e.g. Trinamool Congress), and the government's poor track record of
reforms in its current term to-date. Even now, most key bills have been kept out of
the Budget session (GST, DTC, Lokpal, etc). As a result, expectations from the budget
were running low. In this sense, the budget has lived up to expectation with at least
positive headline numbers, including lowering of fiscal deficit to GDP to 5.1% for FY13
from 5.9% for FY12.
Stretch assumptions and stiff measures
The budget build in some stretch assumptions which imply corresponding stiff policy
measures as tabled below. Slippage on either or both fronts will have negative
implications for achieving the headline macroeconomic targets - 7.6% real GDP growth
with less than 6% inflation, fiscal deficit of 5.1% of GDP, inclusive growth, etc.
The tightrope act between stretch assumptions and stiff measures
Stretch assumptions Stiff measures taken / required to be taken
Controlling total subsidy bill Meaningful increase in fuel and fertilizer prices
at 2% of GDP Acceleration in UIDAI roll-out to enable targeted
subsidy via direct cash transfers to beneficiaries
20% increase in FY13 2% across-the-board hike in excise duty and service tax
tax revenue Widening of service tax net
Jump in non-tax revenue and Completion of telecom spectrum auction to raise
non-debt capital receipts INR400b (zero in FY12)
Successful PSU disinvestment to raise INR300b
(INR155b in FY12)
FY13 average inflation of <6% Preventing higher user charges and higher indirect
taxes from stoking inflation
FY13 real GDP growth of 7.6% Ensuring fiscal discipline to ensure no major
dis-saving by government, which would hurt
investment rate, and hence growth
Some unexpected big blows
The budget has major negative implications for a few large cap stocks, mainly in Oil &
Gas and Healthcare sectors.
Oil & Gas: The Budget raised cess on crude oil production from INR2,500/MT to
INR4,500/MT, leading to an 8-11% downgrade in earnings estimates and fair value
for ONGC and Cairn India.
Healthcare: The Budget extended MAT (minimum alternate tax) to non-corporate
entities as well such as partnership firms. Sun Pharma and Cadila were operating
partnership firms in tax exempt zones for their domestic business. They now
become liable to MAT, which can effectively cut their earnings by 13-15%.
The credibility concern for foreign investors
Again in fine print, the Budget provides for an amendment to the Income Tax Act
which allows the government to tax overseas transfer of shares that are backed by
underlying assets in India. The government plans to enforce this amendment with
retrospective effect from 1962. The major target seems to be Vodafone Group Plc's
purchase of 67% stake from Hutchison, Hong Kong in 2007. The finance secretary, Mr
R S Gujral has said that the government expects to recover INR350-400b from similar
cases. If finally enacted and enforced, the credibility of India's legal system would be
a major concern for foreign investors. This is all the more critical given India's present
CAD (current account of deficit) of almost 4% of GDP.
The consolation positives
The perceptibly "non-event" Budget had a few consolation positives at best -
Marginal relief in personal income tax
No special levy on diesel vehicles
Excise duty hike on cigarettes along expected lines
Tax rebate introduced for the first time on investment in a special equities scheme
20% cut in STT (securities transaction tax, from 0.125% to 0.1%).
Incentives for investment in some key sectors - fertilizers (exemption of customs
duty on equipment), power (zero import duty on natural gas and LNG), roads (no
import duty on road construction equipment), affordable housing (ECB funding
permitted), etc.
Bottomline: Expect range-bound markets
Over the last 1 month, Indian markets are down 5% and have underperformed several
global markets, despite strong FII inflows of USD9b in CY12 to date. The
underperformance is on the back of several uncertainties and build-up of headwinds.
As oil prices climb to over USD120/bbl, lack of political will prevents pass-through,
piles up under-recoveries and pent-up inflation, making RBI's task of inflation
management difficult. Election outcome in Uttar Pradesh has not helped the cause of
the Centre, and the posturing of some UPA allies makes the political scene rather
fragile.
Prior to Budget 2012, expected moderation in inflation was a key catalyst for markets,
as it would have most likely implied a rate cut cycle beginning RBI's April 2012
monetary policy. Now, any meaningful rate cut becomes highly debatable given
increased inflationary pressures on the back of higher indirect taxes and likely hikes
in administered prices. With a 15% rally in YTD CY12, markets are trading back at their
long-period average P/E of 14x. Expect markets to remain range-bound over the next
few months, with oil prices and political realignments as the only potential (yet
unlikely) triggers
Trading economic risk to buy political peace
The Union Budget for FY13 seems to opt for a cautious political path trading for a riskier
growth strategy in the bargain. While contentious reform proposals were kept off the
table, unconventional measures were not attempted.
While elements of DTC and GST were implemented, tax efforts concentrated on indirect
taxes presumably to meet the higher expenditure targets set. This may have adverse
implications for both inflation as well as corporate profitability.
Ambitious increase in planned expenditure contrasts with under-provisioning of key
subsidies imparting lower credibility to fiscal corrective path envisaged. Thus a fiscal
deficit estimate of 5.1% of GDP for FY13 and a net borrowing figure of INR4.8t risks
slippage of 1% and INR1t, respectively.
Significant cuts in customs duty and preference for ECB route for easing financing
constraints for various sector points to complacency in the external sector too. The
inflationary and external sector consequences of the Budget would complicate monetary
policy making with dilution/delay in rate cuts as envisaged earlier.
Broader approach of the Union Budget 2012
Play it safe: The Union Budget seems to tread the relatively politically expedient
route of steering clear of any controversial or unconventional measures, given
the climate of uncertainties generated in the aftermath of State elections and
events surrounding the Railway Budget.
Contentious legislations deferred: To begin with many landmark economic
legislations, viz, DTC, GST, FDI in retail was kept off the table for Budget session of
the Parliament. Also the budget merely mentioned the efforts to "reach
broadbased consensus on FDI in multi-brand retail" without specifying a timeline.
Treading the conventional route: Further, the unconventional routes for resource
mobilization, such as increased tax for diesel cars, simplification of merit/nonmerit
categories of taxation in the direction of GST implementation, timeline for
rationalization of petroleum/fertilizer product prices.
The best bargain? In the current political milieu, however, this may be seen as the
best available course of action.
Tax efforts increased but regressive push towards indirect tax
Tax mobilization efforts increased: The government has sought to give a push to it
tax mobilization effort to meet its expenditure commitment and fiscal
consolidation plan. Thus, net tax revenue is sought to be increased to 7.7% of GDP
in FY13 (from 7.4% in FY12).
Components of DTC/GST implemented: Also the government sought to implement
certain elements of the proposed tax regime ahead of their parliamentary
approval.
Foreign taxation strengthened but with retrospective effect: The government
also tightened the area of taxation related to foreign taxation in accordance with
the DTC principals by providing and explanations for the definition of "property"
and "transfer" in the finance bill, with retrospective effect. While the explanation
plugs a loophole, its retrospective application is sure to be viewed as having
negative implications for attractiveness of FDI.
Service tax net widened: Again service tax net has been widened by adopting a
negative list for exclusion as envisaged in GST.
Mean excise & service tax raised by 2%: However, along with this, the mean tax
rates for both excise and services taxes have been increased from 10% to 12%.
This somewhat conflicts with the proposed GST rates suggested by various
committees and experts that places it in the range of 12-20% with equal share
between the centre and the states. Thus, if this has been done only for the
exigencies for meeting near term revenue target only to be rolled back eventually,
it also points to reduced urgency for meeting an early timeline for implementation
of GST.
Can indirect taxes feed inflation and also reduce corporate profitability: The
significant increase in indirect tax is likely to feed inflation. As the corporate
profitability trend shows limited pricing power at the present juncture this would
allow only incomplete pass through of higher taxes to prices. The reduced
profitability would impact corporation tax collection assumed to grow at 13.9%.
Significant revenue gain from indirect tax proposals: Direct tax proposals are
estimated to result in a net revenue loss of INR45b for FY13 while that for indirect
taxes are estimated to result in a net revenue gain of INR459b.
Tax structure turns regressive: Thus the share of indirect taxes in total taxes that
had shown secular decline from 66% in FY00 to only 41% in FY10 has gone back to
47% in FY13, a level last seen in FY09. The minimal change in direct taxation while
increasing reliance on indirect taxes to meet revenue target is purportedly
regressive and as mentioned could impact both inflation and profitability.
Significant reduction in customs duty: Somewhat as a surprise, significant reduction
in customs duty was effected on various capital goods items. This points to a more
import-led industrial growth strategy with adverse consequence for domestic
capital goods players. On the other hand, customs duty on gold was increased to
discourage ballooning gold imports.
Jump in tax kitty envisaged: Given all of the above, fairly robust revenue growth
is built into budget calculation. Gross and net tax revenue is expected to grow by
19.5% and 20.5%, respectively, way above 13.8% nominal GDP growth assumed.
However, excluding the impact of changes in tax proposals in the current budget,
gross tax revenue is assumed to grow at 14.9%, i.e., 1% higher than the nominal
GDP growth.
Wild cards of spectrum auction and disinvestment: While tax collection targets
appear achievable, significant increase in non-tax revenue has been budgeted
for e.g. (1) implied revenue of INR392b from telecom spectrum auction, and (2)
doubling of PSU disinvestment targets to INR300b from INR155b achieved in FY12.
Needless to add, underachievement on these targets poses a risk to the fiscal
deficit estimate.
Government plans to increase expenditure and improve its quality; underprovisioning
of subsidies continues
Expenditure drives revenue effort: Government has budgeted for 13.1% growth
in expenditure in FY13 over FY12 against only 10.1% expenditure growth in FY12.
Thus, the government seems to have set its expenditure targets first, before
proceeding to explore options for revenue mobilization to fund the expenditure
while containing the fiscal deficit.
Surprise jump in planned expenditure: Most notably, the government has provided
for a whopping 22.1% increase in Plan expenditure in FY13 on top of 12.6% growth
in FY12. This comes as a surprise given that FY13 is the first year of 12th Five-year
Plan and the Plan document is not yet ready.
Tight leash on non-Plan expenditure: Non-Plan expenditure growth is only 8.7%,
in continuation with the tight leash kept on it in FY12 (growth of 9.0%).
Expenditure quality improves: As a pointer to substantial improvement in the
quality of expenditure the share of Plan expenditure in total expenditure is now
ruling at its decadal high of 35% in FY13 (a significant jump from 32% a year back).
Huge jump in capital expenditure: Another pointer for improving quality of
expenditure is 25% jump in the capital component of Plan expenditure, restricting
the revenue component to 21.5%. Similarly, within non-Plan expenditure too,
there is a significant jump in the capital component (36.6%) while revenue
component has been suppressed (6.1%).
Subsidy underprovided by INR520b: The question, however, arises whether the
non-Plan revenue expenditure and within that particularly subsidies have been
under-provisioned. Our analysis shows this indeed is the case! Illustratively, in
the case of oil subsidies, government for the past few years seems to be only
providing for the arrears of the previous year as the subsidy for the current year.
Thus, as per our calculations, oil subsidy bill alone would stand at INR957b in place
of INR437b provided in FY13 budget, i.e. an underprovisioning of a whopping
INR520b. Accounting for the possibility of similar slippages in food and fertilizer
subsidy, our estimate for subsidy is placed at INR2,571b, i.e. 2.5% of GDP.
2% of GDP subsidy target unachievable without reform: This brings us to the point
that restricting the total subsidies to 2% of GDP as envisaged in the budget (and
further reduction to 1.75% of GDP over next three years) is well-nigh impossible
if serious reform for rationalization of subsidy regime is not undertaken soon.
Illustratively, again for the oil sector, if the actual provisioning would need to
come down to zero (implying zero under-recovery) either the oil price has to rule
below USD78/bbl or prices of petroleum prices would need to be enhanced
significantly (INR12/ltr in diesel, INR28.5/ltr in PDS kerosene and INR439/cylinder
in LPG). Both are unachievable under the current global and domestic inflationary
environment. While limited rationalization of petroleum prices, nutrient based
subsidy for urea, etc. could be attempted later, i.e., after the budget session of
Parliament, they would need to overcome considerable political roadblock,
whenever implemented.
Expenditure priorities in place: Focus on basic sectors continues, viz, agriculture,
water and irrigation, food processing, rural development (including measures to
strengthen RRBs), SMEs and infrastructure. The social sectors, viz, education,
women and child welfare, etc receive much higher allocation. A push to the health
sector is given with the launch of National Urban Health Mission.
ECB allowed in several sectors: The budget also attempts to ease financing
conditions by permitting/liberalizing ECBs for certain sectors including airlines,
housing, power and roads. While these do not have budgetary implications, it has
somewhat concerning implications for external sector balance
Fiscal deficit and borrowing estimate risks slipping again
Fiscal deficit at 5.1% of GDP: With somewhat optimistic revenue assumptions
(especially on non-tax revenue and disinvestments) and plans to curtail subsidies,
fiscal deficit is targeted at 5.1% of GDP. While this would mean a substantial
correction in the headline number (v/s 5.9% in FY12RE), the estimate is suspect
again. First, this implies a negative growth in absolute amount of fiscal deficit by
-1.6% vis-à-vis 40% increase in FY12RE over FY11 (Actual) and 27% increase in
FY12RE over FY12BE. Second, if the optimistic assumptions don't hold, it would
still lead to a slippage of more than INR1t, nearly half of it accounted for by subsidies
alone. This can push up the fiscal deficit closer to 6% of GDP, indicating no fiscal
correction.
Medium term fiscal consolidation plan derailed: The fiscal deficit to GDP ratio for
FY12 was revised upwards from 4.6% to 5.9%; i.e. a slippage of 1.3% of GDP and
1.1% over what is mandated as per the medium term fiscal (MTF) consolidation
plan laid down by the Government. Similarly, the FY13 fiscal deficit of 5.1% is still
1% higher than what is predicated as per the MTF plan. MTF rolling targets for FY14
and FY15 have now been reset at 4.5% and 3.9%.
FRBM amendment made part of Finance Bill: In another indication of rather weak
conviction for fiscal correction, amendment to FRBM now warranted in view of
fiscal slippage in FY12 has been made a part of Finance Bill itself.
Gross and net borrowing figures within estimates to begin with: The gross and
net market borrowing estimates have been placed at INR5.7t and INR4.8t,
respectively. These levels are likely to have a smooth passage in the market
without any major concern of crowding out, provided (i) there is no further fiscal
slippage mentioned above, and (ii) RBI ensures money supply close to 15% target
level.
Implications for the economy and the monetary policy
Political de-risking entails higher economic risk: While the budget attempts to
dabble on a surer political footing, this entails a choice towards riskier growth
strategies. First of all, the inflationary consequences of indirect tax proposals
have been ignored. Second, the significant risk of higher international oil prices
creating inflationary overhang have been glossed over. Third, the drive for
industrialization and growth smacks an import-led strategy that invokes memories
of BoP crisis of early 1990s. Fourth, significant recourse to ECB to address sectoral
financing problem too have its consequences for BoP and somewhat bypasses
the domestic monetary policy. In sum, both the levers of inflation and external
gap seem to have been resorted to, to try and achieve growth amidst a relatively
weak fiscal situation.
Complicates monetary policy making: The invitation for higher inflation and
external sector risk is a source of worry for RBI. With government and RBI choosing
their own course of policy action in focusing on growth and inflation, respectively,
they also risk acting at cross-purposes nullifying each other's action later on.
Rate cuts may be of lower magnitude now: The inflationary consequences of the
budget makes the rate cut actions as envisaged earlier less of a certainty. Although
we continue to hold the first rate cut in Apr-12, subsequent rounds of rate cut are
less of a certainty and may be watered down or delayed.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
At first glance, Budget 2012 has delivered on the low expectations: 7.6% real GDP growth
with less than 6% inflation, fiscal deficit of 5.1% of GDP, inclusive growth, etc
These headline numbers, however, build in stretch assumptions which imply taking stiff
policy measures such as lower fuel and fertilizer subsidy.
There are some major negative earnings implication for Oil & Gas and select companies in
Healthcare.
Foreign investors will likely be jolted by a proposed retrospective change in tax laws.
There are also a few positives as well such as marginal relief in personal taxes and incentives
for investment in some key sectors like fertilizers, power and roads.
Overall, the Budget does not strengthen market's conviction of a meaningful rate cut
cycle on the back of easing inflation. With valuations at LPA of 14x one-year forward
P/E, expect markets to remain range-bound for the next few months.
Backdrop: Delivering on low expectations
The Union Budget 2012 has been presented in a backdrop of slowing GDP growth
(6.1% in 3QFY12), high oil prices (under-recoveries of INR2t at current prices), fickle
political allies (e.g. Trinamool Congress), and the government's poor track record of
reforms in its current term to-date. Even now, most key bills have been kept out of
the Budget session (GST, DTC, Lokpal, etc). As a result, expectations from the budget
were running low. In this sense, the budget has lived up to expectation with at least
positive headline numbers, including lowering of fiscal deficit to GDP to 5.1% for FY13
from 5.9% for FY12.
Stretch assumptions and stiff measures
The budget build in some stretch assumptions which imply corresponding stiff policy
measures as tabled below. Slippage on either or both fronts will have negative
implications for achieving the headline macroeconomic targets - 7.6% real GDP growth
with less than 6% inflation, fiscal deficit of 5.1% of GDP, inclusive growth, etc.
The tightrope act between stretch assumptions and stiff measures
Stretch assumptions Stiff measures taken / required to be taken
Controlling total subsidy bill Meaningful increase in fuel and fertilizer prices
at 2% of GDP Acceleration in UIDAI roll-out to enable targeted
subsidy via direct cash transfers to beneficiaries
20% increase in FY13 2% across-the-board hike in excise duty and service tax
tax revenue Widening of service tax net
Jump in non-tax revenue and Completion of telecom spectrum auction to raise
non-debt capital receipts INR400b (zero in FY12)
Successful PSU disinvestment to raise INR300b
(INR155b in FY12)
FY13 average inflation of <6% Preventing higher user charges and higher indirect
taxes from stoking inflation
FY13 real GDP growth of 7.6% Ensuring fiscal discipline to ensure no major
dis-saving by government, which would hurt
investment rate, and hence growth
Some unexpected big blows
The budget has major negative implications for a few large cap stocks, mainly in Oil &
Gas and Healthcare sectors.
Oil & Gas: The Budget raised cess on crude oil production from INR2,500/MT to
INR4,500/MT, leading to an 8-11% downgrade in earnings estimates and fair value
for ONGC and Cairn India.
Healthcare: The Budget extended MAT (minimum alternate tax) to non-corporate
entities as well such as partnership firms. Sun Pharma and Cadila were operating
partnership firms in tax exempt zones for their domestic business. They now
become liable to MAT, which can effectively cut their earnings by 13-15%.
The credibility concern for foreign investors
Again in fine print, the Budget provides for an amendment to the Income Tax Act
which allows the government to tax overseas transfer of shares that are backed by
underlying assets in India. The government plans to enforce this amendment with
retrospective effect from 1962. The major target seems to be Vodafone Group Plc's
purchase of 67% stake from Hutchison, Hong Kong in 2007. The finance secretary, Mr
R S Gujral has said that the government expects to recover INR350-400b from similar
cases. If finally enacted and enforced, the credibility of India's legal system would be
a major concern for foreign investors. This is all the more critical given India's present
CAD (current account of deficit) of almost 4% of GDP.
The consolation positives
The perceptibly "non-event" Budget had a few consolation positives at best -
Marginal relief in personal income tax
No special levy on diesel vehicles
Excise duty hike on cigarettes along expected lines
Tax rebate introduced for the first time on investment in a special equities scheme
20% cut in STT (securities transaction tax, from 0.125% to 0.1%).
Incentives for investment in some key sectors - fertilizers (exemption of customs
duty on equipment), power (zero import duty on natural gas and LNG), roads (no
import duty on road construction equipment), affordable housing (ECB funding
permitted), etc.
Bottomline: Expect range-bound markets
Over the last 1 month, Indian markets are down 5% and have underperformed several
global markets, despite strong FII inflows of USD9b in CY12 to date. The
underperformance is on the back of several uncertainties and build-up of headwinds.
As oil prices climb to over USD120/bbl, lack of political will prevents pass-through,
piles up under-recoveries and pent-up inflation, making RBI's task of inflation
management difficult. Election outcome in Uttar Pradesh has not helped the cause of
the Centre, and the posturing of some UPA allies makes the political scene rather
fragile.
Prior to Budget 2012, expected moderation in inflation was a key catalyst for markets,
as it would have most likely implied a rate cut cycle beginning RBI's April 2012
monetary policy. Now, any meaningful rate cut becomes highly debatable given
increased inflationary pressures on the back of higher indirect taxes and likely hikes
in administered prices. With a 15% rally in YTD CY12, markets are trading back at their
long-period average P/E of 14x. Expect markets to remain range-bound over the next
few months, with oil prices and political realignments as the only potential (yet
unlikely) triggers
Trading economic risk to buy political peace
The Union Budget for FY13 seems to opt for a cautious political path trading for a riskier
growth strategy in the bargain. While contentious reform proposals were kept off the
table, unconventional measures were not attempted.
While elements of DTC and GST were implemented, tax efforts concentrated on indirect
taxes presumably to meet the higher expenditure targets set. This may have adverse
implications for both inflation as well as corporate profitability.
Ambitious increase in planned expenditure contrasts with under-provisioning of key
subsidies imparting lower credibility to fiscal corrective path envisaged. Thus a fiscal
deficit estimate of 5.1% of GDP for FY13 and a net borrowing figure of INR4.8t risks
slippage of 1% and INR1t, respectively.
Significant cuts in customs duty and preference for ECB route for easing financing
constraints for various sector points to complacency in the external sector too. The
inflationary and external sector consequences of the Budget would complicate monetary
policy making with dilution/delay in rate cuts as envisaged earlier.
Broader approach of the Union Budget 2012
Play it safe: The Union Budget seems to tread the relatively politically expedient
route of steering clear of any controversial or unconventional measures, given
the climate of uncertainties generated in the aftermath of State elections and
events surrounding the Railway Budget.
Contentious legislations deferred: To begin with many landmark economic
legislations, viz, DTC, GST, FDI in retail was kept off the table for Budget session of
the Parliament. Also the budget merely mentioned the efforts to "reach
broadbased consensus on FDI in multi-brand retail" without specifying a timeline.
Treading the conventional route: Further, the unconventional routes for resource
mobilization, such as increased tax for diesel cars, simplification of merit/nonmerit
categories of taxation in the direction of GST implementation, timeline for
rationalization of petroleum/fertilizer product prices.
The best bargain? In the current political milieu, however, this may be seen as the
best available course of action.
Tax efforts increased but regressive push towards indirect tax
Tax mobilization efforts increased: The government has sought to give a push to it
tax mobilization effort to meet its expenditure commitment and fiscal
consolidation plan. Thus, net tax revenue is sought to be increased to 7.7% of GDP
in FY13 (from 7.4% in FY12).
Components of DTC/GST implemented: Also the government sought to implement
certain elements of the proposed tax regime ahead of their parliamentary
approval.
Foreign taxation strengthened but with retrospective effect: The government
also tightened the area of taxation related to foreign taxation in accordance with
the DTC principals by providing and explanations for the definition of "property"
and "transfer" in the finance bill, with retrospective effect. While the explanation
plugs a loophole, its retrospective application is sure to be viewed as having
negative implications for attractiveness of FDI.
Service tax net widened: Again service tax net has been widened by adopting a
negative list for exclusion as envisaged in GST.
Mean excise & service tax raised by 2%: However, along with this, the mean tax
rates for both excise and services taxes have been increased from 10% to 12%.
This somewhat conflicts with the proposed GST rates suggested by various
committees and experts that places it in the range of 12-20% with equal share
between the centre and the states. Thus, if this has been done only for the
exigencies for meeting near term revenue target only to be rolled back eventually,
it also points to reduced urgency for meeting an early timeline for implementation
of GST.
Can indirect taxes feed inflation and also reduce corporate profitability: The
significant increase in indirect tax is likely to feed inflation. As the corporate
profitability trend shows limited pricing power at the present juncture this would
allow only incomplete pass through of higher taxes to prices. The reduced
profitability would impact corporation tax collection assumed to grow at 13.9%.
Significant revenue gain from indirect tax proposals: Direct tax proposals are
estimated to result in a net revenue loss of INR45b for FY13 while that for indirect
taxes are estimated to result in a net revenue gain of INR459b.
Tax structure turns regressive: Thus the share of indirect taxes in total taxes that
had shown secular decline from 66% in FY00 to only 41% in FY10 has gone back to
47% in FY13, a level last seen in FY09. The minimal change in direct taxation while
increasing reliance on indirect taxes to meet revenue target is purportedly
regressive and as mentioned could impact both inflation and profitability.
Significant reduction in customs duty: Somewhat as a surprise, significant reduction
in customs duty was effected on various capital goods items. This points to a more
import-led industrial growth strategy with adverse consequence for domestic
capital goods players. On the other hand, customs duty on gold was increased to
discourage ballooning gold imports.
Jump in tax kitty envisaged: Given all of the above, fairly robust revenue growth
is built into budget calculation. Gross and net tax revenue is expected to grow by
19.5% and 20.5%, respectively, way above 13.8% nominal GDP growth assumed.
However, excluding the impact of changes in tax proposals in the current budget,
gross tax revenue is assumed to grow at 14.9%, i.e., 1% higher than the nominal
GDP growth.
Wild cards of spectrum auction and disinvestment: While tax collection targets
appear achievable, significant increase in non-tax revenue has been budgeted
for e.g. (1) implied revenue of INR392b from telecom spectrum auction, and (2)
doubling of PSU disinvestment targets to INR300b from INR155b achieved in FY12.
Needless to add, underachievement on these targets poses a risk to the fiscal
deficit estimate.
Government plans to increase expenditure and improve its quality; underprovisioning
of subsidies continues
Expenditure drives revenue effort: Government has budgeted for 13.1% growth
in expenditure in FY13 over FY12 against only 10.1% expenditure growth in FY12.
Thus, the government seems to have set its expenditure targets first, before
proceeding to explore options for revenue mobilization to fund the expenditure
while containing the fiscal deficit.
Surprise jump in planned expenditure: Most notably, the government has provided
for a whopping 22.1% increase in Plan expenditure in FY13 on top of 12.6% growth
in FY12. This comes as a surprise given that FY13 is the first year of 12th Five-year
Plan and the Plan document is not yet ready.
Tight leash on non-Plan expenditure: Non-Plan expenditure growth is only 8.7%,
in continuation with the tight leash kept on it in FY12 (growth of 9.0%).
Expenditure quality improves: As a pointer to substantial improvement in the
quality of expenditure the share of Plan expenditure in total expenditure is now
ruling at its decadal high of 35% in FY13 (a significant jump from 32% a year back).
Huge jump in capital expenditure: Another pointer for improving quality of
expenditure is 25% jump in the capital component of Plan expenditure, restricting
the revenue component to 21.5%. Similarly, within non-Plan expenditure too,
there is a significant jump in the capital component (36.6%) while revenue
component has been suppressed (6.1%).
Subsidy underprovided by INR520b: The question, however, arises whether the
non-Plan revenue expenditure and within that particularly subsidies have been
under-provisioned. Our analysis shows this indeed is the case! Illustratively, in
the case of oil subsidies, government for the past few years seems to be only
providing for the arrears of the previous year as the subsidy for the current year.
Thus, as per our calculations, oil subsidy bill alone would stand at INR957b in place
of INR437b provided in FY13 budget, i.e. an underprovisioning of a whopping
INR520b. Accounting for the possibility of similar slippages in food and fertilizer
subsidy, our estimate for subsidy is placed at INR2,571b, i.e. 2.5% of GDP.
2% of GDP subsidy target unachievable without reform: This brings us to the point
that restricting the total subsidies to 2% of GDP as envisaged in the budget (and
further reduction to 1.75% of GDP over next three years) is well-nigh impossible
if serious reform for rationalization of subsidy regime is not undertaken soon.
Illustratively, again for the oil sector, if the actual provisioning would need to
come down to zero (implying zero under-recovery) either the oil price has to rule
below USD78/bbl or prices of petroleum prices would need to be enhanced
significantly (INR12/ltr in diesel, INR28.5/ltr in PDS kerosene and INR439/cylinder
in LPG). Both are unachievable under the current global and domestic inflationary
environment. While limited rationalization of petroleum prices, nutrient based
subsidy for urea, etc. could be attempted later, i.e., after the budget session of
Parliament, they would need to overcome considerable political roadblock,
whenever implemented.
Expenditure priorities in place: Focus on basic sectors continues, viz, agriculture,
water and irrigation, food processing, rural development (including measures to
strengthen RRBs), SMEs and infrastructure. The social sectors, viz, education,
women and child welfare, etc receive much higher allocation. A push to the health
sector is given with the launch of National Urban Health Mission.
ECB allowed in several sectors: The budget also attempts to ease financing
conditions by permitting/liberalizing ECBs for certain sectors including airlines,
housing, power and roads. While these do not have budgetary implications, it has
somewhat concerning implications for external sector balance
Fiscal deficit and borrowing estimate risks slipping again
Fiscal deficit at 5.1% of GDP: With somewhat optimistic revenue assumptions
(especially on non-tax revenue and disinvestments) and plans to curtail subsidies,
fiscal deficit is targeted at 5.1% of GDP. While this would mean a substantial
correction in the headline number (v/s 5.9% in FY12RE), the estimate is suspect
again. First, this implies a negative growth in absolute amount of fiscal deficit by
-1.6% vis-à-vis 40% increase in FY12RE over FY11 (Actual) and 27% increase in
FY12RE over FY12BE. Second, if the optimistic assumptions don't hold, it would
still lead to a slippage of more than INR1t, nearly half of it accounted for by subsidies
alone. This can push up the fiscal deficit closer to 6% of GDP, indicating no fiscal
correction.
Medium term fiscal consolidation plan derailed: The fiscal deficit to GDP ratio for
FY12 was revised upwards from 4.6% to 5.9%; i.e. a slippage of 1.3% of GDP and
1.1% over what is mandated as per the medium term fiscal (MTF) consolidation
plan laid down by the Government. Similarly, the FY13 fiscal deficit of 5.1% is still
1% higher than what is predicated as per the MTF plan. MTF rolling targets for FY14
and FY15 have now been reset at 4.5% and 3.9%.
FRBM amendment made part of Finance Bill: In another indication of rather weak
conviction for fiscal correction, amendment to FRBM now warranted in view of
fiscal slippage in FY12 has been made a part of Finance Bill itself.
Gross and net borrowing figures within estimates to begin with: The gross and
net market borrowing estimates have been placed at INR5.7t and INR4.8t,
respectively. These levels are likely to have a smooth passage in the market
without any major concern of crowding out, provided (i) there is no further fiscal
slippage mentioned above, and (ii) RBI ensures money supply close to 15% target
level.
Implications for the economy and the monetary policy
Political de-risking entails higher economic risk: While the budget attempts to
dabble on a surer political footing, this entails a choice towards riskier growth
strategies. First of all, the inflationary consequences of indirect tax proposals
have been ignored. Second, the significant risk of higher international oil prices
creating inflationary overhang have been glossed over. Third, the drive for
industrialization and growth smacks an import-led strategy that invokes memories
of BoP crisis of early 1990s. Fourth, significant recourse to ECB to address sectoral
financing problem too have its consequences for BoP and somewhat bypasses
the domestic monetary policy. In sum, both the levers of inflation and external
gap seem to have been resorted to, to try and achieve growth amidst a relatively
weak fiscal situation.
Complicates monetary policy making: The invitation for higher inflation and
external sector risk is a source of worry for RBI. With government and RBI choosing
their own course of policy action in focusing on growth and inflation, respectively,
they also risk acting at cross-purposes nullifying each other's action later on.
Rate cuts may be of lower magnitude now: The inflationary consequences of the
budget makes the rate cut actions as envisaged earlier less of a certainty. Although
we continue to hold the first rate cut in Apr-12, subsequent rounds of rate cut are
less of a certainty and may be watered down or delayed.
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