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India Strategy
Union Budget review
The fiscal deficit target of 4.6% seems aggressive, with oil subsidies resulting
from US$100 crude potentially adding 70bp. Maintenance of excise duties is a
relief for autos and cigarettes, and a marginal positive for inflation and domestic
demand.
FY12 union budget fiscal deficit estimate of 4.6% seems aggressive
The FY12 union budget forecasts an FY12 fiscal deficit of 4.6%, down from the revised
estimate of 5.1% for FY11. We believe this may be optimistic on both revenue and
expenditure estimates. Separately, the oil subsidy bill could add 70bp to the FY12 fiscal
deficit, as the budget estimates do not provide for under-recovery compensation to oil
marketing companies (OMCs) during the year (for diesel, kerosene and LPG).
No major tax changes in aggregate…
The standard excise and service duties were maintained at 10%, although some market
participants were expecting a hike in the excise duty to 12%. As such, there should be no
negative impact on inflation and domestic demand. The reduction in the corporate tax
surcharge to 5% from 7.5% results in a 77bp decline in the mandated tax rate to 32.4% from
33.2%. Special economic zone (SEZ) units and developers are being brought under the
minimum alternative tax (MAT) in line with Direct Taxes Code (DTC) recommendations. The
reduction in taxation of dividends from foreign subsidiaries to 15% from the current marginal
rate is a positive for companies with foreign operations.
… and no major reforms either
Although the goods and services tax (GST) bill is expected to be introduced in parliament
this session, the finance ministry does not expect it to be implemented by April 2012, which
will disappoint current market expectations. The provision of subsidies via direct cash
transfers should help reduce subsidies but is only expected to be implemented in April 2012.
Budget picks and pans
Picks: ITC (no hike in excise duties versus market expectations of a hike), Tata Motors
(status quo on excise and lower profit repatriation tax for Jaguar Land Rover), and Hindalco
(lower profit repatriation tax for Novelis). Pans: Cement stocks (rise in per bag excise
duties), Reliance Industries (MAT on SEZ to increase cash tax rate) and Sesa Goa (increase
in export duty for iron ore lumps and fines).
Macro-economics view
Our Chief Economist, Sanjay Mathur, expects the FY12 fiscal deficit target to be missed, as
both the revenue and expenditure estimates appear aggressive.
The following section is an extract from Top View: India, FY12 budget: hard to deliver, published
by Sanjay Mathur and Teck Wee Yeo on 28 February 2011.
The FY12 (fiscal year ending March 2012) budget seeks a significant reduction in the fiscal
deficit to 4.6% of GDP from a downwardly revised estimate of 5.1% previously.
We expect the FY12 target to be missed – both the revenue and expenditure estimates
appear aggressive.
The borrowing programme is commensurately lower. However, given our view on the fiscal
situation, this is likely to be breached.
The government has doubled the aggregate foreign investment ceiling in corporate bonds to
US$40bn by increasing the share that can be deployed into infrastructure bonds. While this
may be a temporary positive for the INR, in the longer term we expect fundamental issues
such as the high current account deficit to dominate.
In the fixed income space, there are few immediate implications until the slippage becomes
evident. However, as the issuance programme resumes in April, we expect a bear steepening of
the yield curve as supply will likely be concentrated at the long end of the curve.
Financial markets have reacted favourably to the FY12 (fiscal year ending March 2012) central
government budget. Market participants were particularly gratified by the FY12 deficit target of
4.6% of GDP as opposed to the 4.8% level mandated by the 13th Finance Commission and the
attendant reduced size of government borrowings. Net borrowings have been forecast at
Rs3.43trn compared with market estimates of Rs3.65bn.
Whether we should be gratified or not depends on the feasibility of the FY12 fiscal target. The
fiscal target is built on a nominal GDP (NGDP) growth assumption of 14%, comprised of real
growth of 9% and a deflator of 5%. This follows an unusually strong expansion of 20.3% in the
previous year. Based on this NGDP estimate, the government expects aggregate taxes to rise
18.5%.
Our concerns with this tax estimate are twofold. GDP growth and more importantly, nonagriculture growth is peaking. Typically, tax collections tend to accelerate in the first year of a
recovery and stabilise thereafter. In FY11, the faster than expected recovery provided an increase
of 24% in aggregate tax collections, ie, the tax buoyancy was 1.2. The FY12 budget assumes
further acceleration to 1.3. Also, the two types of taxes that accelerated most rapidly were
customs and excise duties. In FY11, customs and excise taxes had increased 56% and 29%
compared with targets of 36% and 29% respectively. Now if imports are to taper off (as has been
the case recently), consumption has stabilised and base effects have become more demanding,
we think that growth in both categories will slow to a more moderate pace of around 12%. By
contrast, the budget assumes growth of 15% in customs duties and of 19% in excise duties.
The second is that there are no new tax radical measures. If anything, new tax exemptions offset
the new measures. Through new measures such as an increase in the minimum alternative tax
(MAT) from 18% to 18.5% and the imposition of a 1% excise duty on 130 new products is offset
by relaxations in personal taxes and a reduction in the corporate tax surcharge.
In the area of capital revenues, the government has retained the disinvestment target of Rs400bn.
While a number of this order is not unattainable, much will depend on the state of capital markets.
For FY11, the government has scaled down its expectations from Rs400bn to Rs227.4bn, ie, a
slippage equivalent to 0.2% of GDP. Should this be the case, the deficit would be at the mandated
level of 4.8% of GDP.
We also find expenditure forecasts to be overly aggressive. As such, expenditures are expected
to rise only by 3.4% from the FY11 level. This is not necessarily conservative stance, in our view,
as in FY11, expenditures materially overshot budgeted targets. The modest increase should be
view in the context of this overrun.
The overrun was on account of higher development spending as well as subsidies. While the
development spending overrun is digestible in that it is growth augmenting subsidies were an
outcome of higher food and crude oil prices. Now with crude oil prices even higher, a subsidy
overrun can not be ruled out. Several types of fuel including diesel, cooking gas and kerosene
remain price controlled.
Interestingly, the government has budgeted only Rs236bn as fuel subsidy compared with
Rs383bn in FY11. This appears inconsistent with the fact that international crude prices have
hardened significantly over the past three months. We also understand, but are unable to confirm
that the government has provided for fuel subsidies only for the first three quarters of FY12.
Therefore, barring a major collapse in crude prices, a subsidy overrun seems inevitable.
Overall, the point we are making is that there is scope for slippage on both the revenue and
expenditure front. The slippage will most likely surface in the second half of the fiscal year.
We now turn to the borrowing programme and its market implications. As mentioned at the outset,
the net borrowing programme of Rs3.43trn is lower than market expectations. However, the
overall impact on the market should be viewed against the following:
Fiscal slippage from the target will elevate the borrowing programme.
Unlike in the first half of FY11, the credit cycle is considerably advanced now with the
incremental credit-deposit ratio at above 100%. There should be some degree of crowding
out.
Bank holdings of government bonds are already above than that prescribed by the statutory
liquidity ratio.
Unlike in FY11, we are not certain whether the RBI would provide support to the issuance
programme.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
India Strategy
Union Budget review
The fiscal deficit target of 4.6% seems aggressive, with oil subsidies resulting
from US$100 crude potentially adding 70bp. Maintenance of excise duties is a
relief for autos and cigarettes, and a marginal positive for inflation and domestic
demand.
FY12 union budget fiscal deficit estimate of 4.6% seems aggressive
The FY12 union budget forecasts an FY12 fiscal deficit of 4.6%, down from the revised
estimate of 5.1% for FY11. We believe this may be optimistic on both revenue and
expenditure estimates. Separately, the oil subsidy bill could add 70bp to the FY12 fiscal
deficit, as the budget estimates do not provide for under-recovery compensation to oil
marketing companies (OMCs) during the year (for diesel, kerosene and LPG).
No major tax changes in aggregate…
The standard excise and service duties were maintained at 10%, although some market
participants were expecting a hike in the excise duty to 12%. As such, there should be no
negative impact on inflation and domestic demand. The reduction in the corporate tax
surcharge to 5% from 7.5% results in a 77bp decline in the mandated tax rate to 32.4% from
33.2%. Special economic zone (SEZ) units and developers are being brought under the
minimum alternative tax (MAT) in line with Direct Taxes Code (DTC) recommendations. The
reduction in taxation of dividends from foreign subsidiaries to 15% from the current marginal
rate is a positive for companies with foreign operations.
… and no major reforms either
Although the goods and services tax (GST) bill is expected to be introduced in parliament
this session, the finance ministry does not expect it to be implemented by April 2012, which
will disappoint current market expectations. The provision of subsidies via direct cash
transfers should help reduce subsidies but is only expected to be implemented in April 2012.
Budget picks and pans
Picks: ITC (no hike in excise duties versus market expectations of a hike), Tata Motors
(status quo on excise and lower profit repatriation tax for Jaguar Land Rover), and Hindalco
(lower profit repatriation tax for Novelis). Pans: Cement stocks (rise in per bag excise
duties), Reliance Industries (MAT on SEZ to increase cash tax rate) and Sesa Goa (increase
in export duty for iron ore lumps and fines).
Macro-economics view
Our Chief Economist, Sanjay Mathur, expects the FY12 fiscal deficit target to be missed, as
both the revenue and expenditure estimates appear aggressive.
The following section is an extract from Top View: India, FY12 budget: hard to deliver, published
by Sanjay Mathur and Teck Wee Yeo on 28 February 2011.
The FY12 (fiscal year ending March 2012) budget seeks a significant reduction in the fiscal
deficit to 4.6% of GDP from a downwardly revised estimate of 5.1% previously.
We expect the FY12 target to be missed – both the revenue and expenditure estimates
appear aggressive.
The borrowing programme is commensurately lower. However, given our view on the fiscal
situation, this is likely to be breached.
The government has doubled the aggregate foreign investment ceiling in corporate bonds to
US$40bn by increasing the share that can be deployed into infrastructure bonds. While this
may be a temporary positive for the INR, in the longer term we expect fundamental issues
such as the high current account deficit to dominate.
In the fixed income space, there are few immediate implications until the slippage becomes
evident. However, as the issuance programme resumes in April, we expect a bear steepening of
the yield curve as supply will likely be concentrated at the long end of the curve.
Financial markets have reacted favourably to the FY12 (fiscal year ending March 2012) central
government budget. Market participants were particularly gratified by the FY12 deficit target of
4.6% of GDP as opposed to the 4.8% level mandated by the 13th Finance Commission and the
attendant reduced size of government borrowings. Net borrowings have been forecast at
Rs3.43trn compared with market estimates of Rs3.65bn.
Whether we should be gratified or not depends on the feasibility of the FY12 fiscal target. The
fiscal target is built on a nominal GDP (NGDP) growth assumption of 14%, comprised of real
growth of 9% and a deflator of 5%. This follows an unusually strong expansion of 20.3% in the
previous year. Based on this NGDP estimate, the government expects aggregate taxes to rise
18.5%.
Our concerns with this tax estimate are twofold. GDP growth and more importantly, nonagriculture growth is peaking. Typically, tax collections tend to accelerate in the first year of a
recovery and stabilise thereafter. In FY11, the faster than expected recovery provided an increase
of 24% in aggregate tax collections, ie, the tax buoyancy was 1.2. The FY12 budget assumes
further acceleration to 1.3. Also, the two types of taxes that accelerated most rapidly were
customs and excise duties. In FY11, customs and excise taxes had increased 56% and 29%
compared with targets of 36% and 29% respectively. Now if imports are to taper off (as has been
the case recently), consumption has stabilised and base effects have become more demanding,
we think that growth in both categories will slow to a more moderate pace of around 12%. By
contrast, the budget assumes growth of 15% in customs duties and of 19% in excise duties.
The second is that there are no new tax radical measures. If anything, new tax exemptions offset
the new measures. Through new measures such as an increase in the minimum alternative tax
(MAT) from 18% to 18.5% and the imposition of a 1% excise duty on 130 new products is offset
by relaxations in personal taxes and a reduction in the corporate tax surcharge.
In the area of capital revenues, the government has retained the disinvestment target of Rs400bn.
While a number of this order is not unattainable, much will depend on the state of capital markets.
For FY11, the government has scaled down its expectations from Rs400bn to Rs227.4bn, ie, a
slippage equivalent to 0.2% of GDP. Should this be the case, the deficit would be at the mandated
level of 4.8% of GDP.
We also find expenditure forecasts to be overly aggressive. As such, expenditures are expected
to rise only by 3.4% from the FY11 level. This is not necessarily conservative stance, in our view,
as in FY11, expenditures materially overshot budgeted targets. The modest increase should be
view in the context of this overrun.
The overrun was on account of higher development spending as well as subsidies. While the
development spending overrun is digestible in that it is growth augmenting subsidies were an
outcome of higher food and crude oil prices. Now with crude oil prices even higher, a subsidy
overrun can not be ruled out. Several types of fuel including diesel, cooking gas and kerosene
remain price controlled.
Interestingly, the government has budgeted only Rs236bn as fuel subsidy compared with
Rs383bn in FY11. This appears inconsistent with the fact that international crude prices have
hardened significantly over the past three months. We also understand, but are unable to confirm
that the government has provided for fuel subsidies only for the first three quarters of FY12.
Therefore, barring a major collapse in crude prices, a subsidy overrun seems inevitable.
Overall, the point we are making is that there is scope for slippage on both the revenue and
expenditure front. The slippage will most likely surface in the second half of the fiscal year.
We now turn to the borrowing programme and its market implications. As mentioned at the outset,
the net borrowing programme of Rs3.43trn is lower than market expectations. However, the
overall impact on the market should be viewed against the following:
Fiscal slippage from the target will elevate the borrowing programme.
Unlike in the first half of FY11, the credit cycle is considerably advanced now with the
incremental credit-deposit ratio at above 100%. There should be some degree of crowding
out.
Bank holdings of government bonds are already above than that prescribed by the statutory
liquidity ratio.
Unlike in FY11, we are not certain whether the RBI would provide support to the issuance
programme.
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