Budget 2007-08: Impact Analysis

The Finance Minister deserves credit for striking a fine balance between growth and inflation in the Union Budget (2007-08). This budget is in line with the policies that UPA government set a couple of years back.

The budget has allocated more towards education, health, employment, continued infrastructure spending and public- private partnership and has also attempted to improve productivity levels in agriculture.

FRBMA targets on track, Fiscal deficit at 3.3% and Revenue deficit at 1.5% of GDP, will help enhance the sovereigns rating. The maintenance of overall fiscal prudence simultaneously maintaining expenditure on key sectors is remarkable.

This will help the economy to grow at the targeted rate of more than 9%.

The only gray area in this budget seems to be, initiated of curbing the ongoing speculation in the rice and wheat commodity trading instead of incorporating proper regulatory norms, government took a drastic step to stop the future trading altogether. Although rice trading is not as big as wheat, actually it seems that government has put the trading restriction to help FCI during the coming wheat procurement season. Once the procurement season is over, government may restore the trading in wheat subjected to adequate quantity of procurement and stabilization of wheat retail prices. Overall it’s like contradicting its own reform policies and moving a step backward and thus gives a wrong signal to overseas investors.

Capital Market Issues:

Individuals to be allowed to invest in overseas securities through Indian mutual funds. This will channelise domestic investors’ funds into foreign investments. Besides a positive diversification option for domestic investors, will also increases product option for domestic mutual funds.

Delivery based short selling allowed to institutions in capital market will create the required market depth and reduce volatility in the stock markets, thus making markets more efficient and transparent.

Setting up of security borrowing and lending mechanisms for capital market will increase market efficiency and allow more market linked products to be offered.

It seems that allowing Promoters to raise debt through Exchangeable Bonds will allow Indian companies to unlock a part of their holdings in group companies for meeting their financing requirements. Exact impact on cost of capital can only be accessed after looking at the policy blue print.

Money Market Issues:

Setting up of Autonomous Debt Management Office for GOI Debt Management in MOF will give greater flexibility to GOI on terms, on tenure and in markets. Thus, RBI will be more concentrated as the monetary authority and a regulator.

General Tax Provisions:

The reduction in customs duties peak rate for non-agriculture products from 12.5% to 10% will leads to cheaper imports. Thus, domestic industries will need to improve their efficiencies in order to compete.

Effective rate of Dividend distribution tax raised from 14.025% to 16.995% for companies and to 25% for dividends paid by money market and liquid funds will reduce the tax arbitrage available to investors in these funds.

Additional Educational Cess of 1% raises overall tax rates but if directed rightly, it will be a big plus for providing talented inputs for the booming economy in the long term.

The inclusion of ESOP in FBT will cumulatively impact not only IT but also the emerging sectors.

No hike in service tax, the enhancement of exemption limit to Rs 8 lakhs will keep the small service tax provider out of the tax net. Thus, helps small service providers to me more competitive and efficient. Exemption limit enhancement in service tax is the first step towards the GST.

No increase in STT and the Capital Gains provisions is a big positive, completely ignored by the market.

Personal Tax rates have not been changed though a small increase in minimum slabs has been made, which is neutral.

Sectors Review:

Positive Impact:

Agriculture, Water & Irrigation

The exemplary emphasis that the honourable finance minister has put on the agricultural sector in this budget would result in revitalization of Indian agriculture. Several measures announced to raise agricultural productivity and better output as land & water is scarce. The increased allocation to agriculture in terms of rural infrastructure will spur agriculture to move beyond its present unsatisfactory growth rate of 2.3% to the targeted 4 %, in turn improving the living standard of rural India.

Exploring the alternative to fertilizer subsidy will leads to better economies at farm level & thus will not only bring down the overall cost of cultivation but also curb the total fertilizer subsidy bill.

To support the re-plantation of Tea plants, the budget has launched a SPV Fund. Government will soon put in place similar financial mechanisms for coffee, rubber, spices, cashew and coconut.

Pipes larger than 200 mm diameter used for water transport will be fully exempted from excise duty and thus helps in building the required irrigation and water system. Water management, efficient irrigation, farmer training etc will also help not only in achieving the required growth but also able to curb inflation on agriculture commodities. The higher outlay on drinking water schemes will go a long way in improving living conditions of masses.

Banking & Housing Finance Companies

The government proposal to acquire RBI’s equity in SBI backed by budget allocation for resources is positive. This will help is SBI in merging its subsidiaries banks with itself and get synergy in business at branch level. This will also leads to enhanced limits for FII investment in SBI. Banks to benefit from the renewed thrust on agriculture and focus on SHG’s. This would benefit especially the PSU banks that have agricultural portfolios. Profits making corporative banks now have a level playing field with domestic banks. They can claim deductions for making provisions for bad debts. Banks and HFC are to benefit from the establishment of Mortgage guaranteeing authority. State owned banks will also benefit to an extent to the benefits extended to RRB’s. Other measures like Credit wrap insurance for Infrastructure also help banks in increase credit flow.

Insurance

National Agricultural Insurance Scheme to be continued with a provision, a whether based crop insurance scheme to be started on a pilot basis, are some of the indicators of governments increased focus on agricultural insurance. Extending the NIC’s Senior Citizen health insurance scheme to other three PSU insurance companies will bring the required competition in Health Insurance, at least to Senior Citizens. A proposal to bring a comprehensive bill on insurance rules & regulation will makes the industry more competitive & transparent.

Power generation and distribution

The new initiatives by bringing more private sector participation in power generation and transmission and increased budgetary support will benefit the industry. The proposed seven more Ultra Mega Power Projects under process, besides the two already allotted during the current fiscal year and other initiatives like facilitating setting up of merchant power plants by private developers and private participation in transmission projects; will at last helps in achieving the required electrical energy requirement.

Textile and Handloom

Accelerated approval of integrated textile parks, continuation of TUF with higher budgetary allocation will benefit the industry. Customs duty cut in fabrics augurs well for garments. However, at the yarn stage, synthetic and rayon yarn continue to attract higher excise at 8% compare to cotton yarn, against which duty exemption can be claimed. Custom duty cut on PSF and PFY to 7.5% would lower the prices.

Speeding the cluster approach will benefit the handloom industry.

Gas

Extending the concession under section 80IA for infrastructure facilities to gas pipeline and storage facilities will further help in building the required infrastructure. This will propel the growth of city gas distribution and thus helps government in decreasing the LPG subsidiary bill.

Hotel & Tourism

Increased tourism outlay from Rs 423 crore to Rs 520 crore is marginal, but increased anyway will help the industry as a whole. Sops will be given for specific hotels and conventional centers, coming up between March 31’2007 and April’2010. This exemption is limited to National Capital Territory of Delhi.

Pharmaceuticals

With better allocation for health care services & infrastructure, the duty reduction in most chemicals from 12.5% to 7.5% as raw material, and exemption from service tax on new drugs’ clinical trials, will propel the growth in pharmaceutical industry. The exemption of weighted deduction of 150% for expenditure relating to R&D for five more years until March 31, 2012 will give further impetus to R&D spends. Increasing focus on anti AIDS and immunization schemes is expected to benefit MNC & large formulation companies more.

Fertilizer

Delivering the subsidy directly to the farmer will help in streamlining the working capital requirement of the fertilizer industry and thus improves margin.

Food Processing

Reduction in custom duty on food processing machinery and full exemption from excise duty on all kinds of food mixes including instant mixes will help the industry to achieve higher growth.

Gems and Jewelry

Reduction in custom duty on polished diamonds from 5% to 3%, rough synthetic diamonds from 12.5% to 5%, and unworked corals from 30% to 10% is likely to benefit the players in both directions.

Health / Education

The stress on health and education, particularly rural and higher budgetary allocation will again put the industry on the growth trajectory, backed by reduction in import duty on medical equipments to 7.5% and greater emphasis on Health Insurance cover.

FMCG

The duty reduction in most chemicals from 12.5% to 7.5% will helps in reducing the cost of production substantially.

Neutral:

Metals

Cut in peak custom duty will not impact the steel industry as the current rates are already low at 5%. The only positive to the metal industry is limited to curbing the export of natural resources like iron & chrome ore by getting under exports tax net. Although a moderate tax rate of Rs 300/tonne & Rs 2000/tonne on iron ore & chrome ore respectively is negligible at this stage, it’s definitely going to have an impact in long run since India accounts for 13% of global sea born Iron ore trade. The export duty on ore will help significantly in improving the sentiments towards the up-gradation of existing industry as well as setting up of new green field projects. As steel industry is using coking coal and not non coking coal, the reduction in duty on non coking coal to zero will not have any impact. The overall financial impact to the sector is neutral.

IT & ITES

On corporate taxation, the Minimum Alternate Tax (MAT) has been introduced for IT companies, which is not in a way retrograde because they have always been under a scanner being profitable companies. Most of the companies in the sector are enjoying the STPI scheme benefit till 2009 and thus will pay higher taxes 2009 onwards. The impact on large players will be minimal as the effective tax paid is closer to the Mat rate. However, the impact would be higher on tire-II & III players, since their effective tax is lower than the MAT rate.

As far as bringing the ESOP’s under FBT, it will affect more to tire II & III instead of tire I, which has almost stopped issuing the fresh ESOP’s except to core management team.

Hardware players would marginally benefit from excise duty exemption on flash memories and DVD players.

Telecom Services

Service tax levied no the development and supply of content for use in telecom services is not expected to have any impact due to setoff provisions. Request to DOT to constitute a committee to streamline the present multifarious tax structure is not expected to have an immediate impact. The extension of exemption of 4% additional custom duty on cellphone parts, accessories till June 30, 2009 will prevent immediate increase in prices. Overall the impact is neutral.

Auto

No excise hike, but the imposition of 1% education cess, taking total cess to 3%, effectively raised excise rates. The industry will pass them on to the consumer. Car and bike makers would hope to gain indirectly, as more disposable incomes come into play. Cut in peak custom duty on certain component to10% from 12.5% will not benefit OEM’s significantly due to high indigenization level and cost competitiveness of the domestic auto ancillary. Overall, the auto industry impact varies between neutral to negative with no significant change in demand.

Logistics

The completion of golden quadrilateral and other national highway developments will benefit the industry. CST reduced from 4% to 3% - better but not good enough; industry wanted a 2% reduction, but got 1%. At present, the paperwork for the industry remains the same and only on abolition of CST, does logistics really begin to make savings.

Negative Impact:

Cement

The finance minister has tried to use a carrot and stick approach to induce cement manufacturers to reduce cement price, which will only move the sector towards the black marketing era. Cement, being a commodity, price is determined by the market and not certain at the time of dispatch of goods. Thus, bringing Cement under differential duty structure will tighten the supply in certain areas and may result into black marketing. Now, companies will either increasing the cement price by Rs 12/bag or have to absorb the additional excise duty on Rs 210/bag. While former will further irk customers and government; latter will eat into the profit margin of companies.

Real Estate, Infrastructure

FX reserve to be used for Infrastructure Funding through two SPVs is a positive sign. Over time better returns and cheaper source of finance for infrastructure players, will allow them to get wider sources of external borrowings.

Promoting the flow of investment to the infrastructure sector by permitting mutual funds to launch and operate dedicated infrastructure funds, creating more avenues for investments, will also benefit the investors’ fraternity.

Infrastructure development companies will loose on account of bringing the designing & work contracts under service tax net. Besides this, the differential duty structure on Cement will also put pressure on the cost if cement companies decided to pass on the excise duty to consumers.

The extension of service tax to cover rental of commercial properties is unwelcome as it will increase the cost of operations of the retail sector.

Oil

Oil marketing companies will benefit from the 2% reduction in excise duty. Oil fields service companies will lose out because of service tax on oil field services. This will expected to raise the cost of production for exploration companies.

Petrochemical

Reduction in import duty on almost all chemicals, plastics & feed stocks from 12.5% to 7.5%, man-made fibers to 7.5% from 10%, raw material like DMT, PTA & MEG to 7.5% from 10%, will definitely put pressure on domestic producers top line as well as bottom-line.

Mines and minerals

Inclusion of mining service in service tax net and imposition of export duty of Rs. 300 per metric ton on export of iron ore and Rs. 2,000 per metric ton on export of chrome ore bring an adverse situation for the Industry.

Tobacco

Increase in excise duty on cigarettes and biris coupled with withdrawal of exemption containing tobacco and other tobacco products will have an adverse affect on industry.

Overall, what you see today in the markets is not just a reaction to the budget but because of jitters across the world. This entire thing will play out in next two to three weeks and after that we will have the next phase of the bull market. It is a temporary phase, and adjustment of the market to the current macro economic scenario. Given the meltdown, stocks across the sectors have become attractive. Over the next two to three years mid-caps will perform better than stocks of larger companies.

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