Budget 2011 - What's cooking?

From television screens, newspapers, and websites to workplaces, cocktail circuits, and golf courses and whether among corporate executives or housewives, if there is one topic that is prominently discussed during the month of February, it is the much-awaited Union Budget. Whether you understand the nitty-gritty of economics or not, the budget is always a keenly watched event, for it offers an insight into how your finances are likely to shape up in the coming financial year. What the Finance Minister will do has always been a closely-guarded secret and the prologue every time covers the expectations and speculation on what would probably come out.

For us, nothing is more important than the investors who have always looked at DSIJ to have a correct perspective of every aspect that impacts them. Today the mood on the street is sombre as market volatility continues to take its toll every single day. From a peak of 21,000 posted in November 2010, the Sensex has corrected by almost 16 per cent and is now trading at the 17,593 levels. A lot of wealth has already been destroyed, giving investors a nightmarish experience in the New Year. The overall volumes have dropped sharply and even the frontline counters are witnessing this pressure. While everyone knows this has happened, no one is aware as to how long it will last. Experts continues to cook their own theory about finding the bottom from where the market would bounce back, while others continue to hunt for majors triggers, which will not only stop this downside but also give a new direction to the market.

This major trigger currently is none other than the budget itself. Though the markets have over the years challenged the relevance of the budget as a major event, in uncertain times, when investors tend to be confused, there could be no major guiding star than the budget and hence we believe that the budget as a trigger will never lose its relevance. Industry associations or experts, investors, corporates or people at large will continue to have their wish list as the budget season nears and this year is no different. Here is a broader view of what could probably come up and some suggestions which we think are relevant in today’s economic landscape.

A Tightrope Walk
While many would believe that last year’s budget was a tightrope walk for the government given the fiscal deficit which was at a 15-year high of 6.6 per cent, we at Dalal Street Investment Journal believe otherwise. We think the forthcoming budget would be more of a tightrope walk for the government. Last year, though the fiscal deficit was at its peak, the huge success of the 3G auctions which brought in Rs 1,06,262 crore to the government kitty, followed by a better-than-expected tax collection in the first nine months of FY11 and the disinvestment proceeds, helped the government to reduce its fiscal deficit. In fact, for 9MFY11 the fiscal deficit was down by 45 per cent and for FY11 the fiscal deficit could be less than the earlier budget estimate of 5.5 per cent of the GDP.[PAGE BREAK]

Now, in the current budget the government needs to be aggressive on the disinvestment front as it doesn’t have the luxury of a windfall that the 3G auctions brought in last year. How well would it be able to do so would depend on how fast the political scene normalises from the shocks that have been thrust on it by the various scams. Besides, with a mixed bag of numbers that are thrown up by the IIP, rising input costs, and rising interest rates, the growth curve may moderate going forward. If that is the case then it may hit the government kitty on the tax revenue front. Besides, if the stock market sentiment continues to remain volatile on the back of persisting inflation concerns, it may mean that the government may not be able to generate the gains it expects from the disinvestment process.

V K Sharma, Business Head - Private Broking & Wealth Management, HDFC Securities agrees and says, “While the lack of the 3G windfall gain is one part, we also don’t have the luxury of the lower crude. Besides, considering the weak market scenario, it would be difficult for the government to raise the expected amount from IPOs or FPOs they would line up in the coming period.” Another significant initiative that may bring in a windfall gain for the government is the probability of garnering black money through an amnesty scheme. This is something similar to what the government had done in 1997. While the government has already been facing a lot criticism on the black money front, the amnesty scheme would be a step in countering that criticism. In addition, it would also bring in the much-needed inflows required to keep the deficit under a check.

It should be recalled that in 1997 the government was able to garner around Rs 10,000 crore under this scheme. And considering that the Indian economy has grown quite substantially since 1997, imagine the quantum of funds that may come in if the scheme is implemented successfully. But again, in the words of the FM himself, it’s a double-edged sword as at one end of it is the ability to tap money that has been hidden for years and at the same time it tends to draw a lot of criticism as it would be unfair to the honest tax payers. However, the flip side of this could also be that despite the government assurances, the scheme could be a flop if not many come forward to disclose their unaccounted money.

An expert group on the amnesty scheme is already working on the same and would advise the FM soon. We believe the government has got its job cut out for itself whereby it has to bring in a balance of containing the fiscal deficit, fuelling growth momentum, controlling inflation and last but not the least, addressing the lack of governance concerns. We believe it isn’t the last year’s budget but the forthcoming budget which will actually be a tightrope walk for the government.[PAGE BREAK]

Stimulus Package To Stay
Considering the fact that rampant inflation is already turning into a major concern for growth, we don’t believe that the government will further jinx this by going for a complete roll-back of the stimulus package it had announced almost two years back. It should be noted that the government had announced three stimulus packages in FY09 to help push the economy back on track. Though the current fiscal could have been the right time for a complete roll-back of the stimulus packages considering that the economy is growing at close to 9 per cent, the rising inflation and weak industry numbers seen in the month of November have created a road-block on this front. [INSERT_1]

Besides, at a time when inflation has become a global concern that has the potential to derail the growth momentum, we don’t believe the government would take such a rash decision. Reflecting on this situation, Anjan Roy, Adviser for Economic Affairs, FICCI, says, “Currently the industry is under pressure from the tightening monetary policy and also the raw material squeeze. On top of it, if this remnant of stimulus measures, which is actually not for industries but for the consumers, is withdrawn then I suppose it will not be a very pro-growth approach.” Hence there is a good possibility that the government may not touch the stimulus package in this budget.

The Right Priorities
With the tax collection from corporates rising by 22 per cent and the indirect tax collection shooting up by 42.8 per cent, the FM looks in no mood to hurt the government coffers and may continue with a similar tax structure in the coming budget as well. In fact India Inc has voiced its expectations to the FM, wherein it has asked for a corporate tax rate of 25 per cent instead of 30 per cent, while it is also considering MAT as redundant. It expects the government to either abolish it or bring down the rate from about 20 per cent to 15 per cent. It also expects the government to not increase the excise duty. The reason behind these views is that it would enable better surplus with the corporates, which could then be invested to drive future growth.

However, considering the repercussions of tax cuts on the government kitty, the FM wouldn’t take any step that would impact his inflows, especially when he has to manage the fiscal deficit in a more prudent way and bring it in line with the estimates he had presented in the 2010 budget. As far as MAT is concerned, the rate is more in line with the DTC recommendations, which is around 20 per cent. Thus there is no way that the government will accept abolishing the MAT or even reducing it for that matter. However, there could be some relief for individuals though and one can expect an increase in the limit of income exempted from tax to Rs 1.80 lakh from the current level of Rs 1.60 lakh.[PAGE BREAK]

What this will do is help put more money in the hands of the tax payer and that looks like a very probable step that the government could take considering the fact that again it is more in line with the DTC recommendation of setting the exemption limit at Rs 2 lakh. That apart, as far as the GST and DTC are concerned, it is of public knowledge there has been a delay and the implementation is only expected to take place by April 2012. However, we expect the government to give more clarification on the status of the GST and DTC and what measures they would be taking to expedite the implementation of this process. Will all this help in shaping up the economic growth going forward? Let us look at the various areas and how these are likely to be addressed in the forthcoming budget.

Inclusive Growth And Rural Development
Though tax collections have been pretty robust, adding to the government kitty, the government would prefer to curb unnecessary expenditure as a measure to keep the deficit in check. However, there is every possibility that it may spend on issues which are likely to foster inclusive growth. Facilities such as food, health, education, and infrastructure are critical to achieve this inclusive growth, and we believe that the government would continue to spend generously on these fronts which form a vital part of the social sector. It should be noted that the spending on the social sector increased by a massive 37 per cent to Rs 1,37,674 crore last year and a similar allocation could be lined up in this budget as well.

For the UPA government the focus has always been the ‘aam aadmi’, resulting in a better deal for rural India. Hence, higher allocations cannot be ruled out for the government’s flagship schemes like the infrastructure projects under the aegis of Bharat Nirman and especially the Mahatma Gandhi National Rural Employment Guarantee Scheme (MGNREGS). This higher allocation would be required to take care of the linking of minimum wages under the MGNREGS to the consumer price index. It should be noted that the total outlay for this scheme has increased sharply from Rs 16,000 crore in FY09 to Rs 40,100 crore in FY11, making it the government’s largest welfare spend so far.

The other thing that the government could probably do in the developmental programmes for the social sector is to push for cash entitlements rather than in kind. This will benefit the intended beneficiary directly, besides the plugging pilferage that occurs in the system. The public distribution system (PDS) is a classic example, which has been dogged with pilfer-age due to massive subsidy. So if the beneficiary gets cash or food coupons worth their entitlement, then he or she could buy food grains from the open market, while the store owners get that cash or cash in food coupons directly from any bank.[PAGE BREAK]

While this is one example, this concept could be extended to other schemes too such as the Mukhyamantri Balika Cycle Yojna scheme in Bihar, which was a runaway success. Here a cheque of Rs 2,000 was given to school girls upon passing class VIII (a sweetener for the girls to stay in school and educate themselves) so as to buy a bicycle for themselves. This scheme didn’t go for the bulk purchase of cycles through tenders and distributing them as they believed it might have led to a rise in corruption in the future. Hence, such innovative schemes would not only increase the success ratio of the government’s programmes but mainly benefit those for whom it is intended for, thereby creating a more meaningful social spend.

Agricultural Reforms
If India is talking about 9 per cent plus growth for a foreseeable future or even a double-digit GDP growth for that matter, then agriculture will play a major role in giving that edge to the overall GDP number. In fact the GDP growth of 8.9 per cent in the first half of 2011 has not just come from the industry and services, but also agriculture, which carries a weightage of around 15-16 per cent in the GDP. Agriculture has been a silent performer this fiscal and has shown a growth of 3.4 per cent. This is compared to the 1.4 per cent growth seen during the same period last year. Considering the potential that agriculture has, it is only about time that agricultural reforms pick up pace as it has a two-fold advantage.

First, it would address the supply side issues which could take care of the problem of inflation to some extent and second, push the overall GDP growth. Considering the fact that agriculture is estimated to grow at 4 per cent plus for the current fiscal, the government would continue to support agriculture through higher allocations. In the last budget the agricultural credit target was increased by Rs 50,000 crore to Rs 3,75,000 crore, a rise of 15 per cent. We expect the government to increase this target further in the forthcoming budget. Also, we don’t expect the government to tamper with the 2 per cent interest subvention scheme for farmers who repay their short-term debts asper schedule.

That apart, considering the inflation we face due to the supply side constraints, we also expect the government to address the issue of opening up of retail trade and meeting the additional requirement of storage capacities. Last but not the least, we are of the opinion that the government should put more thrust on the implementation of the National Food Security Mission (NFSM), which was launched with the objective of increasing production and productivity of wheat, rice, and pulses on a sustainable basis so as to ensure food security of the country.[PAGE BREAK]

Infrastructure Spending
One of the impeding factors for any country’s growth is its infrastructure bottlenecks and if India has to sustain growth at 9 per cent or plus, then infra-structure-related reforms should happen at a brisk pace. Dinesh Thakkar, CMD, Angel Broking, says, “Our cur-rent infrastructure investments of 5-7 per cent of GDP need to go up to 9-10 per cent if our growth trajectory is to go up. The government will hopefully focus on this big picture and will not get too involved in the minutiae of the numbers.” India already knows this and infrastructure development has been the government’s priority. In fact if these numbers are something to go by then India’s total investment in infra-structure by March 2012 is estimated to be at around USD 500 billion, while it is estimated to spend a massive USD 1 trillion in the next five year plan.

However, while all this looks quite rosy enough and we are confident that the government will continue to give strong support to infrastructure through a higher allocation, the problem is not with the planning but with the execution part of it. Thus it is basically the delay in awarding the projects, the funding issues of these projects, and the eventual cost over-runs that are some of the major concerns we face. We expect the budget to addresses these issues first where the government looks into a mechanism for the speedy awarding of such projects. To address the funding issue of these projects, the government could also look into a deepening of the bond market, which has been widely discussed. And finally, the government could probably incentivise and encourage public private partnership as also iron out the wrinkles, if any, in the regulatory procedure to attract private partners and speed up the infrastructure development process.

Addressing Governance Issues
The government has been in the news for all the wrong reasons in the recent past. Whether it was the CWG or the 2G or even the Adarsh Society scam, the issues have been hurting the image of the government. There is some serious governance deficit which needs to be addressed. Though the government has already gone in for damage control with the arrest of the former telecom minister A Raja, despite the ire of its ally DMK, the issue is far from over. We believe therefore that the government will now want to put its image in order and display zero tolerance for such scams and corruption so that it may come out with a slew of measures or set up a commit-tee to address governance deficit in the budget session itself. One has to look at the issue practically and if the government really wants to improve its image, it has to bear in mind that a simple arrest followed by a bail will not really work. What is needed is for the government to work on such scams to adopt a procedure by which the huge loss in such scams is recovered from the individuals, firms or companies which have benefited from them. That would bring in more transparency and restore the faith of the corporates, investors, and people at large in the system.[PAGE BREAK]

What’s In Store For The Market?
The market is well-aware of the FM’s limitations this time around and hence it isn’t expecting any major reforms from the budget, nor is it expecting any changes in the taxes both on the direct and indirect front or any negative surprises. But the market would be more eager to understand the government’s stance on containing fiscal deficit besides knowing what it would do to maintain the growth momentum in the light of concerns such as rising inflation, increasing costs, etc. But what one should understand is that the market is reacting more to the political uncertainty, which has come into the limelight this time around than the budget itself.

Hence the usually seen pre-budget rally also seems to be missing. In fact if one looks at the market performance on the budget day, over the past four years there has been no major impact of the budget on the markets and the variation on that day was in line with what normally happens on any other trading day, barring 2009. Explains Sharma, “What’s more important than the budget is to understand as to when are these scams going to alleviate. Secondly, what is the government doing about black money? Because if it is, then it would be bad for the markets initially as this money that has come through the PN route will go back. But the good news is that that this will be a good opportunity for investing and considering that this money would re-enter the market through the right door, India is only going to thrive.”

Even as we go to the press there is some good news on the standoff issue between the government and the opposition. The government seems to have softened its stand on the issue and was seen hinting at a JPC probe into the 2G scam. The Finance Minister’s can-did admission that no price was higher that the need to restore normalcy in the house pointedly hints that the government will very soon accept the demand for a JPC probe for the 2G scam. This we believe will happen even before the budget and would act as a major positive trigger for the beleaguered market. Meanwhile, an analysis of what can be expected from the budget can never be complete without including some expert perspectives.