DSIJ Mindshare

Budget 2013 or Elections 2014 ?

Finance Minister P Chidambaram will be presenting the last of the Union Budgets for the UPA II before we go to elections in 2014. Will he be able to help the markets sustain their positive momentum by meeting expectations? Here is what he should ideally be doing to ensure that the markets maintain their upward momentum and at the same time the country’s finances don’t suffer from vote bank motivated government largesse, says Shailendra Lotlikar.

Over the past three to four months, the Indian government’s stance of proactively supporting the markets has been more than evident. Its firm resolve to take forward the reforms agenda and stick to it has changed the market sentiment for the better.

The corporate results have shaped up according to expectations, and in some cases, much better than what was expected. The Sensex is within striking distance of a lifetime high, and it doesn’t look like there are any factors that could go against the markets right now. The next big trigger for the markets in these circumstances will be the Union Budget, which is due on February 28, 2013.

Being the last of the regular budgets that the UPA II will announce before we go to elections in 2014, what should it shape up like? While a populist budget could hurt the government’s resolve in managing its finances (read: Fiscal Deficit and Current Account Deficit), a practical one, on the other hand, could dampen its poll prospects.

So, what should the FM be doing in this budget? Whatever he does, it should certainly be in a direction that will enable the markets sustain their upward momentum. Will there be any surprises in store? There had better not be any. What must the Finance Minister do to ensure a good investment climate? Here is what he needs to do in order to make sure that he doesn’t spook the markets, which have been on a roll since the time he came back to the North Block and ushered in the new wave of economic reforms.

While on our part, we have drawn up a very clear framework which will ensure all of the above, we also sought the views of leading market participants and intermediaries in order to know what the market at large is expecting from the FM this time.

On The Broader Front

After months of criticism that it faced for lacking the will to put the country back on the growth track, the government finally began doing its bit four months ago when it initiated the reforms process. What really turned the tables around was the return of P Chidambaram to North Block. His reinstatement as FM after Pranab Mukherjee was elevated to the President’s post came in as the first sign of what the government was probably gearing up for.

Shortly thereafter, the wheels of reform began moving at a steady pace. Pushing its way past the opposition’s resolve of disrupting the proceedings of the House, the government has successfully pulled through a spate of reforms that have been instrumental in changing the economic situation in general and the market sentiment in particular. But putting the wheel into motion is just one part of the story. It is equally important to ensure that it gathers sustainable momentum.

This leaves no iota of doubt as to what the FM needs to do in this year’s budget. He will have to carry forward the reforms initiated by proposing appropriate provisions in that direction. There is a strong need to ensure that nothing in the budget stalls the upward march of the markets. So, what exactly should the FM be doing? Here is what.

The most critical job at hand for the FM is to spur overall economic growth. This can come about by providing the right support points for certain sectors. Among those that need the most attention right now is Infrastructure, and within that, Power. Two factors that will help these sectors are higher allocation of funds towards the development of these sectors and probably tax sops, particularly for the Power sector, which will help it bounce back. Our take on this part is substantiated by what Motilal Oswal, Chairman and Managing Director, Motilal Oswal Financial Services says. According to him, “Though we need to have an aggressive plan for GDP growth to come above 7 per cent there is also a need to maintain fiscal discipline. There should be more thrust on aggressive infra spend and subsidy provisions on petrol and diesel should be removed.”
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Does this mean that other sectors don’t really need any attention? Of course not. But does the FM really have the leverage of doling out sops to all sectors right now? That does not seem to be possible either. This leaves us with a more realistic option of rooting for the most desired of the lot. Both these sectors have been fairly beaten down, and a slight lift by way of budget provisions to these will provide a further fillip to the markets as stocks from these sectors find favour once again.

On The Tax Front

Taxation: Status Quo Please 

Needless to say, there are a lot of expectations on this front. Though the FM has a very small window of providing any major tax sops, whether on the corporate or on the personal tax front, it is equally true that this is a very important prerequisite if the markets are to maintain their steam.

There have been innumerable discussions on the need to channelise savings into the equity markets. But to save enough, either your income needs to go up or your taxes need to come down. Assuming that incomes will see a moderate rise going forward with a gradual improvement in economic conditions, the FM will have to bring down taxes on individuals. This will lay some extra savings in their hands, which will eventually find their way to the markets.

As easy as it may sound, such a move may come with its own set of pitfalls. Tweaking the tax rates or even the slabs will lead to lower tax collections. This, in turn, could spell danger for the government’s finances. On the corporate tax front too, nothing much can be expected. At best, if left unchanged, it could mean a slight cushion for India Inc., which could benefit if the economy continues to improve as it currently is. But as we said, it is a prerequisite and the FM will have to move in that direction. We are sure his ingenious mind will work out other ways of compensating for this lowered source of income by bringing a set of services under the service tax net. What do experts feel about this? According to Dhirendra Kumar, CEO, Value Research Online, “The government has been working very hard to stimulate growth and it is looking forward to the RBI joining hands with it in this effort. Therefore, I do not see any indirect tax hikes in the budget. If at all it does so, I see a serious disconnect with what is being done by the government till now and will be a growth dampener.”

The real cause for worry would be any new provision that seeks a differential taxation based on how rich you are. First heard of in the US, this concept of a higher taxation for the economic elite has gained currency here too. If such a proposal materialises, it could put a large chunk of high net worth investors on the backfoot. Good sense has always prevailed on our FM, and we expect the same even now. Given Chidambaram’s sensitivity to the capital markets, we are sure that he would avoid any move that could hurt the market sentiment. Increasing taxes on the rich is surely one that he would best avoid right now.

STT + CTT? Will They Benefit The Market?

In 2004, when the UPA first assumed power, Chidambaram was the Finance Minister. In the Union Budget for 2004-05, he introduced the Securities Transaction Tax (STT). This brought about a sea change in the taxation of financial securities. In fact, the markets had reacted to this provision adversely on the day it was declared, with the Sensex going down almost two per cent. In hindsight though, that seems to have been a flash response. We ended FY05 on a positive note, and the Sensex gained a good 12 per cent over that year.
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How does all this become relevant now? Well, there has been a whole lot of talk around the FM introducing a similar tax on commodities transactions (CTT) this year. If this happens, players in that segment are sure to bear the brunt. On the other hand, a section of the market is of the firm opinion that it will help in creating a level playing field between equity and commodities as asset classes. We gather that there is intense lobbying happening against the levying of a tax on commodities, but so far, there are no concrete signs of it being imposed and it may still fail to see the light of day.

Will an imposition of such a tax really help the government in financial terms? Between April and August 2012, the total STT collected by the government stood at Rs 1712 crore. Annualise this, and you have a collection of around Rs 4100 crore for the full year. That is just about one per cent of the direct tax collections of the government. Does it really matter in terms of improving finances? We don’t think so. But yes, it could help in moving funds away from the commodities markets to equities, as even a small percentage of such taxes eats into the returns and hurts particularly those investors who trade on volumes (speculators). So, the best course would be that the FM should do away with STT rather than bring in CTT to ensure the level playing field that is being sought.

RGESS

Fine-Tune And Continue

As the FM last year, Pranab Mukherjee had launched a rather ambitious and novel scheme to address the lack of retail participation in the equity markets – the Rajiv Gandhi Equity Savings Scheme (RGESS). This scheme was meant to invite newer participants from the retail fold into equity by allowing for a tax deduction for first-time investors in the equity market.

The scheme had been drawn out quite meticulously. Any new investor in the equity market would be eligible for a deduction under Section 80CCG to the extent of 50 per cent of the amount invested. This benefit was in addition to the deduction available under Section 80C. How much of an individual’s investment was admissible for deduction? A mere Rs 50000! Now that should give you an indication of many factors, including the strata of the population that the FM had in mind, the quality of investors that he wanted to come to the market and also on the limited thought that probably went in before coming up with such a scheme. 

We are yet to see any meaningful development on this front, and clarity is still emerging on the factors that could really help this scheme take off. Chidambaram has a bigger role to play here. To begin with, he will have to ensure that the scheme continues going forward too. Moreover, it needs to be fine-tuned in order that it becomes really beneficial and serves the purpose it is intended for. If you read the fine print carefully, currently an investor saves anything between Rs 2500-5000 in taxes from this scheme. The money that you invest in the equity market through this scheme is locked in for a period of three years. No matter where the market goes during this period, your money isn’t coming back to you. In case you decide to sell off and protect your capital, you would have to give up on the tax benefit. Three years is too long a period to stay locked in when it comes to the equity markets.
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All these issues have to be addressed if the scheme is to be extended beyond this year. In fact, the limit of Rs 50000 has to be enhanced to make the scheme truly worth its weight. Some changes in the basic provisions also have to be made to make it more investor friendly. After all, who would want to enter the equity market, get stuck and suffer a loss on the capital account to save just around Rs 2500-5000 in taxes? If you thought that we were exaggerating in asking such a radical question, here is what Arun Kejriwal, Founder, Kejriwal Research & Investment Services, a very prominent research and investment expert says about it. According to Kejriwal, “The current scheme is not at all attractive as it comes with a 50 per cent tax break and a lock in for three years and that also only for new first time investors.”

Manage The Twins

There are tasks and then there are priorities within those tasks. The Finance Minster too has many tasks at hand, but what should be high on his priority list? Surely at this juncture, managing the twin deficits, i.e. Fiscal Deficit and Current Account Deficit should be his primary task.

Fiscal discipline and management has come to be more important now than it ever was. The Current Account Deficit as a ratio of the GDP has reached its highest ever mark, standing at 5.4 per cent in the second quarter of FY13. What is even more threatening is that this may increase further in the third quarter and is likely to exceed four per cent for the second successive year in FY13. 

Why has the situation snowballed to this extent? Well, the worsening global economic situation can be partly held responsible for this precarious condition that our finances are today in. Weaker exports and higher imports have augmented the widening gap. According to Deven Choksey, CEO & Managing Director, K R Choksey Shares & Securities, “The twin deficit remained a major overhang for India during the last calendar year. Hence, the finance minister has spelt out targets in respect of reduction of fiscal deficit by around 60 bps per annum to address concerns of investors as well as rating agencies. Chidambaram is planning to attain the same by reducing both subsidies and curtailing other non-planned expenditure; while maintaining the current tax rates.”

While not much can be controlled on the global front, a lot needs to be done at home in order to put the government finances in place. The slew of reforms already unleashed by the FM is definitely a step taken in the right direction. On the revenue front, there is a serious need to augment tax revenues. But as we have discussed earlier, this is in no way going to be an easy task. Each step has its own pitfalls, both political as well as financial.

In these circumstances, the next best recourse available to the FM is to look at rationalising costs. A reduction in expenditure plays an important role. Curtailment of both plan and non-plan expenditure along with rationalisation of centrally sponsored schemes is what the minister needs to look at in the current budget. We have pointed to this earlier too. Control over wasteful expenditure is the only way to improve government finances.
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Bring On The Foreign Money

One of the most important factors from the market’s point of view is the foreign fund flows. In fact, it is the power of FII money that has been instrumental in pushing the Indian markets to dizzying heights. It therefore becomes very important for the FM to ensure that there are no provisions which could turn the FII flows off. Remember GAAR? That had set off alarm bells among FIIs last year. If it were not put off for now, the sentiment would surely have remained one of scepticism despite all the efforts made by the government with respect to reforms. 

While making sure that FIIs who have already invested in the Indian market do not get jittery is one thing, what is more important in the present scheme of things is to ensure that new money finds its way into the Indian markets. Deepak Mohoni, Founder, Trendwatch (India) says that, “FIIs will continue to come into India, as there is a lot of liquidity surplus abroad. What means more is the FDI rather than FIIs as this money will stay even if the situation tightens in the country.” In a previous issue (DSIJ Vol. 28, Issue No. 2, dated January 13, 2013), we have already pointed out how a gush of liquidity is about to be unleashed globally following the easy money policy that is being brought in by governments all over.

Thus, the FM should see to it that his budget provisions build confidence among global investors and lead to higher fund flows into the Indian market. Carrying forward from what has been done so far, Chidambaram should relax and in certain cases expand some of the provisions that are already in place:

  • The Union Budget 2011-12 had permitted Qualified Foreign Investors (QFIs) to invest in mutual funds. The scheme was further expanded on January 1, 2012 to allow QFIs to invest directly in the Indian equity market. As a further step in expanding the foreign investor base, the budget for 2012-13 extended the permission to invest in corporate bonds to this set of investors. The FM could ensure that the scheme is extended through this year’s budget.
  • Currently, the government allows FII investment in government securities and corporate bonds to the extent of USD 20 billion in each of the segments. If these limits can be enhanced, state finances and liquidity could face less of a strain and in turn help the markets remain firm.
  • The FM could also solicit investments from FIIs in certain key sectors which seem to be strained for want of funds; Power and Real Estate being examples of such sectors.

Bring Back The Black

Here is something that could turn out to be a real kicker. There is a whole lot of noise around the quantum of black money that is in circulation. There have been varied estimates of the black money in circulation within and outside the country. Some reports peg the total to be as much as around Rs 45 lakh crore. This figure goes up further to Rs 70 lakh crore, if you are to believe Swami Ramdev’s estimates. Various campaigns run by self-proclaimed activists including Swamiji have failed to bring these humongous amounts back into the country till date.

Now, let’s cut back to what Chidambaram had done in 1997 in his tenure as FM. At that time, he had introduced something novel in order to tap the black money and unaccounted wealth through the Voluntary Disclosure of Income Scheme (VDIS). The current situation demands that he bring in one more such scheme in order to tap that huge resource of national wealth. 

The need for this has existed for many years now. At this juncture, it is even more critical to garner all our resources in order to ensure a stronger economic base. Last time around, some 350000 people had disclosed their income and assets under the scheme and the government had earned around Rs 7800 crore from it until it closed on December 31, 1998. Now, if the FM can tap into all that money that is currently circulating outside of the system, do you really think there would be any other shortfall on the financial front that they would have to worry about? Of course, it is common knowledge what the real quandary in enforcing this is, and who will actually be in a soup in such a situation. Kejriwal’s opinion in this regard is almost similar to ours. “The VDIS scheme is the best way to galvanise the markets but the timing could be all wrong as the elections are now due. This could do well for the economy but be bad for the government. Hence rule out the possibility”, he avers.

Diverting Available Resources

Way back in 2004, the government had put in place the New Pension Plan. Here are some statistics that will tell you how the scheme has done so far. According to a report, as of October 7, 2012, a total of 3864941 people are a part of the scheme. The total corpus under management for all of these put together stands at Rs 21951 crore. There are a total of 36 Point of Presence centres that have been set up by the government so far for this scheme.

Considering that the savings rate in India is around 38 per cent, there is every possibility that a huge part of these savings can be channelised into this scheme. The money will eventually come into the markets, building further strength into them. The FM has to come out with some meaningful provisions which can help garner a larger corpus for this scheme. Adequate sops need to be provided so as to ensure wider participation in the scheme from the masses. Of course, a good buildup of safeguards will also have to be ensured so as to protect the interests of investors. These are schemes that haven’t really taken off and could contribute towards building the financial strength needed to tackle any untoward movement of foreign money out of the market.
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Impact Of Any Negative Surprise

An element of surprise in the budget is always a possibility. The markets are prone to react to such surprises rather nastily. It has happened in the past and there is every possibility that it may happen even now. In fact, the need to be unconventional is far greater now. We just may see the FM take steps that could disturb the peace of the market. What happens in such a situation?

Any negative announcement is not likely to dent the index levels much. The reason for this optimism is the current trading levels of the Sensex, which is at a PE of 17.88x, lower than the median of 19.84x that it has been trading at for the last six years. Even if we calculate the Sensex level on the basis of a forward PE, discounting the FY14 earnings, it would still be trading at a discount. Against the average forward PE of around 14.5x, the Sensex is currently trading at 13.9x (consensus EPS of Sensex companies for FY14 is Rs 1430). However, looking at the Q3FY13 results announced so far, we believe that the EPS for FY14 will surely see an upgrade. As we go to press, 605 companies have declared their results for the December quarter of 2012. Their aggregate topline growth has been 14.2 per cent, whereas the bottomline rose by a whopping 74 per cent. Therefore, we believe that even in the worst case scenario, the downside from here is capped and the levels of around 18800-19000 offer a strong support to the Sensex.

All said, the FM has quite a tightrope to walk this time around. Will he succumb to the political pressures, or will he take some bold steps to put the nation’s finances back on track by managing the deficits? In the need to maintain a fine balance between these two critical demands, Chidambaram surely has a tough job cut out for him. The way he has been handling the economy so far sends out a clear signal that not all will be pampered. After all, what is the point of getting re-elected in a state whose finances are in shambles? Is it not a better idea to build something stronger and pave the way to take it ahead in a stable manner when (and IF) the UPA comes back to power? What’s your take? Will the government bite the bait?

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