The Union Budget 2011-12 can be described as a mildly positive one at best, given the constraints on the fiscal front. The focus was, as expected, largely on containing inflation, fiscal consolidation and inclusive growth. Populist measures like raising personal income tax slabs and interest subsidy to farmers were announced, keeping in mind the upcoming state elections. Agricultural and infrastructure bottlenecks were also addressed. The stock market, which was extremely pessimistic in the run up to the budget, reacted positively as fears of excise and service duty hikes and a bigger government borrowing figure were allayed. Allowing foreign investors to directly invest in equity mutual fund schemes is a big positive from the stock market perspective. The MAT impact on cash flow and lack of action in improving the slowing FDI were let downs in this budget. With subsidies and expenditure appearing understated, meeting the fiscal deficit target of 4.6% for FY12 will be a major challenge.
Direct tax: Sentimentally positive for individuals; MAT increased, surcharge reduced
With an eye on upcoming elections in key states, personal income tax slabs were raised to Rs180,000 from Rs160,000, as rightly predicted in our preview note. This, however is only a feel good element and does not add materially to disposable income of the middle class. We also expected corporate tax rates, surcharge and MAT to remain unchanged. While corporate tax rates were untouched, surcharge was reduced to 5% from 7.5% and MAT was increased to 18.5% from 18%. Additionally, SEZ developers and units in SEZs, which were earlier exempt from tax, will now be required to pay MAT. However, this would impact only the cash flows.
Indirect tax: No change in excise duty rate as per expectations; service tax net widened
Overthrowing fears of a hike in excise duty, the finance minister retained the same at 10%. This was one of the key positives that got the equity market excited. We expected the budget to maintain status quo on excise duties based on our belief that any hike would risk slowing the economy at a time when interest rates were already hardening. Surprisingly, hike in excise on tobacco did not come through, which is a huge positive for ITC.
The service tax net was widened to bring in more services under its purview but the rate was not increased along expected lines. However, we did expect certain cuts on import duties to lower price levels, which did not come through. Instead, the finance minister tackled it differently by hiking export duties on iron ore to 20% from 5% (Sesa Goa is the biggest loser on account of this change). Predictably, the budget was not able to give a detailed roadmap on GST, given the opposition from states.
Other key indirect tax measures:
Agricultural focus to tackle food inflation; infrastructure financing partly addressed
- Excise duty on cement, which was Rs290 per MT on sale price below Rs190/bag, has been changed to 10% on ad valorem basis + Rs80 per MT, and on sale price exceeding Rs190/bag; where duty was 10% on retail sale price, it has been changed to 10% on ad valorem + Rs160 per MT
- Basic custom duty on two critical raw materials of cement industry viz. pet coke and gypsum is proposed to be reduced from 5% to 2.5%
- Basic custom duty reduced on micro-irrigation equipment from 7.5% to 5%
- Basic custom duty reduced for specified agricultural machinery from 5% to 2.5%
Coming to grips with food inflation has been on the top agenda of the government. Besides increasing credit growth to agriculture by 27% in 2011-12 and providing interest subvention for farmers from 2% to 3%, cold storage companies are given infra status and a plan has been put in place to create 4MT of food storage capacity by March 2012. We included this as a key requirement from the budget to reduce wastage and help ease food prices.
On the infrastructure front, the critical issue of dearth of long-term funding was addressed to a credible extent through various measures. Key amongst them being increase in FII limit by a significant US$20bn for investment in corporate bonds issued by infra companies, allowing some infrastructure development institutions to issue tax-free long term bonds and extension of the additional deduction of Rs20,000 u/s sec 80CCF by one more year.
Social sector spending on the rise
Social sector spending was bound to increase as part of the government’s inclusive growth agenda. The finance minister increased allocation in many areas of health, education, rural broadband connectivity programme, allocating additional Rs100bn towards rural development and Rs210bn towards rural literacy. The NREGA scheme has been linked to CPI. Here, the government could possibly have done better by addressing leakages in the system rather than increasing the amount. The minister also stated that the Food Security Bill would be introduced in the current year.
Subsidy bill and expenditure side seem understated
The budget estimates for subsidy in 2011-12 stands at Rs1,436bn, which is 12.5% lower than current year’s revised figure. The crude price is expected to remain firm and the budget estimate for fuel subsidy of Rs236bn (38% lower) looks unreal. Similarly, a flat figure for food subsidy and lower projections for fertiliser subsidy look difficult to achieve. Besides, enhanced interest subsidy to farmers will add to this burden. A fall in non-plan expenditure and a mere increase of 3.4% in total expenditure during 2011-12 looks unmanageable.
Mildly positive budget; fiscal deficit target of 4.6% - big challenge
The budget was largely in line with our expectations - mildly positive in the light of constraints faced. The consumption impetus has remained with no hike in excise duties, linking of NREGA to inflation, plan for direct subsidy, interest subvention to farmers and sentiment boosting personal tax exemption. Attempts to curb inflation will also help sustain demand momentum.
When it comes to fiscal deficit, the government faces a heavy challenge in meeting the target of 4.6% for 2011-12. While budget estimates for direct taxes and indirect taxes largely seem reasonable, the government will face a bigger burden of expenditure and subsidies. This will mean that the non-tax revenue sources will need to be higher than the budgeted figure of Rs1,254bn. Here, the only upside can come from introduction of an amnesty scheme to bring back black money. Upsides to the disinvestment target of Rs400bn are unlikely given the state of equity markets. Non tax revenue of Rs296bn from communication services also appears on the higher side with no 3G auction available this time round. We therefore believe that a 4.9-5% fiscal deficit is more realistic as compared to 4.6% set for FY12. This would also mean that the market borrowings of the government could be higher than the stated figure of Rs3,430bn.