Union Budget 2011-12

Fiscal consolidation poses major challenge

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: 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% Agricultural focus to tackle food inflation; infrastructure financing partly addressed 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.
February 28, 2011

Union Budget 2011-12

Social sector spending on the rise Social sector spending was bound to increase as part of the governments 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 years 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 nonplan 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. Budget at a Glance
Rs bn 1. Revenue Receipts 2. Tax Revenue (net to Centre) 3. Non-tax Revenue 4. Capital Receipts $ 5. Recoveries of Loans 6. Other Receipts 7. Borrowings and other Liabilities* 8. Total Receipts $ 9. Non-plan Expenditure 10. On Revenue Account of which, 11. Interest Payments 12. On Capital Account 13. Plan Expenditure 14. On Revenue Account 15. On Capital Account 16. Total Expenditure 17. Revenue Expenditure 18. Capital Expenditure 19. Revenue Deficit % of GDP 2009-2010 A 5,728 4,565 1,163 4,517 86 246 4,185 10,245 7,211 6,579 2,131 632 3,034 2,539 495 10,245 9,118 1,127 3,390 (5.2) 2010-2011 BE 6,822 5,341 1,481 4,265 51 400 3,814 11,087 7,357 6,436 2,487 921 3,731 3,151 580 11,087 9,587 1,500 2,765 (4.0) 2010-2011 RE 7,838 5,637 2,201 4,327 90 227 4,010 12,166 8,216 7,267 2,408 948 3,950 3,269 681 12,166 10,537 1,629 2,698 (3.4) 2011-2012 BE 7,899 6,645 1,254 4,678 150 400 4,128 12,577 8,162 7,336 2,680 826 4,415 3,636 779 12,577 10,972 1,606 3,073 (3.4)

20. Fiscal Deficit

% of GDP

21. Primary Deficit (20-11)

% of GDP Strategy Note

4,185 (6.4) 2,054 (3.1)

3,814 (5.5) 1,327 (1.9)

4,010 (5.1) 1,602 (2.0)

4,128 (4.6) 1,448 (1.6) 2

* Includes draw-down of Cash Balance, $ Does not include receipts in respect of Market Stabilization Scheme.

Union Budget 2011-12

Sectoral impact
Automobiles
Key announcements Increased budgetary allocations to agriculture and rural development schemes No hike in excise duties against expectations of 2% roll-back Reduction in custom duty on caprolactam from 10% to 7.5% Reduction in custom duty on carbon black feed from 5% to 2.5% Impact Positive for rural demand: M&M, Maruti and Hero Honda to be major beneficiary Positive for the entire sector Positive for tyre manufacturers Positive for tyre manufacturers

Banking
Key announcements FY12 fiscal deficit targeted at 4.6% of GDP with net market borrowing of Rs3.43tn. FII investment in equity schemes of registered mutual fund subject to KYC requirement Recapitalizations to the tune of Rs60bn by GoI in PSU banks enabling them maintain minimum Tier I CAR at 8%. Creation of notified infrastructure debt fund Lending to agriculture sector targeted to grow at 27% yoy to Rs4.75tn IIFCL to refinance bank lending towards infrastructure projects Rs1bn India microfinance equity fund to be controlled by SIDBI Interest rate subvention of 1% on housing loans upto Rs1.5mn on property value of upto Rs2.5mn Additional 1% interest subvention (cumulative 3%) for farmers who repaid their crop loans on time New banking licenses for few private players and NBFC Services provided by life insurance companies in the area of investment to be brought into tax net on the same lines as ULIPs. Impact Positive for the banking space, limited impact on bond yields. Further, the front loading of borrowing programme should ensure smooth credit growth in H2 FY12. Positive for mutual fund industry. Positive for small PSU banks like Dena Bank, UCO Bank, Syndicate Bank, Vijaya Bank. Positive for infrastructure financing companies like IDFC Positive for the sector. Positive for banks as it would improve ALM and increase funding to the sector. Marginally positive for Micro finance industry. No clarity on Micro finance Bill. Positive for Housing finance institutions like HDFC, LICHF, Dewan Housing and GIC Housing and Banks with lower loan size Marginally positive as long as the interest subvention is repaid by the Government The issue continues to lack clarity. RBI, however, shall issue a note by March 2011. Negative for life insurance companies.

Cement
Key announcements Increase in excise duty on cement Impact Negative for all cement manufacturers

FMCG
Key announcements Continued spending on rural and social development No increase in excise duty No change in excise duty on cigarettes Government to set up fifteen additional mega food parks Customs duty on crude palm stearin imported for the manufacture of laundry soap reduced from 20% to 0% Impact Positive for all FMCG companies Positive for all FMCG companies Positive for cigarette manufacturers like ITC, Godfrey Phillips Positive for food processing companies Positive for HUL

Hospitality
Key announcements Hotel accommodation in excess of Rs1,000/day and AC restaurants that serve liquor brought under 10% service tax Impact To impact most organized sector players but likely to be passed on to consumers

Strategy Note

Union Budget 2011-12

Information Technology
Key announcements MAT increased from 18% to 18.5% No extension of tax exemption u/s 10A & 10B (STPI) MAT to be levied on companies operating in SEZ Significant increase in plan allocation for education Additional allocation of Rs5bn for National Skills Development Fund Impact Effective tax rate to be largely unchanged as the increase in MAT rate would be offset by reduction in surcharge No material impact as it was priced in Marginally negative for large sized and select mid-cap cos having material SEZ presence. No P&L impact, only CF impact. Positive for education companies like Educomp, Everonn, etc Positive for education companies having presence in vocational segment like Educomp, Everonn, Aptech etc

Infrastructure
Key announcements Infrastructure allocation increased by 23% to Rs2.14tn FII limit for investment in corporate bonds (with residual maturity of over 5 years) issued by infra companies raised by US$20bn FIIs also permitted to invest in unlisted bonds of Infra SPVs with a minimum lock-in period of 3 years Government undertakings such as Railway Finance Corporation, NHAI, HUDCO, etc allowed to issue tax-free bonds of Rs300bn The additional deduction of Rs20,000 for investment in longterm infrastructure bonds extended for one more year To attract foreign funds for infra financing, Govt to create notified infrastructure debt funds; interest payment on the borrowings of these funds to be subjected to lower withholding tax of 5% IIFCL expected to achieve cumulative disbursement target of Rs250bn by March 31, 2012 and Rs50bn to be sanctioned under take-out financing scheme in FY12 Excise duty on Cement increased Excise duty exemption for equipment supply to UMPPs Impact Positive for the sector Positive for the sector Positive for the sector Positive for the sector Positive for the sector Positive for the sector

Positive for the sector Negative for the sector Positive for capital goods players such as BHEL

Metals & mining

Key announcements Export duty from 5% on fines and 15% on lumps increased to 20% Removal of export duty on pellets to nil Impact Negative for iron ore exporting companies like Sesa Goa and NMDC; Marginally positive for domestic steel manufacturers Positive for JSPL

Oil & Gas

Key announcements No cut in customs duty on crude oil No reduction in excise duty on petrol/diesel Tax benefits not extended for NELP IX Proposed a system of direct transfer of Kerosene & LPG MAT levied on SEZ units Impact Positive for ONGC, Oil India, Cairn Negative for OMCs, ONGC, Oil India and Gail Negative for E&P players bidding for NELP IX Better utilization of subsidies, Longer term positive for OMCs Higher cash tax outgo, but no P&L impact as equivalent deferred tax asset would be created

Real Estate
Key announcements Increase in home loan size to Rs2.5mn, to be characterised as priority sector loan Implementation of MAT on SEZ developers and units operating in those areas Impact Marginally positive for regional players like Purvankara, Unitech, HDIL, Sobha Developers Negative for DLF

Telecom
Key announcements Budgeted receipts from 'Other Comm. Services' such as license fess, spectrum usage charges etc at Rs296bn in FY12, which is nearly double over FY10 level Full exemption from SAD on parts, components and accessories for manufacture of mobile phones extended to March 2012 Strategy Note Impact We reckon govt may have factored implementation of TRAI pricing proposals on excess 2G spectrum, which could be negative for incumbents like Idea, Rcom To continue to aid handset makers; negligible impact on telecom sector

Recommendation parameters for fundamental reports: Buy Absolute return of over +10% Market Performer Absolute return between -10% to +10% Sell Absolute return below -10%

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