Budget Analysis

Budget Analysis Highlights

2011-12

Fiscal deficit pegged at 4.6% of GDP for 2011-12. Fiscal deficit projected at 4.1% and 3.5% for 2012-13 and 2013-14, respectively. Revenue deficit for 2011-12 pegged at 3.4%. Revenue deficit for 2010-11 revised downwards to 3.4% from the budgeted estimate of 4.0%. Net market borrowings for 2011-12 is budgeted at Rs. 3,430 billion, 2.3% over 20 10-11. Total expenditure for 2011-12 to increase by 3.4% over 2010-11. 1.4% fall in capital expenditure, while 4.1% increase in revenue expenditure ove r 2010-11. Personal income tax slabs changed: o Income upto Rs.1.8 lakhs nil. o Income between Rs. 1.8 lakhs and Rs. 5 lakhs 10%. o Income between Rs. 5 lakhs and Rs. 8 lakhs 20%. o Income above Rs. 8 lakhs 30%. o Incomes of senior citizens between 60 and 80 years of age, to be exempted upto R s. 2.5 lakhs and for those above 80 years, exemption applicable upto Rs. 5 lakhs. Standard rate of excise duty on all non-petroleum products to be maintained at 1 0%. Minimum Alternate Tax (MAT) rate to be increased from 18% to 18.5%. Rate of service tax retained at 10%, but coverage extended. Disinvestment receipts for 2011-12 estimated at Rs 40,000 cr. Government to move towards direct transfer of cash subsidy for kerosene and fert ilizers. Foreign investors who meet Know Your Customers (KYC) norms to be allowed to inve st in Indian equity mutual funds. FII limit for investment in corporate bond with residual maturity of over five y ears issued by companies in infrastructure sector, is raised by US$ 20 billion to US$ 25 billio n

Rs 6,000 cr allotted to public sector banks to maintain a Tier 1 CRAR of 8% duri ng 2011-12 Direct Tax Code to be implemented by April 1, 2012 Allocation to infrastructure at Rs. 2,14,000 cr for 2011-12, 23.2% higher over p revious year

Budget Analysis

Overview The three key macroeconomic concerns before the Union Budget 2011-12 were high i nflation, high current account deficit (CAD), and fiscal consolidation. Additionally, there was an expectation that the government would restart the reform process. The Budget has made an attempt to a ddress all these issues, albeit through small steps. Despite the strong performance of the econom y in 2010-11, the outlook for 2011-12 is clouded by stubborn and persistently high inflation, and rising external risks. While the Budget sets a lower nominal gross domestic product (GDP) growth target of 14%, we believe that the real GDP growth target of 9% factored in the Budget is on the optimisti c side. We expect GDP growth to moderate to 8.3% in 2011-12. By lowering the fiscal deficit target to 4.6% in 2011-12 from 5.1% achieved in 2 010-11, the Budget reiterates its commitment towards medium-term fiscal consolidation. The absence of rollback of stimulus (excise) was a bit of a disappointment, though, given that economic gro wth has recovered. As the Budget sets a lower deficit and net borrowing target, it is not expansionary , and does not conflict with the Reserve Bank of India s measures to tame inflation, at least in intent. T he issue is how realistic the target is. We believe that the fiscal deficit will settle around 5 % of GDP in 2011-12 a slippage of 40 bps as we expect lower growth, lower tax buoyancy, and absence of one-off gains. There are further risks of slippages on subsidy expenditure on oil and fertilise rs, the Budget estimates are conservative. Some bold steps towards expenditure reforms were mis sing, and will have to be initiated through the year to keep a lid on the subsidy bill and maintain the fiscal space for increased spending on physical and social infrastructure. On the infrastructure front, like in the previous Budget, physical infrastructur e has been accorded prime importance. An allocation of Rs 2,14,000 cr has been provided for infrastr uctural development in 2011-12, which is 23.3% higher than in 2010-11 and amounts to 48.5% of the gr oss budgetary support to Plan expenditure. To remove the funding constraints for the infrastructure sector, the disbursemen t target of the government-established India Infrastructure Finance Company Limited (IIFCL) will be raised by Rs 5,000 cr to Rs 25,000 cr by March 31, 2012, along with issuance of tax free bond s worth Rs 30,000 cr by various government undertakings. In addition, the FII limit for investment in corporate bonds with

residual maturity of over five years issued by infrastructure companies has been raised by an additional US$20 billion, taking the limit to US$25 billion. In order to facilit ate the funding of rural infrastructure, the corpus of the Rural Infrastructure Fund (RIDF) was raised by Rs 2,000 cr to Rs 18,000 cr for 2011-12. Social sector spending too remains one of the top priorities of the government. However, refraining from announcing new schemes, the Budget has laid stress on providing reasonable allocation to the existing schemes, in order to curb fiscal deficit and provide room for the commi tted Right to Food Act. An allocation of Rs 1,91,400 cr has been provided to social services and rural d evelopment in Budget 2011-12. However, y-o-y growth of total budget support, together with internal a nd extra budgetary resources (IEBR), stands at 7.8% in 2011-12 as compared to 27.4% in 2010-11. On the inclusiveness front, the Budget has inflation-indexed its flagship A scheme to ensure stability in real wages. Its usefulness could have been multiplied if the had been dovetailed with activities that create durable infrastructure and raise productivity iculture. Moreover, improved monitoring of the scheme to check leakages would have made these mmes more credible and effective. MGNREG scheme in agr progra

Budget Analysis

Equity Market Although Budget 2011-12 has not rolled back the stimulus for the markets, it is low on significant policy actions. Hence, we believe it is essentially neutral for the domestic equ ity markets. The markets are expected to cheer the lower-than-expected fiscal deficit target of 4.6% and an effective revenue deficit of 1.8% for FY12. However, we expect 4.6% to be challenging based on GDP growth estimate of 8.3% for 2011-12 which is less than the government s target of 8.75-9.25% growt h. Increased capital outlay and other policy measures for infrastructure, education and realty sectors are expected to boost sentiments and support players growth, but the overall impact o n profitability may not be significant. The allocation to infrastructure has been raised by 23.3% to Rs 2.14 lakh cr. The FII limit for investment in corporate bonds (with maturity over five years) issu ed in the infrastructure sector has been raised by US$20 bn. Further, the additional deduction of Rs 20,0 00 for investment in long-term infrastructure bonds would be extended in FY12. While these measures w ill facilitate financing of infrastructure projects, we believe execution delays rather than fi nancing pose a bigger challenge for infra companies. The budget allocation for education too has been increased by 24%, which includes Rs 21,000 crore under Sarva Shiksha Abhiyan. The liberalisation o f interest subvention of 1% on housing loans and enhancement of housing loan limit to Rs 25 lakh for units under priority sector lending would be positive for players in affordable and lo w income housing. On the taxation front, increase in exemption limits - resulting in uniform tax r elief of Rs 2,000 - would be positive for consumer discretionary items. On the one hand, reduction in surc harge from 7.5% to 5% is positive for corporates; on the other, increase in MAT rate from 18% to 18 .5% is negative. Further, the Direct Taxes Code (DTC) is expected to be rolled out as scheduled a nd the Goods and Services Tax (GST) Amendment Bill will be introduced in this parliament session. Continuing with its divestment agenda, the government has set a target of raisin g Rs 40,000 crore through divestment of its stake in central public sector undertakings. However, volatile market conditions could put a spoke in the government s divestment wheel. We believe that allowing foreign investors to invest in the domestic market thro ugh the mutual fund route is a key positive, and will increase funds flow from foreign investors. It

would prove to be a shot in the arm for the domestic mutual fund industry in the long run. We expect FY12 to be a tale of two halves for the Indian market. In the first ha lf, we expect the market to remain subdued due to concerns over high commodity prices, inflation and earn ings downgrade, whereas in the second half we expect a potential absence or a bare minimum impac t of most of these factors to provide buoyancy to the markets. Expectation of strong GDP growth cou pled with attractive valuation would support the market in the second half. In the light of global co ncerns and earnings downgrade, we have tempered our expectations of returns. We expect the Nifty to trade at 6200-6400 (Sensex 20700-21200) by the year-end (December 31). We expect banking, IT and ph armaceuticals to deliver strong returns but we remain neutral on telecom and infrastructure, and negative on real estate.

Budget Analysis

Sector Analysis Auto components & Tyres -Budget to have neutral impact The Union Budget 2011-12 is not likely to have any significant impact on the Ind ian auto components and tyres industry. The exemption on customs duty on spare batteries for electric ve hicles (cars and twowheelers) and concessional excise duty of 4% on these batteries will reduce the maintenance cost of these vehicles. However, this is not expected to have any significant impact on demand for auto components, given the low population of electric vehicles in India. Natural rubber (NR) will attract customs duty of 20% or Rs 20 per kg (whichever is lower), with effect from April 2011. This will not have any significant impact on the landed cost of NR at current price levels. Automobiles -Budget to have no significant impact on automobile industry The Union Budget 2011-12 is not likely to have any significant impact on the Ind ian automobile industry. The extension and enhancement of interest subvention on crop loans from 2 to 3%, revision of wage rates under the NREGA scheme and continued focus on rural development will have a marg inally positive impact on rural two-wheeler and tractor sales. The extension of tax slabs for in dividual tax payers from Rs 1.6 lakh to Rs 1.8 lakh will aid two-wheeler sales. The overall impact on passen ger cars and commercial vehicles segment will be largely neutral. The launch of a National Mission for Hy brid and Electric Vehicles and various excise and customs duty benefits proposed for hybrid, electr ic, fuel cell and hydrogen cell technology-based vehicles or their parts is unlikely to have any i mmediate impact, though it will aid alternate fuel vehicle sales over the longer term. Banking and Finance - Rise in priority sector home loan limit to benefit banks As per the Union Budget 2011-12, housing loan limit under priority sector would be enhanced from Rs 20 lakhs to Rs 25 lakhs. Also, the limit for interest rate subvention of 1% on home loans would be increased from Rs 10 lakhs to Rs 15 lakhs, for houses priced below Rs 25 lakhs. These meas ures are expected to assist banks in accomplishing their priority sector lending targets and lower le nding rates for borrowers. The hike in interest rate subvention for agriculture loans from 2 to 3% and incr eased target for credit flow to farmers would facilitate availability of funds at cheaper rates. Public sector banks will be provided Rs 6,000 cr in 2011-12 (in addition to the Rs 23,200 cr provided in the last 3 years) to maintain a minimum tier-I capital adequacy ratio of 8%, thu

s improving their ability to pursue loan growth more aggressively. Cement -Increase in excise duty negative The Union Budget 2011-12 has proposed the replacement of existing excise duty ra tes with a 10% ad valorem rate and an additional Rs 160 per tonne of cement. This results in an ef fective 2-4% increase in the excise duty for the cement industry. In the current operating environment, c ement players will not be able to pass on the increase in duty to customers. Further, the Union Budget has proposed a reduction in custom duties for gypsum and pet coke from 5% to 2.5%. Gypsum accounts for a mer e 2-3% of the total cost of sales for cement players. Moreover, pet coke is used as raw material by a select few companies only. Hence, the reduction in custom duties is insignificant for the cement indu stry. Construction -FII limit on corporate infrastructure bonds raised; tax-free bonds permitted An increase in the foreign institutional investment (FII) limit by US$20 billion for investment in corporate infrastructure bonds will help mop up bond issues. Further, select government un dertakings like Indian Railway Finance Corporation have been allowed to issue tax-free bonds totalling Rs 300 billion. Also, the allocation for Bharat Nirman has been increased by 20% in 2011-12. IIFCL s loan di sbursal target has been set higher as well at Rs 25,000 cr for 2011-12 from an estimated Rs 20,000 cr in 2010-11. The additional tax exemption of Rs 20,000, provided in 2010-11, on investment in lon g-term infrastructure bonds has been extended to 2011-12. These proposals are expected to address the funding needs of the infrastructure segment, and could lead to a faster take-off of infrastructure pr ojects. However, these may not push up the bottomlines of construction companies. Hence, we believe that th e impact of the budget on the construction sector is neutral.

Budget Analysis

Housing -Increased focus on affordable housing The interest rate subvention of 1% has been extended for housing loans up to Rs 15 lakhs (for houses costing less than Rs 25 lakhs) from Rs 10 lakhs earlier (for houses costing less than Rs 20 lakhs). Further, priority sector lending limit for housing loans provided by banks has b een enhanced from Rs 20 lakhs to Rs 25 lakhs. The rural housing fund has been enhanced to Rs 3,000 cr fr om Rs 2,000 cr while HUDCO has been allowed the issue of tax free bonds up to Rs 5,000 cr. These meas ures will provide a boost to affordable housing. The budget has also proposed investment linked tax deduction for affordable housing projects. This will lead to higher investments in affordable housing pro jects. Note: The proposal to levy 18.5% minimum alternate tax (MAT) on developers of sp ecial economic zone will have a negative impact on real estate companies with a SEZ focus. This could neg ate the positive impact of the residential segment thus, making the impact neutral for the overall real estate segment. Information Technology -MAT levy on SEZ and non-extension of STPI benefits to im pact player profitability The proposal to bring SEZ units under the purview of the Minimum Alternative Tax (MAT) and the nonextension of tax benefits for STPI units is expected to adversely impact the pro fitability of IT players. Midsized players would be more affected as a larger proportion of their revenues ac crue from STPI units vis-vis tier-I players. MAT has been raised from 18% to 18.5%, whereas surcharge has bee n reduced from 7.5% to 5%, keeping the effective MAT rate at the same level. Domestic IT services, which constitute about 20% of the IT services revenues, ar e expected to get a shot in the arm from the planned government expenditures aimed at improving IT infrastru cture and delivery mechanisms. Oil and Gas -No major impact on oil & gas sector The Union Budget (2011-12) will have no major impact on the oil & gas sector. Ho wever, the government has indicated that it would gradually move towards direct transfer of cash subsi dies on LPG and kerosene to people living below the poverty line. This will reduce under-recoveries for o il marketing companies in the future. The government has provided for Rs 23,700 cr as its share in under-r ecoveries for 2011-12.

This is significantly lower than the revised estimates of Rs 38,600 cr for 201011. However, we believe that if under-recoveries increase significantly, the government will increase its con tribution towards the same. Pharmaceuticals -Neutral impact of the budget on the Pharmaceutical sector The impact of the Union Budget 2011-12 on the Pharmaceuticals industry is neutra l. The increase in excise duty on formulations from 4% to 5% will have negligible impact on the ind ustry. Telecom -Neutral impact on telecom services sector The government has marginally increased the Minimum Alternate Tax (MAT) from 18% to 18.5%. At the same time, it has reduced the surcharge levied from 7.5% to 5%. The cut in the s urcharge rate neutralizes the impact of the increase in MAT by keeping the effective rate of MAT unchanged . The exemption from basic, countervailing duty (CVD) and special additional duty (SAD) on components and accessories of mobile handsets has been extended for the next financial year and a few more ite ms have now been included in its ambit. The extension of duty exemptions would help in sustaining the current low prices of mobile handsets. Textiles -Mandatory excise on branded garments negative for textiles The impact of the Union Budget 2011-12 is negative for the textiles sector. A ma ndatory excise duty of 10% is being imposed on branded readymade garments (RMG) and textile made-ups. S ince it is under Cenvat Credit, yarn and fabric manufacturers may have to pay an increased excise duty at 5% vis--vis an optional and concessional 4% duty paid earlier. This will exert further pressure on the margins of RMG and made-ups manufacturers who are already struggling with an unprecedented rise in input costs. However, the reduction in customs duty on Acrylonitrile and rayon grade wood pul p, from 5% to 2.5% each, will benefit acrylic and viscose fibre manufacturers respectively by reduc ing their raw material costs. As a result, the cost competitiveness of viscose and acrylic will improve vis--vi s cotton and polyester. Higher budgetary allocation under Technology Upgradation Fund Scheme (TUFS) to R s 2,980 cr from Rs 2,270 cr is a positive for the sector.

Budget Analysis

Mutual Funds and Financial Market Budgetary measures and their impact 1. Foreign individual investors allowed to invest in mutual funds To liberalise the portfolio investment route, the government has decided to perm it SEBI registered mutual funds to accept subscriptions from foreign investors who meet the KYC requiremen ts for equity schemes. Currently, only FIIs and sub-accounts registered with the SEBI and NRIs are allo wed to invest in mutual fund schemes. Impact This will widen the investor base of mutual funds and give non-SEBI registered f oreign investors an opportunity to invest in Indian equity markets. The measure would also provide a n avenue to boost equity mutual fund AUM. More technology enabled products with enhanced risk management practices are expected to be launched for the global audience. 2. Increase in Dividend Distribution Tax (DDT) for money market and debt funds DDT increased to 30% from 25% on investments made by firms into money market and debt funds. For retail investors it stays unchanged at 12%. Impact This would place corporate plans of debt and money market funds at par with bank fixed deposits and thus may impact inflows. 3. Increase in FII limit in corporate bonds To enhance the flow of funds to the infrastructure sector, the FII limit for inv estment in corporate bonds, with residual maturity of over five years issued by companies in the infrastruct ure sector, is being raised by an additional limit of US$20 billion; this takes the limit to US$25 billion. This will raise the total limit available to FIIs for investment in corporate bonds to US$40 billion. FIIs would also be permitted to invest in unlisted bonds with a minimum lock-in period of 3 years and will be allowed t o trade amongst themselves during the lock-in period. Impact Although an increase in the FII limit is a positive factor, the corporate bond m arket is expected to remain range bound as the appetite for investment in infrastructure bonds by FIIs, whic h till now was US $5 billion, has not been utilized to its fullest. Moreover, since infrastructure as a segmen t does not account for a major share of issuances in the corporate bond market in India, the impact of the abov

e measure is not expected to be significant in the movement of corporate bond yields. 4. Increase in allocation towards infrastructure bonds For 2011-12, an allocation of over Rs.2,14,000 crore is being made for the infra structure sector a y-o-y growth of 23.3%. In order to give a boost to infrastructure development in railways, ports, housi ng and highways development, the government proposes to allow tax free bonds of Rs.30,000 crore to be issued by various government undertakings in the year 2011-12. This includes Indian Railwa y Finance Corporation (Rs 10,000 crore), National Highway Authority of India (Rs 10,000 cr ore), HUDCO (Rs 5,000 crore) and Ports (Rs 5,000 crore). Impact The continued thrust on infrastructure funding is expected to result in an incre asing appetite for infrastructure-oriented mutual funds. The focus on infrastructure projects is li kely to result in an increasing number of corporate bond and equity issuances for fund raising by infrastructure companies and institutions. This would provide an expanding avenue for mutual funds to invest in. It would also boost the

Budget Analysis

investment avenues for major market participants such as insurance companies and PF trusts enabling them to utilize their investment limit in additional category as defined in their investment guidelines in these bonds. 5. Set-up of notified infrastructure bonds To attract foreign funds for infrastructure financing, the government proposes t o create Special Vehicles in the form of notified infrastructure debt funds. The income of these funds would be exempt from tax. Impact The above measure could lead to fund flow from private equity players and major overseas hedge fund. The added tax incentives could lead to an increase in allocation of their investment s into the emerging market debt through these funds. 6. Life Insurance Companies come under service tax net Services provided by life insurance companies in the area of investment are prop osed to be brought into the tax net on the same lines as ULIPs. Impact This may have a negative impact on the bottom line of the insurance companies. T he incremental impact can be more on insurance companies with a larger share of non-ULIP products. 7. Penetration of Swavalamban The co-contributory pension scheme called Swavalamban announced in the previous bu dget has received over 4 lakh applications from workers in the unorganised sector. Based on feedback, the government proposes to relax the exit norms whereby a subscriber under Swavalamb an will be allowed to exit at the age of 50 years instead of 60 years, or a minimum tenure of 20 years , whichever is later. Further, it is proposed to extend the benefit of government contribution from th ree to five years for all subscribers of Swavalamban who enroll during 2010-11 and 2011-12. An estimated 2 0 lakh beneficiaries are expected to join the scheme by March 2012. Impact The proposal to prepone the exit age as well as government contribution being ex tended to five years from three years would help increase penetration levels in the PFRDA initiative. Disclaimer: The information contained in this report has been obtained from sour ces considered to be authentic and reliable. However, IDBI is not responsible for any error or inaccuracy or for any losses suffered on accoun

t of information contained in this report. IDBI does not solicit any action and is not liable for any investment decisions if made on the basis of th is report. CRISIL Research, a Division of CRISIL Limited has taken due care and caution in preparing this Report. Information has been obtained by CRISIL from sources which it considers reliable. However, CRISIL does not guarantee the accuracy, adequacy or completeness of any information and is not responsible for any errors or omissions or for the results obtained from the use of such information. CRISIL is not liable for investment decisions which may be based on the views expressed in this Report. CRISIL espec ially states that it has no financial liability whatsoever to the subscribers/ users/ transmitters/ distributors of this Report. CRISIL Research o perates independently of, and does not have access to information obtained by CRISIL s Ratings Division, which may, in its regular operations, obtai n information of a confidential nature which is not available to CRISIL Research. No part of this Report may be published / reproduced in any for m without CRISIL s prior written approval.