Union Budget 2011-12 - A balancing act
Mar 01, 2011

Author: PersonalFN Content & Research Team

In the fiscal year 2010-11, the Indian economy has been successful enough to achieve the level of economic growth as seen prior to the crisis of 2008 and early 2009. Moreover, steps taken to move towards fiscal consolidation in the previous budget (Union Budget 2010-11), has also paid off, as fiscal consolidation has been impressive. And now to significantly progress, critical institutional reforms would be needed for our country to achieve double-digit growth in the future.

However at present, there are major challenges (as the one’s mentioned below) for the Government in power:

Inflation - Structural concerns on inflation management still remains as WPI inflation is yet above the comfort levels of Reserve Bank of India (as it sails over the 8.00% mark).

(Source: Office of Economic Advisor, PersonalFN Research)

Moreover to worsen the scenario, food inflation too is in double-digit terrain at (11.49% for the week ended February 12, 2011), along with the fuel price index inflation too remaining sticky (12.41% for the week ended February 12, 2011).

But, in order to control this concern, the Union Budget 2011-12 has made an attempt to improve supply response of agriculture, in order to cater to the widening domestic demand.
Implementation gaps - Despite commendable initiatives taken by the Government so far, implementation gaps and leakages from public programmes pose a serious threat to Government’s “pro-reform” agenda. Also, maintaining the quality of outcomes too pose a challenge for the Government.
Governance and Accountability - At present there seems to be a lacuna in governance and public accountability. In fact the opposition parties are tarnishing the image of the Government in power by tagging them as “corrupt”.

But, in order to cater to this problem the Congress Government has expressed that “corruption” as a problem to be fought collectively, and has also proposed to improve the regulatory standards and administrative practices, thereby leading to a more transparent and result oriented economic management system in India, wherein inputs from both sides (i.e. oppositions and ruling) would be taken for the wider interest of the nation.

ECONOMIC OVERVIEW

The Indian economy is estimated to have grown at 8.6% in 2010-11 in real terms, and has shown remarkable resilience. Going forward too, in the fiscal year 2011-12 this robustness is likely to be retained as the economy is expected to grow by 9.0% (with an outside band of +/- 0.25%) as projected by the finance minister.

(Source: CSO, PersonalFN Research)

Moreover during the period April 2010 to January 2011, exports as well as imports too have grown by 29.4% and 17.6% respectively, thereby reducing the pressure on the country’s current account deficit.

However elevated prices of food articles have been principal concern this year, as they led to high food inflation resulting in stiff WPI inflation. But the monetary actions taken by the RBI so far is now expected to moderate WPI inflation in the coming months, which in turn would also lead to average inflation lowering by next year and current account deficit too mellowing.

Signs of sustenance of growth momentum are also been revealed as fiscal consolidation targets at Centre and States, have shown positive effect on macroeconomic management of the economy.

The major focus areas for the Government include:

Infrastructure - There has been an increase in allocation towards infrastructure development to 2,14,000 crore (an increase of 23.3% over 2010-11), which accounts for over 48.5% of the total plan allocation. The Government also intends to come up with a comprehensive policy for further developing Public Private Partnership (PPP) projects. Moreover in order to provide an impetus to infrastructure development, the Government has proposed to issue tax free bonds worth 30,000 crore in the fiscal year 2011-12.

We think that these are progressive measures taken in the Budget, which will improve the infrastructure of the country, which is also a step towards attracting the much needed Foreign Direct Investment (FDI) in India. Also the offerings of tax free infrastructure bonds, may suck the excess liquidity in the system and thereby tame inflation.
Housing Sector Finance - In order to provide an impetus to the housing sector, the existing scheme of interest subvention of 1% on housing loans has been extended, to housing loan upto 15 lakh where the cost of the house does not exceed 25 lakh from the present limit of 10 lakh and 20 lakh respectively.

Taking into account the ballooning prices of residential properties in urban areas, the existing housing loan limit has also been increased from 20 lakh to 25 lakh for dwelling units under priority sector lending.

In order to provide housing finance to targeted groups in rural areas at competitive rates, the provision under Rural Housing Fund (RHF) has also been increased from the existing 2,000 crore to 3,000 crore.

In order to provide housing credit to Economically Weaker Sections (EWS) and Low Income Group (LIG) households, the Government has proposed to create a Mortgage Risk Guarantee Fund (MRGF) under Rajiv Awas Yojana, which will guarantee housing loans taken by EWS and LIG households and thus enhance their credit worthiness for availing housing loans.

Overall, the measures proposed in the budget, would provide a relief to the housing sector which has been thus far suffered due to constant rise in the interest rates by housing finance companies and banks.
Agriculture - The Government has stated that agriculture development is central to their growth strategy. It has thus proposed to remove production and distribution bottlenecks for items like fruits and vegetables, milk, meat, poultry and fish, which constitute for more than 70% of the WPI basket for primary food items.

Similarly, in order to establish an efficient supply chain thus attempting to deliver quality vegetables at competitive prices, the Government has proposed to provide an amount of 300 crore for implementation of vegetable initiative to set in motion a virtuous cycle of higher production and incomes for the farmers.

The total allocation of Rashtriya Krishi Vikas Yojana (RKVY) is being increased from 6,755 crore (in 2010-11) to 7,860 crore in 2011-12.

In order to make credit flow available to farmers (at affordable cost), the Government has raised the target for agriculture credit to farmers from 3,75,000 crore (this year) to 4,75,000 crore in 2011-12.
Banking Sector - As a measure to follow its agenda of financial inclusion the Government has set a target of providing banking facilities to all 73,000 habitations (having a population of over 2,000) by fiscal year 2011-12. And in order to achieve this, the Government would also be releasing additional banking licenses to private sector players, by bringing in some amendment in the Banking Regulation Act. Moreover, recognising the fact that Micro Finance Institutions (MFIs) have emerged as an important means of financial inclusion, the Government has focused on creating dedicated fund for providing equity to smaller MFIs which would help them maintain growth and achieve scale and efficiency in operations. It has created “India Microfinance Equity Fund” and assigned 100 crore with SIDBI for the said purpose.

In order to strengthen the Regional Rural Banks (RRBs), the Government has proposed to provide an amount of 500 crore (during the fiscal year 2011-12) for enabling them to maintain a Capital Reserve Adequacy Ratio (CRAR) of at least 9% as on March 31, 2012. For recapitalisation of public sector banks, the Government has a sum of 6,000 crore, [thereby facilitating them to maintain their Tier I Capital to Risk Weighted Asset Ratio (CRAR) at 8 %] and also proposed increasing Government equity in some banks to 58%.

We believe that whilst there may be several applications for banking licenses, RBI will continue to be, rightly so, strict on actually issuing licenses and therefore, in reality one may not see too many “new banks” on the streets!
Education - Recognising the importance of a “demographic dividend” of a young population, the Government raised the allocation for the education sector by 24% to 52,057 crore (from 31,036 crore in the previous year). Also, in order to promote and implement the right of children to free and compulsory education, the Government has proposed to allocate 21,000 crore to Sarva Shiksha Abhiyan in order to revise its existing operational norms making it more viable.

Giving a boost to the e-Infrastructure, the Government plans to connect 1,500 institutes of Higher Learning and Research through the National Knowledge Network (NKN) (an optical fibre backbone). However, during the current year only 190 institutes will be connected to NKN while the remaining institutes will get connectivity by March 2012.

Special grants amounting to 700 crore have been allocated to recognize excellence in universities and academic institutions. Also the National Skill Development Council (NSDC) is well on course to achieve its mandate of creating 15 crore skilled work force ahead of 2022 (the stipulated target year) according to the Government.

In our opinion, it is a prudent step by the Government to encourage education in our country where 70% of the population will count in the working age by 2025. Imparting knowledge and developing skills is the only way to reap benefits of the working population of the country and achieve national development.
Mutual Fund Industry - While there was no change made to the structure of fund investment, the Government in order to provide an impetus to the mutual fund industry, permitted them to accept subscription from foreign investors who meet Know Your Client (KYC) requirements for equity schemes.

For liquid mutual funds, the Dividend Distribution Tax (DDT) has been increased from 25% to 30% for corporates; while for debt mutual funds, the DDT for the corporates has been increased to 30% from the earlier 20%, thus removing the advantage which the corporates enjoyed by investing in liquid and debt mutual funds over Fixed Deposits.

In our opinion, while this may enable mutual fund houses to garner more Asset Under Management (AUM) as foreign investors participate in the Indian equity markets (through the mutual fund route), we believe that this may also bring in some wild swings in the flow of funds to the mutual fund industry (unless we get long term foreign investors).

Also mutual funds won’t find it easy to attract short term surplus funds from corporates who park their surplus funds in liquid and debt mutual funds. However corporate who wish to park their long term funds (for a period of over 1 year) can still look at debt mutual funds by participating in the growth option as it still remains tax efficient (as it will continue to provide indexation benefit on long term capital gains).
PSU Disinvestment - While retaining at least 51% Government equity in its enterprises, the Government proposes to encourage people's participation in its disinvestment programme. The Government also proposed to raise 40,000 crore through PSU disinvestment, of which 22,144 crore will be raised in 2010-11.

We think that though this move will help the Government to generate revenue and reduce its fiscal deficit burden, but there could be a risk of not meeting these targets as planned on account of delay in implementation of the programme. However, privatisation of management of some of these PSU’s (which is lacking currently) will, in the long term, be real progress!
New Pension Scheme - “Swavalamban” where the minimum contribution is 1,000 and a maximum contribution of Rs.12,000 per annum during the financial year 2010-11 (where the Government also contributes 1,000 per year to each NPS account opened), the Government has proposed to relax the age of exit from 60 years to 50 years, or the minimum tenure of 20 years, whichever is later. The Government has also proposed to extend the benefit of Government contribution from three to five years for all subscribers of Swavalamban who enroll during 2010-11 and 2011-12.

This measure taken by the Government is a step to make NPS an attractive investment product, and will encourage people from the unorganised sector to voluntarily save for their retirement.
Indira Gandhi National Old Age Pension Scheme - Under this pension scheme available for people below the poverty line, the eligibility for pension is proposed to be reduced to 60 years from 65 years at present. Further, for those who are 80 years and above, the pension amount is being raised from 200 at present to 500 per month.

DIRECT TAXES:

INDIVIDUALS

Base exemption limit increased - Giving a relief to the country’s citizen who are suffering the pinch of already high inflation, Budget 2011 proposed the increase in base exemption limit for individuals (in the general category) from

1,60,000 to

1,80,000, thereby providing a uniform tax relief (to individuals in the general category) of

2,000.

Income-tax rates in Budget 2011
Taxable Income	Tax Rate
Upto 180,000	Nil
180,001 to 500,000	10%
500,001 to 800,000	20%
800,001 & above	30%

Some numbers will help us better recognise the impact of this move.

2010-11
Taxable Income		10,00,000
Upto 160,000	Nil	-
160,001 to 500,000	10%	34,000
500,001 to 800,000	20%	60,000
800,001 & above	30%	60,000
Tax payable		154,000
Education Cess	3%	4,620
Total Tax ()		158,620

2011-12
Taxable Income		10,00,000
Upto 180,000	Nil	-
160,001 to 500,000	10%	32,000
500,001 to 800,000	20%	60,000
800,001 & above	30%	60,000
Tax payable	-	152,000
Education Cess	3%	4,560
Total Tax ()		156,560

Let’s take the case of a male individual whose net taxable income is

10,00,000. As per the current tax laws his income tax liability will be

1,58,620 (for FY 2010-11), while in the FY 2011-12, once the the new base exemption limit applies, his tax liability will work out to

1,56,560, i.e. a saving of

2,060.

For Senior citizens, the base exemption was increased to

2,50,000 (from

2,40,000 at present), while the qualifying age for senior citizens was reduced from 65 year to 60 years. Also going an extra mile, budget 2011-12 introduced a special category called “Very Senior Citizens”, age 80 and above and set their base exemption limit at

5,00,000.

For women however, the base exemption limit remains unchanged at

1,90,000.

We think the proposed increase in the base exemption limit, would provide some relief to a large number of individual tax payers, as it means more disposable income in the hands of consumers, which may drive the consumption story. Also, the budget 2011-12 reflects populist sentiments of the Government and is a step to move closer to DTC. Given, the political clout under which the UPA Government was caught, in our opinion the budget is fair.

Deduction for income tax - The Government also retained the additional income tax deduction of 20,000 under section 80CCF (of the Income Tax Act, 1961) by extending it by another year, as focus on infrastructure spending remains.

Section 80C too did not see any change.
Surcharge - Current surcharge of 7.5% on domestic companies has been reduced to 5.0%.

This will help corporates to reduce some of their tax burden and thereby increase their profitability. We also feel that such a move is an initiative to phase out surcharge.

Mimimum Alternate Tax (MAT) - Rate of Minimum Alternate Tax (MAT) has been increased from the current rate of 18% to 18.5% of book profits.

This increase will negatively impact some corporates in the manufacturing sector, as their profitability would be affected.
Withholding tax rate - In order to attract foreign funds for financing of infrastructure, the withholding tax rate on them have been reduced to 5% (from 20% at present)

DIRECT TAX CODE

The Direct Tax Code (DTC) will be finalised for enacting, and will be proposed with effect from April 1, 2012. At present wide-ranging discussions with stakeholders are taking place, for it to take its right form.

INDIRECT TAXES:

Goods and Services Tax (GST) - As the areas of divergence with states on proposed GST have been narrowed, and significant progress in establishing GST Network (GSTN), (which will serve as IT infrastructure for introduction of GST) would be achieved, the Government is on course to introduce GST by April 1, 2012.
Service Tax – The rate of service tax has been left unchanged at 10%, thus seeking to achieve a closer fit with the GST. However following new services have been proposed to be introduced to the ambit of service tax which are as under:
- Hotel accommodation, in excess of declared tariff of 1,000 per day with an abatement of 50%, so that the effective burden is only 5% of the amount charged.
- Service provided by air-conditioned restaurants that have license to serve liquor, by giving an abatement of 70%, so that the effective burden will be 3% of the bill, amount.
- Service tax on domestic air travel levied at 50, while 250 on international journeys by economy class. Also it has been proposed to tax travel by higher classes on domestic sector at the standard rate of 10%, thus bringing it on par with journeys by higher classes on international air travel.
- Hospitals with 25 or more beds that have the facility of central air-conditioning and which are providing high-end treatment; however, after providing an abatement of 50%, the actual burden is kept at 5% of the value of service.
- For life insurance policies the Government has proposed to increase the service tax on life insurance to 1.5% from 1.0%, a move that would increase the premium cost for policyholders.
Moreover, individual and sole proprietor tax payers with a turnover of upto 60 lakh would be freed from the formalities of audit.
Central Excise - The Government would maintain the Central Excise rate at 10%, but has reduced the number of exemptions in Central Excise rate structure. The minimum rate of Central Excise Duty has been enhanced from 4% to 5%.

We believe this measure is taken as a step towards withdrawal of fiscal stimulus which may hurt the sentiments of the manufacturing sector in the near term.
Custom duty - The Peak rate of Custom Duty has been held at its current level of 10%. However, in order to increase agriculture productivity basic custom duty on specified agricultural equipments has been reduced from 5.0% to 2.5%. Similarly for micro-irrigation equipment, the basic custom duty has been reduced from 7.5% to 5.0%.

Also in order to improve the state of infrastructure in our country, the custom duty on bio-asphalt and specified machinery for application in the construction of national highways, has been fully exempt from tax. Taking care that shipments too do not get affected, import duty for spares and capital goods required for ship repair units (extended to import by ship owners) are also proposed to be exempt.

Overall we feel that the Budget 2011-12 is keeping the growth agenda intact, as infrastructure, agriculture, banking & finance and education has been catered to in balanced form which may also help the Government to achieve its fiscal deficit target of 4.6% for fiscal year 2011-12. Also over a period of time, private capital expenditure would pick up due to Government’s focus on overall infrastructure development.

On the direct tax front, we believe that the Budget 2011-12 has moved a step closer to DTC, by increasing the base exemption limits for the respective categories of individuals. For corporates, the reduction in surcharge is intended to fuel their earnings and leaving them with more profits for expansionary purpose.

The budget speech led to a relief rally in both equity and debt markets. However after reading the fine prints, the equity markets were not able to sustain their day’s high, while the debt markets managed to remain buoyant.

Impact on Equity Markets

Equity markets cheered the Budget day (February 28, 2011). Before ending the day with a gains of 112.49 points at 17,823.40 points, the markets hit an intra-day high of 595 points on relief that the finance minister did not raise excise duties and opened a window for foreign investors to participate in Indian equity markets by investing in Indian mutual funds. However the finance minister’s optimistic estimates of 18% tax revenue growth and an expenditure growth of just 3.4% did not help the markets to sustain their day highs, as the worries of high crude oil prices prevails and the Government too has failed to factor in the rising crude prices in the subsidy numbers.

Impact on Debt Markets

As the Government’s announcement of net borrowing figures ( 3,43,000 crore) remained low than the market estimates ( 3,80,000 crore), the bond prices advanced thus leading to a drop in the bond yields across the yield curve on the budget day. Yield on the most actively-traded Government bond (8.13% G-sec 2022) dropped 5 bps (basis points) to 8.09%; while the yield on the 10 year G-sec 7.80% 2020 eased 6 bps to 8.01%. The budget estimates of the average inflation rate of 5% for 2011-12 as against 9% for 2010-11 led to easing the major concern in the bond markets i.e. high inflation. Also the lower fiscal deficit target coupled with monetary tightening raised the expectation of ease in the headline inflation in the financial year 2011-12.

So overall, in our opinion the budget is pro-reform and has addressed to various economic needs in light of the present economic constraints. But now, the implementation of the proposals of the Budget will be the key that will lead to overall economic development.