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 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.
Budget at a Glance
Rs bn 2009-2010 A 2010-2011 BE 2010-2011 RE 2011-2012 BE
1. Revenue Receipts 5,728 6,822 7,838 7,899
2. Tax Revenue (net to Centre) 4,565 5,341 5,637 6,645
3. Non-tax Revenue 1,163 1,481 2,201 1,254
4. Capital Receipts $ 4,517 4,265 4,327 4,678
5. Recoveries of Loans 86 51 90 150
6. Other Receipts 246 400 227 400
7. Borrowings and other Liabilities* 4,185 3,814 4,010 4,128
8. Total Receipts $ 10,245 11,087 12,166 12,577
9. Non-plan Expenditure 7,211 7,357 8,216 8,162
10. On Revenue Account of which, 6,579 6,436 7,267 7,336
11. Interest Payments 2,131 2,487 2,408 2,680
12. On Capital Account 632 921 948 826
13. Plan Expenditure 3,034 3,731 3,950 4,415
14. On Revenue Account 2,539 3,151 3,269 3,636
15. On Capital Account 495 580 681 779
16. Total Expenditure 10,245 11,087 12,166 12,577
17. Revenue Expenditure 9,118 9,587 10,537 10,972
18. Capital Expenditure 1,127 1,500 1,629 1,606
19. Revenue Deficit 3,390 2,765 2,698 3,073
% of GDP (5.2) (4.0) (3.4) (3.4)
20. Fiscal Deficit 4,185 3,814 4,010 4,128
% of GDP (6.4) (5.5) (5.1) (4.6)
21. Primary Deficit (20-11) 2,054 1,327 1,602 1,448
% of GDP (3.1) (1.9) (2.0) (1.6)
* Includes draw-down of Cash Balance, $ Does not include receipts in respect of Market Stabilization Scheme.

Strategy Note 2
Union Budget 2011-12

Sectoral impact

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

Banking
Key announcements Impact
Positive for the banking space, limited impact on bond yields.
FY12 fiscal deficit targeted at 4.6% of GDP with net market
Further, the front loading of borrowing programme should ensure
borrowing of Rs3.43tn.
smooth credit growth in H2 FY12.
FII investment in equity schemes of registered mutual fund
Positive for mutual fund industry.
subject to KYC requirement
Recapitalizations to the tune of Rs60bn by GoI in PSU banks Positive for small PSU banks like Dena Bank, UCO Bank,
enabling them maintain minimum Tier I CAR at 8%. Syndicate Bank, Vijaya Bank.

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.
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 Impact
Increase in excise duty on cement Negative for all cement manufacturers

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

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

Strategy Note 3
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 Impact
Infrastructure allocation increased by 23% to Rs2.14tn Positive for the sector
FII limit for investment in corporate bonds (with residual maturity
Positive for the sector
of over 5 years) issued by infra companies raised by US$20bn
FIIs also permitted to invest in unlisted bonds of Infra SPVs with
Positive for the sector
a minimum lock-in period of 3 years
Government undertakings such as Railway Finance Corporation,
Positive for the sector
NHAI, HUDCO, etc allowed to issue tax-free bonds of Rs300bn
The additional deduction of Rs20,000 for investment in long-
Positive for the sector
term 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 Positive for the sector
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 Positive for the sector
under take-out financing scheme in FY12
Excise duty on Cement increased Negative for the sector
Excise duty exemption for equipment supply to UMPPs Positive for capital goods players such as BHEL

Metals & mining

Key announcements Impact
Export duty from 5% on fines and 15% on lumps increased to Negative for iron ore exporting companies like Sesa Goa and
20% NMDC; Marginally positive for domestic steel manufacturers
Removal of export duty on pellets to nil 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 Impact
Increase in home loan size to Rs2.5mn, to be characterised as Marginally positive for regional players like Purvankara, Unitech,
priority sector loan HDIL, Sobha Developers
Implementation of MAT on SEZ developers and units operating
Negative for DLF
in those areas

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
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

Strategy Note 4
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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