Budget First Reactions: Long Term Gain With A Short Term Pain

07 July, 2009

This is a pragmatic budget which has dealt with the realities of the economically challenged world we live in today. The finance minister has continued the investment in infrastructure, clean governance and “aam aadmi”. The fiscal stimulus measures have been extended to stimulate domestic demand and make available abundant liquidity for the infrastructure and farm sectors, even if as a priority over others.

Infrastructure has continued to be a focus area with increased outlay for JNNURM (up 87%), highways (up 23%), irrigation (up 75%) and Bharat Nirman (up 47%) scheme amongst others. Energy Security got a fillip with the proposed blueprint for development of a National Gas Grid, including tax incentives for building the same, which should help utilize our gas reserves better. 

Government also made positive steps towards clean governance by introducing measures such as 100% deduction for electoral trusts. Moving fertilizer subsidy to the farmer level instead of giving it to fertilizer companies is an important step in improving delivery of government subsidises to the aam aadmi.  Setting up the National Unique ID registry and database will pave the way for direct payment of subsidies as well as customisation by regions or groups, for all programmes like NAREGA in the long-term.

The promises to the electorate from the UPA were indeed met, as expected, by extension of existing as well as new programmes to improve standards of living of our Below Poverty Line (BPL) and rural population, nearly 50% of society. There is a significant increase in outlay to support education/skills, healthcare insurance coverage and employment and income support. It is notable that the 1.5% of India’s first 10 Lakh Crore expenditure budget has been allocated for urbanization and housing.

Budget has put more money in the hands of consumers with reduction in effective tax rates through elimination of surcharge and increased limit for income exempt from tax. The finance minster has done what he could in context of what was available for him to give, without affecting inclusive development as well as infrastructure.

In the short-term, there are genuine concerns around the level of budgeted expenditure and the high fiscal deficit and what it can do to the yields on bond papers issued by GOI. The bank’s bond books look vulnerable. No relief was announced in corporate tax and instead the MAT was increased to 15%. Large deficit also retains the threat to India’s sovereign credit rating which was put under the watch list by S&P recently. Downgrade in rating will move India from last in investment grade to junk bond status increasing the cost of debt for Indian companies.

Markets are understandably upset but are also victims of unrealistic expectations. Perhaps the air-time of the speech was mainly on expenditure, and the 6.8% deficit (very much more if State deficits and off-balance sheet items are taken) has been expected, but was still bitter medicine when swallowed! And several measures such as STT removal, dividend tax repeal which were potentially factored into the indices, failed to materialize.

Also, the markets may have discounted a lot of shorter term reforms (some of which may have not been announced yet).  Instead the focus of the budget has been on supporting long-term reforms in education & skills, urbanization, provision of healthcare, affordable housing which are all building blocks to long-term sustainability and growth.

These expenditure areas are more positive from Private Equity perspective as many companies investing in them are relatively smaller and a few years away from going public. Moreover, over longer term, these steps will help the nation move towards a more homogeneous consumer base which will create a bigger market for products and services in future. In the near future we expect PE interest to increase for businesses in education, healthcare and infrastructure.

For the VC/PE sector and fund management industry, It is noted with regret that the budget was silent on the inclusion a broader range of sectors of private equity funds for “pass through” taxation under section 10 (23FB). Hopefully, the inclusion of more sectors of PE investment will be re-considered in near future.

This is an important step to increase the flow of capital pools into the Indian PE sector.  The incentives to encourage the Pension Fund Management sector is welcome, as they will create a very large pool for investments in PE funds in the long term, as well as provide an important form of social security.

In addition, clarity on taxation status of LLP firms was also something we missed, and hope to work on in coming months. Globally, many PE managers are structured as LLPs, as this practice is an important and relevant form of organisation for professional services organisations.

As the Finance Minister himself highlighted, budgetary items involves significant challenges and the success of the plan will depend on sharp execution. We note with keen interest the FM’s specific mention about corporate leaders assuming key government roles.

Many of his very developmental macro statements could find voice in legislations and executive actions that will hit the ground in the next two months, so we should wait and watch. Budget, after all is one of the instruments of state policy, but perhaps a very important one. And of course, as always, we have to study the fine print to fully understand the budgetary implications at a micro level! The impact is often in these details!


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Budget First Reactions: Long Term Gain With A Short Term Pain

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