The Union Budget for 2014-15 was expected to be the growth Budget, intended to reignite a sluggish Indian economy. There are five that highlight its importance:
1. India’s economy is currently undergoing a challenging combination of less than 5 per cent growth and double-digit inflation
2. This is the first Budget of the NDA government to lay down a broad policy indicator of the direction in which it wishes to take this country.
3. The Budget is designed to achieve a target growth rate of 7-8 per cent over the 3-4 years
4. India’s economy is currently experiencing a need to revive growth, particularly in the manufacturing and infrastructure sectors
5. Observers expect bold steps to enhance economic activities and spur growth in the economy
As imports have been restricted to lower the CAD (current account deficit) and GDP per capita has been low for the past two years, a balance of both FDI and indigenous ventures are being encouraged. Specifically, IT sector policies include FDI encouragement and internal R&D protection. The Budget allocation for IT spending is $1.3B, with a focus on the digitisation of India, the development of smart cities and modernising government services.
IT sector policy changes during the Budget
IT services are currently a significant portion of Indian exports and Indian IT Industry in general. Thus, the focus of this Budget - in terms of IT - is on a balanced growth model for the lagging sub-sectors.
One of the chief means of doing so is by encouraging more foreign direct investment (FDI), particularly in the defense and insurance sectors. The defense sector which relies heavily on hi-end technology (technology being the second-biggest component in defense manufacturing) received cap expansion from 26 per cent to 49 per cent. As the present FDI yield in defense sector adds up to less than $5 million, foreign defense manufacturing companies are expected to seize this high revenue generating opportunity (the Indian army is currently the fourth-largest army in the world). Similarly, the insurance sector is expected to earn an extra $2 billion in one year via FDI due to the cap increase. That amount would represent a 3 per cent growth for the $60 billion sector. Many observers expect global technology companies collaborating with defense manufacturing firms and/or insurance companies to either invest in an Indian firm, acquire an existing Indian firm or setup centres in India for their R&D foreseeing big revenue markets in these sectors.
Another measure towards to boost the IT sector in India is increased protection for internal R&D. A 10 per cent import tax has been imposed on IT and telecom import services excluding those under the purview of Information Technology Agreement (ITA-1) of WTO. Niche technologies firms are expected to organically grow from the abundant talent pool of software engineers available in India. Such entrepreneurial initiatives are attractive to global big players who see high accretive value from acquisition of small startups.
IT allocations from budget
Technology growth in India has been lagging behind the growth seen in the sector itself. This is because technology has struggled to reach far beyond urban regions. Major hurdles were government policy and education. In this Union Budget, the Modi government has taken several initiatives to address these issues.
The first initiative is to digitise India by connecting remote rural regions via the internet – wired and wireless. Telecom sector has been foreseen as a growth opportunity over the past decade; it slowed down by the lack of project approvals from the government. Finally, the government’s move to include remote access to IT enabled platforms, fund startups in IT space and build a conducive environment through stable tax regime should change this longstanding opportunity into reality.
The second initiative is to build 100 smart cities across India. Currently, a lack of good infrastructure – such as commutation, communication, remote access, emergency services – essential to establish businesses outside the major metropolitan centres (Delhi, Mumbai, Chennai, Kolkatta, Bangalore, etc.) has discouraged corporates from moving into more rural areas. $1.18 billion has been set aside in the Budget to develop channels connecting metros identified as economic zones. Additionally, the percentage of FDI has been increased to 100% and minimum investment threshold has been reduced by 50 percent to $5 million. Hence, an investment in a satellite town of Mumbai (included in the first phase of development) is not only less expensive but also provides direct access to best infrastructure in India and close proximity to big companies located in the financial capital. These projects will generate large volume of data which consumer goods companies and government data collection agencies can analyse and use to develop enhanced products and services. Technically, apart from telecom companies seeing growth in volumes, smart city projects can potentially attract Big Data companies to India.
The final initiative is automation of government services through introduction of E-Visa technology, modernisation of railways using technology, building virtual schools and integrating other government services into a single platform by December 2014. The idea of E-visa is to provide visas to tourists on arrival. This provision involves large-scale integration of the visa office’s database, wired and wireless networks and SaaS solutions. Business intelligence and big data solutions will be necessary for tracking, analyzing and future services’ improvement. A revamp of the Indian railways will introduce new features such as Wi-Fi services on trains, next-gen e-ticketing system, GIS mapping and digitisation of records. In its10 year-plan, the government has outlined more than 200 government services to be made available online and increase tax base through digitisation of the collection process. To overcome the education hurdle virtual schools will be made available online. Other than leveraging the broadband networks for connectivity, part of the allocation of $16.7 million for virtual schools can be used for building cloud based services for specialised and self-learning type of coursework.
To summarise, there are six observable opportunities in the Indian IT space
First, greater FDI and M&A activity – FDI is likely to increase through investments in technology for the defense, insurance and construction (smart cities) sectors whereas M&As are likely outcomes of big global players’ attraction to niche technology startups.
Second, e-commerce and Big Data have a promising future with wide application in development of products for insurance sector and smart cities’ project. Further, e-commerce industry can diversify into selling manufacturing units online (which is now allowed after the budget).
Third, indigenous networking services firms are expected to grow organically in light of the tax increase for telecom imports. This policy combines well with other government measures like expansion of rural internet network; remote access for IT enabled platforms and virtual schools’ development.
Fourth, cloud services will be central to providing remote access services for the digitisation of India project, virtual schools and improving access to government services.
Fifth, Indian IT companies can focus on domestic market for providing services for building a stable tax regime, developing creative software solutions for virtual schools and modernising the railway ticketing system.
Finally, innovation and research boom. FDI will drive innovation and research largely in the defense and telecom sectors. Due to the import duty levied on certain telecom services, it presents an opportunity to foreign companies to invest in Indian startups.
To conclude, the key is implementation of the objectives laid down and Modi is strong in governance and execution. Generally people were expecting a bolder budget than this. However, I feel it’s a smart Budget which will allow the Modi government to leverage IT to advance India’s overall growth significantly.
(Gaurav Sharma is the Senior Vice-President and Managing Director of the India Practice Group of martinwolf M&A Advisors.)
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