Finance Minister Arun Jaitley presented his first union budget yesterday. It was a budget that was awaited with much anticipation and that was beginning, even before it was presented, to be described in certain sections of the media and in the tweetosphere as #SuperBudget. For a nation that had been reeling under the shock of one cluster of bad news after another on the economic front for the past 3 years, #SuperBudget seemed like an inspiring sobriquet that highlighted the hopes and aspirations of its economic stakeholders.
It is not my goal here to imprudently attempt a comprehensive analysis of this budget. Rather, what I seek to do is to share my thoughts on whether the budget presented by the Finance Minister yesterday is indeed a “SuperBudget” from point of view of turbocharging the floundering Indian economy, and whether it can be reasonably expected to reinvigorate investments into Indian industry, both by Indian businesses as well as by foreign investors.
Foreign Direct Investment (FDI)
The Finance Minister announced the following reform measures relating the FDI laws:
• Insurance – The sectoral cap for insurance has been increased from the existing 26% to 49%. While this is certainly a welcome and long-awaited reform move, an enhancement of the FDI ceiling from 26% to 49% does not achieve much from a foreign investor’s perspective. Whether a foreign investor owns 26% or 49%, from a control and management perspective, it is really the same thing!
Therefore, this reform is not likely to cause a deluge of investments from international insurance companies that are looking to enter the Indian market, as they would still not be able to own a controlling stake in the Indian JV.
However, private equity investors looking at growth equity deals in the insurance and insurance-related sectors (like TPAs, insurance broking etc) will undoubtedly welcome this move as it enables them to take larger stakes in these companies. Therefore, we can expect healthy volume of PE deals in the insurance sector, which is good for the sector.
Notably, while the Finance Minister’s budget speech did not include reference to any “strings attached” to this reform, news reports prior to the announcement of the budget strongly suggested that the Government might impose conditions which limit the voting rights of the foreign shareholders to 26%. One will have to wait and read the fine print to see what kind of restrictions, if any, are imposed.
Also, while the announcement of Government’s decision to liberalize FDI in insurance is a positive move, this move will require suitable amendments to the Insurance Act (which requires parliamentary approval) and the regulations issued by the IRDA, all of which could take some time.
• Defence – The sectoral cap in defence too, was enhanced from the existing 26% to 49%. I fear this will turn out to be a damp squib reform measure that will probably not attract much investment interest.
In a sector like defence, where the companies with the best technologies have to spend billions of dollars and huge amounts of time on R&D, any international company that is keen on entering the Indian market would be very anxious about protecting its technology and know-how and in this background, would expect at the very minimum that they are able to exercise control and management over the Indian JV and to be able to treat the Indian JV as their subsidiary.
While I don’t think 100% FDI needs to be allowed, at the minimum, the Government should have been a bit bolder and permitted 51%. I consider this an opportunity missed for India to attract some big-ticket investment in this sector, and also the opportunity for partially indigenizing the manufacture of certain defence equipment.
• Real Estate/Urban Construction – The norms under the existing Press Note 2 of 2005 have been relaxed a bit – the minimum investment limit has been reduced from USD 10 million to USD 5 million, and the minimum built-up area requirements have been reduced by half. This measure will surely benefit smaller scale greenfield real estate development projects as they can now look to bring in foreign investors.
• Railways – While the railways budget announced by the Railways Minister two days ago expressed clear intent to open up certain segments of the railways sector to private sector participation and FDI, there was no reference to the same in the union budget presented by the Finance Minister yesterday. While the notion of railways sector projects being privatized and being thrown open to foreign investors is very exciting and promising, I am inclined to restrain my optimism till it becomes clear as to what kind of policies and rules are eventually made by the Government in this regard. This is a sector which could seriously benefit from attracting private sector capital and foreign technologies.
• No Ecommerce – There were strong expectations that this budget would include a reform permitting 100% FDI in ecommerce. It is therefore, very disappointing that there has been no mention of ecommerce at all in this budget. An announcement pertaining to ecommerce would have provided an immense boost to a sector that is already growing at an astonishing rate in India and one that needs levels of growth capital that simply cannot be provided by the Indian market alone. In order for this sector to thrive and reach its multi-billion dollar potential, allowing FDI would be a key factor. I hope the Government re-considers its decision here and announces a liberalization of this sector at the earliest.
• No Automatic Route for FDI in AIFs – Disappointingly, the ambiguity over the eligibility of AIFs registered under the SEBI AIF Regulations to raise funds from foreign LPs continues to exist, as this budget has not provided any clarity in this regard. This is an issue that has been plaguing the funds industry in a major way and impeding AIFs in their fundraising efforts, as they are not specifically permitted to raise funds from foreign investors other than registered FVCIs. This is a huge limiting factor that needs to be done away with by clearly permitting FDI under the automatic route into all categories of AIFs.
Another long-standing issue has also not been addressed in the budget speech, and that is the issue of exempting non-FVCI foreign LPs in Indian AIFs from the pricing restrictions applicable to other FDI investors. This is again an impediment to AIFs from raising money from foreign LPs that are not FVCIs – a much bigger one than is commonly acknowledged.
If foreign LPs are subject to pricing restrictions under FEMA upon redemption of their units in the AIF, that pretty much hits at the very basis of investing in alternative investment funds!
As expected, this budget had a strong thrust on infrastructure projects.
The Finance Minister announced the following decisions with respect to infrastructure projects:
• Development of metro projects in several Tier 1 and Tier 2 cities on a PPP basis.
• Allocation of Rs. 1000 crores for augmenting and developing rail connectivity in the North-eastern part of India, which again presents opportunities for PPP concessionaires and EPC companies.
• Picking up a cue from the Vajpayee-led last NDA Government’s vision of a “Sagar Mala”, the Finance Minister announced development of sea ports and augmenting capacity at existing ports.
• Development of industrial corridors across the country.
• Development of airports in several cities on a PPP basis.
The above are all great ideas and it is hard to argue with the benefits that these proposals could bring, if executed in a time-bound fashion.
The budget stayed a fairly conservative course on direct taxes. While several minor tweaks to various aspects of taxation, the following are the important ones that could impact deal-flows into India:
• Retrospective Taxation – While he did not announce withdrawal of existing cases and did not give a very strong statement in this regard, he did quite clearly say that his Government would not normally pursue a path of retrospectively taxing transactions. He did talk about the need for rational and predictable tax administration and emphasized that tax authorities are not mere enforcement authorities. All this points towards Governmental thinking that retrospective taxes may not be levied by his Government, but some in the international market may wish for more assurance from the Finance Minister than this.
• Pass-Through for REITs and Infra Investment Trusts – He made a specific proposal that REITs and Infrastructure Investment Trusts would get tax pass through status, which is an excellent announcement, in my view. Our country has long needed a rational and workable REITs regime with a tax pass-through status for such trusts. This is a very welcome move.
• But…..No pass-through for AIFs – While the Finance Minister’s decision to allow tax pass through for REITs and Infra Investment Trusts was very heartening, what was disappointing is that his speech gave no clarity on tax treatment of AIFs registered under the SEBI AIF Regulations, 2012.
This will therefore, continue to be a nagging uncertainty for the funds industry. In my view, clarity on tax pass-through for AIFs should have been a bigger priority for the Government than REITs, Infra Trusts etc.
After all, a bird in hand is worth several in the bush!
• Investment Allowance for Manufacturing Units – An investment allowance of 15% has been announced for a period of 3 years for manufacturing companies that set up new plants and machinery with an investment of Rs. 25 crores or more. This is a great move that will provide a good incentive for Indian businesses to invest much needed capital in new industrial facilities. Given that there has also been a fall in India’s Industrial Production Index in recent years, this move should contribute to shoring up the manufacturing sector and also create some manufacturing jobs.
• New DTC – Since the existing DTC has lapsed with the change of Government, the Finance Minister announced that a new DTC would be put in place after comments and feedback has been received from the public.
While the Finance Minister announced a slew of good tweaks on indirect taxes, the decision to rationalize import duty on various different grades of coal by bringing them under the same tax rate caught my attention as a key change which could have a positive impact on development of infrastructure projects in the country. With coal being a major imported input for most independent power projects in India, the delays, disputes and transactional costs of attempting to grade the imported coal for determining the applicable import duty rate was a wasteful exercise, which will now be done away with on account of this rationalization.
Overall, I would say that this budget is a good balancing act, one that manages to be bold while still being sensitive to the prevailing realpolitik on the ground. The assessment of impact potential of any budget has to be a contextual exercise, and given the context in which this budget was presented, I’d say it is a responsibly thought-through and very positive-sounding budget that will surely restore a lot of confidence amongst global investors as well as Indian businesses on the attractiveness of the Indian market.
However, as I have discussed above, I do believe that this budget could have been much more impactful had it considered some transformational changes to the system and gone all the way with some reforms rather than announcing measures that in some cases, seem moot. One hopes that the Government keeps constantly looking for ways to better the policy framework to grow the economy in a rational and balanced manner.
The ultimate test of the impact that this budget, though, lies not in the content of this budget speech alone, but in the execution! While the budget seems to have been well-received by the markets, the skeptics will turn believers if the Government demonstrates a consistent ability to walk the talk on its promises!
(Vijay Sambamurthi is the founder and managing partner of Lexygen)
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