India's Union Budget FY 2013

 

The run-up to the Union Budget has seen a plethora of ‘experts’ (bankers, corporate executives, investors, economists, journalists, etc.) voicing their opinion of what the Union Budget FY2013 should look like. The Union Budget is probably the most hyped up event in the economic calendar. From being a simple event of the government declaring the profit and loss account of the public finances, it has undergone a metamorphosis, whereby the government now provides a snapshot of the nitty-gritties of the economy, policy ingredients, and guidance for the next fiscal year. Nobody gains from this parliamentary Budget session as much as the media. In fact, judging by the past few years, the Budget has been more of the TRP (Television Rating Point) event than a GDP (Gross Domestic Product) event.

 

Budget Day in India is somewhat of a close follower of the British counterpart. For many years in Britain, the Chancellor of the Exchequer ceremonially enters the House of Commons with a Victorian-era ‘budget box’ briefcase. In similar fashion, Indian Finance Minister Pranab Mukherjee clutched his red leather briefcase as he entered the Indian Parliament building. Mr. Mukherjee presented India’s 81^st annual Budget on March 16^th; Individually, it was his seventh, the second highest by any Finance Minister in India. Several ‘experts’ were hoping the budget would introduce the much-awaited reforms that would spur economic growth, and bring back the investor confidence. The key reforms anticipated by the markets included:

1. A revamp of Tax-structure by introducing Goods and Service Tax (GST) and a Direct Tax Code (DTC)
2. Allowing Foreign Direct Investment (FDI) in sectors such as Aviation, Retail, and Insurance
3. Trimming the fiscal deficit
4. Removing infrastructure bottlenecks
5. Breakup of the state-run Coal monopoly
6. Cutting back on subsidies (Fuel, Fertilizer, and Food)
7. Maybe even some tax relief for the middle class

However, one doesn’t need to be a genius to realize that making everybody happy was impossible. The FY-2013 Budget, like most of its predecessors, stuck to the age-old trend of taxing consumption, raising taxes for existing taxpayers to pay for the handouts given to the impoverished, bail-out ailing sectors, and optimistically talk about reforms to come. The emphasis was on Inclusive Growth, with increased spending on agriculture, healthcare, and education. Little wonder that his choice of literary quote was from Hamlet: “I must be cruel, only to be kind”, compared to Dr. Manmohan Singh citing Victor Hugo in 1991, “a reformed and confident India was an idea whose time had come”.

The FM started his budget speech reminding everyone of the tough global economic environment (high oil prices due to tensions in the Middle East, European Crisis, the usual suspects really). Then he moved on to present India’s economic performance. FY2012 GDP growth rate pegged at 6.9%, compared to 8.4% in the previous year. GDP growth for FY2013 expected to be around 7.6%. Then he moved on to talk about fiscal consolidation, saying that issues regarding public finance – something that investors and the RBI have been demanding for quite some time now – would be addressed. The fiscal deficit, targeted at 4.6% of the GDP, was likely to be around 5.9% for the year ending March 2012. However, factoring in the states’ deficit, and off-balance sheet items, the overall deficit could touch 9%. He announced the target for next fiscal year to be 5.1% (and below 4% in 3 years), which would be achieved on the back of increased service and excise taxes, and subsidy expenditure reduced to 2% of the GDP (and 1.7% in 3 years) from about 2.7% now. It also set a divestment target of Rs 300 billion for FY2013 compared to its FY2012 target of Rs 400 billion, of which it only managed to raise Rs. 139.1 billion (through an FPO of Power Finance Corp. and a 5% stake auction on Oil &Natural Gas Corp.)

He also tried to excite the financial markets by proposing Qualified Foreign Investors (QFIs) access to Indian Corporate Bond Markets; and incentivize greater participation by retail investors in equity markets through Rajiv Gandhi Equity Savings Scheme, which would give them 50% income-tax deduction upto Rs. 50,000. Then he announced that small investors could e-vote in companies. Obviously their e-vote would not be sufficient to stop the Government from looting PSUs (Remember ONGC?). Furthermore, he lowered the Securities Transaction Tax (STT) to just 0.1%.

Mr. Mukherjee then moved on to talk about the bottlenecks in the economy:

• Provided Rs 158.88 billion for recapitalization of public sector banks, regional-rural banks, and other financial institutions like National Bank for Agriculture and Rural Development (NABARD)
• Allowed another Rs. 600 billion worth of tax-free bond issuances to fund infrastructure projects
• Cut customs duty on imported coal to ensure fuel supply for power generation
• Directed Coal India to sign long-term Fuel Supply Agreements (FSAs) with Power plants
• Allowed Airlines to raise more foreign loans (ECBs) for Working Capital
• Allowed ECBs for Capex Requirements of Infrastructure Projects (more specifically, power projects, roads and highway projects)
• Set up a Credit Guarantee Trust Fund and allowed ECBs for Low-Cost Housing Projects to address shortage of affordable housing in many cities
• Provided for Telecom Towers to get viability gap-funding
• Increased funding for National Rural Health Mission (NRHM) to Rs. 20.8 billion
• Announced a “White Paper” is being prepared to deal with on black money (illicit funds) stashed both, at home and abroad
• Increased Defense spending by 17% to Rs. 1.93 trillion
• Provided Rs. 255.55 billion to the Right to Education, a 21.7% yoy increase, and also proposed setting up a Credit Guarantee Fund for students

Finally he spoke about Taxes. On personal taxes, he enhanced the basic limit for tax exemption to Rs. 200,000, and expanded the 20% tax slab upto Rs. 1 million. The new tax slabs is illustrated below. Furthermore, there would be no separate tax slabs for women. Interest-income upto Rs. 10,000 from savings account in banks or post offices would now be tax-free. But custom duty on Gold and Platinum were increased (understandably so, to curb gold imports and to channel that money into more productive areas of the economy). Additionally, Sin tax increased on some tobacco products.

 There was no change in corporate tax rates. Broadly, service taxes and general excise duties were hiked to 12%. However, peak excise duty remains unchanged at 10%. This surely would be inflationary as services account for 59% of our GDP. I have compiled a chart to illustrate which goods or services will now cost more and which will cost less.

Overall, Union Budget 2013 was expected to deliver big-bang reforms. But all it had to offer was the traditional mix of more public spending and reshuffled taxes, none of which will be revitalize the stalled engines of economic growth. However, one announcement that was big bang in nature was that of General Anti Avoidance Rules (GAAR), a proposal to amend tax laws to retroactively levy capital gains tax on Indian assets (even on deals that take place abroad by foreign entities). This would apply to transactions as far back as April 1962. It appears that the amendment is principally aimed at taxing Vodafone, but this could well scare off foreign investors – the same people who fund India’s current account deficit; the same people that the Indian Government has been trying to woo.

Brief Background on Vodafone Case:

The British telecom giant bought an Indian operator from Hutchison Telecom of from Hong Kong in an offshore deal in 2007 for $11 billion. However, the Supreme Court of India, in January 2012, ruled that Vodafone should not have to pay a $2.2 billion tax that the Indian government claimed.

Later in the day, Mr. Mukherjee tried to explain that the government was only clarifying the 1962 tax law, and trying to close a loophole that allowed some companies to structure transactions in tax-havens such as Mauritius, purely to avoid paying any capital gains tax. “We are making it very clear that it is the law of the land — this is the intention of the legislature,” he said on NDTV, a news channel.

My Reaction

  

The Union Budget continued with the present Government’s theme of Inclusive Growth. Thankfully however, it refrained from announcing any extremely populist measures, especially considering its poor performance in recent state elections. Instead, it focused on fiscal consolidation. However, no big-ticket reforms were announced either. It seems like whatever additional revenues they’re raising will all be diverted to welfare programs and wasteful subsidies. So in short, our government continues to play Robin Hood.

The government has missed targets before. Furthermore, the last 2 quarters have seen so many revisions that government estimates can no longer be considered a reliable source. There is something really wrong with the way the official statistics are calculated and maintained. Hence pardon my cynicism but I’d take these Budget numbers with a pinch of salt too.

One major takeaway is that the government has missed an opportunity to deliver reforms and jumpstart the productive engines of the economy. I was not expecting the budget to deliver too much, but at least a few reforms were desperately needed. Politics is once again driving the nation at the detriment of economics.

We witnessed this two days ago as well, when a coalition ally Ms. Mamata Bannerjee, populist leader of West Bengal based Trinamool Congress, demanded the Railway Minister (who belongs to her own party) to be fired. 

His crime? Proposing a fractional rise in rail fares to modernize Indian Railways and improve its safety and hygiene. The rail budget was forward-looking, and the fare-hike was very modest, ranging from 2p – 30p per kilometer (or 0.04 – 0.6 cents per km); the fares had not been revised since 8 years. But by proposing this, Rail Minister Mr. Dinesh Trivedi had apparently “gone against the Trinamool Congress Party’s DNA” and that was unacceptable. Imagine their reaction if the government proposed privatizing the railways.

With such obstructing allies, it would be near impossible for the Congress to carry out any significant reforms even if they had a stomach for them. Another problem is that India Inc is a spoilt bunch that loves to sulk; hence business and investment climate will not improve until some policy action from the government. This budget failed to do that. The measures announced were marginal at best. It didn’t help RBI either. The central bank is terrified that inflation would pick up again, reflecting a host of supply-side constraints ranging from agricultural supply chain to inadequate infrastructure.

So what should the Budget have focused on? Even taking baby-steps, but in the right direction, can go a long way to fixing things. In addition to all that Mr. Finance Minister announced, he should have formed a Priority Group to maneuver the following:

1. Raise diesel prices, incrementally and quietly, but offset that by matching cuts in the tax on diesel. That way, the fiscal hole starts getting plugged, and the consumers don’t feel much of a pinch.
2. Set-up a facility to fast-track land acquisition and environmental clearances. This would kick-start the implementation of stalled projects, which would create employment along with boosting infrastructure, and housing markets, financial markets, and business sentiment – and all this without investing a single new penny.
3. Present a draft on GST and DTC, outlining how the overall economy (include every stakeholder) would benefit from it. Start discussions with an established deadline for the rollout.
4. As of now, India has only 790 diplomats and ambassadors, compared to about 3,000 in Brazil, over 6,000 in China, and well over 20,000 in America. While this may not have much of a direct impact on Indian’s finances (except their payrolls), it does increase India’s presence in different nations. This not only helps in economic ties, but also strategic ties. For a nation trying to strengthen its global footprint, India is severely under-represented on a diplomatic level.

In a separate post, I would like to share 2 open letters addressed to Finance Minister Pranab Mukherjee in response to his budget announcement. They sum up pretty well how some segments of the economy will be affected. A transcript of his BS (I mean Budget Speech) can be found here:

http://indiabudget.nic.in/ub2012-13/bs/bs.pdf

Greece gets its 2nd Bailout

Greece has been on the brink of its second bailout for weeks. The  130 billion bailout was first delayed because of the terms of the deal, where private bondholders would take a “voluntary haircut” to avoid triggering the Credit Default Swap (CDS) payouts. Then it was the details of the austerity package, where Greek Finance Minister Evangelos Venizelos was battling the “Troika” of rescuers (European Central Bank, the IMF, and the European Commission) over the details of  3.3 billion of spending cuts. Finally, the Troika wanted the leaders of all political parties to give written assurances that they will not renege on the deal after elections (penciled for April 8^th). 

According to an IMF report published in October last year, a 50% write-down on private sector bonds, stringent targets set by the EU summit, along with  130 in additional low interest financing would give Greece a decent chance to trim its public debt to 120% of the GDP by 2020, from 160% at present. However, since then, Greece's economy has been in much worse shape; it’s already in its fifth year of recession. Naturally, its rescuers – especially Germany – did not want to plug in the bigger financial hole because Greek politicians had already broken several promises on introducing economic reforms in the past. The implications were dire. If there had been no deal by March 20, when a big repayment of  14.4 billion was due (expiration of sovereign bonds), Greece would have no choice but to default. This would trigger a series of CDS payments (the quantum of which are unknown), and that could cause chaos across the entire financial system. Greece could well even be ejected from the Euro (inevitable in my opinion) since the European governments have failed to build a “firewall” around other high debt-ridden nations such as Portugal, Italy and Spain.

Background

For 30 years, the Greeks lived lavishly. Public spending bloated as cheap funding from the US and the EU seeped in, and as citizens incessantly cheated the system, and routinely avoided taxes. The last 3 years have seen Greeks humiliated and forced to endure hardship. Since the first bailout ( 110 billion) in May 2010, the government has imposed austerity and increased the taxes (not a very bright idea for a culture notoriously renowned for evading taxes). Taxes on restaurants more than doubled from 11% to 23%. Property prices and rents have plummeted but property taxes have tripled. An increase in taxes on cars prompted many drivers to hand in their license plates.

Protests against Austerity in Athens

The middle class has been driven into poverty. Many of the small-to-medium sized family businesses (50 employees or less), which make up of about 99% of Greece’s enterprises and 75% of its private sector workforce have either closed down or have sacked many employees. Big businesses aren’t faring much better either. Close to 470,000 private sector jobs have been lost since 2008. In contrast, the (bloated) public sector has seen not even a single job-loss. The civil sector has had a small pay-cut and a minor reduction in benefits, but no job losses. 
 

As a result, the GDP has contracted 12.5% since 2008, and is expected to fall by another 4% this year. Unemployment rate is at 19%, but youth unemployment is close to 50%. Those who do have jobs are over-qualified, underpaid, and overtaxed. In their frustration, they have taken to the streets in protest. Not surprisingly, both, crime rate and homelessness have been surging while investments have practically halted. 

Brinkmanship

Official Handover from Papandreou to Papadamos in November

The leadership battle started in Greece after George Papandreou stepped down halfway through his 4-year term, handing the power to Lucas Papademos. Mr. Papademos, a former ECB vice-president, has already suggested that he will not run; he is expected to take an academic post in America. So the current finance minister Evangelos Venizelos is the socialist party’s front-runner to succeed Papandreou. But preoccupied by the bailout and debt restructuring process, he has hardly been able to campaign. Little wonder that many observers believe that he may have to spend some time in Opposition first.

Evangelos Venizelos (Panhellenic Socialist Movement)

Antonis Samaras (New Democracy)

On the other hand, there is the leader of the conservative New Democracy (ND) party, Antonis Samaras. In opinion polls, his party has an unassailable lead with 33% of the vote, however that is not enough for a clear majority. Hence, the most likely outcome is for Greece to have a coalition party rule. However, a major concern remains the discontent among citizens, many of whom may not even bother to vote at all. They blame not only the New Democracy who was a reckless borrower when in power, but also the Panhellenic Socialist Movement (PASOK) failed to clean up the mess. Also another crucial concern is that without the calm leadership of Papademos, the coalition of populists may not fare well for reforms. Further street unrest could test politicians' commitment to cuts in wages, pensions and jobs. Hence, one cannot blame the Triorka for its lack of trust in Greek politicians, and the reluctance to bail them out.

The Bailout Arrangement

At 5 AM local time (0400 GMT), after 13 long hours of discussion, the Eurogroup of Finance Ministers, chaired by Luxembourg’s Prime Minister Jean-Claude Juncker, finally agreed on the second bailout package for Greece. In return, Athens had to commit unpopular and painful cuts, and private bondholders had to take even bigger losses. The deal still leaves doubts about Greece’s ability to recover, and avoid the default in the long term; but it does buy the 17-nation currency bloc to buy some time to strengthen their ‘firewalls’. The response to this was very dull as expectations of an agreement had been largely priced into financial markets.

As mentioned already, one of the biggest concerns of the deal is the pain that private bondholders have to bear. They will be offered new government bonds with only 31.5% of the principal value, at lower yields and maturities ranging between 11 and 30 years. They will receive another 15% in short-term bonds back by the Eurozone’s temporary bailout fund. The resulting loss of 53.5% is higher than the 50% that was agreed upon in October, but it was necessary to give Greece a fighting chance. This could cause problems in the future as private investors may stay away from Eurozone nations (such as Portugal or Spain) that may need a bailout later.

The Euro zone central banks will also play their part. According to a Eurogroup statement, the ECB would pass up profits it made from buying discounted Greek bonds (over the past two years) to the national central banks so that their respective governments can further pass it on to Athens. This would “further improve the sustainability of Greece's public debt.” The ECB has bought Greek bonds with Face Value of  50 billion on a 24% discount (i.e. for only  38 billion).

Usage of the Bailout Funds

The bond-swapping process for private bondholders, expected to take 3 days, will start on 8^th March. This means that the  14.4 billion bond-repayment, due on March 20^th, will be restructured and Greece will avoid a chaotic default. While a vast majority of the bailout money will be used to finance the bond-swap, some  30 billion will be needed for “sweeteners” to convince private bondholders to sign-up. The remaining funds will be used to cover the budget deficit, recapitalize Greek banks, and finance a bond-buyback. At the end, almost nothing will be left to actually stimulate the Greek economy.

Growth in Austerity

The highlight of the bailout is the demand for austerity from Greece. While it may sound only fair that the Greek Government tightens up its purse strings, it may not exactly be the best approach as it could well lead to a downward debt spiral. Some of the features of the austerity package include a 22% reduction in minimum wage, another round of pension cuts, and 15,000 public-sector job cuts. Mr. Venilezos called these demands “unrealistic” and “farcical” before giving in. Spending cuts are also demanded are in the sectors of defense and healthcare, and to scrap the habit of paying “holiday bonus”. All in all, Greece has been asked to make further cuts in Government spending of 1.5% of GDP. Furthermore, from 2013 Greece is supposed to sustain “primary” budget surpluses (i.e. excluding interest payments). To do this, the government has been considering privatization of national assets such as land, utitilities, ports, mines, etc. 

German finance minister Wolfgang Schäuble suggested that the Greek elections be postponed and a small technocratic government be set up like Italy’s for the next two years to carry out reforms. But the Greeks have now grown resentful of what they regard as German high-headedness.

In such an environment of social upheaval, political uncertainty, insufficient capital, it is not hard to see why Greece has been Eurozone’s most troublesome child; couple that with Eurozone’s out of sync monetary policy, and lack of fiscal unity, and what you get is a system designed to collapse under its own weight. Many economists doubt that Greece will ever be able to pay off even a reduced debt burden, and hint that the bailout has only pushed the can down the road, and Greece will eventually default. After all a return to economic growth could take well over a decade. Little wonder that rating agencies have downgraded Greece and several other Eurozone economies. Yields on Greek bonds have been above 30%, compared to less than 3% on German bonds. However, Considering that Germany has the highest exposure to Greek debt after France, they find themselves stuck in a Catch-22 situation.