»5 Minute Wrap Up by Equitymaster

On This Day - 16 MARCH 2012
A Budget as meek as it could be!

In this issue:
» Who were the major inflation contributors in 2011-12?
» What does the Budget have for retail investors?
» FM doubles customs duty on gold imports
» Employees will have to bear with this sharp rate cut
» ...and more!

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The financial year 2011-12 was quite a challenging year for the Indian economy on several fronts. A series of global shocks coupled with internal problems such as high food and fuel inflation, and a political deadlock that ensured no significant reforms be made, put tremendous pressure on the domestic economy. These factors not only slowed down economic growth, but led the government into a fiscal mess. With this is mind, we hoped that today the government would wake up from it deep slumber and initiate some tough reforms to curb the aggravating fiscal crisis.

At one point during the Budget speech, Finance Minister Pranab Mukherjee borrowed a Shakespearean line before presenting some of his proposals: "I must be cruel to be kind." But the Budget he presented was just too meek to wheedle any kind of change. He played it safe, keeping away from any radical reforms that could take the economy in a new direction. In other words, the game of politics won over economics and reason.

The Indian government failed terribly on the fiscal deficit front for the financial year 2011-12. Against a projected deficit of 4.6% of Gross Domestic Product (GDP), the year ended at about 5.9% of GDP. The deficit target for the next fiscal has been pegged at 5.1%. What is even worse is the fact that the Budget showed no inclination towards bringing down expenditure in the form of subsidies.

Also, there were no concrete steps to expand the direct tax net. Even the disinvestment target of Rs 300 bn was quite disappointing. How the government will achieve this remains obscure. But unfortunately, the proceeds from divestments still remain critical for capital expenditures. Moreover, the implementation of key measures such as the Goods and Services Tax (GST) and Direct Tax Code (DTC) has been left to a later stage.

So forget the mandate as per the Fiscal Responsibility and Budget Management (FRBM) Act to bring down fiscal deficit to 3% of GDP. That is already long forgotten. Will the government even be able to meet the 5.1% target? We can only pray. All in all, Budget speeches, akin to the Monetary Policy Review, are increasingly becoming mere rituals with no substance.

How would you rate the Union Budget 2012-13? Let us know your comments or post them on our Facebook page / Google+ page.

 Chart of the day
During the financial year 2011-12, one of the biggest spokes in India's growth engine was inflation. The Reserve Bank of India (RBI) continued to tighten money supply with a series of consecutive interest rates hikes. After several vain attempts, the inflation showed signs of cooling only around December 2011. Today's chart of the day shows the major inflation drivers. The contribution of primary articles has declined substantially to 28% in 2011-12 (April-January) from about 46% in the corresponding period of the previous fiscal. However, the contribution of manufactured products rose significantly to 49% in 2011-12 (April-January) from 35% in 2010-11 (April-January). In comparison, the contribution of fuel has remained relatively stable.

Data source: Economic Survey 2011-12
*April to January 2012

The Budget certainly lacked any big bang wealth creating opportunity as far as the stock markets are concerned. But it did try to do its bit to enhance the depth of the market and pump in more liquidity into the same. Enter the Rajiv Gandhi Equity Savings scheme. Introduced for the first time ever, the scheme allows for income tax deduction of 50% to new retail investors. However, the investment is subject to a maximum limit of Rs 50,000 and restricted to investors with annual income of less than Rs 10 lakh. Besides, the scheme also has a lock-in period of 3 years.

This move is certainly a precursor to the proposed Direct Taxes Code. But it is also an attempt to bring in more retail investors into the markets. It is indeed sad that Indian markets have to still rely on Foreign Institutional Investors (FIIs) inflows for its daily movements. Thus, if it has to have any hope of reducing this dependence, measures like the ones taken in the latest budget are more than welcome, we believe.

Financial sector reforms have been high on the government's agenda for not one or two but several years. However, each successive Union Budget fails to convince us about their implementation. The one designed for financial year 2012-13 was hardly a departure from the past. It took some baby steps towards financial inclusion and equity participation. However, it remained silent on some of the most pertinent reforms- subsidised lending to agriculture and low income housing to continue. Funding of infrastructure projects through wider external commercial borrowings (ECB) route was no novelty either. Hence, funds allocated for recapitalisation of PSU banks was also well in line with expectations. After all, they are the ones to bear the burden of subsidised lending on their asset quality. Infrastructure projects that have been deprived of funds from private sector, too, did not see any respite. For there were no announcements citing tangible measures to avert problems like land acquisition. Prospects of public private partnership (PPP) projects also remain clouded! The Goods and Services Tax (GST) and Direct Tax Code (DTC) could be expected sometime in the next 12 months. Other than that, the latest Budget did nothing to alleviate our worries about financial sector reforms remaining in the backburner.

The final rollback of stimulus doled out to the economy in 2008-09 was announced in the Union Budget 2012. The Finance Minister has stated that excise duty would be increased from 10% to 12%. What this means is that the manufacturing companies would be paying higher on the excise front. What this means for the common man is that the cost of manufactured items is set to go up. But isn't that what's already been happening? Due to increase in commodity prices, cost of manufactured items has been on the rise as they pass through the increase in costs to the customers. The increase in excise duty would just lead to higher costs.

But the buck does not end here. The Finance Minister has also decided to widen the service tax net. Only services in the negative list would be exempt from the service tax. Services that are exempt include school education. Good for that. And to add to this, the tax rate has been increased from 10% to 12%. The only relief that the common man has is the savings due to the change in income tax rate slabs. But even there the savings is paltry as tax slabs have not been radically revised.

Citing heavy gold imports as a major reason for the high current account deficit, the Finance Minister decided to double the import duty on gold from 2% to 4%. Increase in levy is likely to discourage imports and impact the jewellery demand in domestic markets. It may be noted that recently government had changed the duty structure on gold imports. The levy was now linked to the value rather than the quantum of bullion that was being imported. This had already led to an implicit rise in the duty on gold imports. And within a span of one month, the government has further proposed to increase the duty to 4%. Considering that India is the biggest importer of gold this would significantly impact the demand and may also give rise to illegal trafficking.

The Employees Provident Fund Organisation (EPFO) is set to dole out lower rate of interest going forward. A day ahead of the Budget, it slashed the return on statutory savings to 8.25% for the current fiscal. The rate was 9.5% last year. This means that in the present structure, the returns will also be lower than the 8.6% paid by the public provident fund (PPF) deposits, which is a popular voluntary savings scheme. While banks also offer relatively higher interest rates, where EPFO gains the upper hand is that the annual contribution and interest on the balance are tax free. One of the main reasons that EPFO has cut rates steeply was that it was saddled with a deficit. Thus, even with the slash in interest rates, it will still report a deficit of Rs 2.4 m. And with the chances of the government bailing them out being quite low, this move seems to be the only way out to trim its losses. This certainly does not spell good news for employees.

The Union Budget 2012-13 and the Finance Minister's speech occupied the nation for the past few hours. But the markets were not too impressed with what Mr Pranab Mukherjee had to offer. In reaction to a fairly lackluster Budget, the Indian stock markets have fallen further into the negative territory after opening trade on an upbeat note. At the time of writing, BSE Sensex was down by 173 points (1%). Red marks were seen across all sectoral indices, except for FMCG stocks. Asian stock markets presented a mixed picture with China (up by 1.3%) being the top gainer, while other markets faced selling pressure.

 Today's Investing Mantra
"Charlie and I are competent to make judgments on certain things, and not other things. We try to focus on what we can understand, which is a reasonable amount." - Warren Buffett

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