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Budget 2011: Would it be a double-edged sword? - Views on News from Equitymaster
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  • Feb 18, 2011

    Budget 2011: Would it be a double-edged sword?

    The Indian economy has sailed well in the past years and has also recovered well from the recession of 2008 and early 2009 as revealed by the resilient GDP number posted. This is largely because main economic activities such as manufacturing, mining & quarrying, trade, hotels, transport and communications, along with finance and insurance, have continued to fuel and manage growth, amongst the other economic activities as they were focal area of the previous budget (Union Budget 2010). Hence, the recovery so far for the Indian economy has been quite robust and broad based.

    (Source: CSO, PersonalFN Research)

    Moreover, the Government of India (GoI) now expects an 8.6% economic growth this fiscal year backed by robust agriculture growth from 0.4% (a year before) to 5.4%.

    But these growth estimates in our opinion belie the fears of a slowdown in the economy, caused by factors such as high inflation (8.23% in January 2011) and widening fiscal deficit. We think that WPI inflation would continue to be high, fuelled by food inflation remaining in double-digit terrain and crude-oil prices remaining above the U.S. $ 100 per barrel mark. Moreover, any Egypt like unrest in countries such as Algeria and Yemen may threaten the oil-rich Gulf region, which would impact oil consuming nations like ours (as Oil prices are sensitive to the supply disruptions) by ballooning the current account deficit.

    To control spiralling inflation, the RBI would adopt calibrated exit stance (by increasing policy rates at each step, thereby attempting to unhurt growth), but that would again elevate borrowing cost and result in slowdown in credit off-take. Moreover, the hike in interest rates would also lead to increase in input cost and slowing demand.

    Also with the Government in power at present being confronted with various scams (especially the 2G spectrum scam and the Adarsh Housing Society Scam), and the opposition parties (especially the NDA - National Democratic Alliance) being opportunistic about such issues, they may pressurise the Congress at every point - in fact the NDA has already demanded a JPC (Joint Parliamentary Committee) to be set up on the 2G spectrum scam (as its cost to the Government is 1.76 lakh crore). Moreover, the NDA is already doing its best to tarnish the image of the Congress Government by tagging it as "corrupt" and pressurising the Prime Minister - Dr. Manmohan Singh to quit.

    Hence in order to retain their power, the Congress Government may declare a populist budget despite the economic atrocities faced by it (as seen above). Moreover, with elections coming up in major states the prospects of the budget 2011 being "populist" strengthens. Tax revenue growth in 2011-12 can soar as inflation would act as an "indirect positive" as wage bills go up. But again that may not be sufficient to match the expenditure bill.



    • Base exemption

      On the direct tax front, the Government is likely to move a step closer to the DTC (Direct Tax Code) where we expect the base exemption limit to be extended to Rs. 1.80 lakh, but keeping the current tax slabs unchanged.

      Income-tax rates as per inance Act, 2010 Expected Income-tax rates in Budget 2011
      Taxable Income Tax Rate Taxable Income Tax Rate
      Upto Rs. 160,000 Nil Upto Rs. 180,000 Nil
      160,001 to Rs. 500,000 10% Rs. 180,001 to Rs. 500,000 10%
      Rs. 500,001 to Rs. 800,000 20% Rs. 500,001 to Rs. 800,000 20%
      800,001 & above 0% Rs. 800,001 & above 0%

      So, let say if you are a male individual having a net taxable income of Rs. 10,00,000; and if the base exemption limit is increased to Rs. 1.80 lakh, then your income tax liability will be Rs. 1,56,560 - thereby resulting in a tax saving of Rs. 2,060.

      Taxable Income   10,00,000
      Upto Rs. 160,000 Nil -
      Rs. 160,001 toRs. 500,000 10% 34,000
      Rs. 500,001 toRs. 800,000 20% 60,000
      Rs. 800,001 & above 30% 60,000
      Tax payable   154,000
      Education Cess 3% 4,620
      Total Tax (Rs)   158,620
      Taxable Income   10,00,000 
      Upto Rs. 180,000 Nil -
      Rs. 180,001 to Rs. 500,000 10% 32,000
      Rs. 500,001 to Rs. 800,000 20% 60,000
      Rs. 800,001 & above 30% 60,000
      Tax payable   152,000
      Education Cess 3% 4,560
      Total Tax (Rs)   156,560

      For senior citizens and women, the basic exemption limit is also likely to increase by Rs. 20,000 each to Rs. 2.10 lakh and Rs. 2.60 lakh respectively.

    • Deduction from Income Tax

      Investment limit in section 80C and 80CCF:
      Displaying its populist emotions, the Government may also expand the Section 80C limit to Rs. 1.5 lakh (from the present Rs. 1.0 lakh) thereby attempting to move closer to the Rs. 3 lakh limit proposed in the DTC, and boost investments in the country. Also in an attempt to fuel infrastructure growth in the country (thereby making its attempts to match international standards) the Government is expected to raise the limit for investment in long-term infrastructure bonds from Rs. 20,000 to Rs. 30,000; which provide a tax benefit under section 80CCF of the Income Tax Act, 1961. The Government may also consider banks in the list of issuers of long-term infrastructure bonds, which is currently limited to only infrastructure financing companies.

      Premium paid for medical insurance:
      Similarly healthcare cost today are on a rise; hence in such a case if prudence prevails medical claim exemption limit may also be increased to Rs. 20,000 (from the present Rs. 15,000), and in case of senior citizens to Rs. 30,000 (from the present Rs. 20,000). Because the present limits are inadequate for an individual to cater to the medical expenses of his entire family.

      Interest on housing loan:
      In a measure to provide a relief to the housing sector, which is at present suffering the pain of the housing loan scam as well as the brunt of rising interest rates (thereby affecting their sales), the Government may also increase the maximum limit for deducting interest paid on housing loans (available under section 24(b) of the Income Tax Act, 1961) from the present Rs. 1.50 lakh (in case of Self Occupied Property) to Rs. 1.80 lakh, thereby attempting to infuse renewed energy in the real estate and housing loan market.


    • Surcharge

      Again on the corporate taxation side the Government is expected to refrain from taking any hawkish measures which would hurt the sentiments of the industries. And with the IIP number (1.6% in December 2010) reflecting dismay along with the borrowing cost going up (which would lead to increase in input cost and may affect profitability); the surcharge is unlike to be increased from the present levels of 7.5%.

    • Minimum Alternate Tax (MAT)

      With the present nervousness in the economy due to increase in borrowing cost (which would lead to increase in input cost and may affect profitability) and dismaying IIP number of November 2010, the Government in order to maintain its agenda of growth, may reduce the MAT to 15% (earlier rate as was applicable in the year FY 2009-10) from 18% at present.

      Hence, overall in our opinion there are unlikely to be any major changes in the direct tax segment in Budget 2011, as the DTC is anyways going to implemented from next year (with effect from April 1, 2012).


    • Service Tax

      While this would be one way the Government can meet its requirement for the expenditure bill, the Government may again avoid increasing the tax rate (at present 10%) here, because any increase towards this would again add to cost of living for the citizens, thereby infusing inflationary pressures in the economy. (This is because the service tax is passed on by the service provider to the customers, who bear it).

    • Central Excise

      With slowing IIP numbers and increase in borrowing cost we don't think the Government would dare to increase the rate of excise from the present 10% level. Because this would lead consumption being getting negatively impacted, thereby hurting the overall economic sentiments. Moreover, just last year anyways central excise rate was rolled-up from 8%.

      Also last year in budget 2010, the Government had increased the excise on the petrol and diesel by Rs. 1 per litre for both fuels and since the time they (petrol prices) were decontrolled they have gone up by about 13% and about 22% in the current financial year. Prices of cars off late (since December 2010) have already seen an increase of about 20% - 25% on account of rise in input cost.

    • Custom Duty

      As far as the custom duty is concerned the Government may display its move smartly by opting to go product / sector specific. With we (India) being heavily dependent on foreign oil imports, the chances of custom duty increased for this product is unlikely, as Brent crude oil prices are already hovering at U.S. $ 100 per barrel mark. So, would be the case of imported machinery, fertilizers and chemicals. However, foreign gems may see an upward revision in rates.

      Hence overall in our opinion we believe that on the direct tax front the Government may move a step closer to the DTC (which will be effective from April 1, 2012). However, on the indirect tax front major tinkering is not expected as anyways the Goods and Services Tax (GST) would be implemented with effect from April 1, 2012. Moreover, with the Government facing manifold macroeconomic challenges as well as the political turmoil caused by scams stories unfolding; to save their political image of being "reform pro", the Congress Government may take populist steps in Budget 2011, which may instil a challenge to the Government of managing ballooning fiscal deficit.

    • This article has been sourced from PersonalFN has been providing independent research since 1999 on mutual funds, insurance, fixed income instruments and gold. It also provides research based advice on investments and financial planning to individual clients. To know about our financial planning services, simply write to info@personalfn.com.


      The views mentioned above are of the author only. Data and charts, if used, in the article have been sourced from available information and have not been authenticated by any statutory authority. The author and Equitymaster do not claim it to be accurate nor accept any responsibility for the same. The views constitute only the opinions and do not constitute any guidelines or recommendation on any course of action to be followed by the reader. Please read the detailed Terms of Use of the web site.



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