March 3, 2008

Union Budget for 2008-09

Indian investors need to have patience for the next 12 months

By Ajay Bagga

The Union Budget has laid the grounds for the next Lok Sabha elections , subject to a good monsoon this calendar year. There are several broad themes that emerge from this general budget presented by Union finance minister P Chidambaram. Every segment of the budget can be explained in detail.

A. Capital Markets: While STT has been kept constant, CTT has been introduced in commodity trading which should be positive for volumes. The increase in Short Term Capital Gains Tax to 15% is a mild negative .A currency ETF and interest rate future market is to be developed. Stamp duty rates to be rationalized. PAN has been mandated as an identifier for all financial transactions.  

2. Mutual Funds: Unlike last year, there are no announcements of any new schemes . However the fund industry will benefit with longer-term investors being encouraged and short term churning being discouraged by the short-term capital gains tax being raised to 15%. Also the imposition of service tax on ULIPs will level the playing field with mutual funds, who have been paying this for a number of years already.

3. Welfare: With Education allocation up 15% at Rs 34,000 crore and Health spends up 20% at Rs 16,000 crore, and Rs 31,000 crore allocated to the Bharat Nirman Programme, there is a visible effort to increase the welfare footprint. Rural housing, BPL workers insurance, employment expansion are all positives.

4. Farm Loans Waiver: This Rs 60,000 crores action is THE Defining point of this Budget. This is a populist  measure with an eye on early elections. However, this could create moral hazards in the subsequent years, with parties competing with each other to lay out populist giveaways to the electorate at the cost of fiscal responsibility. It represents a write off of nearly 4% of outstanding bank loans and 25% of outstanding agricultural credit. We must remember what the free power dole outs to farmers did. As SEBs went bankrupt, new power capacities got neglected and we became a hugely power deficit nation. Nearly 4 crores farmers will be benefited by this measure, so it will be a huge election plank indeed. Since this money has already been consumed, it will not create any fresh purchasing power immediately, though over time, the principal and interest servicing payments will flow into consumption.

5. Fiscal : FRBM targets have been met under present accounting methodology, but this leaves out Oil Bonds, Food subsidies, Fertilizer subsidies and the sixth Pay Commissions recommendations as well as the latest Rs 60,000 crore dole out. Given that, the FM needs to be congratulated on keeping expenditure in control and delivering at least an ostensibly creditable 3.1% fiscal deficit.

6. Excise Duty Changes: These are positive for Auto and two wheeler segment and the price reductions to consumers should have some demand impact. Pharma companies will welcome the halving of excise . The Oil and Gas sector will benefit from the removal of ad-valorem duty and its replacement by a specific tax. This will be positive in the future for the sector.

7. Direct Taxes: The reduction in the personal income tax rates will mean a saving of Rs 4000 for someone earning Rs 1,50,000 per annum and Rs 50,000 for someone earning Rs 500,000 per annum at present. The Section 80D benefit for health insurance bought for parents is a welcome move indeed. Surcharge, Cess and Corporate Tax rates stay constant, which was as per expectations. Sec 80 M has been reintroduced to avoid double taxation of dividends. 

8. Service Tax:  The holding of the rates at present levels of 12.5 % is welcome keeping in mind the inflation. The GST Roadmap for April 1, 2010 needs to be made firm. The raising of limit for Small Service Providers to Rs 10 lakhs per annum will free 65,000 SSPs from the service tax net. Service tax net extended to some more services.

Sectoral Impact:

Positive for Auto, Two wheelers ,PSU Banks ,FMCG, Construction, Agro, Food Processing, Irrigation, Power Utilities  and Industrials as well as select Pharma.

Neutral for Tobacco and Cement

To conclude, the ruling coalition has subtly announced an Electoral budget which has a huge doleout for the poor farmers and the middle class both.

The markets did not expect much, but the fact that corporate taxes and STT were not raised  and long-term capital gains tax was not tinkered with is a positive for investors.

We don’t expect any more reforms till the formation of the next government and in a high inflation, slower growth economy in a global recessionary environment, the best investment strategy would be a bottom up, value driven, domestic consumption focused sector selection one.

Patience is the virtue most required for Indian investors for the next 12 months and more as the Election bugles are blown.

This is a syndicated guest column of Mr Ajay Bagga. He is CEO, Lotus India Asset Management Company.

Highlights of Union budget for 2008-09