Union Budget 2014-15 assumes significance as it was the first major policy document by the government after a landslide victory in the general elections. It is also important given the backdrop of slow economic growth, high inflation, weak monsoons, elevated geopolitical risks and policy uncertainties that it was set against. Expectations were running high and benchmark stock indices had also rallied on hopes of policy reforms.
However, Union Budget 2014-15 was low on big bang announcements. It was silent on specifics. But, it touched upon various important aspects, giving it a practical and credible look.
In a nutshell, the budget focussed on fiscal discipline, increasing household savings, infrastructure boost through public-private-partnerships (PPP), jobs and skill development, conditional opening of sectors for Foreign Direct Investments (FDI) and innovative funding mechanism for the industry.
Having said that there were few misses as well in the budget: unchanged subsidy bills, no timeline for goods and services tax (GST) rollout, and no clarity on closure of past retrospective tax cases. No concrete roadmap was provided for long-term capital infusion from the government in public sector banks. However, it is important to note that the government has been in power for just over 45 days. Even though the government had a landslide victory in the general elections, it kept politically contentious issues for later years, once they are settled in their offices. Many believe that they can and will take reforms beyond the ambit of the budget.
THE FISCAL MATH
The government has decided to walk on a tight fiscal path. For FY15, fiscal deficit (FD) has been pegged at 4.1% of the GDP. Fiscal deficit is the shortfall between the government's income and its spending that has to be met with market borrowing. It is expressed as a percentage of the GDP. Taking fiscal consolidation plans forward, the government intends to take fiscal deficit to 3.6% and 3% of GDP for FY15-16 and FY16-17, respectively.
The 12.9% expenditure growth in FY15 is directed towards asset creation. Plan allocation has been higher in agriculture, health and education, infrastructure. The focus on infrastructure will help enhance the growth prospects of the economy. The fiscal deficit will be filled by market borrowing of Rs. 6,000 billion in FY15 as against Rs. 5,489 billion in FY14 and Rs. 5,970 billion in the interim budget. Since these numbers are still high, it will crowd out private players and keep interest rates high in the system.
Analysis:
The government has assumed a nominal growth rate of 13.7%, while coming at a fiscal deficit target of 4.1% of the GDP. Nominal GDP includes inflation impact over real GDP. It also assumed an exchange rate of 61 to the US dollar and crude oil level of US $110/barrel for the fiscal. So, are there chances of a slippage? While growth in taxes looks optimistic, a slowdown in non-plan expenditure growth and lower-than-expected disinvestment targets gives confidence that the government might meet the fiscal deficit target in FY15. Around 80% of central government revenues come from taxes. Therefore, an improving economy can help tax collections. The rest comes from dividends from PSUs, disinvestments and auctioning of telecom resources.
The Street feels the latter has been conservatively pegged, giving a confidence that the fiscal deficit target can be achieved. For the next few years, the finance minister has said: "We cannot spend beyond our means," and tax-to-GDP ratio, which is around 10, and low as compared to world averages, will have to be raised.
HOUSEHOLD SAVINGS
One of the key takeaways from the current budget is its efforts to boost household savings. Worryingly, the savings rate in the economy has come down to 30.1% in FY13 from 33.7% in FY10 due to weak financial markets and diversion of savings to physical assets like gold and real estate, among others.
Following are the measures announced in the budget that will boost consumer demand and increase savings, which can then be channelized to fund infrastructure needs of the country:
The budget has given some relief to individual tax payers. While tax rates were not lowered, tax slabs have been slightly tweaked. This move will provide a much-needed relief to the individual tax payer in the present inflationary environment, saving Rs. 5,000 per tax payer. For senior citizens who are 60 or more but less than 80, the threshold limit has been proposed to be increased to Rs. 3 lakh from Rs.2.5 lakh. However, the exemption limit for resident senior citizens who are of the age of 80 or more will remain the same at Rs. 5 lakh as before.
Any home loan borrower can avail of tax benefits on the interest paid on the principal amount to the lending bank. From the earlier limit of Rs. 1.5 lakh the budget has now hiked deduction on home loan interest to Rs. 2 lakh. This is a much-needed breather as property prices have appreciated sharply in recent times, and even cost of finance was elevated due to high interest rates in the system.
However, this proposal is applicable only to self-occupied house property. Depending upon the tax payer's slab, the change will lead to tax savings of Rs. 5,000 – Rs. 15,000. This measure by the government will boost housing demand and result in reduction in net interest cost for the borrower.
Deduction Limit Under Section 80C of the Income – Tax Act
In order to encourage household savings, the budget has proposed to raise the deduction limit under Section 80C from the existing limit of Rs. 1 lakh to Rs. 1.5 lakh. Also, to address concerns of decline in savings rate and to increase tax exempt earnings, the annual ceiling limit under the public provident funds (PPF) scheme was enhanced to Rs. 1.5 lakh per annum from Rs. 1 lakh.
AGRICULTURE AND INFLATION
A slew of measures were announced for agriculture in the budget. These measures will improve supply and tame inflation at the same time. The budget envisaged a sustained growth of 4% in the agriculture sector. Apart from rolling out soil cards to educate farmers on the right usage of agri-inputs depending on quality of soil in their farms, the government is also planning to formulate a new urea policy. The Union Budget has set a target of Rs. 8 lakh crore during 2014-15 towards rural credit.
To tame inflation, the budget proposes to restructure Food Corporation of India (FCI), sell food grains in open markets, reduce transportation and distribution losses and increase efficiency of public distribution system (PDS).
The budget also proposes to set up a ‘price stabilization fund' with a corpus of Rs. 500 crore and set up private markets across towns in India to enable farmers to sell their produce directly by bypassing middlemen. This will mitigate the risk of price volatility in the agriculture produce. The central government also plans to work closely with state governments to re-orient their respective Agricultural Produce Market Committee (APMC) Acts.
FOREIGN DIRECT INVESTMENT (FDI) LIBERALIZATION
The budget proposed raising FDI limit in the defense and insurance sectors to 49% from 26%, with full Indian management and control. This move was on expected lines. For the insurance sector, this move will help insurance companies to raise funds and help domestic financial institutions, mostly banks, to monetize their stake. Remember, insurance is a capital-intensive business and in the Indian context benefits of insurance are yet to reach to a large section of the people.
Capital for the sector would be readily available now for insurance companies to expand. For defence, according to rating agency India Ratings, the country has managed to attract FDI worth US $4.94 billion in the defence sector in the past 14 years, since 2000. Now, post the FDI limit hike the defence sector has the potential to attract FDI to the tune of around Rs. 120 billion. While the FDI hike is conditional, the move is likely to get better technology into our defence. This will also provide some incentive for foreign manufacturers to set up factories in India, given that India is one of the largest importers of defence equipment. Fine print is awaited in this regard.
JOB CREATION
The budget has announced several measures to impart skills and vocational training to youth with an emphasis on employability and self-employment. The measures will help labour-intensive sectors like textile, footwear, hospitality, food processing and construction to find easy labour.
The budget has proposed to create five tourist circuits with e-visa facility, set up six mega textile clusters, increase allocation to construction of roads and lower excise duty in sectors like footwear and food processing. The budget has also proposed to establish a Rs. 10,000-crore fund for start-up companies and tweak laws to make legal environment entrepreneur-friendly for easy exit. All these measures will create jobs.
CAPITAL MARKET-RELATED PLANS
The budget had quite a few capital market-related announcements.
The Union Budget has increased capital gains tax arising from transfer of units of non-equity mutual funds from 10% currently to 20%. The holding period for such calculation has also been increased from 12 months to 36 months.
Analysis:
Fixed income-oriented mutual funds have always received special treatment on taxation as compared to other avenues of fixed income investment like bank deposits, bonds and debentures, among others. This has allowed tax arbitrage opportunity. Corporates in India are heavy investors in such short-term debt mutual funds. This arbitrage has hardly benefitted retail investors as their percentage is rather small among such mutual fund investors.
Banks have faced competition from debt mutual funds, especially from schemes like fixed maturity plans(FMPs). FMPs are similar to term deposits of banks where the money is locked for one to three years. While FMPs enjoy concessional capital gains tax, higher taxes are applicable on other banking instruments. Now, with the change in the tax treatment, deposits are likely to move from debt funds to bank deposits and other instruments. This proposal is going to create a significant impact on debt assets of the mutual fund industry in India.
In order to attract long-term domestic savings into the equity market, the budget has proposed to give uniform tax treatment to pension fund and mutual fund-linked retirement plan.
Analysis:
Now, mutual funds and pension funds would be on level-playing field. This is great news for the mutual fund industry.
The budget has decided to classify income from all foreign portfolio investment as capital gains and not as business income.
Analysis:
This will allow fund managers investing in India to operate from India and benefit from carry forwarding their gains to offset losses. This treatment will help boost foreign investments in the Indian markets.
The budget proposes to liberalize regulations for the issue of American depository receipts and global depository receipts for all types of permissible securities.
Analysis:
This proposal opens an alternative channel of funding for Indian corporates.
TAX REFORMS
While the government announced that there would be no retrospective tax amendments going forward, it was silent on past cases. Among other announcements, the budget propounded various measures to reduce tax-related litigation. A high level committee would regularly provide clarity on tax laws to corporates. As for the GST, the government aims to approve legislative reforms to introduce GST during the course of the year.
SECTOR
REAL ESTATE
The government has taken positive steps like tax pass-through for real estate investment trusts (REITs) to fix the financing challenges of the sector. This would help the sector to attract long-term capital at cheaper rates.
Apart from this, the budget has announced steps to boost low-cost housing. To tackle the problem of migration of people from rural to urban cities, the FinMin proposed the development of 100 ‘Smart Cities' as satellite towns of larger cities and by modernizing the existing mid-sized cities. A sum of Rs. 7,060 crore has been provided in this fiscal for the same. The government has also lowered the FDI requirements in the real estate sector in this budget. The requirement of the built up area and capital conditions for FDI has been reduced from 50,000 sq metres to 20,000 sq metres and from US $10 million to US $5 million, respectively, with a three year post-completion lock in.
Analysis
All steps are in the right direction. Pass-through status to REITs will avoid potential double taxation - the reason why REITs never took off in India.
Now, under the tax pass-through status, income generated in REITs would not be taxed at the corporate level and would be taxed in the hands of the investor only. Increase in the deduction limit on account of interest on loan in self occupied house to Rs. 2,00,000 from  Rs. 1,50,000 earlier also augurs well for the demand side of the realty business.
BANKS
The budget has two key positive measures for banks. One, to allow banks to raise long-term funds to finance infrastructure projects and get exemption or reduction in cash reserve ratio (CRR) or Statutory Liquidity Ratio (SLR) or Priority Sector Lending (PSL) requirements. Two, hike in FDI limit in the insurance sector from 26% to 49%. Also, the other important proposal was that public sector banks would sell shares to retail investors to meet their capital requirements.
Analysis
While details are awaited on the sale share to retail investors, hike in FDI in insurance will provide much-needed capital for the insurance sector to expand. Some promoter banks in these insurance firms might also look at partial exit.
Surplus due to proposals like increase in income tax slab will help banks to mobilize cheap deposits. Also, helping the cause would be unfavorable tax treatment to debt mutual funds as proposed in the budget, which will shift investments from debt funds to bank deposits.
INFRASTRUCTURE
With a 24% increase in planned expenditure over previous year's investments, the budget has many proposals for the infrastructure sector to boost investment. It mainly focused on PPP mode for developing these projects. The government raised the target for highway development. It announced a corpus for ‘100 Smart City' projects.
The budget also included provisions for the development of metro rails, 16 new ports, development of industrial corridors and low-cost housing projects. The budget also proposed to set up an institution to ensure quick dispute redressal for PPP projects.
Analysis
The budget has provided the much-needed thrust to the infrastructure sector. Measures like infrastructure investment trusts (InITs) would take care of their funding needs. Increased construction opportunity will help engineering firms. Allied sectors like steel, cement and capital goods would also benefit from impetus to the infra sector. The only negative is that the budget is silent on land acquisition for these projects.
IN A NUTSHELL
While a single budget cannot bring the economy out of the low growth phase, this year's budget proposals are in the right direction of long-term sustained growth. Although there were few populist measures, a good part of the Union Budget this year focused on kick-starting the capital expenditure cycle. It is expected that the government will clear road blocks for development and come out with a roadmap for a host of initiatives mentioned in the budget.
However, Union Budget 2014-15 was low on big bang announcements. It was silent on specifics. But, it touched upon various important aspects, giving it a practical and credible look.
In a nutshell, the budget focussed on fiscal discipline, increasing household savings, infrastructure boost through public-private-partnerships (PPP), jobs and skill development, conditional opening of sectors for Foreign Direct Investments (FDI) and innovative funding mechanism for the industry.
Having said that there were few misses as well in the budget: unchanged subsidy bills, no timeline for goods and services tax (GST) rollout, and no clarity on closure of past retrospective tax cases. No concrete roadmap was provided for long-term capital infusion from the government in public sector banks. However, it is important to note that the government has been in power for just over 45 days. Even though the government had a landslide victory in the general elections, it kept politically contentious issues for later years, once they are settled in their offices. Many believe that they can and will take reforms beyond the ambit of the budget.
THE FISCAL MATH
The government has decided to walk on a tight fiscal path. For FY15, fiscal deficit (FD) has been pegged at 4.1% of the GDP. Fiscal deficit is the shortfall between the government's income and its spending that has to be met with market borrowing. It is expressed as a percentage of the GDP. Taking fiscal consolidation plans forward, the government intends to take fiscal deficit to 3.6% and 3% of GDP for FY15-16 and FY16-17, respectively.
The 12.9% expenditure growth in FY15 is directed towards asset creation. Plan allocation has been higher in agriculture, health and education, infrastructure. The focus on infrastructure will help enhance the growth prospects of the economy. The fiscal deficit will be filled by market borrowing of Rs. 6,000 billion in FY15 as against Rs. 5,489 billion in FY14 and Rs. 5,970 billion in the interim budget. Since these numbers are still high, it will crowd out private players and keep interest rates high in the system.
Analysis:
The government has assumed a nominal growth rate of 13.7%, while coming at a fiscal deficit target of 4.1% of the GDP. Nominal GDP includes inflation impact over real GDP. It also assumed an exchange rate of 61 to the US dollar and crude oil level of US $110/barrel for the fiscal. So, are there chances of a slippage? While growth in taxes looks optimistic, a slowdown in non-plan expenditure growth and lower-than-expected disinvestment targets gives confidence that the government might meet the fiscal deficit target in FY15. Around 80% of central government revenues come from taxes. Therefore, an improving economy can help tax collections. The rest comes from dividends from PSUs, disinvestments and auctioning of telecom resources.
The Street feels the latter has been conservatively pegged, giving a confidence that the fiscal deficit target can be achieved. For the next few years, the finance minister has said: "We cannot spend beyond our means," and tax-to-GDP ratio, which is around 10, and low as compared to world averages, will have to be raised.
HOUSEHOLD SAVINGS
One of the key takeaways from the current budget is its efforts to boost household savings. Worryingly, the savings rate in the economy has come down to 30.1% in FY13 from 33.7% in FY10 due to weak financial markets and diversion of savings to physical assets like gold and real estate, among others.
Following are the measures announced in the budget that will boost consumer demand and increase savings, which can then be channelized to fund infrastructure needs of the country:
- Income Tax for Individuals
The budget has given some relief to individual tax payers. While tax rates were not lowered, tax slabs have been slightly tweaked. This move will provide a much-needed relief to the individual tax payer in the present inflationary environment, saving Rs. 5,000 per tax payer. For senior citizens who are 60 or more but less than 80, the threshold limit has been proposed to be increased to Rs. 3 lakh from Rs.2.5 lakh. However, the exemption limit for resident senior citizens who are of the age of 80 or more will remain the same at Rs. 5 lakh as before.
- Interest on Housing Loan for Self-Occupied House Property
Any home loan borrower can avail of tax benefits on the interest paid on the principal amount to the lending bank. From the earlier limit of Rs. 1.5 lakh the budget has now hiked deduction on home loan interest to Rs. 2 lakh. This is a much-needed breather as property prices have appreciated sharply in recent times, and even cost of finance was elevated due to high interest rates in the system.
However, this proposal is applicable only to self-occupied house property. Depending upon the tax payer's slab, the change will lead to tax savings of Rs. 5,000 – Rs. 15,000. This measure by the government will boost housing demand and result in reduction in net interest cost for the borrower.
Deduction Limit Under Section 80C of the Income – Tax Act
In order to encourage household savings, the budget has proposed to raise the deduction limit under Section 80C from the existing limit of Rs. 1 lakh to Rs. 1.5 lakh. Also, to address concerns of decline in savings rate and to increase tax exempt earnings, the annual ceiling limit under the public provident funds (PPF) scheme was enhanced to Rs. 1.5 lakh per annum from Rs. 1 lakh.
AGRICULTURE AND INFLATION
A slew of measures were announced for agriculture in the budget. These measures will improve supply and tame inflation at the same time. The budget envisaged a sustained growth of 4% in the agriculture sector. Apart from rolling out soil cards to educate farmers on the right usage of agri-inputs depending on quality of soil in their farms, the government is also planning to formulate a new urea policy. The Union Budget has set a target of Rs. 8 lakh crore during 2014-15 towards rural credit.
To tame inflation, the budget proposes to restructure Food Corporation of India (FCI), sell food grains in open markets, reduce transportation and distribution losses and increase efficiency of public distribution system (PDS).
The budget also proposes to set up a ‘price stabilization fund' with a corpus of Rs. 500 crore and set up private markets across towns in India to enable farmers to sell their produce directly by bypassing middlemen. This will mitigate the risk of price volatility in the agriculture produce. The central government also plans to work closely with state governments to re-orient their respective Agricultural Produce Market Committee (APMC) Acts.
FOREIGN DIRECT INVESTMENT (FDI) LIBERALIZATION
The budget proposed raising FDI limit in the defense and insurance sectors to 49% from 26%, with full Indian management and control. This move was on expected lines. For the insurance sector, this move will help insurance companies to raise funds and help domestic financial institutions, mostly banks, to monetize their stake. Remember, insurance is a capital-intensive business and in the Indian context benefits of insurance are yet to reach to a large section of the people.
Capital for the sector would be readily available now for insurance companies to expand. For defence, according to rating agency India Ratings, the country has managed to attract FDI worth US $4.94 billion in the defence sector in the past 14 years, since 2000. Now, post the FDI limit hike the defence sector has the potential to attract FDI to the tune of around Rs. 120 billion. While the FDI hike is conditional, the move is likely to get better technology into our defence. This will also provide some incentive for foreign manufacturers to set up factories in India, given that India is one of the largest importers of defence equipment. Fine print is awaited in this regard.
JOB CREATION
The budget has announced several measures to impart skills and vocational training to youth with an emphasis on employability and self-employment. The measures will help labour-intensive sectors like textile, footwear, hospitality, food processing and construction to find easy labour.
The budget has proposed to create five tourist circuits with e-visa facility, set up six mega textile clusters, increase allocation to construction of roads and lower excise duty in sectors like footwear and food processing. The budget has also proposed to establish a Rs. 10,000-crore fund for start-up companies and tweak laws to make legal environment entrepreneur-friendly for easy exit. All these measures will create jobs.
CAPITAL MARKET-RELATED PLANS
The budget had quite a few capital market-related announcements.
- Debt Mutual Funds
The Union Budget has increased capital gains tax arising from transfer of units of non-equity mutual funds from 10% currently to 20%. The holding period for such calculation has also been increased from 12 months to 36 months.
Analysis:
Fixed income-oriented mutual funds have always received special treatment on taxation as compared to other avenues of fixed income investment like bank deposits, bonds and debentures, among others. This has allowed tax arbitrage opportunity. Corporates in India are heavy investors in such short-term debt mutual funds. This arbitrage has hardly benefitted retail investors as their percentage is rather small among such mutual fund investors.
Banks have faced competition from debt mutual funds, especially from schemes like fixed maturity plans(FMPs). FMPs are similar to term deposits of banks where the money is locked for one to three years. While FMPs enjoy concessional capital gains tax, higher taxes are applicable on other banking instruments. Now, with the change in the tax treatment, deposits are likely to move from debt funds to bank deposits and other instruments. This proposal is going to create a significant impact on debt assets of the mutual fund industry in India.
- Tax Treatment To Pension Fund and Retirement – Linked MF
In order to attract long-term domestic savings into the equity market, the budget has proposed to give uniform tax treatment to pension fund and mutual fund-linked retirement plan.
Analysis:
Now, mutual funds and pension funds would be on level-playing field. This is great news for the mutual fund industry.
- Foreign Portfolio Investors
The budget has decided to classify income from all foreign portfolio investment as capital gains and not as business income.
Analysis:
This will allow fund managers investing in India to operate from India and benefit from carry forwarding their gains to offset losses. This treatment will help boost foreign investments in the Indian markets.
- ADR/GDR
The budget proposes to liberalize regulations for the issue of American depository receipts and global depository receipts for all types of permissible securities.
Analysis:
This proposal opens an alternative channel of funding for Indian corporates.
TAX REFORMS
While the government announced that there would be no retrospective tax amendments going forward, it was silent on past cases. Among other announcements, the budget propounded various measures to reduce tax-related litigation. A high level committee would regularly provide clarity on tax laws to corporates. As for the GST, the government aims to approve legislative reforms to introduce GST during the course of the year.
SECTOR
REAL ESTATE
The government has taken positive steps like tax pass-through for real estate investment trusts (REITs) to fix the financing challenges of the sector. This would help the sector to attract long-term capital at cheaper rates.
Apart from this, the budget has announced steps to boost low-cost housing. To tackle the problem of migration of people from rural to urban cities, the FinMin proposed the development of 100 ‘Smart Cities' as satellite towns of larger cities and by modernizing the existing mid-sized cities. A sum of Rs. 7,060 crore has been provided in this fiscal for the same. The government has also lowered the FDI requirements in the real estate sector in this budget. The requirement of the built up area and capital conditions for FDI has been reduced from 50,000 sq metres to 20,000 sq metres and from US $10 million to US $5 million, respectively, with a three year post-completion lock in.
Analysis
All steps are in the right direction. Pass-through status to REITs will avoid potential double taxation - the reason why REITs never took off in India.
Now, under the tax pass-through status, income generated in REITs would not be taxed at the corporate level and would be taxed in the hands of the investor only. Increase in the deduction limit on account of interest on loan in self occupied house to Rs. 2,00,000 from  Rs. 1,50,000 earlier also augurs well for the demand side of the realty business.
BANKS
The budget has two key positive measures for banks. One, to allow banks to raise long-term funds to finance infrastructure projects and get exemption or reduction in cash reserve ratio (CRR) or Statutory Liquidity Ratio (SLR) or Priority Sector Lending (PSL) requirements. Two, hike in FDI limit in the insurance sector from 26% to 49%. Also, the other important proposal was that public sector banks would sell shares to retail investors to meet their capital requirements.
Analysis
While details are awaited on the sale share to retail investors, hike in FDI in insurance will provide much-needed capital for the insurance sector to expand. Some promoter banks in these insurance firms might also look at partial exit.
Surplus due to proposals like increase in income tax slab will help banks to mobilize cheap deposits. Also, helping the cause would be unfavorable tax treatment to debt mutual funds as proposed in the budget, which will shift investments from debt funds to bank deposits.
INFRASTRUCTURE
With a 24% increase in planned expenditure over previous year's investments, the budget has many proposals for the infrastructure sector to boost investment. It mainly focused on PPP mode for developing these projects. The government raised the target for highway development. It announced a corpus for ‘100 Smart City' projects.
The budget also included provisions for the development of metro rails, 16 new ports, development of industrial corridors and low-cost housing projects. The budget also proposed to set up an institution to ensure quick dispute redressal for PPP projects.
Analysis
The budget has provided the much-needed thrust to the infrastructure sector. Measures like infrastructure investment trusts (InITs) would take care of their funding needs. Increased construction opportunity will help engineering firms. Allied sectors like steel, cement and capital goods would also benefit from impetus to the infra sector. The only negative is that the budget is silent on land acquisition for these projects.
IN A NUTSHELL
While a single budget cannot bring the economy out of the low growth phase, this year's budget proposals are in the right direction of long-term sustained growth. Although there were few populist measures, a good part of the Union Budget this year focused on kick-starting the capital expenditure cycle. It is expected that the government will clear road blocks for development and come out with a roadmap for a host of initiatives mentioned in the budget.