Nidhi Kedia || Research Analyst || nidhi.kedia@bmastock.com

March 06, 2012

Union Budget 2012-13 Preview

| 1

Detailed sectoral preview

The year that was... • Inflation taking a toll on growth

• Burgeoning fiscal deficit

Expectations from the Budget

Topics

| 2

Detailed sectoral preview

The year that was... • Inflation taking a toll on growth

• Burgeoning fiscal deficit

Expectations from the Budget

Topics

| 3

Inflation has been above the RBI’s comfort zone of 5-5.5%

for over two years now…

WPI YoY (%)

SOURCE: Bloomberg, BMA Research

-1%

0%

1%

2%

3%

4%

5%

6%

7%

8%

9%

10%

11%

12%

Ja

n

Feb

Ma

r

Ap

r

Ma

y

Ju

n

Ju

l

Au

g

Se

p

Oct

Nov

Dec

2009

2010

2011

▪ Remained above 9% in each of

the 11 months of 2011 up to

November 2011

▪ Touched double digit in

September 2011

▪ Each component of inflation,

viz., primary, fuel and

manufacturing remained above

RBI's comfort level at 5%

▪ Though core inflation has

started to come down, it needs

to be tracked for some more

time before we are confident it

will remain at lower levels

| 4

RBI took an anti- inflationary stance to control inflation

Policy Rates(%)

SOURCE: Bloomberg, BMA Research

3%

4%

5%

6%

7%

8%

9%

10%

Ja

n-0

7

Ju

l-0

7

Ja

n-0

8

Ju

l-0

8

Ja

n-0

9

Ju

l-0

9

Ja

n-1

0

Ju

l-1

0

Ja

n-1

1

Ju

l-11

Ja

n-1

2

Repo Rate

Reverse Repo Rate

Cash Reserve Ratio

▪ The constant increase in inflation

has forced the Central Bank to

tighten its monetary policy

▪ Repo Rate was hiked by 375 bps

since Mar-10

▪ In its recent monetary policy

review, it cut CRR by 50 bps in

order to ease liquidity conditions

▪ Though RBI has stalled with rate

increases and signaled that the

interest rate cycle has peaked, a

cut in the interest rates would

depend on how the other macro-

economic factors shape up in

future

| 5

Tight monetary policy took a toll on the economic growth…

SOURCE: Bloomberg, BMA Research

4%

5%

6%

7%

8%

9%

10%

11%

Ma

r-0

8

Ju

n-0

8

Se

p-0

8

Dec-0

8

Ma

r-0

9

Ju

n-0

9

Se

p-0

9

Dec-0

9

Ma

r-1

0

Ju

n-1

0

Se

p-1

0

Dec-1

0

Ma

r-11

Ju

n-1

1

Se

p-1

1

De

c-1

1

▪ The high inflation and tight

monetary policy maintained by

the RBI have taken a toll on

growth

▪ GDP slowed to its weakest

annual pace in almost three

years, as high interest rates and

rising input costs constrained

investment and manufacturing

▪ With GDP growth moderating

after significant monetary

tightening by the RBI, fiscal

consolidation is the only

alternative to maintain a

sustainable growth rate

GDP(%)

| 6 6

FY12 Deficit will likely be significantly higher than budgeted

In FY11, the government was able to reduce the central fiscal deficit to 4.7% of GDP, on

account of a significant revenue from 3G license fees. However, this year (FY12) the

government has been facing several receipt gaps. We expect central government’s fiscal

deficit to overshoot to about 6% of GDP in FY12 vs. budget estimate of 4.6% of GDP.

Some of the factors that have contributed to the rise in fiscal deficit are as follows:

▪ Loss in revenue on account of cut in custom and excise duty on petroleum

products: The government had cut excise duty and custom duty on petroleum

products in June last year, which has resulted in a loss of revenue to the

government

▪ The ensuing growth slowdown has weighed heavily on tax collections: Excise

and customs duty growth which are directly related to the production levels has

already slipped below budget estimates. Further, corporate tax growth has also

slowed led by the on-going moderation in economic activity, washing off the

optimistic revenue forecasts of the government

▪ Divestment shortfall from the budgeted target: Given the volatile capital market

environment, the government found it difficult to raise sufficient revenue from the

divestment program as was planned in the budget

▪ Subsidies over-run: Higher oil prices has resulted in an increase in oil subsidies

beyond budgeted, thereby increasing the subsidy bill of the country

| 7

Detailed sectoral review

The year that was... • Inflation taking a toll on growth

• Increasing fiscal deficit

Expectations from the Budget

Topics

| 8 8

Expect policy reforms to improve the growth situation

▪ The macroeconomic conditions in India have been very challenging over the last few

months. From inflationary pressures to high interest rate environment and slowdown in

growth, from sovereign debt problems in the euro zone to the domestic issues, there

were a multitude of factors that impacted sentiments negatively

▪ In the midst of decelerating economic growth, policy formation had been difficult on

account of persistently high inflation clubbed with dwindling investments. Further,

volatility in the foreign exchange market had added to the difficulties of the policy

makers

▪ Till now, RBI had taken an anti-inflationary stance through its various monetary

policies. However, in monetary policy, there is not much of a room for a further

maneuver. Any further increase in interest rates will certainly impact growth and the

consequences of a slowdown in growth can be really damaging. Therefore, fiscal

consolidation is the only alternative to improve the growth situation

▪ The Union Budget for FY13 is to be presented in the parliament on 16th March. This

will be a crucial Budget as it sets the tone for policy stance relating to not just fiscal

issues but also monetary policy and economic reforms. Also, it is being announced at a

time when the economy is looking for a boost from the government through

appropriate policy announcements

| 9 9

Fiscal Consolidation to revive the growth momentum

▪ We believe the current macro economic backdrop warrants a reduction in fiscal deficit

partly by cutting expenditure and partly by increasing tax rates. We expect a focus on

balance between fiscal consolidation and public spending. The government must

consider steps that strengthen confidence and encourage a faster recovery in growth

▪ Two major structural reforms to overhaul the direct and indirect tax system are on the

agenda, a new direct tax code (DTC) and a uniform goods and service tax (GST).

Though these tax reform measures are unlikely to be implemented in the FY13 budget,

the FM might introduce some changes in the tax structure so that the move to the new

system is staggered and non-disruptive

▪ The government can also initiate some long pending reforms such as allowing FDI in

multi brand retail. This may however, require government’s conviction to move ahead

with reforms, post assembly elections.

▪ Re-sale of 2G spectrum through auctions may also come in.

▪ The Budget may also help devise some serious strategy on selling PSU stocks that

takes into account varying market conditions to raise sufficient revenue from

divestment

▪ On the expenditure side, support to the five year plan will have to be kept to the bare

minimum. This again has to be done without hurting infrastructure investments

| 10 10

Key focus of the upcoming Budget

▪ Subsidy Rationalization: The ultimate credibility test will lie in the FM’s ability to move

on subsidies and take small but decisive steps towards pruning them.

▪ It may opt raising diesel, kerosene and LPG prices in order to control its oil

subsidy bill. This will however result in higher prices of diesel and petroleum.

▪ Partial decontrol of urea prices may also be done in order to check the rising

fertilizer subsidy bill. This will result in increasing the much needed investments

into the fertilizer sector.

▪ Food subsidy however may be raised as government introduces food security bill.

▪ Withdrawal of fiscal stimulus: Given that there is a possibility of slippages in fiscal

targets of the Government, the government might use the revenue side to drive the

fiscal consolidation. One can expect that the Finance Ministry would try and increase

revenue collections by

▪ Raising excise duty and service taxes, perhaps back to the pre-crisis levels of

12%, thereby also laying ground for a GST at 12%.

▪ Widening the service tax net by bringing more services under the tax umbrella

and increase service tax collections

| 11 11

Key focus of the upcoming Budget

▪ Socialization of personal tax structure: The FM may introduce some changes in the

personal tax structure in order to alter one’s disposable income substantially.

▪ It may raise the maximum income tax exemption limit to Rs. 2,50,000 from Rs.

1,80,000, thereby providing more disposable income into the hands of lower

earning group.

▪ It is also likely that the government may re - introduce surcharge on personal

income tax (10%) particularly for assesses with gross taxable income in the

maximum tax bracket.

▪ The budget may also raise the MAT Rate to 20% (from 18.5%) and increase the

surcharge on corporate taxes to 10% (vs. 5% currently)

▪ Deduction under section 80C may be revised to Rs. 1,50,000 from the existing

limit of Rs. 1,00,000 to provide enhanced options of investments to the

assessees.

▪ Accelerating retail investments in equity markets: Some of the key avenues that

the FM can consider in this regard include:

▪ Lowering/ eliminating short term capital gains tax on equities

▪ Increasing tax allowances for retail investment in equity mutual funds

| 12

Detailed sectoral preview

The year that was... • Inflation taking a toll on growth

• Increasing fiscal deficit

Expectations from the Budget

Topics

| 13

Automobile sector Negative

▪ We expect a potential increase in excise duties by 200 bp for the

sector, particularly for diesel powered vehicles. The duty is expected

to be immediately passed on to the consumers

▪ The much-debated imposition of additional tax on diesel cars might go

through as the step will not only add to the revenues for the

government but may also restrict the growth in diesel subsidies. While

the petroleum ministry is pushing for additional duty of Rs. 80,000 on

diesel cars and UVs, we expect a lower hike

▪ Any further allocation to rural employment schemes such as NREGA

would provide further strength to rural demand for tractors and other

vehicles. Increase in allocation under Rural Development program is

positive for auto companies with rural presence

Budget

Expectations

| 14

Banking sector Neutral

▪ Fresh budgetary allocation for recapitalization of PSU banks which

would improve tier-1 capital and provide adequate capital to support

increased lending

▪ Further clarity on modalities of issuing new private sector bank

licenses

▪ Any policy initiatives affecting infrastructure projects

▪ Increase in exemption limit for borrower on housing loans

▪ Potential reduction in the lock-in period of term deposits to be eligible

for tax deduction from 5 years to 3 years. This would help in correcting

the asset liability mismatch of the banks

▪ Tax benefits on long-term deposits may be taken out of 80C and

provided as a separate tax exempt deduction

Budget

Expectations

| 15

Capital Goods sector Neutral

▪ The budget might levy import duties on Power Equipment at 10-12%

or even higher, following demands from domestic power equipment

companies like L&T, BHEL etc for a level-playing field

▪ A potential increase in excise duty rate from current 10%

▪ Any increased spending on major infrastructure projects would also

revive demand for capital goods

Budget

Expectations

| 16

Cement sector Positive

▪ We do not expect any industry-specific changes

▪ The outlook on infrastructure spending will be important. Better

implementation of plan allocations could result in higher construction

demand from infrastructure segments

▪ The industry also expects removal of import duty on coal, pet coke,

gypsum and other fuels. Any import duty changes, if any, will give a

positive boost to the sector

Budget

Expectations

| 17

Construction & Infrastructure sector Positive

▪ A pickup in spending is expected across various segments of Indian

infrastructure – Ports, Roads, Airports, Rail and Urban Infra, especially

focused on social spending through schemes such as Bharat Nirman,

JNNURM, etc. This will not just lead to higher investments but also

bring about improvements in the quality of urban infrastructure

▪ We also expect that the budget will increase the tax exemption limit

under Sec 80 CCF for infrastructure bonds from current Rs 20,000 to

Rs.1,00,000 to address funding constraints

▪ Specialized institutions may be allowed to fund infrastructure projects

since most banks are ill-equipped as it creates inherent Asset –

Liability Mismatch (ALM) issues

▪ Given the coal shortage in the country, we expect that the current 5%

import duty on coal may be abolished to reduce the cost of imported

coal

Budget

Expectations

| 18

FMCG sector Neutral

▪ We expect specific excise duty on cigarettes to be raised by nearly

10%. However, Companies will resort to price increases affecting

volumes. We believe that ITC is best placed to absorb the hike in

excise duties as it has demonstrated a track record of passing on

excise duty hikes to the end consumer

▪ There might also be a 200 bp increase in excise rates for consumer

products. While companies like Marico, Dabur etc won’t be affected,

as they have manufacturing facilities in excise exempt zone, Asian

Paints would get impacted and would have to pass it on

▪ Any increase in income tax slabs (particularly hike in the maximum

exempt slab), which lowers tax outgo and increases disposable

income will be positive for the consumer sector

Budget

Expectations

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Oil & Gas sector Positive

▪ We expect status quo to be maintained on customs and excise duties

in the oil & gas sector in light of the tight fiscal situation and sustained

high losses on sales of subsidized petroleum products at current retail

selling price. The customs duty was cut in June 2011 by 5% to nil for

crude oil and to 2.5% for petrol and diesel, and excise duty on diesel

was cut by INR2.6/lit to INR2/lit.

▪ The budget might grant extension of the commissioning date of new

refineries to avail the seven-year tax holiday. The exemption is

currently available for only those refineries which have been/would be

commissioned by March 2012. This will benefit Indian Oil Corporation

(IOC) which is setting up a greenfield 15 mmtpa refinery in Orissa

▪ Deregulation of all administered prices on fuel products is unlikely to

happen immediately but some price increases are possible to reduce

the subsidy burden and signal policy direction. The increase in prices

will be positive for the Oil Marketing Companies like HPCL, BPCL and

IOC as it will reduce the under-recoveries to some extent. It will also

reduce subsidy burden of ONGC, GAIL and Oil India

Budget

Expectations

| 20

Pharmaceuticals sector Positive

▪ We expect increase in healthcare budgets which will be a positive for

the sector

▪ Higher weighted deduction (currently at 200%) on R&D related costs

and lower taxation on R&D incomes will be beneficial to the CRAMS

players.

▪ Excise duty on Bulk Drugs may be reduced from 10% to 5% to bring it

at par with formulations

▪ We expect an increase in MAT to 20% from 18.5%. This will affect

most of the front-line companies, especially those having SEZ units

Budget

Expectations

| 21

Real Estate sector Positive

▪ Incentives for affordable housing such as

▪ an increase in the limit for income tax deduction on interest on

home loans, which is currently Rs1,50,000 and/or

▪ an increase in the limit for income tax deduction on home loan

principal payments, which is currently Rs1,00,000.

▪ Thrust on infrastructure would be a longer term demand driver and

positive for the market

▪ Lower FDI restrictions and facilitation of foreign borrowings will help

companies overcome balance sheet issues

Budget

Expectations

| 22

Utilities sector Positive

▪ Reduction of customs duty on imported coal which currently stands at

5%

▪ Financial relief for SEBs in the form of new schemes in power

distribution

▪ Assistance to raise low‐cost long‐term resources to re‐finance power

projects

▪ Tax holiday under section 80IA for power plants may be extended.

▪ Differential between MAT and Income Tax rate may come down

Budget

Expectations

| 23 23

Positive hope of stimulating growth

▪ In a scenario of high inflation, liquidity crunch, high interest rates and subdued

business sentiment, the Budget is expected to provide certain policy directions which

will shape the course of the economy in the coming months

▪ Ideally, the response from the policymakers should be a quick reversal in less

productive government spending, and at the same time initiating policy measures to

boost private investments. Apart from this, the government should consider expediting

the disinvestment process and ensure key reforms such as GST are implemented

quickly

▪ With this, we also need to tackle the implementation risk that has often been

associated with the Indian economy for many years. Particularly, on the expenditure

growth target, the implementation of the promise in the budget is more important than

the promise itself

▪ Industry expects the government to give policy directions to re-build investors'

confidence. Yes, not all of the issues are directly addressable in a Budget, but the

Budget this year can be a starting point towards such enabling policy making

▪ If the Budget assures a certain degree of fiscal prudence, without compromising on

growth excessively, the sentiment should improve. Nonetheless, in order to surge

ahead, industry will seek signs of at least an optimistic outlook from the FM

| 24

All values in

INR Cr FY10 FY11 FY12BE*

REVENUE EXPENDITURE 911809 1053678 1097162

Plan Expenditure 253884 326928 363604

Non Plan Expenditure 657925 726750 733558

CAPITAL EXPENDITURE 112678 162898 160567

Plan Expenditure 49507 68096 77943

Non Plan Expenditure 63171 94802 82624

TOTAL EXPENDITURE 1024487 1216576 1257729

On Revenue Account 911809 1053678 1097162

On Capital Account 112678 162898 160567

Central Government Accounts

All values in

INR Cr FY10 FY11 FY12BE*

REVENUE RECEIPTS 572811 783833 789892

Tax Revenue 456536 563685 664457

Non-Tax Revenue 116275 220148 125435

CAPITAL RECEIPTS 453063 447743 447836

Capital Recpt. (Borr.) 419869 415998 392816

Capital Recpt. ( Ex . Borr) 33194 31745 55020

TOTAL- RECEIPTS 1025874 1231576 1237728

Revenue Receipts 572811 783833 789892

Capital Receipts 453063 447743 447836

All values in

INR Cr FY10 FY11 FY12BE*

Revenue Deficit 338998 269845 307270

Fiscal deficit 418482 400998 412817

*Budgeted Estimates

Source: Ministry of Finance, Government of India

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Nidhi Kedia || Research Analyst || nidhi.kedia@bmastock.com

March 06, 2012