Union Budget - Analysis & Outlook

Union Budget - Analysis & Outlook

Crisil Research

Outlook 2010-11

There is a growing consensus across the world that the worst of the financial crisis is over. Economies globally have started to stabilise and recover either from the recession or severe slowdown in the past 2 years. After having contracted in 2009, the global economy is expected to expand by 3.9 per cent this year (International Monetary Fund, January 2010). The Indian economy has displayed remarkable resilience over the course of the downturn and is expected to have grown at a rate of 7.2 per cent in 2009-10 (Central Statistical Organisation, February 2010). Since 2008-09, the government had engineered a substantial increase in demand through fiscal measures to compensate for the decline in private and export demand. The focus has now shifted to private consumption and investment, which are being viewed as key d rivers of growth in 2010-11.

A timely and orderly exit from the fiscal stimulus is crucial to maintain the credibility of government finances, and thereby, the potential growth in coming years. If the fiscal stimulus has to generate net long-term gains, and not merely end up as a transfer of expenditure from the private sector to the government, a realistic fiscal tightening plan is essential. This would be the most important economic challenge facing India over the next few years. The budget of 2010-11 made some progress on this account by partially rolling back the reductions in indirect taxes. The real boost to sustainable fiscal correction, however, would have come from expenditure reforms, which are largely missing in the budget, with government expenditure expected to rise by around 8.5 per cent in 2010-11 (over revised estimate 2009-10) over the exceptionally high growth of 15.5 per cent in the previous year.

Economic Analysis

Based on the measures announced in the budget and also taking into account the global macroeconomic scenario, the economy is expected to grow by 8.0 per cent at factor cost in 2010-11.

Growth in the services sector, which accounts for nearly 57 per cent of the GDP, is expected to moderate marginally from 8.7 per cent in 2009-10 to 8.4 per cent in 2010-11 due to slower growth of government expenditure, As a result, growth in community and social services is expected to weaken despite significant additions to several infrastructure and development initiatives, In contrast, the hotels, transport, communication, finance and real estate sectors would expand at a faster pace as compared to 2009-10 with the expected revival in household demand. Industrial growth is expected to remain at 2009-10 levels on the back of sustained increase in demand - both exports and domestic. In the event of a normal monsoon, agriculture is expected to grow at a higher rate than its trend because of a low base of 2009-10, when the sector had contracted due to severe drought.

Budget Highlights


▪	Fiscal deficit pegged at 5.5 per cent of GDP for 2010-11; Fiscal deficit projected at 4.8 percent and 4.1 percent of GDP in 2011-12 and 2012-13, respectively.

▪	Net market borrowings for 2010-11 is budgeted at Rs. 3,450 billion, 13.4 per cent lower as compared to the previous year.

▪	Total expenditure in 2010-11 to increase by 8.6 per cent over 2009-10.

▪	Defence allocation pegged at Rs. 1,473.4 billion in 2010-11 as against Rs. 1,417 billion in the previous year; of this, capital expenditure would be Rs 600 billion.

▪	30 per cent increase in capital expenditure and 5.7 per cent increase in revenue expenditure over 2009-10.

▪	Personal income tax slabs changed: ▪ Income up to Rs. 1.6 lakhs – Nil ▪ Income between Rs. 1.6 lakhs and Rs. 5 lakhs - 10 per cent ▪ Income above Rs. 5 up to 8 lakhs - 20 per cent ▪ Income above Rs. 8 lakh - 30 per cent.

▪	Additional income tax deduction of Rs. 20,000 allowed on long-term infrastructure bonds in addition to the Rs. 1 lakh deduction allowed already.

▪	Standard rate of excise duty on all non-petroleum products increased from 8 per cent to 10 per cent.

▪	Minimum Alternate Tax (MA T) to be increased from 15 per cent to 18 per cent on book profits.

▪	Excise duty on petrol and diesel up by Re. 1 per litre.

▪	Restoration of the customs duty on crude oil to 5 per cent, on diesel and petrol to 7.5 per cent, and on other refined products to 10 per cent.

▪	Rate of service tax retained at 10 per cent, but coverage extended.

▪	Disinvestment receipts for 2010-11 are estimated at Rs. 400 billion.

▪	Proceeds from 3G auction estimated at Rs. 350 billion.

▪	Government to provide oil and fertilizer subsidy in cash instead of issuing bonds.

▪	Nutrient based fertiliser subsidy scheme to come into force from April 1, 2010.

▪	Allocation to infrastructure at Rs. 1,735.5 billion.

▪	Spending on social sector increased to Rs. 1376.7 billion, which is 37 per cent of total plan outlay.

▪	Rs 165 billion allocated for enhancing bank's Tier-1 capital to 8 per cent by March 31, 2011.

▪	Direct Tax Code (DTC) to be implemented by April 1, 2011.

▪	Endeavour to introduce GST by April 1, 2011.

Investment activity is likely to pick up, with gross fixed capital formation growing at 12.5 per cent as compared to 5.2 per cent in 2009-10. The notable improvement in both domestic and export demand should enhance business prospects, and hence, attract investments. Corporate profits are at relatively healthy levels and corporates are having increasing access to external sources of finance. Hence, supply of funds is not expected to present any roadblocks to investment growth, unless government borrowing programmes go beyond the budgeted numbers and crowds out private demand. Private consumption growth should recover to around 6.5 per cent from a mere 4.2 per cent in 2009-10, as personal disposable income would rise owing to the new direct tax slabs announced in the budget. This along with relatively improved conditions for retail credit availability should aid household consumption growth.

The main threat to growth arises from the escalating inflation, at least in the first half of 2010-11, due to the agricultural price shock, rising commodity prices and recent petrol and diesel price hike. In the event of an unanticipated sharp rise in inflation, the Reserve Bank of India would have to tighten the monetary policy at a faster pace and this would impact market interest rates, albeit with a lag. In the latter half of 2010-11, year-on-year inflation should start to slow down in spite of demand pressures, given the exceptionally high base of this year. We expect average WPI inflation of around 6.5-7.0 per cent for 2010-11. As for the 10-year government securities rate, the pressures would arise from the RBI's move towards hiking interest rates from April 2010 as well as the government's demand for funds to finance its deficit.

In recent months, the Rupee has remained relatively stable at around 45.5 to 46.5 per US$ mark. Foreign investments are expected to start flowing back into the country at a faster pace in 2010-11, thus enabling the currency to continue on its fundamental trend of appreciation. We expect the Rupee to stabilise in the range of Rs. 43.5-44.0 per US$ by March 2011. The margin of error for the exchange rate forecast remains high in view of the continuing global economic uncertainty.

On the fiscal front, tax receipts are expected to increase sharply by 14.8 percent (over RE 2009-10) along with rising economic growth. In addition, the combined expected revenues of Rs. 750 billion from disinvestment in public sector enterprises and revenues from the auction of 3-G would bring in additional revenues. As a result of a significant increase in government revenues, the fiscal deficit to GDP ratio for 2010-11 is expected to decline to 5.6 per cent from 6.7 per per cent a year earlier.

Does Budget Promote Growth?

GDP growth from the demand side arises from changes in four main components: private consumption expenditure, domestic investment, government consumption expenditure and net exports (difference between the value of exports and imports). The contribution to growth of each of these GDP components is defined as the ratio of the change in that component relative to the previous year to the total change in GDP over the same period, expressed as a percentage of those components.

In 2009-10, private consumption is expected to have contributed around 36 per cent to overall GDP growth, while government consumption is estimated to have contributed around 14 per cent to growth. Unlike in a number of other countries which are experiencing economic slowdown or recession, investment continued to grow in 2009-10, albeit at a lower pace, contributing around 26.0 per cent to GDP growth. Also, unlike in the previous years, net exports contributed positively to GDP in 2009-10, as import contraction in 2009-10 was higher than export contraction.

Sectoral Impact

Auto Components & Tyres – Neutral

Auto components and tyres demand to continue to grow despite cost push

The proposals in Union Budget 2010-11 will not have a significant impact on the auto component and tyre industries. The increase in excise duty on auto components could be passed on to automobile manufacturers. Even if this is absorbed by the industry, it will be offset by healthy demand. The interest subvention of 2 per cent will have a marginally positive impact for SMEs engaged in the export of auto components. For the tyre industry, the 2 per cent increase in excise duty will be fully passed on to the OEM and replacement segments.

Impact on Companies

Budget measures to have neutral impact on auto components and tyres industries

Auto Parts: Company Impact

Company	Impact	Impact factors
Bharat Forge Ltd		A, B
Bosch Ltd		A, B
Amtek Auto Ltd		A, B
Sona Koyo Steering Systems Ltd.		A, B
Sundaram Fasteners Ltd		A, B

Source: Crisil Research

Tyres: Company impact

Company	Impact	Impact factors
Apollo Tyres Ltd		A, C
Ceat Ltd		A, C
Goodyear India Ltd		A, C
JK Industries Ltd		A, C
MRF Ltd		A, C

Source: Crisil Research

Impact factors


A)	Excise duty on auto components and tyres has been increased from 8 per cent to 10 per cent. The increase in excise duty for tyres will be fully passed on to the OEM and replacement segments. In the auto components sector, the increase in duty may be passed on to OEMs. However, even if the same is absorbed, it will be offset by an increase in OEM offtake due to buoyant demand.

B)	Excise duty on raw materials for auto components has been increased from 8 per cent to 10 per cent. Further, the increase in raw material prices is estimated to be in the range of 1.0-1.5 per cent.

C)	Carbon black feedstock is exempted from additional customs duty of 4 per cent (special CVD). This, if fully passed on, will marginally benefit tyre manufacturers.

D)	Interest subvention of 2 per cent on pre-shipment credit for small and medium exporters has been extended up to March 31, 2011. This will benefit players with higher exposure to exports.

Automobiles – Neutral

Rise in disposable income to support demand despite increase in prices

The budget announcements for 2010-11 will have a mixed impact for different automobile segments. While the overall impact is positive on passenger cars, the impact on the commercial vehicles sector will be marginally negative. Continued focus on rural development will benefit two-wheeler and tractor sales. Commercial vehicle prices will rise in line with the increase in excise duty. Further, operating expenses will be higher by around 2 per cent (with increase in diesel prices) for a typical transporter, thus negatively impacting their profitability marginally. Passenger car prices are expected to rise by Rs. 6,000-7,000 for a typical compact car in line with the hike in excise duty. Rise in petrol and diesel prices will also hike fuel costs by around 1-2 per cent for passenger vehicles. Increase in vehicle prices and other costs will be more than offset by the rise in disposable income. Disposable incomes are estimated to increase by Rs. 20,000-50,000 for people with income between Rs. 5-8 lakh. CRISIL Research expects the benefits of increase in disposable income to more than offset any impact of increase due to increase in excise duty.

Rising input costs to offset benefits of strong demand, leading to pressure on profitability


▪	The Indian automobile industry grew by around 22 per cent in 2009-10, to Rs. 1,946 billion with strong recovery across segments. Exports registered an increase of 10 per cent, aided by buoyant growth in exports in the passenger car segment, which constitutes around 25 per cent of total exports.

▪	Recovery in commercial vehicle purchases by transporters could be attributed to recovery in freight movement, reducing operating and finance costs and improving transporter profitability. Healthy rural demand and the favourable financing environment led to strong revival in volume growth of passenger cars and two-wheelers in 2009-10.

▪	Lower input prices, falling fixed costs with recovery in volumes led to sharp improvement in operating profit margins of automobile players in 2009-10. While vehicle prices are estimated to increase in 2010-11 with implementation of emission norms and rising input prices, manufacturers will not be able to offset the complete rise in input prices, leading to pressure on margins.

▪	Automobile sales are expected to grow by around 13 per cent in 2010-11 in value terms, led by volume growth in the commercial vehicles and passenger cars segment.

Budget to have neutral impact on automobile sector

Company	Impact	Impact factors
Maruti Suzuki Ltd		A, B, C, D
Tata Motors Ltd		A, B, C, D
Ashok Leyland Ltd		A, B, C
Bajaj Auto Ltd		A, B, C, D
Hero Honda Motors Ltd		A, B, C, D
Mahindra & Mahindra Ltd		A, B, C, D

Source: Crisil Research

Impact factors


A)	Excise duty on small cars has been hiked by 2 per cent, which will lead to an increase in prices by Rs 6,000 to Rs. 7,000 for a typical compact car. Large cars and utility vehicles will attract an excise duty of 22 per cent, up from 20 per cent in the previous year. The price hike for a typical medium and heavy commercial vehicle would be around Rs. 25,000-30,000, due to an increase of 2 per cent in excise duty.

B)	Increase in petrol and diesel prices will inflate fuel costs for consumers by 1-2 per cent. Operating expenses for transporters will increase by around 2 per cent due to rise in diesel prices.

C)	Alteration in tax slabs will lead to an estimated rise of Rs. 20,000-50,000 in disposable income.

D)	Weighted deduction for R&D expenses has been increased from a rate of 150 per cent to 200 per cent. This will benefit players who are actively involved in R&D activities.