Union Budget - Analysis & Outlook

Crisil Research

Outlook 2011-12

▪	India not only emerged relatively unscathed from the global financial crisis of 2008, but has returned to its trend growth rate in 2010-11. Driven by the inherent strength of its domestic demand, which was suitably complemented by the Reserve Bank of India's monetary management and the Central government's fiscal stimulus, India's GDP is expected to grow by 8.6 per cent in 2010-11 as per the CSO Advanced Estimate. This will again make India one of the fastest growing economies in the world.
▪	The expansionary fiscal stance that began in 2008-09 continued through 2009-10 and was reversed in 2010-11. With growth now becoming more balanced due to revival in both private consumption and investment, it is time to return to fiscal consolidation, which was deferred due to the global financial crisis. The Budget of 2010-11 took the right step by reducing the fiscal deficit to 5.5 per cent of GDP, which, as per the revised estimate, is now 5.1 per cent mainly due to the unexpected non-tax revenue garnered from 3G/ broadband auction. Taking the fiscal consolidation process forward, the fiscal deficit for 2011-12 has been pegged at 4.6 per cent of GDP.
▪	In view of rising food prices, the Budget for 2011-12 announced numerous initiatives for the agricultural sector, such as ushering in the green revolution to the eastern region, promotion of palm oil, initiatives on vegetable clusters, national mission for protein supplements, enhanced agricultural credit, mega food parks, augmentation of storage and cold chains etc. The target for agricultural credit for 2011 -12 has been raised by 27 per cent.
▪	Based on the measures announced in the Budget, and also taking into account the global macroeconomic scenario, we expect the economy to grow by 8.3 per cent at factor cost in 2011-12. Growth in the services sector, which accounts for nearly 57 per cent of the GDP, is expected to move up from 9.6 per cent in 2010-11 to 9.9 per cent in 2011 -12 due to higher growth in hotels, transport, communications, finance, and real estate. However, industrial growth is expected to moderate from 2010-11 levels due to the impact of RBI's monetary tightening measure undertaken in 2010-11. In the event of a normal monsoon, agriculture is expected to grow at a lower rate than last year because of the high base of 2010-11.

 

Budget Highlights ▪  Fiscal deficit pegged at 4.6 per cent of GDP for 2011-12.   ▪  Fiscal deficit projected at 4.1 per cent and 3.5 per cent for 2012-13 and 2013-14, respectively.   ▪  Revenue deficit for 2011-12 pegged at 3.4 per cent.   ▪  Revenue deficit for 2010-11 revised downwards to 3.4 per cent from the budgeted estimate of 4.0 per cent.   ▪  Net market borrowings for 2011-12 budgeted at Rs 3,430 billion, 2.3 per cent higher than in 2010-11.   ▪  Total expenditure for 2011-12 to increase by 3.4 per cent over 2010-11.   ▪  Capital expenditure to be 1.4 per cent lower than in 2010-11; revenue expenditure to rise by 4.1 per cent.   ▪  Change in personal income tax slabs following increase in exemption limit: ▪  Income upto Rs 1.8 lakh - Nil   ▪  Income between Rs 1.8 lakh and Rs 5 lakh -10 per cent   ▪  Income between Rs 5 lakh and Rs 8 lakh - 20 per cent   ▪  Income above Rs 8 lakh - 30 per cent   ▪  Incomes up to Rs 2.5 lakh of senior citizens between 60 and 80 years of age to be exempted from tax; for those above 80 years, exemption limit Rs 5 lakh.   ▪  Standard rate of excise duty on all non-petroleum products to be maintained at 10 per cent.   ▪  Minimum Alternate Tax rate to be increased from 18.0 per cent to 18.5 per cent.   ▪  Rate of service tax retained at 10 per cent, but coverage extended.   ▪  Disinvestment receipts for 2011-12 estimated at Rs 400 billion.   ▪  Government to move towards direct transfer of cash subsidy for kerosene and fertilisers.   ▪  Foreign investors who meet Know Your Customers (KYC) norms to be allowed to invest in Indian equity mutual funds.   ▪  Fll limit for investment in corporate bond with residual maturity of over five years issued by companies in infrastructure sector raised by US$20 billion to US$ 25 billion.   ▪  Rs. 60 billion allotted to public sector banks to maintain a Tier-1 CRAR of 8 per cent during 2011-12.   ▪  Direct Tax Code to be implemented from April 1, 2012.   ▪  Allocation to infrastructure at Rs 2,140 billion for 2011-12, 23.2 per cent higher over previous year.

 

▪	Investment activity is likely to dip marginally, with gross fixed capital formation growing at 8.1 per cent in 2011-12 as compared to 8.4 per cent in 2010-11 due to higher interest rates that have had an adverse impact on investor sentiment. Although corporate profits are at healthy levels now, it is likely to come under pressure during 2011-12 mainly on account of rising wage and input cost. However, supply of funds is unlikely to present any roadblocks to investment growth, unless government borrowing programmes go beyond the budgeted numbers and crowd out private demand. Private consumption growth would remain flat at 8.1 per cent in 2011-12 vis-à-vis 8.2 per cent in 2010-11 due to high level of inflation and rising cost of retail credit.
▪	The main threat to growth arises from sustained inflation, particularly food inflation. Throughout 2010-11, food inflation remained a policy challenge and RBI had to resort to monetary tightening at a faster pace. Although y-o-y inflation is expected to slow down during 2011-12 due to the high base of 2010-11 and the moderation in food prices, the recent spurt in oil and commodity prices, if it continues, can pose an upside risk to inflation. Assuming an average crude oil price of around US$ 85 per barrel in 2011-12, and normal monsoon, we expect average WPI inflation to be around 5.8 - 6.0 per cent in 2011 -12. As for 10-year government securities, the interest rate would largely be dictated by the government's demand for funds to finance its deficit. We expect the interest on G-secs to settle down around 7.9 - 8.2 per cent by the end of March 2012.
▪	In recent months, the rupee has moved both ways largely dictated by capital inflows/outflows and rising current account deficit. At the moment, it is hovering around 45.1 to 45.4 per dollar mark. Although foreign investment has retreated of late, it is likely to return in view of the sustained growth outlook and some positive announcements made in the Budget such as allowing foreign investment in mutual funds and letting foreign institutional investors invest up to US$40 billion in corporate bonds. However, the pace would remain uneven and a bit lower than what was witnessed during 2010-11. Therefore, we expect the rupee to stabilise in the range of Rs. 43 to 44 per dollar by March 2012. The margin of error for the exchange rate forecast remains high in view of the asymmetrical growth prospects in the global economy and the sovereign debt crisis in some EU countries.
▪	On the fiscal front, tax receipts are expected to increase by 17.9 per cent (over RE 2010-11). Moreover, the government intends to generate Rs. 400 billion from disinvestment despite missing the target in 2010-11. Although, the Budget has pegged the fiscal deficit at 4.6 per cent of GDP for 2011 -12, we feel that in view of the government's track record on the disinvestment front, and also the likely increase in subsidies on oil and fertilizers - not to forget, the impact of Food Security Bill - our view is that the fiscal deficit will be higher than the budgeted figure. We expect it to be 5.0 per cent of GDP in 2011-12.
▪	The CRISIL macroeconomic forecasts presented here are firmly based on our view of the fundamentals as we see them now. However, we do recognise that any unanticipated developments either at the domestic and/ or global level would make revisions to our outlook necessary as 2011-12 progresses.
Fiscal Scenario
▪	The Centre has budgeted a fiscal deficit of 4.6 per cent for 2011-12, against a downward-revised estimate of 5.1 per cent for 2010-11. However, CRISIL expects fiscal deficit to be 5.0 per cent - higher than the budget estimate - in 2011 -12 because, in addition to an overtly ambitious disinvestment target and upside risks to expenditure due to likely slippages arising from higher oil and fertiliser subsidies, we believe real GDP growth during the fiscal will be 8.3 per cent (lower than what the budget has factored in). Despite marginally higher market borrowings in 2011-12, encouragement to higher foreign capital inflows could weigh down pressures on the 10 year G-sec yield.
▪	During 2010-11, in addition to windfall gains from non-tax revenue (3G/BWA spectrum auctions), and higher than budgeted tax revenues buoyed by expanding economic activity and part reversal of indirect tax/duty cuts, the 20.3 per cent growth in nominal GDP helped the government tighten its belt on fiscal consolidation. The Centre's estimate for lower fiscal deficit ratio for 2011-12 is largely on the back of its higher 9 per cent (+/- 0.25 per cent) estimate of real GDP growth and slower expenditure growth vis-à-vis previous year.
▪	Consequent to a higher fiscal deficit, despite availability of cash balances with RBI and lower redemptions during the year, the Centre's net market borrowings for 2011-12 are pegged marginally higher at Rs. 3.43 trillion, compared to Rs. 3.35 trillion in 2010-11.
▪	Meanwhile, the revenue deficit, which shrank from 5.2 per cent in 2009-10 to 3.4 per cent in 2010-11, is budgeted to remain unchanged in 2011-12. The 13th Finance Commission's (TFC) revised roadmap recommends elimination of the Centre's revenue deficit by 2014-15, and attainment of fiscal deficit of 3 per cent. On the debt front, much ahead of the target year, the Centre's debt to GDP ratio has already fallen to 44.2 per cent in 2011-12 and is lower than TFC's stipulated target of 45 per cent.
▪	The Centre's expenditure growth is budgeted to be lower at 3.4 per cent in 2011-12, versus 18.7 per cent in 2010-11. Much of this deceleration is due to ironing out of additional (stimulus-led) Plan allocations made in 2009-10 and 2010-11, lower allocation for subsidies and significantly lower commitments on agriculture debt waiver and debt relief facilities. Plan expenditure is budgeted to rise by 11.8 per cent in the absence of major announcements of increased outlay on schemes, whereas non-Plan expenditure is expected to fall marginally. However, ratio of Plan expenditure to GDP has been maintained at 2010-11 levels, while the ratio of non-plan expenditure to GDP is budgeted lower.
▪	While the Budget proposes a relatively low expenditure increase, it has not managed to augment revenue significantly. For 2011-12, while retaining the standard rate of service tax at 10 per cent, the service tax net has been somewhat widened. Within direct taxes, major measures include hike in exemption limit in personal income tax for individual taxpayers, and raising Minimum Alternate Tax rate paid by corporates to 18.5 percent. Within indirect taxes, measures proposed are largely to align tax/duty rates with those that would be applicable once GST is adopted.
▪	Growth in gross tax receipts is budgeted to be lower in 2011 -12, at 18.5 per cent, due to slower growth in excise and customs duty collections. During the previous year, part reversal of tax/duty reductions on customs and excise had lifted revenue collections. In contrast, collections from corporate tax, income tax and service tax are expected to remain buoyant. The Centre's gross tax to GDP ratio is, therefore, expected to rise marginally to 10.4 per cent in 2011-12, from 10 per cent in 20ID-11. Based on the budgeted incremental gross tax revenue and incremental nominal GDP, overall tax buoyancy is likely to be lower at 1.55 in 2011 -12 versus 2.17 the previous year.
▪	The government expects higher proceeds of Rs. 400 billion (same as was budgeted in the previous year) from disinvestment in public sector units (PSU) to offset the slowdown in revenue growth. However, there are some concerns over actual accruals, given the limited investor appetite in PSU disinvestment. Out of the budgeted amount in 2010-11, the government raised Rs. 221 billion from divesting stakes in SCI, MOIL, Coal India, SJVNL, PGCIL, and EIL. Although disinvestment receipts will boost the Centre's revenues, this source of revenue is unsustainable over the long term. Instead, the government should actively focus on increasing its tax revenue via better reforms for widening the tax base and improving its administration and compliance. Not accounting for the one-off gains from 3G spectrum sales, the Centre's non-tax revenue growth remains poor at about 6 per cent. Improving receipts from dividends and profits of PSUs could provide a fillip to revenue buoyancy.
Sectoral Impact Auto Components & Tyres - Neutral Impact Healthy growth in domestic automobile production, recovery in exports drive auto component players' revenues in 2010-11
▪	Auto component production is estimated to grow by 21-23 per cent in 2010-11, led by strong demand from OEMs on the back of buoyant sales of commercial vehicles, cars, tractors and two-wheelers. Exports are estimated to grow by 16-18 per cent with revival of automobile production in key global export markets. Growth of the automobiles segment is likely to moderate in 2011-12 from the high growth rates seen earlier, due to rise in cost of ownership and high interest rates. Consequently, growth in production of auto components will moderate to 15-17 per cent in 2011-12. The OEM segment is expected to record a growth of 16-18 per cent. Exports are likely to grow by 19-21 per cent, while the replacement segment will grow by 7-9 per cent.
▪	Raw material cost for auto components has risen by 21 per cent during April-December 2010, leading to a pressure on margins. Operating margins are estimated to fall by 150-200 bps (y-o-y) to 12.2-12.8 per cent in 2010-11. In 2011-12, operating margins are likely to drop further by 90-120 bps due to a continuous increase in the raw material cost and the limited pricing flexibility of auto component players.
Operating margins of tyre manufacturers to remain under pressure
▪	The tyre industry's revenues are estimated to grow by 26-30 per cent in 2010-11, aided by a 14-16 per cent growth in volumes (tonnage) and a 12-14 per cent increase in tyre prices. In 2011-12, growth (in tonnage terms) is projected to be 13-15 per cent, while tyre prices will rise by 12-14 per cent on account of higher input cost.
▪	The raw material cost rose sharply by 50-52 per cent in the first 9 months of 2010-11. Although tyre manufacturers hiked prices by 10-12 per cent across auto segments, they were unable to fully offset the increase in raw material cost, resulting in a significant decline of 6-7 per cent in operating margins. The industry's margins are expected to be under pressure at 7-9 per cent for 2010-11.
▪	Raw material prices are likely to remain firm in 2011-12 and will keep margins under pressure.

 
Impact on Companies

Auto Parts: Companies 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: Companies impact

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

Source: Crisil Research

 
Impact factors

A)	There is no change in customs duty on the auto components industry, other than the following specific changes. Certain specified parts of electrical vehicles were fully exempted from basic customs duty on actual-user basis in Budget 2011. This concession has been extended to batteries imported by vehicle manufacturers for the replacement markets. The reduction in customs duty will bring down the maintenance cost of these vehicles. However, this will not have a significant impact on demand for auto components, given the low population of electric vehicles in India.
B)	There is no change in excise duty other than the following specific change. Concessional central excise duty of 4 per cent has been levied on batteries imported by vehicle manufacturers for replacement markets, in Budget 2011-12. However, this too will not have a significant impact on demand for auto components, given the low population of electric vehicles in India.
C)	In Dec'10, the government had reduced the basic customs duty on natural rubber (upto the limit of 40,000 tonnes) to 7.5 per cent from 20 per cent for Jan-Mar'11. This customs duty will be revised to 20 per cent or Rs. 20 per kg, whichever is lower, effective from Apr'11. This will not change the landed cost of NR significantly from the current price levels, thus, having no significant impact on the tyre industry.
D)	The customs duty on Carbon Black Feedstock (which is used to manufacture carbon black) has been reduced to 2.5 per cent from 5 per cent and customs duty on caprolactum, which is used to produce Nylon Tyre Cord (NTC), has been reduced to 7.5 per cent from 10 per cent, resulting in a marginally lower input cost.

 
Automobiles - Neutral Impact

Demand growth to moderate in 2011-12 over a high base; rising input costs to exert pressure on margins

▪	The domestic automobiles industry is estimated to grow by 30 per cent (in value terms) in 2010-11. Growth is expected to be driven primarily by a strong volume growth in passenger cars and utility vehicles (30 per cent), commercial vehicles (CV), tractors and two-wheelers (26 per cent).
▪	Strong growth in industrial production and healthy agricultural production has translated into buoyant freight availability for transporters in 2010-11. This, along with favourable financing environment, has led to healthy growth in sales of CVs. Two-wheeler and passenger car volumes have been driven by higher disposable incomes, launch of new models and increasing rural penetration.
▪	In 2011-12, the domestic automobile industry is expected to grow at a relatively lower rate of 17-18 per cent given the increasing cost of ownership caused by hardening interest rates and rising vehicle and fuel prices. Revival in key export markets will enable a 19-21 per cent growth in 2011-12.
▪	Higher demand and tight supplies of key inputs like steel and tyres have led to an increase in raw material costs, which in turn resulted in a 3-8 per cent increase in vehicle prices in 2010-11. However, manufacturers have not been able to pass on the entire increase in input costs, which has exerted pressure on operating margins.
▪	Operating margins are expected to decline marginally in 2011-12 with a sustained increase in prices of raw materials like steel and tyres, given the limited flexibility of automobile manufacturers to pass on the price increase to their consumers.

 
Budget to have neutral impact on the automobile industry

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

Source: Crisil Research

 
Impact factors

A)	The Union Budget 2011-12 has proposed to extend the excise duty refund available to taxis having a seating capacity of less than 7 to vehicles having a seating capacity of up to 13 passengers. This is expected to marginally aid the sales of utility vehicles in the specified category. Also, the concessional excise duty of 10 per cent has been extended to vehicles based on fuel cell and hydrogen cell technology, which will improve the long term growth prospects of these vehicles.
B)	Specified parts of hybrid vehicles have been exempted from basic customs duty and special CVD in the budget. In addition, excise duty on these parts has been reduced to 5 per cent from 10 per cent earlier, in order to incentivise domestic production and reduce import dependence. These factors are expected to aid the sales of hybrid vehicles and have a marginally positive impact on the passenger cars industry over the longer term.
C)	The increase in exemption limits of tax slabs for individual tax payers from Rs. 1.60 lakh to Rs. 1.80 lakh is likely to lead to increase in disposable incomes of addressable households, and thus aid two-wheeler sales.
D)	Enhancement of interest subvention on crop loans from 2 to 3 per cent, revision of wage rates under the Mahatma Gandhi National Rural Employment Guarantee Act (NREGA) scheme and increased allocation towards rural development projects like Rashtriya Krishi Vikas Yojana are expected to have a marginally positive impact on two-wheeler and tractor sales. Moreover, announcement of the launch of the 'National Mission for hybrid and electric vehicles' is expected to benefit sales of hybrid and electric vehicles over the longer term.

 
Roads - Positive Impact

Momentum expected to continue; quicker awarding under National Highway Development Programme

▪	CRISIL Research estimates an investment of Rs. 6,372 billion in roads and highways over 2010-11 to 2014-15, more than double the investment spend in the previous 5-year period. National highways are expected to comprise the largest share of total investment at Rs 2,706 billion followed by state roads and rural roads.
▪	The resolution of policy issues such as termination clause and exit clause in the second half of 2009-10 sped up awarding of national highway projects. However, land acquisition issues are hampering project execution.
▪	Overall, around 50 per cent of the total length under the NHDP remains to be awarded. Stretches under Phase II have largely been awarded while awarding of projects under Phase III is going on at a brisk pace. Awarding of projects under Phase IV and Phase V has picked up in 2010-11.

 
Impact Factors
 

A)	National Highways Authority of India has been allowed to raise tax-free bonds amounting to Rs. 100 billion, and the foreign institutional investment limit for investment in corporate infrastructure bonds has been raised by $20 billion. Further, IIFCL's loan disbursal target has been set higher at Rs 250 billion for 2011 -12. These proposals are expected to have a positive impact on BOT (build-operate-transfer) road developers, in terms of faster awarding of projects and additional availability of funds.
B)	Increase in the Minimum Alternate Tax to 18.5 per cent is expected to be offset by a reduction in surcharge to 5 per cent.