Indian Pulse - Q2 2013

The Union finance ministry expects Indian Economy would grow at least 6% in the current financial year, citing a pickup in investment and rising investor confidence. RBI has projected the Indian economy to grow at 5.7%, which is lower than even some private forecasts.

Indian Economy

However, RBI reduced policy rates by 25 basis points in May. It also announced rather liberal OMO (Open Market Operations). If the inflation trends goes down further, it will decide scope for further policy action.

The RBI trimmed the repo rate -- the rate at which the central bank lends short-term money to banks -- to 7.25 percent, its lowest since May 2011. It kept the cash reserve ratio (CRR) -- the proportion of deposits that banks have to mandatorily park with the RBI -- for banks unchanged at 4 percent.

India's headline inflation in March fell to its lowest in more than three years at 5.96 percent, but the consumer price index remained elevated at 10.39 percent.

The current account deficit swelled to a record 6.7 percent of GDP in the December quarter. While it is expected to ease on lower global commodity prices and a rise in exports, it is on track to remain well above the 2.5 percent level that is seen as sustainable.

Indian GDP grew only 5 per cent last year, a respectable performance by the standards of the developed world but still the country’s lowest rate for a decade. Public finances have deteriorated. Inflation and interest rates remain high, while the current account deficit has swollen and industrial output is stagnant.

All of this is a grave disappointment for a country whose economy was expanding at a rate of more than 9 per cent just two years ago. Once heady talk that the growth rate of Asia’s third-largest economy might soon overtake China’s has disappeared.

Now the question is whether India’s government can introduce more economic reforms to escape this surprisingly steep slowdown, an issue complicated by political maneuvering ahead of a closely contested national poll early next year. If not, the country will be condemned to relatively sluggish growth for many years, an outcome with significant implications for the global economy, which is muddling through its own recovery.

India's industrial output rose for the third straight month in March, raising hopes that the economic slowdown may have ended and a gradual recovery could be underway.

The index of industrial production in March rose 2.5% from a year earlier, benefiting from a stronger expansion in manufacturing output. This comes after a revised 0.5% expansion in February.

The March output reading is better than the median forecast of a 1.8% increase in a poll of 11 economists.

Indian industry has been in turmoil over the past couple of years. Bureaucratic hurdles to industrial projects such as delay in grant of approvals, a downbeat business environment due to slow policy reforms and a restrictive monetary policy have contributed to a collapse in investments, dragging down economic growth to its weakest in a decade.

However, things are looking up now - Industrial output rose 1% in the last fiscal year ended March 31, after a 2.9% expansion the year before. It contracted during six of the months last year.

Indian economy is expected to grow at around 6 percent in 2013-14 on account of robust domestic demand, strong savings and growth in private investment rate. With food prices expected to remain stable, manufacturing prices weak due to slow growth, and commodity prices stable, inflation is expected to be on a broad downtrend for the next six months and this, we believe, opens up room for more rate cuts by RBI to propel growth.

Union budget of India 2013 – 14: highlights

  • Fiscal deficit seen at 4.8 point of GDP in 2013/14
  • Faced with huge fiscal deficit, India had no choice but to rationalize expenditure


  • Gross market borrowing seen at 6.29 trillion rupees in 2013/14
  • Net market borrowing seen at 4.84 trillion rupees in 2013/14
  • Short-term borrowing seen at 198.44 billion rupees in 2013/14
  • To buy back 500 billion rupees worth of bonds in 2013/14


  • 2013/14 major subsidies bill estimated at 2.48 trillion rupees from 1.82 trillion rupees
  • Petroleum subsidy seen at 650 billion rupees in 2013/14
  • Revised petroleum subsidy for 2012/13 at 968.8 billion rupees
  • Estimated 900 billion rupees spending on food subsidies in 2013/14
  • Revised food subsidies at 850 billion rupees in 2012/13
  • Revised 2012/13 fertiliser subsidy at 659.7 billion rupees


  • India faces challenge of getting back to its potential growth rate of 8 point
  • India must unhesitatingly embrace growth as highest goal


  • Total budget expenditure seen at 16.65 trillion rupees in 2013/14
  • Non-plan expenditure estimated at about 11.1 trillion rupees in 2013/14
  • India's 2013/14 plan expenditure seen at 5.55 trillion rupees
  • Revised estimate for total expenditure is 14.3 trillion rupees in 2012/13, which is 96 point of budget estimate
  • Set aside 100 billion rupees towards spending on food subsidies in 2013/14


  • Expect 133 billion rupees through direct tax proposals in 2013/14
  • Expect 47 billion rupees through indirect tax proposals in 2013/14
  • Target 558.14 billion rupees from stake sales in state-run firms in 2013/14
  • Expect revenue of 408.5 billion rupees from airwave surcharges, auction of telecom spectrum, license fees in 2013/14

Current account deficit 

  • India's greater worry is the current account deficit - will need more than $75 billion this year and next year to fund deficit
  • Food inflation is worrying, will take all steps to augment supply side


  • Proposes surcharge of 10 point on rich taxpayers with annual income of more than 10 million rupees a year
  • To increase surcharge to 10 point on domestic companies with annual income of more than 100 million rupees
  • For foreign companies, who pay the higher rate of corporate tax, the surcharge will increase from 2 per cent to 5 per cent.
  • To continue 15 point tax concession on dividend received by India companies from foreign units for one more year
  • Propose to impose withholding tax of 20 point on profit distribution to shareholders
  • Amnesty on service tax non-compliance from 2007
  • 10 billion rupees for first installment of balance of GST (Goods and Services Tax) payment
  • Propose to reduce securities transaction tax on equity futures to 0.01 point from 0.017 point
  • Time to introduce commodities transaction tax (CTT)
  • CTT on non-agriculture futures contracts at 0.01 point

Corporate sector and markets 

  • To issue inflation-indexed bonds
  • Proposes capital allowance of 15 point to companies on investments of more than 1 billion rupees
  • Foreign institutional investors (FIIs) can use investments in corporate, government bonds as collateral to meet margin requirements
  • Insurance, provident funds can trade directly in debt segments of stock exchanges
  • FIIs can hedge forex exposure through exchange-traded derivatives
  • Investor with less than 10 point stake in a company will be regarded as FII, more than 10 point stake as FDI (foreign direct investment)
  • Stock exchange regulator will simplify know-your-customer norms for foreign portfolio investors
  • To implement quickly recommendations of financial sector legislative reforms commission
  • To cut factory gate duty on trucks to 13% from 14%

Power and energy sector 

  • Zero customs duty for electrical plants and machinery
  • Move to revenue-sharing from profit-sharing policy in oil and gas sector
  • To equalise duties on steam and bituminous coal to 2 point customs duty and 2 point CVD (countervailing duty)

Foreign trade 

  • To cut duty on exports of precious and semi-precious stones to 2 point from 10 point
  • No duty on import of ships, vessels


  • To provide 140 billion rupees capital infusion in state-run banks in 2013/14


To allocate 2.03 trillion rupees to defense in 2013/14


  • To allocate 801.94 billion rupees to rural development in 2013/14
  • Plan to allocate 270.49 billion rupees for agriculture in 2013/14

Finance minister comments 

  • "Faced with a huge fiscal deficit, I have no choice but to rationalize expenditure. We took a dose of bitter medicine. It seems to be working."

Impact of Indian Budget on Foreign Investors

India's budget disappointed foreign investors by failing to deliver a much anticipated cut in withholding taxes for debt investments and creating confusion with a proposal that appeared to target tax treaties.

Several measures for foreign investors were unveiled for the 2013/14 fiscal year starting in April, including simplifying a cumbersome registration process and allowing investments in corporate bonds and government securities to be used as collateral to meet margin requirements.

However, the measures on their own were seen as unlikely to significantly boost foreign inflows at a time when India needs capital flows to plug a current account deficit that hit a record high in the quarter ended in September.

Indian shares were hit in part by concerns about the impact of the budget on foreign investors, with the benchmark BSE index ending down 1.5 percent.

Easing the registration process for foreign investors is a facilitator, but the game changer would have been a withholding tax cut across the board, which would have helped the current account deficit and the development of the onshore debt market.

The main announcement for foreign investors was the simplification of the complicated "Know Your Customer" rules.

Finance Minister also said the country would consolidate the current system of mandating different registration rules for different types of investors.

However, the government did not announce a cut in the withholding tax imposed on income from government and corporate debt investments and deducted at source that can now reach up to 20 percent.

The government also created confusion with a proposal stating a tax residency certificate "shall be necessary but not a sufficient condition" to take advantage of double taxation avoidance agreements, according to the Finance Bill that was part of the 2013/14 budget.

Tax authorities had previously considered this tax residency as enough proof to allow foreign investors registered in countries with these treaties to avoid paying taxes in India.

The amendment, due to take effect in 2016, sparked fears tax authorities would have wider discretion to go after foreign investors.

It also comes about a year after poorly written rules to ensnare tax evaders, called the General Anti-Avoidance Rules (GAAR), had sparked an outcry among foreign investors, prompting the government to amend their provisions and delay implementation for two years.

To help plough back more money into the local economy and stimulate growth, finance minister has made it difficult for foreign investors to repatriate funds from India while encouraging inflow of funds from foreign subsidiaries of Indian companies.

FM was silent on the retrospective tax laws introduced in the previous budget, making foreign investors still wary of putting their money in the country.

The budget also included a clause in the finance Bill that countries will have to provide both tax residency certificates (TRC) as well as establish beneficial ownership to avoid taxes under double tax avoidance agreements (DTAAs).

The provision that tax residency certificates are necessary but not sufficient was put in the memorandum last year but has been included in the Bill this year. This will impact investments routed from so-called tax havens like Mauritius.

Foreign investors will need to provide both residency and beneficial ownership under a DTAA and the TRC addresses only the residency issue.

Finance Minister Chidambaram announced a withholding tax of 20% on profits distributed by unlisted companies to shareholders through buyback of shares.

This will impact foreign investors, including private equity funds, based in countries such as Singapore and Mauritius with which India has beneficial tax treaties and who were using share buybacks to repatriate surplus profits from Indian businesses without paying taxes.

The buyback route was treated as capital gains in the foreign country allowing shareholders to get away with paying zero or a very low rate of tax in India.

But with the reclassification of such buybacks as dividends, there will be a significant tax on investors. They will have to pay tax akin to a dividend distribution tax at 20%.

This amendment will discourage adoption of selective buybacks as a means of distributing surplus to foreign investors. Also, since the tax is on the distributing company, it will impact the ability of the shareholder to claim credit in the home country.

Finance Minister also proposed increasing the tax on royalties companies pay to their parents abroad from 10% to 25%, but analysts say this may have little impact because of tax treaties India has with countries where many of these firms are headquartered.

The move is an effort to clamp down on arrangements by companies seeking to avoid paying higher taxes. The rate of tax on royalty in the Income Tax Act is lower than the rates provided in a number of double tax avoidance agreements. But where a parent company receiving the royalty is based in a country with which India has a DTAA, the rate of tax stipulated therein would apply.

Analysis of Indian Budget

Prudence over populism

The Finance Minister has delivered on one of the most important aspects in this Budget - fiscal consolidation. The budgeted fiscal deficit for FY2014 at 4.8% of GDP is in line with our and market expectations. In terms of the fiscal deficit for FY2013, the Finance Minister has exceeded expectations and reined it at 5.2% and it is slightly lower than the government's own estimate of 5.3% of GDP. In addition, the actual FY2012 headline deficit has also narrowed to 5.7% of GDP from 5.9% of GDP.

Overall, we believe that the FY2014 Budget is responsible and more credible since it seeks to narrow the fiscal deficit by increasing revenues as well as reprioritizing expenditure. Although the Finance Minister has refrained from announcing any big bang reformist measures (as expected by the market) in the Budget, he has also abstained from 'playing to the galleries' and resorting to major populist policies ahead of the election year and we view that as a positive.

Balancing revenues and expenditure

Finance Minister has calibrated fiscal policy towards a good growth mix. Non plan expenditure is expected to moderate to 9.8% of GDP in FY2014BE from the revised estimate of 10.0% of GDP in FY2013RE. Plan expenditure, on the other hand is expected to inch upwards to 4.9% of GDP in FY2014BE as compared to 4.3% of GDP in FY2013RE.

Overall, despite the over-estimation in receipts the fiscal deficit number looks credible. We believe that the government would stick to its fiscal deficit target of 4.8% of GDP in FY2014 and akin to the previous fiscal year, any shortfall in revenues is likely to be offset by similar compression on the plan expenditure side. We believe that it spells positively for the economy to avert a sovereign ratings downgrade by credit ratings agencies. The narrowing of the fiscal deficit is also a positive for the interest rate environment in the economy as monetary policy is expected to adopt to a more accommodative stance to support growth in the wake of fiscal consolidation by the government.


We believe that the Finance Minister has delivered a budget that suggests economic stability, superseding political considerations. We regard it as a prudent but non-reformist budget. Despite the many misses, delivering on the fiscal deficit target is a key positive. We believe that it is crucial for averting a sovereign rating downgrade and thereby ensuring stability of capital flows to finance the current account deficit. Credibly lower fiscal deficit target for FY2014 is also expected to provide monetary policy with more headroom to ease policy rates and crowd in private sector investment.

Going forward, we believe that maintaining the momentum on reforms beyond the Budget is pertinent to tackle structural supply side constraints in the economy, particularly in the mining and power sector, for revival of growth in the economy.