Highlights of the Budget 2012 proposals

• NDB Stockbrokers comment on 2012 Budget

Focus on public investments and external sector

The Government has acknowledged the need to address the increasing trade deficit in its proposals for the 2012 Budget. Certain long-term measures have been proposed to encourage exports as well as substitute imports to improve the external sector.

A conscious effort has been put to maintain public investments while controlling the increase in recurrent expenditure. Broadly it could be seen as a continuation of the direction set in the previous Budget proposals as no major changes are proposed on the revenue side.

Salient proposals

Over Rs. 120 b has been allocated to improve the national road networks. Rs. 164 b has been allocated for 2011 to 2014 to improve water supplies. An investment of Rs. 177 b has been allocated for irrigation projects due to be completed before 2014.

To encourage the local value-added industries, cess has been increased or imposed on import of dried vegetables/dried fruits, wheat flour, thriposha, refrigerators, etc.  With a view to encourage large investment projects, a six to 12 year tax holiday and other tax incentives are extended to investments in the range of Rs. 300-2,500 m.

Incentives to encourage the expansion of existing enterprises will also be granted. Land given to the private sector which is not utilised for the purpose for which lands were given will be taken back by the Government. The Government has identified 37,000 hectares of such land and proposes to enter into 30-year lease arrangements, having demarcated two acre blocks, which will be distributed among smallholders.

A 10% increase of the basic salary of all public servants. It is essential that the total cost of salaries, pensions and allowances will be around Rs. 38 b. The Government will look into suitable merging opportunities for enterprises (which were privatised after being in State control), because control is currently with the Government.

In order to encourage the exporters and eliminate the disadvantageous position with regional countries, the exchange rate will be depreciated by 3%.

A snapshot of the 2012 Budget

The Government projects a budget deficit of Rs. 468.9 b for 2012, down 2% YOY. The narrowing of the Budget deficit is attributable to an expected 19.8% increase in Government revenue and grants to Rs. 1,126.1 b, against a 14.15% increase in Government expenditure to Rs. 1,594.9 b. The 2012 Budget deficit (excluding grants) is targeted at 6.2% of GDP, down from 7% estimated for 2011.

The proposed budget deficit of Rs. 433.70 b for 2011 has fallen short by 6.1% as the budget deficit is revised to Rs. 460 b. Therefore, the ambitious deficit targets need to be monitored strictly as the Government has failed to meet its goals in the past.

Government revenue

Income tax is expected to rise 19.01% to Rs. 190.3 b, while taxes on goods and services are set to rise 19.07% to Rs. 569.4 b. Taxes on external trade are projected to increase 27.19% to Rs. 240.9 b.

Although the revenue budget for 2011 has not been successfully achieved, the significant increase in revenue (compared to 2010) despite reductions in tax rates is a positive sign. The broadening of the tax base seems to have been broadly successful.

Government expenditure

Revised recurrent expenditure/GDP in 2011 was 15.6% as opposed to the budgeted figure of 16.1% while public investment/GDP has also come down to 6% from the budgeted 6.5%. The shortfall in Government revenue seems to have reduced both recurrent and capital expenditure.

Compared to the revised 2011 expenditure/GDP of 21.4%, 2012 figure is projected to come down to 21.2%. Recurrent expenditure/GDP’s reduction to 14.7% and increase in public investment/GDP to 6.6% signifies the long-term growth-oriented nature of the Budget proposals.

Deficit financing

Amidst the Government’s initial motive to rely less on foreign funding in financing the deficit for 2011, foreign funding increased by 93% over the budgeted amount of Rs. 94.5 b.

 Even though the amount of domestic financing has decreased, use of local bank borrowings has increased by a staggering 280% to Rs. 160 b while non-bank borrowings have decreased by 63.1% to Rs. 95.1 b. Ability to attract funding from foreign sources could be seen as a positive sign.

The 2012 budget deficit is to be primarily funded by domestic borrowings. The domestic (63%), foreign (37%) funding mix has not changed drastically as opposed to the revised 60:40 mix achieved in 2011. The non-banking borrowings are projected to increase to Rs. 207.6 b while domestic bank borrowings are projected to reduce to Rs. 64 b.

Impact on the macro economy

The depreciation of the rupee will have a one-off adverse impact on inflation in the short run. In addition tax increases in imported items will also exert upward pressure on inflation. Further the increase in salaries and subsidies will introduce demand-side inflation as well. Therefore we feel inflation could increase close to 9% in 2012.

We expect a slight increase in market interest rates over the next 12 months (due to the marginal slowdown in deposit mobilisation in the banking sector and depreciation of the rupee).

However the lower budget deficit projected for 2012 would lower the need for public sector borrowings, which will ease the pressure on interest rates.

We feel the exchange rate is likely to be stable in 2012 after the immediate depreciation due to strong capital inflows expected.

The encouragement given to exporters and import substitution will augur well for the long-term stability of the exchange rate.

In view of the increasingly fragile nature of global economies, we feel that it will be challenging to achieve a GDP growth of 8% in 2012 (although we are confident 8% could be achieved in 2011). Hence we expect the GDP growth to be between 7.5% - 8% in 2012.

Impact on the stock market

Depreciation of the rupee will benefit the export-oriented companies whereas import-based companies will be negatively impacted.

Certain plantation companies will be adversely impacted with the distribution of the unutilised land among smallholders. However, the introduction of a concessionary loan scheme at 8% annual interest, repayable in seven years, to encourage planting and re-planting will be helpful to plantation companies.

Proposed infrastructure projects as well as relocation of Government institutions (such as the Inland Revenue Department) will benefit the manufacturing and the construction sector companies.

Removal of VAT on importation of buses, lorries and trucks will be advantageous to motor sector companies that import these vehicles.

Exemption of all taxes imposed at the point of Customs on the importation of yarn will be beneficial to textile manufacturers.

However, garment manufacturers will get affected by the introduction of a tax of Rs. 75 per kg on imports of fabrics.

Reduction of income tax on health services to 12% will be advantageous to healthcare sector. Increase in levy on outgoing and incoming international calls may have an adverse impact on the telecommunication sector.

 Detailed guidelines of the above proposals need to be studied for a more comprehensive understanding of their real impact on the economy.