f o r    m a n a g i n g    t o m o r r o w
MARCH, 2007
 Cover Story
 Sector Analysis

The centre is looking at removing the distinction between FDI and FII investments. This will impact sectors like asset reconstruction, real estate and aviation, where separate ceilings apply to FDI and FII investment. However, allowing FDI through the FII route in the realty sector could result in prices shooting through the roof. The Asian financial crisis of the '90s is still fresh in mind, and a method should be devised to moderate possible volatility in key sectors.

S&P And After
For the first time in 14 years, international credit rating agency, Standard and Poor's (S&P), has raised India's credit rating to investment grade. S&P is the last of the three major international rating agencies to do so. Moody's Investors Service did it in January 2004 and Fitch Ratings in August 2006. The upgrade is likely to spur the flow of foreign investment into power, steel and other industries, which receive less than a tenth of the funds going China's way.
More Net Specials
Outlays vs Outcomes
"In my mind, the thrust areas for this Budget are around the agricultural and social sectors to ensure inclusive and sustainable growth and to address India's infrastructure bottlenecks"

In the history of independent India, this year has probably presented the strongest backdrop for the Budget from an economic and fiscal performance perspective. India's GDP has grown at over 9 per cent this financial year and at over 8 per cent over the last three years. Industrial production is up 11.3 per cent and we have a combination of a high savings and investment rate, both of which have been over 30 per cent of GDP in the last year. India's foreign exchange reserves, at $180 billion (Rs 7,92,000 crore), are one of the highest amongst emerging economies. Tax collections have risen 28 per cent over the previous year and the fiscal deficit, at 3.7 per cent of GDP, is well within the FRBM targets. Inflation is the only area of concern and is possibly an outcome of the growth that the Indian economy has experienced.

In this context, the Finance Minister was batting on a very strong wicket from a macroeconomic perspective and could have initiated some bold reform measures that would go a long way in ensuring sustainable long-term growth for the Indian economy. I believe that the Budget has taken some steps in these areas but more could have been done in terms of setting bolder targets and addressing the pressing issue of outlay versus outcome in various Budget initiatives. In my mind, the thrust areas for this Budget are around the agricultural and social sectors to ensure inclusive and sustainable growth and to address India's infrastructure bottlenecks.

With agriculture growth at less than 3 per cent over the last few years and the avowed inclusiveness agenda of the government, the announcements for the farm sector are welcome. Agriculture-based supply side constraints have also been key contributors to the increase in inflation. This Budget provides for an increase in outlays for programmes on increased farm credit, irrigation, watershed management, seeds supply and agri research, and higher allocations for safety net schemes, including flagship programmes such as Bharat Nirman, the National Rural Employment Guarantee Scheme, etc., are positives. However, the outlay versus actual implementation (and addressing key issues such as corruption and leakages) is paramount. In my opinion, creating linkages for the agricultural sector through a more open policy on retail will result in a much greater "pull-up" effect for the rural sector in the years ahead.

The fm must be complimented for stepping up the funding for education by 34.2 per cent and for health and family welfare by 21.6 per cent. I have long maintained that India needs both physical and soft infrastructure (read: skilled talent) to sustain our growth momentum and leverage our demographic dividend. Spiralling wage rates in most sectors in recent times are a result of demand-supply mismatch in skilled labour.

The plan to address the problem of dropouts after the eighth standard-by offering scholarships, etc.-is laudable, but the education sector now needs transformational changes. Multiple studies have shown that learning outcomes at most government schools compare poorly with those of their private counterparts, leading to high dropout rates in early years. Vocational education needs a big push as also higher education. In this context, a clear framework to better target public investment in education and to provide incentives for increased private participation is warranted.

I don't think Indians have felt the pinch of inadequate infrastructure more strongly than has happened in the last 6-12 months, possibly as a result of unprecedented economic growth across sectors. The privatisation of the airports in Delhi and Mumbai has sent out a very positive signal about the commitment of the government to set things right. The setting up of a $5-billion (Rs 22,000 crore) fund to finance Indian infrastructure and the attempt to attract global financial capital and investments in capacity building at the central level are encouraging steps.

In order to realise incremental power capacity additions of 66.4 GW and 86.5 GW planned for the 11th and 12th Five Year Plans, policy initiatives in the power sector need to be more favourable for companies at the generation, transmission and distribution levels. The Ultra Mega Power Projects (UMPP) were meant to leapfrog generation capacity. However, against the planned five UMPP projects to be awarded last year, only two could be awarded. This year, the government has committed to an additional seven UMPP projects. The key question is: how many of these projects will see the light of day?

"There are parts of the Budget that I believe are negative and bring back to my mind the prevailing policy environment in India 15-20 years ago-the tax on the cement industry being a case in point"

There have been a few laudable initiatives, like the proposal to permit the issue of tax-free bonds through state-pooled entities and for mutual funds to issue dedicated infrastructure funds. This is likely to assist funding for local development and urban civic bodies. The initiative to utilise forex reserves for infrastructure development through the IIFC is a positive move. These are only incremental steps to improving infrastructure but the government could have done more in enunciating bold targets to remove key infrastructure bottlenecks over the next 3-5 years.

There are parts of the Budget that I believe are negative and bring back to my mind the prevailing policy environment in India 15-20 years ago-the tax on the cement industry being a case in point. The reduction in excise duty rate to rein in retail prices and reward those who hold the price line and the decision to penalise those who don't is an indirect measure of price control and counter-intuitive. Cement consumption is not price elastic and I believe that the larger players will mark up prices to account for higher excise anyway, defeating the underlying purpose of controlling inflation.

Despite high growth in the industrial sector, India's mining sector has been plagued by low growth and excessive controls. The much-awaited fiscal recommendation of removing the cap on the deductibility of exploration expenditure in the mining sector did not find place in the Budget. This anomaly needs to be corrected, given the input availability and cost-effect linkages of mining to other core sectors of the economy.

On the taxation front, more needed to be done to address the needs of a growing urban population. To my mind, this was an opportunity for the Finance Minister to increase the i-t exemption slab to Rs 2 lakh from the current level. The minor increase in slabs, resulting in a tax saving of approx.

Rs 1,000, does nothing to address the needs of people in the lower tax bracket grappling with the current cost of living in our urban centres.

The Finance Minister has mentioned that we will transition towards a Goods and Services Tax (GST) environment by 2010, which is a very positive step. There is an urgent need to address the multiplicity of taxes in our country that results in a large amount of litigations and an inefficient tax administration environment. As per various studies conducted by UNDP, India still remains one of the highest taxed countries in the world. I believe this Budget could have balanced the tax equation by increasing the rates on short-term capital gains and STT while reducing the rates on corporate tax.

In conclusion, I believe this is a Budget that reflects the government's mood to encourage inclusive growth and do more in the social sectors which is spot on. Corporate India has been doing well and is fully supportive of this agenda.

The pressing agenda is to push through harder second-generation reforms in the areas of pensions, labour laws and foreign investment policies in key sectors such as retail, insurance, infrastructure, etc. The early signs of economic benefits that could accrue from these initiatives, including substantial improvements in the supply chain infrastructure for agricultural products are very positive.

Delays in second-generation reforms is akin to swimming against the tide and could result in India not adequately capitalising on its demographic dividend. I believe that greater growth is a strong driver to generate additional resources that can be ploughed back into education, agriculture and healthcare. I hope that the Finance Minister has only tactically stayed away from taking on a bolder stance to address these issues to avoid the excessive media and political glare around the Budget event.

Rajiv Memani is Chairman and CEO of Ernst & Young India