The BT Budget MM Special: Debates; Bourses: Boom!..No, Kaboom!

Describing the five fundamental reform thrusts of Budget:2000, JMMS's Mihir Doshi openly admits that he is still bullish...

India's stockmarkets have reacted negatively to 2 provisions in Budget 2000: the higher tax on dividend payouts by corporates, and the 20 per cent reduction in the tax-concessions on export earnings. While the latter could marginally reduce the earnings-growth of companies with large exports, the reaction-the BSE Sensex fell by more than 500 points from its intra-day high-seems overdone.

Especially since the impact of the provisions on the technology sector should be muted as companies operating businesses under Section 10A/10B of the Income Tax Act will not be liable to pay the tax on their existing revenue-streams. And Budget 2000 pursues critical reforms: a structural decline in interest rates, a widening of the tax-base, a deepening of the capital markets, a rationalisation of indirect taxes, and a reduction in subsidies. However, the new tax-initiatives may marginally reduce corporate earnings growth for the next 12 months. Let me analyse these issues one by one:

REDUCING INTEREST RATES. The reduction in the interest rate on the General Provident Fund to 11 per cent, and the move to raise the tax on debt funds' dividend-payouts to 20 per cent should help the on-going structural decline in interest rates. While the latter will soften the competitive environment the debt funds are creating for the banks, the removal of the interest tax of 2 per cent should make credit a little cheaper for borrowers.

WIDENING THE TAX BASE. The proposal to tax all earnings from exports in phases over the next 5 years is a major initiative to widen the tax-base. Finance Minister Yashwant Sinha has indicated that a committee will review the current services tax, which has the potential to become a large revenue-contributor. In addition, the Minimum Alternative Tax has been reduced to 7.50 per cent, export-related benefits have been removed, and the facility to carry forward tax-credits has been withdrawn. Sinha has also proposed that certain exemptions on income-tax-such as on capital gains tax-be removed. In addition, the effort to expand the number of tax-payers through the 1-by-6 scheme has been extended to 79 more cities from 54.

DEEPENING THE CAPITAL MARKETS. The foreign institutional investment (FII) limit has been raised to from 30 to 40 per cent. Also, steps have been taken to create a friendly environment for venture capital funds, such as the introduction of the pass-through principle, which will be applied at the concessional rate of 20 per cent. The benefit of a reduced long-term capital gains tax has been extended to mutual fund units in the current fiscal itself. The indirect benefit of raising the tax on dividend payouts is likely to result in higher flows into equity funds, which will continue to remain exempt from the tax. And the government has also announced the simplification of the tax-issues relating to business reorganisations (de-mergers and amalgamations).

REFORMING INDIRECT TAXES. Budget 2000 proposes to replace the present Excise duty structure with a value-added tax. As a first step, the government has replaced the 4 existing Excise duty slabs with a single rate of 16 per cent. And the Budget has also reduced the peak Customs tariff by 5 per cent to 35 per cent, thereby reducing the number of slabs to 4, namely 5, 15, 25, and 35 per cent respetively .

REDUCING SUBSIDIES. The government has made a serious attempt to reduce the subsidies on food and fertilisers. While subsidies are estimated to fall by Rs 2,890 crore-or 11.20 per cent over last year-the steep rise in defence expenditure (up by 28 per cent) and interest-payments (up by 13 per cent) seems to have camouflaged the decline.

Well, corporate earnings growth could be marginally compressed next year: the changes to both the Minimum Alternate Tax and the taxation of export earnings could lead to a higher marginal tax-rate for companies, which may reduce earnings growth. And dividend payouts could fall since the tax on the distributed profits of companies (i.e., dividends) has been raised from 10 to 20 per cent. This may force corporates to reduce payouts in the coming fiscal year.

However, the Indian economy's strong liquidity, earnings-growth (although slightly tempered), low levels of stock-ownership, strong retail demand for equities, fair valuations, and growing visibility (particularly for tech companies) are the key reasons to be invested in India. I stay bullish.

..No Kaboom!
..While DSP's Shitin Desai cannot but agree, especially since Budget:2000 has provided fresh incentives for the housing industry.

By Shitin Desai

Budget 2000, at first glance, sends out mixed signals. But, by and large, it is a consolidating budget. A closer analysis reveals that Finance Minister Yashwant Sinha has followed a two-pronged strategy as a basis for the budget. He wanted to raise resources without disturbing India's growth path, and, at the same time, manage the capital markets.

The first part has been achieved by managing tax-rates only at the margin to prevent any major contraction. The finance minister has held off on any major expenditure-cuts and has, actually, raised Plan and defence spending. Subsidy-cuts, though significant as a gesture, haven't offset these increases, and he has decided to live with a relatively high fiscal deficit of 5.10 per cent for the time being. The other part of Sinha's strategy is to keep the sentiment in the stockmarket positive through measures like raising the foreign institutional investment limits. In any case, the budget seems to focus more on consolidating earlier measures, like the rationalisation of indirect taxes.

If the 22 per cent increase in Plan spending, as proposed in Union Budget 2000, actually materialises, it will help in continuing the growth momentum in the country's economy. This increase, coupled with the measures to channelise funds into infrastructure spending, is geared to drive an upturn in the economy. Besides, the government appears committed to cap its borrowings and promulgate a Fiscal Responsibility Act later in the year. It might also exert pressure on the Reserve Bank of India to soften interest rates, and, possibly, cut the Credit Reserve Ratio since the government is trying to reduce the rigidities in the financial system.

Budget 2000's steps to prune subsidies, on the other hand, will go a long way in ensuring fiscal discipline in the long run. This budget also introduces a facility to use the disinvestment proceeds to retire government debt, and commits the states to greater fiscal discipline. On the whole, the fiscal deficit target of 5.10 per cent of GDP, albeit high, seems credible. Although the budgeted fiscal deficit estimates came in at higher than market expectations, the cut in Provident Fund interest-rates, accompanied by the abolishing of the interest tax, will lead to a downward bias in interest-rates.

In line with the expectations, Sinha has adjusted the tariffs to provide for greater refining-margins for companies in the oil sector. This is the first step towards decontrol. The government will have to follow this up with strong reforms measures, like raising the price of petroleum products and pursuing aggressive privatisation policies. The software sector will not be as big a loser as the stockmarkets are making it out to be. Over the next few years, most software companies will not be big tax-payers as they operate from Software Technology Parks, where income is exempt from tax. Importantly, software companies are looking for growth through acquisition. And the increase in the limit for automatic approval for acquisitions abroad will be a big boon.

What is noteworthy is that there is more emphasis on social issues in Budget 2000, with increased investment allocated to the social infrastructure including education, ecology, job-creation etc.. Moreover, measures have been announced for the housing sector, which should benefit the demand for housing especially by the common man. In particular, the extension of the terminal date is likely to improve the sentiment for acquiring fresh houses in the construction phase.

Some of the key measures introduced for this sector include the fact that the capital gains tax arising from the transfer of long-term assets, if invested in a second house, are now exempted. Earlier, if an individual owned one house, he received no exemption for buying a second house. In the previous budget, interest upto Rs 75,000 per annum paid on a housing-loan was exempted provided the construction of the house was completed before April 1, 2001. This outer date has now been extended to March 31, 2003. Additionally, the repayment of the principal amount is exempt upto Rs 20,000 per annum against the earlier limit of Rs 10,000.

To conclude, I firmly believe that Budget 2000 is a balanced budget, aimed at the consolidation of the country's economy as well as a critical engine to maintain a high growth-rate.

Shitin Desai is Vice-Chairman and Managing Director, DSP Merrill Lynch