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Union Budget 2013-14

A PERSPECTIVE

FEBRUARY 28, 2013

SALIENT POINTS

• FY13 growth rate pegged at 5% down from 6.2% in the previous year and FY14 growth pegged at 6.1-6.7%

• Inclusive growth remains a key theme, alongside investments

• Planned expenditure stands increased by 29.4% - allocations increased to various programmes includingurban infrastructure, roads, health and education

• Capital Markets: Proposed launch of inflation indexed bonds; RGESS modified to include mutual fundsand investments in three consecutive years; RGESS income limit raised to Rs. 12 lakhs; STT reduced andintroduced commodities transactions tax

• Provided Rs. 14,000 crore for recapitalization of public sector banks

• Infrastructure: Additional 15% investment allowance for companies investing Rs. 100 crore or more onplant & machinery

• Disinvestment:Target raising Rs. 55,814 crore

• Fiscal Deficit:To be reduced to 4.8% in FY14 from the revised 5.2% in FY13

• Taxation:

- No change in taxation slabs or tax rates

- Tax credit of Rs. 2000 for individuals with total income upto Rs. 5 lakhs

- Surcharge of 10% on individuals with annual taxable income of over Rs. 1 crore

- Surcharge increased to 10% from 5% on companies with annual taxable earnings of over Rs. 10 crore (5%for foreign companies)

- Surcharge on dividend distribution tax raised to 10% from 5%

The Union Budget was broadly along expected lines (given the constraints/fiscal deficit) and the governmentcontinued to focus on inclusive growth.Whilst there were no big bang populist measures ahead of next year’s elections,there were no reform oriented measures announced.There were some expectations of directional statements in termsof expenditure rationalization, boosting of investment activity and curbing of the current account deficit.

Expenditure allocation was raised for various social/development schemes but no new schemes were announceddue to limitations of a high fiscal deficit. The budget arithmetic may however prove to be aggressive as theeconomic growth rate remains modest and there seems to an overdependence on tax revenues and divestments.

The additional deduction of interest up to Rs. 1 lakh paid on home loans up to Rs. 25 lakhs could be positivefor the housing sector.With a view to boost savings rate, the government is working with the RBI to introduceinflation-indexed savings instruments. DTC is expected to be introduced in the current session of the Parliamentand there is a renewed push for GST in the form of allocation towards reimbursements to the states.

On the capital markets front, the focus was on streamlining the procedures applicable to foreign investors -uniform registration for all categories, risk-based KYC, etc. It was proposed that a broad principle be adopted todifferentiate FDI (Foreign Direct Investment) from FII (Foreign Institutional Investment) – stake of 10% or lessto be treated as FII and above 10% as FDI.There were various measures to boost the depth and activity in thedebt markets.

The government acknowledged the need to boost investments but there were few definite measures.The focuson building further investment corridors across the country is a positive step. However, we could see measuresoutside the Union Budget to boost growth and investment activity. The third quarter GDP growth at 4.5%underscores the need to spur growth on all fronts. Given the limited room available on the fiscal front, monetarypolicy also needs to become accommodative.

Consolidated Fiscal Deficit and Current Account Deficit

Source: CLSA Asia-Pacific Markets, CEIC

EQUITY MARKETS

Lack of big bang reforms and specific measures to address the current issues seem to have weighed on market sentimentand leading indices lost ground.The hike in exemption limits and increased rural spending gave a boost to FMCGstocks. Despite the hike in excise duties, auto stocks closed in the positive territory. Indications that RBI will announceguidelines for issuing banking licenses to private sector players boosted NBFC stocks.Amongst FMCG stocks, ITC wastrading firm as duty hike on cigarettes was lower than market expectations.The reduction in Securities TransactionTax(STT) on delivery transactions is a positive for brokerages.

% change From yesterday’s % change From yesterday’sclose close

S&P BSE Sensex -1.52% S&P BSE Realty -2.72%

CNX Nifty -1.79% S&P BSE Power -4.29%

S&P BSE MidCap -2.46% S&P BSE FMCG -0.37%

S&P BSE SmallCap -1.97% S&P BSE IT 0.47%

S&P BSE Bankex -3.59% S&P BSE Healthcare -0.68%

S&P BSE Oil & Gas -1.64% S&P BSE PSU -2.81%

S&P BSE Metals -2.95% S&P BSE CG -3.39%

Lack of new policy initiatives alongside increase in dividend and corporate surcharge led equity markets to reverse earlygains and close in the red.The corporate surcharge is expected to bring down earnings estimates slightly. Power, bankingand capital goods stocks were the top losers – due to lack of major announcements to spur investment.The Budgetproposes 15% deduction for companies investing Rs. 100 crore or more on plant & machinery in 2013-15 and a newroad regulatory authority.To augment finances for infrastructure, the Budget provides for up to Rs. 50,000 crore tax

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FY91 FY93 FY95 FY97 FY99 FY01 FY03 FY05 FY07 FY09 FY11 FY13 FY15

(% of GDP) CA deficit Consolidated fiscal deficit

Actual Forecast

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free infrastructure bonds and encouraged setting up of Infrastructure Development Funds.The Budget reiterated on the

need to adopt a pooled pricing policy for coal and proposed a joint public-private effort to reduce dependence on

imported coal.

The reduction in Securities Transaction Tax is a positive for brokerages.The additional surcharge on high income

individuals and rise in duties of luxury items is unlikely to have a significant impact on consumption. Retail sector

should benefit from lower excise duty on apparels.

DEBT MARKETS

The Union Budget delivered on the fiscal deficit front, but the gross market borrowings were higher than market

expectations (partly due to the buyback).The FY14 targeted fiscal deficit at 4.8% of GDP is to be achieved through

tax revenues and divestments.At the same time, there have been no concrete measures to control expenditure and

this has increased quite sharply (especially planned expenditure at 29% yoy).This means that the achievement of

the fiscal deficit projection would depend on tax revenues and we need to see concrete progress on subsidy

rationalization. Given the expanding current account deficit, a lot depends on the global commodity prices, export

growth and currency movements. Given this uncertainty, debt markets have reacted negatively and yields have

moved up across the curve.

27/2/2013 28/2/2013

1-yr gilt yield (%) 7.88 7.93

5-yr gilt yield (%) 7.80 7.87

10-yr gilt yield (%) 7.80 7.87

5-yr AAA corporate bond yield (%) 8.86 8.90

The announcement of new measures to boost the depth in the debt markets and reiteration of the old measures were

positive –

• Stock exchanges to have a dedicated debt segment and insurance companies, provident funds and pension funds will

be allowed to trade directly.

• FIIs will be allowed to participate in currency derivatives (for their rupee exposure) and also use their bond/gilt

investments collateral

• Debt funds and ABS made eligible securities for Pension and Provident Funds

• Securitisation Trust to be exempted from Income Tax – removes uncertainty

Overall, the sentiment in the debt markets appears to have been impacted by the heightened pre-budget expectations

on the fiscal consolidation front. There has been disappointment over the absence of measures to address the CAD.

Another factor to watch out for the potential flows into tax-free infrastructure bonds, which would impact the overall

liquidity in the debt markets.We continue to remain cautiously optimistic amidst the various uncertainties, but are clear

that interest rates have to move down to support economic growth. RBI’s comfort with the government’s fiscal

consolidation measures will reflect in its monetary policy review measures in the coming months and investors will also

closely watch the reaction of global rating agencies.We would continue to recommend a portfolio of funds that offer

exposure to corporate bonds and have the potential to benefit from any capital gains.

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