India's Weakest Growth in Six Quarters

GROSS domestic product (GDP) growth in India continued to slide falling to 7.7 per cent in the first quarter of the current financial year (April-June 2011-12), against a 7.8 per cent growth in the preceding quarter and an 8.8 per cent growth recorded in the first quarter of the previous year (according to the revised estimates based on the new series of IIP). The country's GDP at factor cost at constant (2004-2005) prices stood at Rs12,26,339 crore, as against Rs11,38,286 crore in the first quarter of the previous fiscal (2010-11), according to figures released by the Central Statistical Organisation (CSO). Sectors driving the first quarter growth include electricity, gas and water supply (7.9 per cent), trade, hotels, transport and communication (12.8 per cent), financing, insurance, real estate and business services (9.1 per cent). As per the latest estimates of the index of industrial production (IIP), growth in the index of mining, manufacturing and electricity slowed to 1.0 per cent 7.5 per cent and 8.2 per cent, respectively, in April-June 2011-12 against growth rates of 8.0 per cent, 10.3 per cent and 5.4 per cent, respectively, during the first quarter of the previous fiscal. GDP at factor cost at current prices is estimated to have grown 16.7 per cent year-on-year to Rs19,37,123 crore during the first quarter of 2011-12 quarter, against Rs16,59,708 crore in the corresponding period of 2010-11. The sector-wise breakdown showed that the construction sector had been one of the worst-performing parts of the economy.

Construction grew at 1.2%, down from 8.2% in the previous quarter, as rising interest rates and delays in planning approvals held up building projects. Agricultural output rose 3.9%, which was down from the previous quarter but above the level of 2.4% in the same period last year. Manufacturing grew 7.2%, an improvement from the previous quarter, but well below the 10.6% in the corresponding quarter of 2010-11.Private final consumption expenditure (PFCE) at constant (2004-05) prices is estimated at Rs7,95,683 crore in Q1 of 2011-12 against Rs7,48,395 crore in Q1 of 2010-11, while Government final consumption expenditure (GFCE) at constant (2004-2005) prices is estimated at Rs1,36,935 crore in Q1 of 2011-12 against Rs1,34,161 crore in Q1 of 2010-11. Gross fixed capital formation (GFCF) at constant (2004-2005) prices is estimated at Rs4,10,533 crore in Q1 of 2011-12 against Rs3,80,544 crore in Q1 of 2010-11.

The first GDP numbers for the current fiscal confirm several analysts’ assessment of economic prospects for the financial year which would involve further moderation in growth due to stricter monetary policy to curb inflationary pressures. Signs are already visible as according to data from the Centre for Monitoring Indian Economy, new investment announcements by companies have more than halved to Rs 32.5 lakh crore during April-June 2011 from Rs 71.4 lakh crore in the corresponding period last year as high interest rates, decline in demand and policy uncertainty have taken a toll. Declining investment can only aggravate inflationary pressures as supply–side bottlenecks increase. While the 7.7 per cent growth silhouetted against a murky

New Investment Announcements
Industry	Apr-Jun 2011-12 (Rs. Crore)	%change over April-Jun 2010-11
All	32,53,158	-55
Manufacturing	13,31,621	-52
Electricity	9,02,591	-61
Cement	30,000	-83
Services (Non-financial)	6,85,889	-59
Source: Times of India, 1st Sep, 2011

global scenario seems impressive, given the estimated requirements that we spoke about in our previous blog, a 7.7 per cent and slower future growth could well jeopardize a lot of calculations on achieving deficit targets as well as infrastructure development and inclusive growth.

India’s Road to Fiscal Consolidation — Diversions Ahead

Total public debt of the Indian government stood at Rs. 31.5 trillion at that end of June 2011 against Rs. 29.7 trillion at the end of March 2011 according to the June 2011 public debt management report released by the finance ministry. Central government debt rose nearly 6 per cent, but dropped as a percentage of GDP because of a revision in GDP estimates. The gross fiscal deficit (GFD) stands at 39.4 per cent of budget estimates (BE) during the first quarter of 2011-12 compared to 10.5 per cent at the same time last year. The major reason for a worsening fiscal situation is the fall in receipts, particularly non-tax receipts. Revenue and non-tax receipts were at 11.5 and 9.7 per cent of BE respectively during Q1 2011-12, compared with 29.3 and 78.2 per cent respectively during Q1 of last fiscal. The fiscal outcome during the first of quarter of 2011-12 indicates that all the key deficit indicators as percentage of budget estimates (BE) for 2011-12 were substantially higher than their levels during the corresponding period of the previous year because of lower revenue collections both from tax and non-tax sources. Gross tax collections during the quarter at 6.6 per cent of BE were lower than 8.3 per cent a year ago. In the direct taxes, corporation tax collections showed a negative growth of (-) 27.8 per cent while personal income tax increased by 6.5 per cent as against budgeted growth rates of 21.5 per cent and 16.2 per cent, respectively, for 2011-12. All the major indirect taxes (customs, excise and service tax), however, showed buoyant growth rates (37.7 per cent, 23.2 per cent, and 31.1per cent, respectively) during April-June 2011 as against budgeted growth rates (15.1 per cent, 19.2 per cent and 18.2 per cent, respectively) for 2011-12. This, combined with the facts that India's high savings rate allows a larger share for internal debt (90.3 per cent of public debt, at end-June 2011) vis-à-vis other countries and a small share of external debt along with a comfortable maturity profile improves the credibility of government debt and increases sustainability, gives some reason to rejoice.

India’s central bank in its recently published Annual Report has asked the crucial question whether the fiscal consolidation witnessed in the fiscal year 2010-11 is sustainable or not. The RBI mentions that the fiscal deficit ratios in 2010-11 turned out to be better than envisaged in the Union budget as the Central government’s gross fiscal deficit (GFD) was 4.7 per cent of GDP against 5.5 per cent budgeted. This compared with a GFD of 6.4 per cent of GDP in 2009-10 was indeed impressive. However, the RBI notes that a qualitative assessment of fiscal correction during 2010-11, raises concerns as improved fiscal position had a large temporary component arising from a business cycle upswing and one-off non-tax revenue gains from spectrum auctions, which resulted in the improvement in headline deficit numbers. Not accounting for the revenue proceeds of two main one-off items – spectrum auction and the disinvestment – the GFD/GDP ratio works out to be 6.3 per cent of GDP during 2010-11. Also, revenue buoyancy was supported by a cyclical upswing in the global and Indian economy that led to above trend growth. So the one-off gains and higher growth in nominal GDP of 20 per cent against the budgeted 12.5 per cent contributed largely to lower deficits. Moreover, not only did the correction in revenue account reflect more than- anticipated revenues there has been a spillover of subsidy expenditure from the last quarter of 2010-11 to the current fiscal year. Although the share of capital expenditure in total expenditure increased in 2010- 11 from 2009-10, it was marginally lower than the budget estimates. In particular, capital outlay-GDP ratio fell short of the budgeted ratio in 2010-11 and is still significantly lower than that achieved during pre-crisis period. Consequently, in outstanding terms, the Central government’s capital outlay (as ratio to GDP) as at end-March 2011 was lower at 12.9 per cent than 13.8 per cent a year ago.

Further, both internal and external dynamics could well alter the course of fiscal consolidation taken during 2010-11. The darkening external environment leaves little space for complacency as export revenues are very unlikely to remain elevated particularly if the downturn in the US and EU/UK affect the demand for exports, and particularly software exports, as also a prolonged recession like scenario in the developed world may destabilize India’s so far successful strategy of expansions in export destinations. Domestic demand is being curbed through tight monetary policy to fight inflation, however, the hardest hit has been investment demand which has started to show up in slowing growth and dwindling revenues. Growth projections have been revised down in the range of 8 to 7 per cent by several agencies (see www.ecofin-surge.co.in); falling growth and inflation eating into budgets leaves little room for any expectations of tax buoyancy. India has also lost some of its attractiveness as a destination for international capital flows due to staggering growth; short-term portfolio flows have seen reversals and the Indian stock market gains in 2011 have been much lower than some of the Asian markets. Given the strong positive relation between international flows and public debt, India should be wary as India’s public debt to GDP ratio is among the highest in the region (the ratio stands at 69.2 per cent for India in 2010, compared with 17.7 per cent for China, 26.9 per cent for Indonesia, 44 per cent for Thailand and 54.2 per cent for Malaysia, according to the IMF, WEO Database). On the other hand getting back to the concerns on the Indian economic outlook raised by RBI which mentions that apart from monetary tightening, complementary policies to lower inflation and inflation expectations need to be put in place including improved supply response for food, higher storage capacity for grains, cold storage chains to manage supply-side shocks in perishable produce and market-based incentives to augment supply of non-cereal food items, management of water as also technical and institutional improvements in the farm sector and allied activities. Further, the infrastructure gap of India, both in relation to other major countries and its own growing demand has been a key factor affecting the overall productivity of investments. As per the assessment of the Planning Commission, during the Twelfth Plan (2012-17) India may need infrastructure investments of over US$ 1 trillion. Fiscal consolidation and reorientation of expenditure towards capital expenditure is necessary to meet such targets. The RBI rightly points out that the challenges faced by the Indian economy that are constraining growth relate to education, health, energy, infrastructure and agriculture sectors, where public policy interventions are needed as markets by themselves may not be able to do enough to remove the constraints. Thus, we have reason to believe that addressing these concerns in all seriousness could well call for policies that lead to a diversion, may be a welcome one, in the road to fiscal consolidation.

Global Gloom — Decelerating Growth & Accelerating Deficits

Recent global economic assessments and outlooks of major international agencies like the IMF, United Nations and World Bank, show slowing global growth and worsening of unresolved problems related to fiscal crises. The global economic growth after powering up to 3.9 per cent in 2010 will slow to 3.2 per cent, as high food prices, possible additional oil-price spikes, and lingering post-crisis difficulties in high-income countries pose downside risks, according to the World Bank. According to the UN new headwinds have also emerged in 2011; the earthquake, tsunami and nuclear crisis in Japan shook world financial markets and disrupted important global supply chains. The political unrest in Western Asia and North Africa has been a source of a renewed surge in oil prices and international prices of food and other primary commodities have also soared in the year.

The United States economy expanded by 2.9 per cent in 2010, driven mainly by domestic demand, while weaker net exports had a dampening effect on growth; the economy is expected to slow down or at best stagnate in the current year. In April 2011, Standard & Poor's downgraded its outlook on United States sovereign debt, underscoring the urgency for policymakers to set up a credible framework to address its public debt. According to the IMF, the deficit projection for 2011 has been revised significantly downward, as post–April 15 data on revenues have come in stronger (in part because of sizable capital gains in 2010) and expenditures have been more contained than initially projected. However, the situation stands nowhere near resolved.

In the Euro zone negative sovereign ratings actions have spread beyond Greece, Ireland, and Portugal further into other euro area countries reflecting concerns that it will be difficult to reach the political consensus necessary for fiscal consolidation and structural reforms, according to the IMF. According to the United Nations, the recovery in Western Europe continues at a modest and uneven pace. Industrial business confidence indicators have returned to pre-crisis peaks in early 2011, but economies will face strong headwinds during the remainder of the year: GDP growth in the euro area is expected to average 1.6 per cent in both 2011 and 2012. Germany is expected to grow by 2.9 per cent in 2011, while the countries most affected by the fiscal crisis—Greece, Ireland, Portugal and Spain—will either remain in recession or, at best, register very modest growth rates. The positive demand effects from slowly improving employment conditions will be dampened by the negative impact of fiscal retrenchment.

Policy Measures Adopted or Announced for 2011 in Selected European Countries
(Announced impact on 2011 general government balance in percent of GDP)

---

Country	Revenue and other receipts	Expenditure	Total
Greece	Reduction in tax expenditures, including property taxes and VAT; various measures to speed up collection of tax arrears and penalties; measures against fuel smuggling; renewal of Telecom licenses; and extension of airport concessions (2.4 percent of GDP)	Wage cuts and tariff increases in public enterprises; restructuring of public entities; reduction in public wage bill (e.g. through reduction in short-term contracts and attrition-based reductions in employment); health reforms (drug and other cost savings and increases in co-pay for hospitals); rationalization of entitlements, including means-testing of family benefits; and reductions in transfers to public entities outside general government, operational expenditures, and military deliveries (2.7 percent of GDP)	5.1
Ireland	Revisions to PIT bands and credits; integration of health and income levies into universal social charge; tightening of various tax reliefs on private pensions contributions; and reduction in tax expenditures (1.2 percent of GDP)	Reduction in public payroll and discretionary expenditure, non-progressive social welfare benefits and capital spending (2.6 percent of GDP)	3.8
Portugal	Increase in the VAT standard rate (by 2 percentage points) and PIT and CIT rates; broadening of the SSC base; introduction of a new tax on the banking sector; adoption of tolls; and revision of penalties and fees (2 percent of GDP)	Reduction in public payroll (cuts in wages and the number of employees); pension freeze; cuts in social transfers and improvement of means-testing; reduction in capital expenditures and intermediate consumption; savings in health/pharmaceutical products; and cuts in transfers to SOEs and local governments (3.7 percent of GDP)	5.7

Fiscal Monitor Update, June 2011, IMF.

Market concerns about debt sustainability remain acute in Greece, where spreads have risen by 600 basis points since end-2010, to almost 1,700 basis points in early June. In Ireland and Portugal spreads have risen by 100–230 basis points to reach more than 700 basis points. Contagion to other Euro-area countries has been more limited, with spreads broadly stable in Belgium, Italy, and Spain. Despite ongoing fiscal consolidation, however, spreads remain in the 140–260 basis points range for these countries. Purchases of government bonds by the U.S. Federal Reserve since end-2010 have amounted to US$500 billion—with total envisaged asset purchases of US$600 billion under the second round of quantitative easing slated to end in June—bringing its holdings to 15 percent of publicly-held government debt. Securities purchases by the Bank of Japan (BOJ) are continuing. The BOJ now holds 7½ percent of outstanding government debt. Meanwhile, there have been no further market interventions by the ECB since March; its holdings of government securities remain equivalent to 11 percent of the outstanding debt of Greece, Ireland, and Portugal. In contrast, the Bank of England essentially halted its net purchases of government debt about a year ago, though its stock of holdings still stands at 16 percent of outstanding U.K. sovereign debt.

At home the Indian economy has slowed down resultant on the tight monetary and fiscal policies needed for fighting accelerating inflation. The government has been banking on strong economic growth to help meet its deficit target of 4.6 per cent for the current fiscal, but a spike in global oil & commodity prices leading to a slowing economy and a rising subsidy bill could well upset the fiscal calculations. In a signal that the government is worried about the state of its finances, the finance ministry announced a host of other measures to reduce expenditure and restrict the fiscal deficit. The last time such measures were taken was in 2008-09 after the collapse of Lehman Brothers that pushed the global economy into recession, when the finance ministry had asked all departments to cut non-Plan expenditure by 10 per cent.

Another Move towards Market-Linked Interest Rates...

Another Move towards Market-Linked Interest Rates — Reforms to Small Saving Schemes (NSSF)

A government panel, headed by RBI deputy governor Shyamala Gopinath, was set up to review the small investment schemes of post offices and banks. The panel has recommended — a 0.5% raise in the interest rate for post office savings account to 4% in line with the rate on savings bank deposits; raising the annual contribution limit in Public Provident Fund (PPF) to Rs.1,00,000, from the current Rs.70,000; discontinuation of the Kisan Vikas Patra; reduction in the maturity period of National Savings Certificates (NSCs) to five years from six, and introduction of a 10-year NSC scheme.

The panel has also advocated benchmarking of interest rates on other small savings schemes to rates of government securities of similar maturity with positive spread of 25 basis points for most schemes, while it proposes a 100 basis points spread for senior citizens' schemes, keeping in view its social objective, and a 50 basis points spread for the proposed 10-year NSC, keeping in view of its higher illiquidity.

The administered rates may be notified by the government at the beginning of every financial year based on the average yields on government securities in the previous calendar year. The Committee also agrees with an earlier recommendation made by the Rakesh Mohan Committee on placing a cap of 100 basis points so that the administered rates are neither raised nor reduced by more than 100 basis points from one year to the next, even if the average benchmark interest rates rise or fall by more than 100 basis points. This would keep in check undue volatility in the administered rates, which if approved will be effective July 1, 2011 .

The proposed benchmarks and the administered (/current) rates for various instruments are given in the following tables (Table 1 and Table 2).

As for the usage of small savings funds the panel recommends that the mandatory component of investment of net small savings collections in state government securities be reduced to 50%. States can access up to 80% of NSSF for financing their annual expenditure. (The funds are given as a 25-year loan carrying 9.5% interest, higher than market rates. It has been proposed that the tenure of these loans may be reduced from the current 25 years, so states might be able to minimise their interest outgo and borrowing requirement by opting for 10-year loans at lower rates.) The balance amount could either be invested in central government securities or could be on-lent to other states on basis of requirement or could be lent for financing infrastructure projects requiring long-term finance, according to the panel.

The share of small savings as a percentage of net financial savings of households increased sharply from 7.9 per cent in 1996-97 to 22.3 per cent in 2004-05. Thereafter, the share declined and even turned negative during 2007-08 and 2008-09 as the alternative savings instruments became relatively more attractive. The outstanding amount of collections under small savings stand at Rs. 7,93,447 Crore in 2010-11. The measures to reform the small savings plans offered by the government, if implemented, would help to ensure transparency, move towards market-linked rates and reduce the government’s fiscal burden.

RBI Unmoved by Pointers to Moderating Demand and Growth

The RBI formulated its Annual Monetary Policy for the year 2011-12 against a backdrop of moderating demand and growth, however, uncontrolled inflation has led the central bank to raise its key policy rates, for the 9th time since March 2010 and this time, quite sharply. While the RBI’s strong hawkish stance and bias, has been lauded by many, several analysts have also expressed the view that it is time that the emerging economy’s central bank adds to its arsenal more specific weapons to fight inflation rather than simply sacrificing the growth momentum. The RBI has of course pointed to the need to adjust domestic energy prices in line with the rising global prices, in order to reduce misalignment of energy demand with prices. Energy price adjustments may raise inflationary pressures in the short term but should definitely help curb the twin (fiscal and current account) deficits through adjustment of demand to actual prices. The problem with the continued hawkish bias is that it is the infrastructure sector which suffers most leading to further supply bottlenecks fuelling and adding to inflation imported from overseas.

The Review states that :

• According to the IMF WEO (April 2011), global growth is likely to moderate from 5.0 per cent in 2010 to 4.4 per cent in 2011. Growth is projected to decelerate in advanced economies due to waning of impact of fiscal stimulus, and high oil and other commodity prices. Growth in EMEs is also expected to decelerate on account of monetary tightening and rising commodity prices. Consumer confidence in major countries, which improved during January-February 2011, moderated in March 2011 on the back of higher oil prices.

• The Indian economy is estimated to have grown by 8.6 per cent during 2010-11. The index of industrial production (IIP), which grew by 10.4 per cent during the first half of 2010-11, moderated subsequently, bringing down the overall growth for April-February 2010-11 to 7.8 per cent. The main contributor to this decline was a deceleration in the capital goods sector. The growth is projected to be in the range of 7.4 per cent and 8.5 per cent in 2011-12 with 90 per cent probability

• According an RBI Survey (OBICUS), the order books of manufacturing companies grew by 7 per cent in October-December 2010 as against 9 per cent in the previous quarter indicating some moderation. The Reserve Bank’s forward looking Industrial Outlook Survey (IOS) shows a decline in the business expectations index for January-March 2011 after two quarters of increase. The services PMI for March 2011 showed some moderation as compared with the previous month.

The baseline projection for WPI inflation for March 2012 is placed at 6 per cent with an upward bias. Inflation is expected to remain at an elevated level (around 9 per cent in the first half of the year due to expected pass-through of increase in international petroleum product prices to domestic prices and continued pass-through of high input prices into manufactured products. Against this backdrop the Monetary Policy Measures announced are

• The repo rate under the liquidity adjustment facility (LAF) has been increased by 50 basis points. Accordingly, it goes up from 6.75 per cent to 7.25 per cent.
• As per the new operating procedure, the reverse repo rate under the LAF, determined with a 100 basis point spread below the repo rate, will stand adjusted at 6.25 per cent.
• The Marginal Standing Facility (MSF) rate, determined with a spread of 100 basis points above the repo rate, gets calibrated at 8.25 per cent.
• The Bank Rate remains at 6.0 per cent.
• The cash reserve ratio (CRR) remains unchanged at 6 per cent of NDTL of scheduled banks.

Savings Bank Deposit Interest Rate

• Pending a final decision on the policy of deregulating the savings bank deposit rate, it has been decided to increase the savings bank deposit interest rate from the present 3.5 per cent to 4.0 per cent with immediate effect.

Changes in operating procedures of Monetary Policy and several developmental and regulatory policies have also been announced. Detailed Highlights are presented in our monthly statistical bulletin EUpDates (contact for subscription: ecofin.surge@gmail.com)

Highlights of Economic Survey & Union Budget 2011-2012

Overview of the Economy

• GDP is estimated to have grown at 8.6% in 2010-11, with agricultural growth showing strong momentum and growing 5.4% compared with 0.4% last year, while manufacturing growth remained at the previous year’s level at 8.8%. Demand –side GDP measured in constant prices is estimated to grow at 9.7% in 2010-11. Compositionally positive shifts in demand are indicated with private final consumption expenditure picking up, government expenditure decelerating and a pick-up in gross fixed capital formation and net exports.
• Exports in April-December 2010 up 29.5 per cent; imports up 19 per cent. Trade gap narrowed to $82.01 billion in April-December 2010.
• Data on IIP exhibited sharp volatility in the current fiscal with growth varying from 1.6% to 16.6%. IIP growth during Apr-Dec is at 8.6%.
• Services (excluding construction) growth slowed to 9.6% in 2010-11 from 10.1% in 2009-10.
• Production of foodgrains in 2010-11 is likely to be 232.07 million tonnes as compared to 218.11 million tonnes last year.
• Food inflation declined from a peak of 20.2% in February, 2010, to 8.6% in December, 2010.
• In the current financial year (2010-11), overall average inflation from April-December 2010 at 9.4 per cent, is the highest recorded in the last ten years. WPI inflation which peaked at 11% in April 2010 has come down to 8.4% by December. Build-up in FY 2010-11 (April-Dec) at 6.11% is lower than the corresponding period of the previous year at 7.9%.
• Gross Fiscal Deficit stands at 4.8 per cent of GDP, down from 6.3 per cent last year.
• Saving has gone up to 33.7 per cent, while the investment rate is up at 36.5 per cent of GDP.
• Net bank credit has grown by 59 per cent. Deposit growth was slow as real interest rates were depressed.
• India’s external debt stood at US$295 bn. at end-September, increasing by 12.8% over end-March 2010.

Economic Outlook

• Economy expected to grow at 9% in 2011-12 with a margin of +/-0.25%.
• Inflation is expected to be lower in 2011-12 with the measures taken by both the Government and the RBI showing further lagged effect.
• Current account deficit seen lower in 2011-12 with improvements in foreign trade and investment.

Budget Estimates for 2011-12

• Gross Tax receipts are estimated at Rs. 9,32,440 crore an increase of 24.9% over the Budget Estimates (BE) for 2010-11. Non-tax revenue receipts estimated at Rs. 1,25,435 crore.
• Total expenditure proposed at Rs. 12,57,729 crore, an increase of 13.4% over BE for 2010-11, with an increase of 18.3% in total Plan allocation and 10.9% in the Non-plan expenditure.
• Effective Revenue Deficit estimated at 2.3 per cent of GDP in the Revised Estimates (RE) for 2010-11 and 1.8 per cent for 2011-12. Fiscal Deficit brought down from 5.5 per cent in BE 2010-11 to 5.1 per cent of GDP in RE 2010-11. Fiscal deficit seen at 5.1 percent of GDP in 2010-11; 4.6 percent of GDP in 2011-12 and 3.5 percent of GDP in 2013-14. All subsidy related liabilities to be brought into fiscal accounting.
• Net market borrowing of the Government through dated securities in 2011-12 to be Rs. 3.43 lakh crore and an additional Rs.15,000 crore to be financed through Treasury Bills. Central Government debt estimated at 44.2 per cent of GDP for 2011-12 as against 52.5 per cent recommended by the 13th Finance Commission.
  

Tax Proposals

Direct taxes

• Exemption limit for the general category of individual taxpayers enhanced from Rs. 1,60,000 to Rs. 1,80,000 giving uniform tax relief of Rs. 2,000. Exemption limit enhanced to Rs. 2,50,000 and qualifying age reduced to 60 years for senior citizens. Exemption limit for citizens, who are 80 years or above raised to Rs. 5,00,000.
• Surcharge for domestic companies reduced from 7.5% to 5% and for foreign companies from 2.5% to 2%.
• Minimum Alternate Tax (MAT) rate increased from 18% to 18.5% of book profits. MAT to be levied on developers of Special Economic zones (SEZs) and units in SEZ.
• Concessional tax rate of 15% proposed on dividends received by the Indian companies from their foreign subsidiaries during financial year 2011-12.
• Investment linked deduction extended to housing projects under a scheme for affordable housing and production of fertilizer.
• DTC proposed to be effective from April 1, 2012.

Indirect taxes

• The Budget has proposed to stay on course for transition to GST. Significant progress in establishing IT infrastructure for introduction of GST.
• Central Excise Duty maintained at standard rate of 10 per cent.
• Nominal Central Excise Duty of 1 per cent has been imposed on 130 items entering in the tax net.
• Lower rate of Central Excise Duty enhanced from 4 per cent to 5 per cent.
• Parallel Excise Duty exemption granted for domestic suppliers producing capital goods needed for expansion of existing mega or ultra mega power projects.
• Peak rate of Custom Duty held at its current level.
• Standard rate of Service Tax retained at 10 per cent, with proposals of expansion in the tax base.

Some Proposals Related to Infrastructure, Agricultural and Social sector Development

• Allocation to infrastructure in 2011-12 increased by 23.2% over the previous year.
• To boost infrastructure development in railways, ports, housing and highways, tax free bonds of Rs. 30,000 crore proposed to be issued by Government undertakings during 2011-12.
• Allocation for social sector in 2011-12, proposed at Rs.1,60,887 crore amounting to 36.4% of total plan allocation and increased by 17% over the current year. Allocation for education increased by 24% over current year. Plan allocations for health stepped-up by 20%. Allocation for Bharat Nirman programme proposed to be increased by Rs.10,000 crore from the current year to Rs.58,000 crore in 2011-12. Plan to provide Rural Broadband Connectivity to all 2,50,000 Panchayats in the country in three years.
• Credit flow for farmers raised from Rs.3,75,000 crore to Rs.4,75,000 crore in 2011-12.
• Interest subvention enhanced from 2% to 3% for providing short-term crop loans to farmers who repay their crop loan on time.
• NABARD's capital base to be strengthened by infusing Rs.3000 crore, as Government equity in a phased manner.
• To attract investment in the cold storage sector, capital investment in the creation of modern storage capacity to be eligible for viability gap funding scheme of the Finance Ministry. Cold chains and post-harvest storage to be recognized as an infrastructure sub-sector. Full exemption from excise duty extended to certain machinery required for this sector.
• To ensure greater efficiency, cost effectiveness and better delivery for of kerosene, LPG and fertilisers, Government to move towards direct transfer of cash subsidy to people living below poverty line in a phased manner.
• Mortgage Risk Guarantee Fund proposed under Rajiv Awas Yojana to guarantee housing loans taken by Economically Weaker Sections and LIG households and enhance their credit worthiness.

• For removal of production and distribution bottlenecks for items (constituting 70% of WPI basket of primary food articles) contributing to the recent inflationary pressure, allocations under the ongoing Rashtriya Krishi Vikas Yojana increased from Rs.6,755 crore in 2010-11 to Rs.7,860 crore in 2011-12.
• Allocation of Rs.400 crore to improve rice based cropping system in Eastern India. Allocation of Rs.300 crore each to promote: 60,000 pulses villages in rainfed areas; 60,000 hectares under oil palm plantations; implementation of vegetable initiative; higher production of nutritious millets like Bajra, Jowar, Ragi and others; animal based protein production through livestock development, dairy farming, fisheries etc; and fodder development in 25,000 villages.
• State Governments to review and enforce a reformed Agriculture Produce Marketing Act.

Some Proposals Related to the Investment Environment

• Notified infrastructure debt funds to attract foreign funds for financing of infrastructure proposed; a reduced withholding tax rate of 5% (instead of the current rate of 20%) to apply to interest payment on the borrowings of these funds; and income of the funds to be exempt from tax.
• FII limit for investment in corporate bonds issued in infrastructure sector raised.
• Additional deduction of Rs.20,000 for investment in notified long-term infrastructure bonds extended
• Disinvestment receipts for 2011-12 estimated at Rs. 40,000 crore.
• SEBI registered MFs permitted to accept subscription from foreign investors who meet KYC requirements for equity schemes.
• Discussions underway to further liberalise the FDI policy.
• Amendments proposed to the Banking Regulation Act in the context of additional banking licences to private sector players to be considered.
• Legislative changes to be introduced in Insurance and Pension funds sectors. Changes are also proposed to Acts related to bank debt recovery.
• Self assessment to be introduced in Customs to modernize the Customs administration.
• Proposal to introduce simplified scheme for refund of taxes paid on services used for export of goods.
• Mega Cluster Scheme to be extended for leather products and handicrafts.
• Recapitalisation for PSBs and RRBs include Rs.6,000 crore allocated to enable PSBs to maintain a minimum of Tier I CRAR of 8% and Rs.500 crore for RRBs to maintain a CRAR of at least 9% as on March 31, 2012.
• Keeping in mind the recent problems related to Micro Finance Institutions, India Microfinance Equity Fund of Rs.100 crore is proposed to be created with SIDBI and Women’s SHG’s Development Fund to be created with a corpus of Rs.500 crore.
• Rs.5,000 crore to be provided to SIDBI for refinancing incremental lending by banks to Micro Small and Medium Enterprises. Rs.3,000 crore to be provided to NABARD to provide support to handloom weaver co-operative societies.
• Provision under Rural Housing Fund enhanced to Rs.3,000 crore.
• Existing housing loan limit for dwelling units under priority sector lending enhanced to Rs.25 lakh.

The MFI Industry in India — from Micro to Macro?

The operating style of many microfinance institutions (MFIs) in India has been criticised by several eminent policy makers. MFIs provide small loans to the poor who do not qualify for traditional banking credit, help lift them out of poverty and spur entrepreneurship. Rash and faulty practices both on part of the lenders and borrowers in the industry have now led to borrowers defaulting on payments and taking their lives and banks ceasing to lend to the cash-strapped micro-loan companies. Collections by MFIs in Andhra Pradesh had deteriorated considerably and there were some incipient signs of contagion spreading to other States. To deal with the problem, the RBI has temporarily relaxed provisioning norms to enable banks to continue lending to the cash-strapped MFIs. Banks can now restructure loans extended to MFIs even if they are not fully secured; bank loans to MFIs were mostly unsecured but to avail of the regulatory asset classification benefits under the present restructuring guidelines of the RBI, the accounts had to be fully secured. As a special case, banks need not for now classify such loans as non-performing assets (NPAs).

The RBI also constituted a committee, headed by Y H Malegam, to look into issues facing the microfinance sector in order to bring about long term and structural changes in the functioning of MFIs. According to the committee report the players in the Microfinance sector fall under three main groups: The (Self help Group) SHG-Bank linkage model (pioneered by NABARD) accounting for about 58% of the outstanding loan portfolio; Non-Banking Finance Companies (NBFCs) accounting for about 34% of the outstanding loan portfolio, which encourage villagers to form Joint Liability Groups (JLG) and give loans that are jointly and severally guaranteed by the other members of the group, and Others including trusts, societies, etc, accounting for the balance 8% of the outstanding loan portfolio. All NBFCs are currently regulated by RBI (under Chapters III-B, III-C and V of the Reserve Bank of India Act). There is, however, no separate category created for NBFCs operating in the Microfinance sector, which is required as the borrowers in the microfinance sector represent a particularly vulnerable section of society lacking individual bargaining power, financial literacy and the ability to absorb external shocks The need for regulation is also strengthened because over 75% of the finance obtained by NBFCs operating in this sector is provided by banks and financial institutions including SIDBI. As at 31st March 2010, the aggregate amount outstanding in respect of loans granted by banks and SIDBI to NBFCs operating in the Microfinance sector amounted to Rs.13,800 crores. In addition, banks were holding securitized paper issued by NBFCs for an amount of Rs.4200 crores. Banks and FIs (including SIDBI) also had made investments in the equity of such NBFCs.

Many NBFCs in this sector started off as non-profit entities providing micro-credit and other services to the poor however, as they found themselves unable to raise adequate resources for a rapid growth of the activity, they converted themselves into for-profit NBFCs. Others entered the field directly as for-profit NBFCs seeing this as a viable business proposition. Significant amounts of private equity funds have consequently been attracted to this sector. As there have been accusations of MFIs charging unreasonable fees and using loan sharks to collect outstanding payments, the Malegam panel has proposed a cap of 24% on the interest charged and an upper limit of 25,000 Rupees ($549; £344) on individual loans (as well as the aggregate value of all outstanding loans of an individual borrower). It has recommended an average ‘margin cap' of 10 per cent for MFIs having a loan portfolio of Rs.100 crore and of 12 per cent for smaller MFIs It also proposed a transparency in charges, with an MFI allowed to levy only three charges - processing fee, interest and insurance charge. Further, NBFCs operating in the Microfinance sector not only compete amongst themselves but also directly compete with the SHG-Bank Linkage Programme. The committee has made a number of recommendations to mitigate the problems of multiple-lending, over borrowing, ghost borrowers and coercive methods of recovery. These include: a borrower can be a member of only one self-help group or a joint liability group; not more than two MFIs can lend to a single borrower; there should be a minimum period of moratorium between the disbursement of loan and the commencement of recovery; the tenure of the loan must vary with its amount; a credit information bureau has to be established; the primary responsibility for avoidance of coercive methods of recovery must lie with the MFI and its management; and the RBI must prepare a draft customer protection code to be adopted by all MFIs. As there may be a need to give special facilities or dispensation to NBFCs operating in this sector, a separate category of NBFCs for microfinance institutions is suggested, defined as “A company (other than a company licensed under Section 25 of the Companies Act, 1956) which provides financial services pre-dominantly to low-income borrowers with loans of small amounts, for short-terms, on unsecured basis, mainly for income-generating activities, with repayment schedules which are more frequent than those normally stipulated by commercial banks and which further conforms to the regulations specified in that behalf”. The committee also recommends that bank advances to MFIs shall continue to enjoy “priority sector lending” status. However, advances to MFIs which do not comply with the regulation should be denied “priority sector lending” status. While the committee guidlines are overall well balanced in favour of both borrower and lender, certain recommendations raise additional challenges in terms of both compliance and operations and may phase-out smaller MFIs. For example, the ascertaining of family income and that a lender borrows from not more than two sources would be very difficult in reality. For the borrowers, a Rs.25,000 limit may not be enough in certain circumstances to pull a family out of poverty and make the borrower credit worthy in future. Insistence on loans being made primarily for income-generating activities may, again defy the very purpose of microfinance. Currently an MFI being a NBFC is required to have a minimum capital of Rs.2 crores, the suggestion that for a NBFC MFI this should be increased to a minimum Net Worth of Rs.15 crores, if adopted would raise entry-barriers to the industry.

Tiding over some Crisis Induced Weaknesses

Fiscal risks remain elevated in advanced economies where public debt ratios as percentage of GDP are still rising rapidly, the International Monetary Fund (IMF) said in its latest edition of the Fiscal Monitor. Market views on fiscal developments are being reflected in bond yields and spreads becoming more polarized; yields have declined in countries regarded as safe, or at least safer, havens, while they have increased (and spreads have widened) for a few countries that are considered to be more at risk. Developments in Europe also seem to have favored a portfolio reallocation toward emerging markets, particularly emerging Asia. EMEs are seeing historically low spreads, reflecting large capital inflows spurred by their relatively strong growth and fiscal positions and prospects. An analysis of the determinants of polarization of some specific type of spreads reveals that, although cross-country variation in spreads reflects country-specific fiscal fundamentals and other variables affecting solvency (growth prospects and banks balance sheet fragilities), global variables—such as risk aversion and global growth—have recently played an important role.

The Monitor, drawing on projections from the October 2010 World Economic Outlook (WEO), shows that: global fiscal deficit is projected to fall from 6.75 percent of GDP in 2009 to 6 percent this year, in line with earlier projections. Deficit declines are mostly due to improved economic conditions and to lower support to the financial sector. Further, in 2011, the global fiscal deficit will fall further, to about 5 percent of GDP. About 90 percent of countries are projected to record smaller deficits in 2011 (relative to 2010), with most of the deficit decline due to policy tightening. The advanced G-20 economies on average plan to improve their CAB by 1.25 percentage point annually during 2011–13, including through the unwinding of the 2009–10 stimulus. In the United States, the largest adjustment is expected to come in 2012. Fiscal consolidation plans of most economies are tilted toward expenditure cuts and spending cuts are more tilted toward the wage bill, size of civil service, and social transfers rather than public investment. On the revenue side, measures affecting direct taxation dominate, which may raise concerns for the impact on growth. Of the announced and already implemented revenue measures, personal income tax , corporate income tax, and social security contributions accounted for nearly half of all revenue measures, while increases in the value-added tax (VAT) (ranging from 1 to 4 percentage points in Europe) and excise taxes represent some additional revenue generating measures.

India

India faces a dilemma similar to some other emerging markets; on the one hand the return to fiscal sustainablility has led to cut back in government expenditures and stimuli once growth revived, on the other hand private sector demand is being pushed back through rate hikes in the fear of stoking inflation. The Reserve Bank of India recently increased both its policy rates by a quarter of a percentage point; the rate at which the central bank lends to banks was raised to 6.25%, and the rate at which it borrows from them was increased to 5.25%. The tightening was India’s sixth this year, mainly driven by the need to tame inflationary expectations. However, food price inflation the main cause for concern seems very unlikely to soften significantly as the spectre of inflation looms larger over global agricultural markets after the US slashed key crop forecasts and warned of shortfalls in grains, adding to problems raised by a massive drought in Russia; the UN’s Food and Agriculture Organisation noted the inevitable tightening of the overall food price situation as we go into 2011. On the other hand, successive rate hikes By RBI is now accompanied by a certain renewed sluggishness in industrial growth borne out by the vertiginous fall in IIP number to 5.6% (6.9 revised) in August and 4.4% in September predicted by the 18 month low September growth figures of 2.5% for the 6 infrastructure industries which account for over a quarter of IIP.

Despite being delinked with the global financial sector, the Indian banking sector has witnessed a relatively sluggish performance in the year 2009-10 with some emerging concerns with respect to asset quality and slow deposit growth. Bank deposits, which constituted around 78 per cent of the total liabilities of SCBs, registered a decelerated growth for the third consecutive year since 2007- 08. One of the factors responsible for a decline in the deposits growth in 2009-10 was the prevalence of low interest rates for a major part of the year. The other emerging concern was with respect to asset quality of banks. The gross Non-Performing Assets (NPAs) ratio showed an increase from 2.25 per cent in 2008-09 to 2.39 per cent in 2009-10. Moreover, there was an increase in the proportion of doubtful and loss assets in 2009-10. The increase in gross NPA ratio coupled with a decline in the (outstanding) provisions to gross NPA ratio in 2009-10 at the aggregate level, underlined the need for further strengthening of provisions by banks, though, notwithstanding the weakening asset quality, the Capital to Risk-Weighted Assets Ratio (CRAR) of Indian banks remained strong at 14.5 per cent, way above the regulatory minimum of 9 per cent after migration to the Basel II framework, providing banks with adequate cushion for emerging losses. In 2009-10, the profitability of Indian banks captured by the Return on Assets (RoA) was a notch lower at 1.05 per cent than 1.13 per cent during the previous year. Low levels of financial penetration and inclusion in the global comparison continued to be an area of concern for the Indian banking sector. However, data on sectoral deployment of gross bank credit does show significant improvement in credit flow to industry, services and personal loans during the current financial year, while credit to agriculture has declined further. Overall flow of resources from the financial sector to the commercial sector increased significantly in the first half of 2010-11 relative to the flows in the corresponding period of last year, though domestic non-bank sources of funds have declined.

Thus looking ahead, given the unstable global scenario, as the balancing act continues considerable volatility in all indicators of the Indian economy could be expected for some time to come. Track the global and Indian economy with our monthly statistical bulletin E-UpDates with monthly as well as daily data on the Indian and global economy for over 20 indicators.

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India Part of the IMF’s Surveillance for the World’s Top 25 Financial Sectors

According to the IMF Executive Board the recent crisis has made clear the need for mandatory and regular assessments of financial stability for countries with large and interconnected financial systems. Economies with financial sectors that have the greatest impact on global financial stability are now required to undergo in-depth reviews of their financial health by the International Monetary Fund every five years. All of the IMF’s 187 member countries are already required to undergo an annual economic health check-up, known as an Article IV consultation. In addition, Financial Sector Assessment Program (FSAP) offers the opportunity to all member countries to undergo, on a voluntary basis, a comprehensive financial sector assessment. The financial stability component of the voluntary FSAP will now be a mandatory part of the IMF’s surveillance for the world’s top 25 financial sectors. Under the Fund’s existing legal framework, it is open to the Fund to require members with systemically important financial sectors to engage in regular mandatory financial stability assessments under Article IV while not requiring such assessments of other members. The mandatory financial stability assessments will comprise three elements: 1) An evaluation of the source, probability, and potential impact of the main risks to macro-financial stability in the near term, based on an analysis of the structure and soundness of the financial system and its interlinkages with the rest of the economy; 2) An assessment of each countries’ financial stability policy framework, involving an evaluation of the effectiveness of financial sector supervision against international standards; and 3) An assessment of the authorities’ capacity to manage and resolve a financial crisis should the risks materialize, looking at the country’s liquidity management framework, financial safety nets, crisis preparedness and crisis resolution frameworks.

For defining systemic importance for this exercise a conceptual framework was developed by the IMF, BIS, and FSB. This framework approaches systemic importance from both a domestic and a global point of view. It identifies the following three key concepts: (i) size, i.e., the volume of financial services provided by an individual financial institution or market; (ii) interconnectedness, i.e., the extent of linkages with other financial institutions or markets; and (iii) substitutability, i.e., the extent to which other institutions or markets can provide the same services in the event of the failure of part of the system. The methodology for identifying jurisdictions with systemically important financial sectors is a three-stage process that uses available financial data for the entire Fund membership. The results identify 25 jurisdictions with the most systemically important financial sectors, which cover almost 90 percent of the global financial system and represent almost 80 percent of global economic output. At present the countries, in order of ranking, are: United Kingdom, Germany, United States, France, Japan, Italy, Netherlands, Spain, Canada, Switzerland, China, Belgium, Australia, India, Ireland, Hong Kong, Brazil, Russian Federation, Korea, Austria, Luxembourg, Sweden, Singapore, Turkey and Mexico.

Cause Enough for RBI to Pause?

RBI’s tightening cycle was almost unanimously presumed to continue in its September policy review, however, the global economic scenario has clouded considerably recently and though the Indian economy seems to be steaming on there are a few warning signs which ought to be heeded before it is too late.

Growth in the world's largest economy decelerated to a pace of 1.6 percent, signaling a more pronounced slowdown in the recovery from recession. July consumer spending a key driver of US economic growth, usually accounting for two-thirds of output rose 0.4% and incomes rose a mere 0.2%, with spending outpacing income. The US Unemployment rate for August came in higher as forecasted at 9.6%, while the Change in Nonfarm Payrolls for the same period showed a better than predicted shed of 54 thousand jobs. However, the Change in Manufacturing Payrolls showed a shed of 27 thousand jobs, which is actually worse than the predicted outcome, and also Change in Private Payrolls showed that jobs added were lower than expected. Europe looked better; economic confidence in the 16 countries that use the euro rose to its highest level in nearly two-and-a-half years during August, as unemployment concerns eased somewhat. The UK economy expanded at 1.6% year-on-year, faster than previously estimated in the second quarter in the biggest growth spurt since 2001 as companies rebuilt stocks and construction work surged.

Japan's government and the central bank had to throw the economy a double lifeline; accompanied by an unanimous vote to keep its key interest rate at a 0.1 percent the central bank unveiled a new six-month low-interest loan program to financial institutions to boost liquidity, combined with an existing three-month funds-supplying operation worth 20 trillion yen ($236 billion) so that banks would have access to a total of 30 trillion yen ($355 billion).

India's economy grew 8.8 percent in the first quarter of the current fiscal, its best performance since 2007, led by a 12.4 percent year-on-year surge in manufacturing, a 9.7 percent leap in services and an 8.9 percent jump in construction and was also boosted by agricultural output expansion of 2.8 percent. Yet many economists suggest that the central bank, which has hiked rates four times since the start of the year to curb inflation, should pause its monetary tightening — the most aggressive in the Asia-Pacific region — in the face of the shaky global outlook. If that is not cause enough RBI should possibly heed the warning signals emitted from the slowdown in domestic investment; not only has manufacturing growth slowed from 16.3% in the previous quarter to 12.4%, essential supplies and construction outputs have also shrunk as compared to the previous quarter, while services growth in important sectors have not really picked up. More concerning is the fact that gross fixed capital formation has decelerated compared to the last 2 quarters at a time that it ought to be rising with a need for vast infrastructure spending both for physical and human resources development. Should inflation control measures delinked from monetary policy and targeted at select necessary commodities now be evaluated instead?

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