“Interim Budget Report”

The interim budget will be presented at the parliament by the government on February 16. General expectations from this budget are relatively muted as typically interim budgets do not change the tax structure or announce any large-scale capital projects – a convention unlikely to be overturned completely.

Accordingly, any large-scale infra-project is unlikely. Still the budget is another opportunity to roll out a few more stimulus measures. However, given the fiscal constraint, such measures are unlikely to be sizeable. The focus of the budget is likely to be agriculture, social infrastructure, small and medium enterprises (SMEs), and labour intensive and export oriented sectors (such as IT and ITES, textiles, gems and jewellery, leather, jute). Agriculture will continue to be favoured. Boosting affordable housing could be a priority.

Currently the corporate tax rate, and the peak personal income tax rate is at 30% apart from the surcharge and education cess. Given the difficult business environment, demands from industry have been strong to reduce corporate tax rates. There are speculations also on reduction in personal income tax rates or rationalization of tax slabs.

At the moment, however, the burden of fiscal deficit has been high for the central government. With slowdown in corporate profitability, both corporate tax and income tax collection is certain to take a hit. Large part of the direct taxes is actually collected in the January-March quarter, outlook for which remains muted. Any significant change in direct tax rates is, thus, unlikely. At the most, there can be some reduction in surcharge or cess components. Tax benefits on housing loan can be increased.

With sharp fall in inflation and substantial reduction in cenvat rate, indirect tax collection is likely to be low as well. The slowdown in revenue collection will reduce the possibility of a blanket reduction in indirect tax rates. However, sector-specific reduction in indirect tax rates can not be ruled out.

The focus of the interim budget is likely to be on social infrastructure, SMEs, labour intensive and export oriented sectors (such as IT and ITES, textiles, gems and jewellery, leather, jute).

Amidst threats of large-scale job loss across the economy, the government is likely to demonstrate its commitment towards generating employment. Agriculture will continue to be favoured. The latest measures of hiking the minimum support prices (MSPs) of several crops is an important measure towards that direction. Demonstaring priority for social infrastructure like education, health, water, sanitation etc will be in the agenda. Boosting affordable housing could be a priority.

IT and ITES industry is demanding further extention of tax holiday under Software Technology Park (STPI) scheme. Tax exemption has recently (April 2008) been extended by one year untill March 2010. Any further amendment of the existing tax clauses for the industry is likely to be kept out of the purview of the interim budget. However, we do not rule out the possibility of extention of STPI benefits for small and mid-tier players.

This week itself the supplementary borrowing programme of the central government during February 20-March 20 has been announced. The additional issuance of INR 460 bn of dated government securities is far above the street expectations. This will take the overall gross market borrowing (dated securities) of the central government to ~INR 2600 bn.

The surprisingly large government borrowing programme scheduled during February-March possibly reflects government’s expectations of further slowdown in tax revenue in Q4, which generally contributes the biggest chunk of overall direct tax collection for any fiscal year. Uncertainties related to the much talked-about auction of 3G licenses and likely intention of the government to disburse the remaining of the overall pay commission recommendation related outgo in April has enhanced the government’s appetite for additional funds.

The larger-than-expected borrowing by the govrnment has enhanced the possibility of further monetary accommodation by Reserve bank of India (RBI). In the absence of a significant monetary accommodation from the central bank, the large government borrowing will put pressure on interest rates. RBI, however, reaffirms their commitment towards maintaining ample liquidity in the system and to keep interest rates benign. We expect reduction of both repo and reverse repo rate by 50 bps each (to 5% and 3.5%, respectively) in February itself. RBI has already announced additional quantitative measures like purchase of government securities through open market operations (OMO), and infusion of liquidity.