The Union Budget 2004-05Context and Impact

Presentation at

Delhi School of Economics

July 30, 2004

2

Structure of Presentation

The Macroeconomic Context of the Budget

Impact on Key Macro Indicators

3

Overall GDP Growth

4.84.4

5.8

4.0

6.5

8.2

6.1

0

1

2

3

4

5

6

7

8

9

1997-98 1998-99 1999-00 2000-01 2001-02 2002-03 2003-04

Per

cen

t

Overall GDP Grow th

4

Sector-wise GDP Growth

-5.5

-3.5

-1.5

0.5

2.5

4.5

6.5

8.5

10.5

1999-00 2000-01 2001-02 2002-03 2003-04

Per

cen

t

Agriculture Industry Services Overall GDP Grow th

5

Drivers of Industrial Recovery

Critical background developments

Structural changes in interest rates

Revival of public capital spending

Retail Finance

Construction

Investment Upturn

6

PPF and G-sec Rates

Interest Rates

4.8

5.8

6.8

7.8

8.8

9.8

10.8

11.8

FY

98

FY

99

FY

00

FY

01

FY

02

FY

03

FY

04

Per

cent

1-yr 5-yr 10-yr PPF

7

PLR and Housing Finance Rates

Lending Rates

9.0

10.0

11.0

12.0

13.0

14.0

15.0

16.0

Per

cen

t

PLR Housing Finance Rate

8

Capital Outlay as % of Total Exp (Centre)

7.66.7

8.1 7.6 7.3 7.5

9.6

0.0

2.0

4.0

6.0

8.0

10.0

12.0

1997-98 1998-99 1999-00 2000-01 2001-02 2002-03(RE)

2003-04(BE)

Revival in Public Capex

9

Capital Outlay as % of Total Exp (States)

10.08.7 8.1

9.0 9.5 10.1

0.0

2.0

4.0

6.0

8.0

10.0

12.0

1997-98 1998-99 1999-00 2000-01 2001-02(RE)

2002-03(BE)

Revival in Public Capex

10

Growth drivers: From Auto and Construction to Capital Goods

Manufacturing Sector Growth

2.61 2.52.9

3.35

4.07

6.91

6.08

6.90

5.95

7.577.95

7.52

-1.00

0.00

1.00

2.00

3.00

4.00

5.00

6.00

7.00

8.00

Q1FY02 Q2FY02 Q3FY02 Q4FY02 Q1FY03 Q2FY03 Q3FY03 Q4FY03 Q1FY04 Q2FY04 Q3FY04 Q4FY04

%

Basic Chemicals & Chemical Products Non-metallic Mineral ProductsBasic Metals Machinery and EquipmentTransport Equipment OthersManufacturing Sector

11

Budget 2004-05:Main Impressions

Clear signals of persistence with reforms

Major rural focus, with objective of de-risking agriculture

Revenue increases appear highly optimistic

Intent to address investment, competitiveness and subsidy issues in February 2005

12

Rise in Plan Spending

Growth in Plan Outlay

3.66.8

0.4

15.5

20.6

10.0

0.0

5.0

10.0

15.0

20.0

25.0

Total Budgetary Support IEBR

2003-04RE 2004-05BE

13

Growth in Plan Infra Spending 2004-05 BE (Budget Support + IEBR)

62.8

41.629.8

19.39.1

-5.8-20.0

0.0

20.0

40.0

60.0

80.0

14

Foreign Direct Investments—current status

0.00

0.50

1.00

1.50

2.00

2.50

3.00

3.50

4.00

4.50

5.00

1996-97 1997-98 1998-99 1999-00 2000-01 2001-02 2002-03 2003-04

US

$ b

illi

on

15

FDI – Expanding Space

Announcement to raise FDI limits in telecom , insurance unanticipated and a positive surprise.

Expected to enhance FDI inflows not just to these sectors but other sectors as well.

However, unless other bottlenecks for investment such as power costs, administrative delays resolved, sharp jump in FDI inflows unlikely.

16

What does all this mean for growth?

In the short run, no significant triggers for acceleration, but no impediments either

Direct tax changes – higher threshold, but education cess – may neutralize each other as far as consumption spending goes

Increased spending will not have much impact in the remaining months of 2004-05

Current momentum in industry and services sustainable

GDP growth for 2004-05 6-6.5%; Non-agri GDP 8% +

17

What does all this mean for growth?

In the long run:

Expanding plan expenditure on infrastructure will clearly contribute (even in medium term, as spending begins)

Roads programme continues, with sightly expanded allocation for the year

De-risking agriculture critical to stabilizing the contribution of this sector to growth

Hope from concerted thrust on investment climate and manufacturing competitiveness

18

Revenue Arithmetic

% Share Growth

2003-04 2004-04BE

Gross Tax revenue 100.0 17.9 24.6

Union Excise 36.2 12.2 18.2

Corporation Tax 24.7 36.4 40.4

Customs 19.4 10.0 9.9

Income Tax 15.8 9.3 26.5

Service Tax 3.3 101.4 70.5

Other Tax 0.6 23.3 -61.9

:

19

Room for Slippage

ITEM SLIPPAGE (Rs crore) COMMENT

Tax Revenue 20,000

(After factoring in 100 in new taxes)

Unrealistic Tax Arithmetic. Premised on recovery of arrears

Expenditure Nil Non-Plan Expenditure reduction Target Ambitious

Fiscal Deficit 0.6 of GDP

20

The Industry – Revenue Nexus

0.00

1.00

2.00

3.00

4.00

5.00

6.00

7.00

8.00

1998-99 1999-00 2000-01 2001-02 2002-03 2003-04RE

Ind

. G

row

th

-5.0

0.0

5.0

10.0

15.0

20.0

25.0

Tax R

even

ue G

row

th

IIP Grow th Tax Revenue Grow th

21

What does this mean for the Fiscal Deficit?

Budgeted Fiscal Deficit of 4.4% of GDP as per the requirements of the Fiscal Responsibility and Budget Management Act

Our analysis shows that this is premised on highly optimistic revenue projections

Possibility of slippage of 0.6 per cent of GDP

22

Inflation: Inching Up

6.6

6.6

5.4

4.7

3.9

4.9 5.1 5.4 5

.8

6.5

6.1

4.8

4.5 4.6

5.8

0.0

1.0

2.0

3.0

4.0

5.0

6.0

7.0

Apr-

03

May-0

3

Jun-0

3

Jul-03

Aug-0

3

Sep-0

3

Oct-

03

Nov-0

3

Dec-0

3

Jan-0

4

Feb-0

4

Mar-

04

Apr-

04

May-0

4

Jun-0

4

23

Inflation: Sectoral Trends

0.0

2.0

4.0

6.0

8.0

10.0

12.0A

pr-

03

May

-03

Jun

-03

Jul-

03

Au

g-0

3

Sep

-03

Oct

-03

No

v-03

Dec

-03

Jan

-04

Feb

-04

Mar

-04

Ap

r-04

May

-04

Jun

-04

Primary Fuel Mfg

24

Inflation Prospects

Inflation firming up in fuel and manufacturing; direct impact of budget marginal

Result of both demand and supply factors Fuel and metal prices the cost push factors Recovery in manufacturing is the demand pull factor

Prospects of inflation staying in the band of 5- 5.5 per cent.

International crude prices - a risk factor, but current outlook moderate

25

Domestic interest rates—pulls and pressures

‘Push’ factors Harder US rates Sustained demand for

domestic credit Slowdown in forex

inflows affecting domestic liquidity.

Anticipation of overrun in fiscal deficit

‘Pull’ factors RBI’s policy bias

towards keeping rates low

Current high levels of liquidity –estimated at Rs 75000 cr and Rs 90000 cr

Moderate core inflation

26

The interest rate momentum

40

55

70

85

100

115

Basis

po

int

4.50

5.00

5.50

6.00

Per ce

nt

Yield Spread 10-yr Govt Security Yield

27

The interest rate view

Potential fiscal deficit overshoot of Rs 20000 crores and slowdown in forex inflows to drive interest rates up.

100 bps increase in 10 year yields, 20-30 bps at the short end projected by year-end

Turnover tax on debt transactions to push up short-run volatility, reduce volumes

28

The Rupee

US interest rate hike to drive re-alignment of global capital flows

Export growth prospects good, but domestic recovery also causing acceleration of imports

Rate of net forex inflows will slow Rupee to remain stable in 45-46/US$ range for

rest of the year

29

Conclusions

Relief: Reforms are still on track, for now

Concerns: Unrealistic revenue expectations Criticality of delivery mechanisms

Hopes: Concrete solutions for investment, competitiveness and subsidy issues

De-risking agriculture