ECONOMY & STRATEGY January 2015
Modi's ambitions will reshape India's fiscal construct Analysts: Ritika Mankar Mukherjee, CFA
[email protected] Tel: +91 22 3043 3175 Sumit Shekhar
[email protected] Tel: +91 22 3043 3229
Economy & Strategy
CONTENTS ‘Strongman economics’ takes shape…………………………………………………………. 4 Section 1: Modi’s objectives will shape India’s fiscal dynamics……………………….…..5 Section 2: The resultant fiscal forces and their impact on India’s fiscal construct………9 Section 3: Investment and macroeconomic implications ……………..........................25 Appendix: Impact of implementation of the Goods and Services Tax (GST)…………...29 from April 1, 2016
January 22, 2015
Ambit Capital Pvt. Ltd.
Page 2
Economy & Strategy THEMATIC
Modi’s ambitions will reshape India’s fiscal construct Narendra Modi is likely to focus on four fiscal objectives during his tenure, namely: (1) enhancing India’s low tax: GDP ratio; (2) incentivising states to embrace growth-friendly policies; (3) cutting “leakages” in subsidy programs through the use of Direct Benefit Transfer (DBT); and (4) increasing Government spending on infrastructure. Whilst the Government’s improved focus on infrastructure creation should benefit stocks like Coal India, Concor and PGCIL, superior targeting of subsidies through DBT can boost bottom-of-thepyramid consumption. However, adverse fiscal pressures in FY16 could restrict the RBI’s room for administering rate cuts. In our noted dated 24 November 2014 note titled, ‘Can Modi’s Megathemes reshape India’ we highlighted that PM Narendra Modi is likely to follow the brand of ‘strongman economics’. In this note we explore the dynamics that are likely to pan out as Modi creates fiscal forces to further his ambitions. Modi’s objectives will reshape India’s fiscal dynamics Our extensive discussions over the past three months with experts who are a part of the policy ecosystem in New Delhi suggest that the PM is likely to focus on four main objectives namely: (1) enhancing India’s abysmally low tax-GDP ratio (by widening the tax base through measures like GST), (2) incentivising states by using the discretionary funds available to the Centre to adopt the ‘Modi template’ of reforms, (3) creating savings on the subsidy front by shifting subsidies to the Direct Benefits Transfer (DBT) platform and thus limiting ‘leakages’, and (4) increasing Government spending on infrastructure creation. The resultant fiscal forces and their impact on India’s fiscal construct The PM is likely to pursue these objectives by using four fiscal forces namely: (1) the recommendations of the 14th Finance Commission (FC), (2) the creation of the NITI Aayog, (3) the creation of DBT infrastructure, and finally, (4) the recent deregulation of diesel prices. Whilst we expect the 14th FC to recommend a markedly higher share for states in Central Government tax revenues, given that the NITI Aayog will have no say in transfers to states, the FC is likely to also direct the Central Government to partially offset this increase (in the tax outgo to States) by a reduction in the States’ share in Central plan expenditure. Furthermore, in view of the ideological conviction shown by Dr Arvind Panagariya, the vice chairman of the NITI Aayog, to drive GDP growth via public investments, we expect the plan expenditure (or an expenditure category corresponding to capex) to rise over FY16-17 at a fast clip. The net impact of these fiscal forces is likely to impose expansionary pressure on the fiscal deficit in FY16 but the net impacts seem likely to turn favourable by FY18-19, provided the benefits of the DBT system come through. Investment Implications Whilst the Government’s improved focus on infrastructure creation should benefit stocks like Coal India and PGCIL, superior targeting of subsidies through DBT can boost rural consumption. However, the adverse fiscal pressures in FY16 could restrict the RBI’s room for rate cuts. Additionally, even after adjusting for the reduction in the transfer of plan spends from the Centre to the States, a reasonably large sum (~1.5% of GDP) will be available to the Centre in terms of discretionary sums that can be transferred to the States. Given the PM’s focus on ‘competitive federalism,’ it seems likely that these transfers will go to States which initiate growth-friendly policies (such as land and labour reform). This in turn could provide a fillip to manufacturing.
January 22, 2015 Exhibit A: India’s tax-GDP ratio is abysmally low
Source: CEIC, Ambit Capital research
Exhibit B: The 14th FC is likely to recommend an increase in States’ share in Central taxes and a reduction in plan spends
Source: CEIC, Ambit Capital research
Exhibit C: The Modi-led Government is likely to increase the incremental capex expenditure
Source: CEIC, Ambit Capital research
Analyst Details Ritika Mankar Mukherjee, CFA +91 22 3043 3175
[email protected] Sumit Shekhar +91 22 30433229
[email protected]
Ambit Capital and / or its affiliates do and seek to do business including investment banking with companies covered in its research reports. As a result, investors should be aware that Ambit Capital may have a conflict of interest that could affect the objectivity of this report. Investors should not consider this report as the only factor in making their investment decision.
Economy & Strategy
‘Strongman economics’ takes shape In our 24 November note, ‘Can Modi’s Megathemes reshape India’ we highlighted that, “The series of crises starting from the East Asian crisis of 1997 damaged the credentials of liberal free market economics. This in turn gave rise to what we call ‘strongman economics’ (i.e. ad-hoc economic policies driven by an aggressive leader with a focus on nationalism) in a range of emerging markets. Cross-country experience suggests that this ideology of ‘strongman economics’ has rarely changed the structure of the economy but has nevertheless resulted in lower inflation and higher GDP growth. Against this backdrop, we argue that Modi is India’s ‘strongman’ who is unlikely to be able to change the composition of India’s GDP but is likely to engineer a cyclical recovery and deliver lower inflation.”
The series of crises starting from the East Asian crisis of 1997 damaged the credentials of liberal free market economics. This in turn gave rise to what we call ‘strongman economics’…
Having established that India’s 15th Prime Minister, Narendra Modi, is likely to follow the brand of ‘strongman economics’ (as opposed to the popular notion that he is likely to be the proponent of economic liberalism), in this note we explore the ‘fiscal policy’ dynamics that are likely to pan-out in India over FY16-19 as Modi uses and creates fiscal forces to further his policy goals and ambitions. The subsequent note is divided into three sections. Section 1 (from page 5 onwards) focusses on articulating the contours of the PM’s goals and objectives based on our extensive discussions with experts who are part of the policy ecosystem. This section also elaborates upon the forces that Modi is likely to use, create and manipulate to meet these objectives. Section 2 (from page 9 onwards) then elaborates on the fiscal forces and quantifies the net impact that these forces are likely to have on India’s fiscal deficit over the remaining period of Modi’s tenure i.e. FY16-19. Section 3 (from page 25 onwards) elucidates the macroeconomic and investment implications of these forces.
January 22, 2015
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Page 4
Economy & Strategy
Section 1: Modi’s objectives will shape India’s fiscal dynamics Extensive discussions with policy experts who are part of the policy ecosystem suggested to us that Modi over his remaining four-year term is likely to focus on four main objectives namely: (1) enhancing India’s abysmally low tax-GDP ratio, (2) incentivising States to adopt the ‘Modi template’ of reforms, (3) creating savings on the subsidy front by plugging leakages, and (4) increasing Governmental spending on infrastructure. Objective#1: Enhancing India’s abysmally low tax-GDP ratio India’s tax-to-GDP ratio has been rangebound between 8% and 12% over the past two decades (see the exhibit below). Furthermore, a comparison with peers as well as with developed countries like the UK points to the vast tax revenue-generating potential in India which suffers from large-scale tax evasion. Exhibit 2: India’s tax GDP ratio is lower than that of most emerging market peers
2015
2011 2013
2007 2009
2003 2005
Russia
10
S. Africa
0
Net tax revenue
Source: CEIC, Ambit Capital research, Note: Data is presented on financial year basis
UK
5 2012
Gross tax revenue
2001
1997 1999
1993 1995
1989 1991
0%
India
15
2011
2%
20
2010
4%
Brazil
2009
6%
25
2008
8%
30
2007
10%
35
2006
12%
Tax revenue (as a % of GDP)
India's tax revenue (as a % of GDP)
14%
2005
Exhibit 1: India’s tax-to-GDP ratio remains abysmally low at 11% as per FY15 Budget Estimates
Source: World Bank, Ambit Capital research, Note: Data is presented on calendar year basis
Our discussions with well-placed policy experts suggest that enhancing India’s abysmally low tax-to-GDP ratio is likely to be one of the primary objectives that Modi will pursue over his five-year term. The motives for the aim range from wanting to improve the financial firepower of the Centre, to augmenting funds which allow the Government to play a more active role in funding infrastructure growth in India. How will Modi achieve this goal? The prime tool that Modi is likely to mobilise to inorganically boost India’s tax revenue is by activating the unified Goods and Service Tax (GST) regime as soon as possible. As highlighted in our email on 12 December 2014, our discussion with one of India’s leading GST experts suggested that GST even in its diluted form will be a gamechanger when implemented as it will be tax revenue–accretive. This is because:
GST will bring the unorganised sector under the ambit of taxation, thereby adding to the tax base of the country.
GST implementation is likely to result in higher income tax collections, as: (1) GST payments by tax-payers will be linked to their respective Permanent Account Number (PAN); and (2) the National Securities Depository Limited (NSDL) which maintains the Tax Information System (TIN) will also look after the GST database. This integration of the indirect tax system with the income tax system will enable authorities to triangulate information, thereby automatically leading to improved tax buoyancy.
January 22, 2015
Ambit Capital Pvt. Ltd.
The prime tool that Modi is likely to mobilise to inorganically boost India’s tax revenue is by activating the unified Goods and Service Tax (GST) regime as soon as possible
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Economy & Strategy Refer to the Appendix, ‘Impact of implementation of the Goods and Services Tax (GST) from April 1, 2016’ on page 29 for details regarding the fiscal impact of GST implementation in India. Objective#2: Incentivising States to adopt the ‘Modi template’ of reform The 14th Finance Commission recommendations have been submitted to the President of India and are likely to be presented to the Parliament in the coming Budget Session. We expect the 14th FC to recommend a significant increase in States’ share in Central Government taxes. Simultaneously, given that the NITI Aayog appears likely to play a minimal role in terms of determining the quantum of plan expenditure transfers to states, the FC is likely to also direct the Central Government to offset this increase in FC-recommended transfers by a reduction in States’ share in the Central plan expenditure. However, given that cutting expenditure is always more challenging than increasing transfers, we expect the Centre to be able to reduce this component (which currently amounts to ~2% of GDP) by 0.5% of GDP in FY16 and 0.1% per annum of GDP in subsequent years (see the exhibits below and refer to page 11of this note, ‘Fiscal Force #1: The recommendations of the 14th Finance Commission’ and refer to page 16 of this note, ‘Force #2: Replacement of the Planning Commission by the NITI Aayog’ for details of the fiscal impact of these two dynamics).
Exhibit 3: The 14th FC is likely to recommend increasing States’ share in Central taxes and a reduction in plan spends transferred by the Centre to States
4% 2%
1.0%
0% -0.8%
-2% FY15 E
FY19 E
Exhibit 4: The Central Government will offset the increase in FC-recommended transfers by a reduction in States’ share in Central plan expenditure
Plan Exp. (as a % of GDP)
6%
Change
States' share in Central taxes (as % of GDP) States' share in Central Plan Spends (as % of GDP) Source: CEIC,RBI, Ambit Capital research, Note: Data is indicative and is calculated using FY14 actuals as a base
We expect the 14th FC to recommend a significant increase in States’ share in Central Government taxes… also it seems likely that the FC will direct the Central Government to offset this increase in FC-recommended transfers by a reduction in States’ share in Central plan expenditure
5%
4.2%
4% 3%
2.0%
2%
1.4%
1% 0% Central Plan Plan spends Plan spends Exp. transferred by transferred by Centre to Centre to State State post 14th FC adjustments
Source: CEIC,RBI, Ambit Capital research, Note: Data is calculated using FY13 and FY14 actuals as a base
Even after adjusting for the reduction in the transfer of plan spends from the Centre to the States, a reasonably large sum of funds, amounting to 1.5% of GDP in FY16, will be available to the Centre in terms of discretionary sums that can be transferred to the State (see the exhibit above for details). How will Modi achieve this goal? The prime tool that Modi is likely to use to further this goal of incentivising States to adopt the ‘Modi template’ of reform is likely to first involve migrating the allocative power regarding this discretionary sum of funds (amounting to 1.5% of GDP in FY16) away from the erstwhile Planning Commission into the Ministry of Finance (MoF). Once this migration is done, Modi is likely to use the newly formed NITI Aayog to legitimise these discretionary transfers by recommending a formula that rewards States that follow policies which Modi believes are growth-friendly and, even more specifically, are “Make in India” friendly.
January 22, 2015
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Modi is likely to use the newly formed NITI Aayog to legitimise these discretionary transfers by recommending a formula that rewards States that follow policies which are growth-friendly
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Economy & Strategy Objective #3: Creating savings on the subsidy front by plugging leakages In our note, ‘Can Modi’s Megathemes reshape India?’ we made the point that: “A focus on providing each household with access to banking services is likely to help Mr Modi in two ways. Firstly, the provision of banking services is likely to act as a tangible deliverable that Modi can use to his advantage when the next set of elections are due (as opposed to the relatively intangible deliverables like an improvement in social indicators). Secondly, the provision of banking services to the lowest socioeconomic strata of India is equivalent to creating financial ‘pipes’ to connect to a large vote bank, which in turn can be used to deliver subsidies to the final user. Thus, improved access to banking facilities through the PM Jan Dhan Yojana (PMJDY) appears to be the core deliverable that Modi will focus on over the next five years in a bid to plug an evident need-gap in India.
By using the foundation created by the PMJDY and the Aadhar scheme, Modi is likely to aim to improve the targeting of subsidies in India dramatically
By using the foundation created by the PMJDY and the Aadhar Scheme, Modi is likely to aim for a major improvement in the targeting of subsidies in India. This is in sharp contrast to the previous administration’s strategy of poorly targeted subsidies that amounted to dropping cash out of a helicopter. Also, this could set the stage for Modi to launch a health insurance safety net and basic social security cover, which in turn would pave the way for the promulgation of labour reforms at the Central Government level. How will Modi achieve this goal? After making assumptions regarding the extent of leakages and the pace at which subsides are shifted to the DBT platform it appears that the Government could save expenditure amounting to as much as 0.4% of GDP (refer to page 19 of this note, ‘Force #3: Creation and use of the DBT infrastructure for transfer of subsidies’ for details of the fiscal impact of this dynamic).
January 22, 2015
Ambit Capital Pvt. Ltd.
Page 7
Economy & Strategy Objective #4: Increasing Governmental spending on infrastructure In our note published on January 12, 2015, we made the point that our discussions with the newly appointed NITI Aayog Vice Chairman (and the key source of economic thinking for the Modi Government) suggests that Dr. Panagariya’s prime focus will be to propel India’s GDP growth to a higher trajectory. Dr. Panagariya believes that higher growth alone is the solution to India’s economic as well as social woes. Furthermore, Dr. Panagariya has also argued for loosening India’s fiscal deficit to boost capital spending and to revive growth. This view has takers in the Ministry of Finance as well, as the mid-year analysis report of the Ministry of Finance published in December 2014 said, “…consideration should be given to address the neglect of public investment in the recent past and also review medium term fiscal policy to find the fiscal space for it”.
Share in GFCF (in %)
50% 40% 30% 20% 10%
Government Private Corporate Households Source: CEIC, Ambit Capital research
FY13
FY12
FY11
FY10
FY09
FY08
FY07
FY06
FY05
0%
Exhibit 6: The Modi-led Government appears likely to step up annual incremental capex-related expenditure
Average annual increment in plan exp. (as a % of GDP)
Exhibit 5: The Government’s share in GFCF has been low for the past few years
Dr. Panagariya suggests that his prime focus as the Vice Chairman of the NITI Aayog will be to propel India’s GDP growth to a higher trajectory…Dr. Panagariya has also argued for loosening India’s fiscal deficit
0.35%
0.3%
0.30% 0.25% 0.20%
0.1%
0.15%
0.2%
0.10% 0.05%
0.04%
0.00% 10 yr FY14-15 FY16-17 FY18-19 average (BE) E E
Source: CEIC, Ambit Capital research
How will Modi achieve this goal? In view of the ideological conviction shown by the vice chairman of the newly formed NITI Aayog to prime GDP growth by undertaking public investments, we expect the plan expenditure (or expenditure category corresponding to a capex-intensive category) to rise by 0.3% of GDP per annum over FY16-17 and then taper off to an increment of 0.2% of GDP per annum over FY18-19 (see the exhibit above and refer to page 25 of this note, ‘Investment and macroeconomic implications’ for details of the fiscal impact of this dynamic).
January 22, 2015
Ambit Capital Pvt. Ltd.
We expect the plan expenditure (or expenditure category corresponding to a capexintensive category) to rise by 0.3% of GDP per annum over FY16-17 and then taper off to an increment of 0.2% of GDP per annum over FY18-19
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Economy & Strategy
Section 2: The resultant fiscal forces and their impact on India’s fiscal construct Having articulated the contours of the goals and objectives of India’s strongman based on our extensive discussions with policy experts, we now elaborate on the resultant fiscal forces and quantify the net impact of these forces. The four fiscal forces which we elaborate on include: (1) the recommendations of the 14th Finance Commission coming into force, (2) the replacement of the Planning Commission by NITI Aayog, (3) the creation and use of the DBT infrastructure for the transfer of subsidies, and finally, (4) the deregulation of diesel and petrol prices (see the exhibit below). Exhibit 7: The four fiscal forces that are likely to shape India’s new fiscal construct Fiscal forces
Name
Details
Net fiscal impact (Accretive/ Dilutive)
Force #1
The recommendations of the 14th Finance Commission (FC) coming into force
The FC recommends the share of taxes collected by the Centre that should be transferred to the States and also recommends the quantum of the Centre’s non-plan expenditure that needs to be provided to States as ‘Grants’. In light of the Planning Commission (PC) being scrapped, it appears likely that the 14th FC is likely to provide recommendations regarding plan expenditure as well.
Dilutive: We expect the 14th FC to recommend a markedly higher share for states in Central Government tax revenues. Whilst States have been demanding a 50% share in Central Government taxes, we expect the FC to concede to a demand of a 10% increase, thereby increasing the share of States in Central revenue to 42% from 32% as recommended by the 13th FC. As a share of nominal GDP, all other things being equal, this will translate into the total value of FC-mandated transfers rising to ~4.6% of GDP from FY16 vs an average of 3.6% of GDP in FY15 as per budget estimates. Correspondingly, the FC appears likely to recommend a reduction in previously PC-directed transfers from the Centre to the States (refer to the section below for details).
Force #2
Replacement of the The PC used to prepare five-year plans for the Accretive: The combination of two NITI Aayog–related Planning Commission (PC) country’s development, thereby playing the role of forces is likely to be fiscally-accretive. by the NITI Aayog providing a vision or ideology to policies of the Firstly, in view of the ideological conviction shown by the Central Government. vice chairman of the newly formed NITI Aayog to prime More importantly, the erstwhile PC defined the GDP growth by undertaking public investments, we quantum of plan spends undertaken by the expect the plan expenditure (or expenditure category Central Government as well as vertical transfers corresponding to capex) to rise by 0.3% of GDP per (i.e. Centre to State transfers) and horizontal annum over FY16-17 and then taper off to an increment transfers (i.e. distribution across States). of 0.2% of GDP per annum over FY18-19. Secondly, given that we expect the 14th FC to recommend an increase in States’ share in Central Government taxes and given that the NITI Aayog appears likely to play a minimal role in terms of vertical transfers to States, it seems likely that the FC will also direct the Central Government to offset this increase in FC-recommended transfers by a reduction in States’ share in Central plan expenditure. However, given that cutting expenditure is always more challenging than increasing transfers, we expect the Centre to be able to reduce this component (which currently amounts to ~2% of GDP) by 0.5% of GDP in FY16 and 0.1% per annum of GDP in subsequent years spanning FY17-19.
Force #3
The creation and use of The Government plans to move the payment of the DBT infrastructure for major subsidies onto the DBT platform in a phased transfer of subsidies manner over the next few years so as to create savings for the Central Government by plugging leakages.
Force #4
The deregulation of diesel The Government has deregulated diesel prices and Accretive: The deregulation of diesel will bring down the and petrol prices with petrol being already deregulated, the Government’s petroleum subsidy bill from 0.5% of GDP in petroleum subsidy will now comprise only FY15 to 0.07% of GDP in FY19. kerosene and LPG.
Accretive: After making assumptions regarding the extent of leakages and the pace at which subsides are shifted to the DBT platform (see page 18 for details), it appears that the Government could save expenditure amounting to as much as 0.4% of GDP by FY19.
Source: Ambit Capital research
January 22, 2015
Ambit Capital Pvt. Ltd.
Page 9
Economy & Strategy As is evident from the table below, the net impact of these fiscal forces is likely to impose expansionary pressure on the fiscal deficit in FY16 (see the column highlighted in red in the exhibit below). Subsequently, these four fiscal forces seem likely to turn favourable in FY18-19, as the benefits of the DBT system begin to get amplified. Exhibit 8: The net impact of these forces is likely to spell an expansionary pressure for India’s fiscal deficit in FY16 Change in variables (as a percentage of GDP)
FY16 (change)
FY17 (change)
FY18 (change)
FY19 (change)
Overall impact
Force #1
The recommendations of the 14th Finance Commission coming into force
1.0%
0.0%
0.0%
0.0%
Dilutive
Force #2
Replacement of the Planning Commission by the NITI Aayog leading to a focus on higher capex
0.3%
0.3%
0.2%
0.2%
Dilutive
Replacement of the Planning Commission by the NITI Aayog leading to a reduction in PC-directed spends to States
-0.5%
-0.1%
-0.1%
-0.1%
Accretive
Force #3
Creation and use of the DBT infrastructure for transfer of subsidies
-0.1%
-0.2%
-0.3%
-0.4%
Accretive
Force #4
Deregulation of diesel and petrol prices
-0.4%
0.0%
0.0%
0.0%
Accretive
0.3%
0.0%
-0.3%
-0.4%
Net increase in fiscal deficit
Source: Ambit Capital research. Note: The figures are change from the previous year in terms of percentage of GDP
In the section below we elaborate on each of the above mentioned four fiscal forces. The table below succinctly captures how the FC and PC provide the Central Government with guidelines on the transfer of funds from the Centre to the States. Exhibit 9: Funds from the Centre to the States flow through two bodies - Finance Commission (FC) and Planning Commission (PC) Central Government transfers to States
Finance Commission transfers (amounts to ~65% of the total transfers to states)
Share in Central Govt.'s taxes (amounts to ~84% of total FC transfers)
Planning Commission transfers (amounts to ~35% of the total transfers to states)
Grants-in-aid (amounts to ~16% of total FC transfers)
State plan schemes (amounts to ~48% of total PC transfers)
Centrally sponsored schemes (amounts to ~23% of total PC transfers)
Central plan schemes (amounts to ~6% of total PC transfers)
Special plan schemes (amounts to ~1% of total PC transfers)
Source: Ambit Capital research. Note: Aggregates are based on RBI sourced figures for FY14.
January 22, 2015
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Economy & Strategy
Force #1: The recommendations of the 14th Finance Commission coming into force Most federal systems globally resolve imbalances between Central and State finances through mechanisms like the Finance Commission (FC) in India. Examples of such organisations in other countries include the Commonwealth Grants Commission in Australia or the Equalization Program in Canada.
Most federal systems globally resolve imbalances between Central and State finances through mechanisms like the Finance Commission (FC) in India
As defined by the Indian constitution, FCs are appointed every five years and it is the duty of this commission to make recommendations regarding two key items:
The distribution of tax proceeds collected by the Centre between the Union and the States - This transfer is a part of the gross tax revenue collected by the Centre. Define the quantum of grants given by the Centre to the States and Union Territories - This allocation is made out of the Centre’s non-plan expenditure.
On 31 December 2014, the 14th FC submitted its recommendations to the President of India; its recommendations will cover the five-year period commencing from 1 April 2015. Whilst the recommendations of the commission are yet to be made public, an analysis of the recommendations of the previous commissions leads to the following conclusions regarding what the 14th FC is likely to say:
Vertical transfers: States’ share in Government is likely to be increased
taxes collected by the Central
A time-series analysis of FC recommendations suggests that every commission has recommended incrementally increasing the share of States in Central Government taxes (see the exhibit below). Exhibit 10: FCs have been recommending a higher share in Central taxes for States Income tax (in %)
Basic excise duties (in %)
Number of commodities
55
40
3
2 FC (FY57-62)
60
25
8
3rd FC (FY62-66)
67
20
35
4th FC (FY66-69)
75
20
All
5 FC (FY69-74)
75
20
All
6th FC (FY74-79)
80
20
Al
Finance Commission (FC) 1st FC (FY52-57) nd
th
th
7 (FY79-84)
85
40
All
8th FC (FY84-89)
85
45*
All
85
45
All
78
48**
All
th
9 FC (FY89-95) th
10 FC (FY95-00)
Share in all Central taxes for General category states (in %) 11th FC (FY00-05)
29.5
12th FC (FY05-10)
30.5
th
13 FC (FY10-15)
32.0
Source: RBI, Ambit Capital research Note: (1) All Central taxes do not include cess and surcharges. (2) Percentages before FY2000 have been rounded-off. *40% of the net proceeds to be distributed whilst the remaining 5% would be earmarked for non-plan revenue deficit states. **40% of the net proceeds to be distributed whilst the remaining 75% would be earmarked for non-plan revenue deficit states.
As is evident from the exhibit above, from FY2000 onwards States’ share in Central taxes was widened to include all Central taxes as against on only income tax and excise duties.
From FY2000 onwards States’ share in Central taxes was widened to include all Central taxes as against on only income tax and excise duties
In fact, an analysis of recommendations made by the last three FCs suggests that every subsequent commission has recommended an increase in the States’ share in the total taxes collected by the Central Government (see the exhibit below).
January 22, 2015
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Page 11
Economy & Strategy Exhibit 11: The last three FCs have recommended a higher share in taxes for both Special and General Category states Parameter
11th FC (FY01-FY05)
12th FC (FY06-FY10)
Share of the General Category states in total tax devolution
The share of states in the total The share of states in the total sharable sharable Central taxes to be fixed at Central taxes to be fixed at 30.5%. 29.5%.
Share of Special Category The share of special category states states in total tax devolution in taxes was fixed at 7.04%.
The share of special category states in taxes was fixed at 8.09%.
13th FC (FY11-FY15) The share of states in the total sharable Central taxes to be fixed at 32%. The share of special category states in taxes was fixed at 9.44%.
Source: Finance Commissions, Ambit Capital research
The impact of these recommendations is visible on the annual Central Government budget where states’ share in gross taxes collected by the Centre has been rising steadily (see the exhibit below). Exhibit 12: The rising share of States’ share in gross taxes collected by the Centre
States' share in gross Central taxes* (in %)
30%
28%
26%
24% FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15 (BE) Source: Union Budget, Ambit Capital research, Note: In this chart, the states’ share included National Calamity Contingency Duty transferred to the National Disaster Response Fund which amounted to Rs50bn in FY15 – i.e. a sufficiently small amount that will not affect the calculation of this aggregate substantially.
The exhibit below shows the rationale of the previous FCs that has led them to recommend a higher share in taxes for States. Exhibit 13: Rationale provided for increase in ‘vertical transfers’ from the Centre to the State Finance Commission (FC)
Rationale provided
4 FC (FY66-69)
“Practically all the States have urged for an increase in the share to be assigned to them and have pointed out that as a result of change in the classification of income tax paid by companies brought about by the Finance Act, 1959, the rate of growth of the divisible pool was adversely affected. It was further argued that what the framers of the constitution had intended to be a flexible and expanding source of revenue to the States had ceased to have the significance that was once contemplated.”
11th FC (FY00-05)
“After the Eightieth constitutional amendment, additional excise duties are now part of tax revenue receipts of the Central Government and are sharable with States. In view of these changes, there is a need for a review of the earlier arrangement. Pending that, we further recommend that 1.5% of all shareable Union taxes and duties be allocated to the States separately, thus totaling 29.5% of the net proceeds of all Union taxes and duties.”
12th FC (FY05-10)
“Many states have asked for increasing the share of states in the shareable pool from 29.5% to 33%. Some states have even suggested a figure of 50%. We consider that if the share of states is increased, the redistributive content in the inter se distribution will have to be increased significantly by altering the weights among the distribution criteria so as to be consistent with the equalisation objective. However, for this purpose, grants provide a more effective mechanism. We have, therefore, used grants to a larger extent as an instrument of transfers. At the same time, we recommend that the share of the states in the net proceeds of shareable central taxes be raised from 29.5% to 30.5%.”
13th FC (FY10-15)
“After due consideration of the views of the Centre and states, we are of the opinion that vertical devolution should be informed by the revenue-raising capacity of the Centre and states as well as emerging pressures on their expenditure commitments. There has been a significant increase in non-tax revenues of the Centre, particularly from royalties and the telecommunication sector. Receipts from telecommunication services increased from `80bn in FY02 to `270bn in FY08. Royalties from off-shore hydrocarbon resources are expected to increase substantially in the near future. The Union Government presently shares profit petroleum only from on-shore fields under the New Exploration Licensing Policy (NELP). The resource position of the Centre is expected to improve on account of buoyant non-tax revenues. Thus, there is a case for increasing the share of states in the net tax revenue of the Centre.”
th
Source: Finance Commissions, Ambit Capital research
January 22, 2015
Ambit Capital Pvt. Ltd.
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Economy & Strategy Given this historical pattern of rising share of States in Central taxes, the 14th FC appears likely to also recommend increasing States’ share in taxes as against the 32% share recommended by the 13th FC.
Grants: Whilst Special Category States are likely to be given a higher share, the share of grants to States could be cut
Whist grants to State Governments and Union Territories as a percentage of total expenditure of the Central Government have been declining, this is of limited significance as grants typically amount to a little more than a fifth of the absolute value of the States’ share in Central Government taxes that are transferred to States each year. At an aggregate level, the summation of States’ share in Central Government taxes and grants as a percentage of GDP have been rising since FY99 at an average pace of 0.06% of GDP per annum (see the exhibit below).
The summation of States’ share in Central Government taxes and grants as a percentage of GDP have been rising since FY99 at an average pace of 0.06% of GDP per annum
3.2% 3.0% 2.8% 2.6% 2.4% 2.2%
FY15 (BE)
FY14
FY13
FY12
FY11
FY10
FY09
FY08
FY07
FY06
FY05
FY04
FY03
FY02
FY01
FY00
2.0%
FY99
Sum of grants and State's share in Central taxes (as a % of GDP)
Exhibit 14: The summation of the states’ share in Central Government taxes and grants as a percentage of GDP have been rising
Source: Union Budget, Ambit Capital research
Likely fiscal impact of Force #1: Given this historical pattern of multiple FCs diverting a greater share of Central Government resources to States, what is undisputable is the fact that the 14th FC also appears likely to recommend increasing States’ share in taxes as against the 32% share recommended by the 13th FC. The pace of increase is the summation of: (1) States’ share in Central taxes as well as (2) grants recorded at an average of 0.06% of GDP per annum over the last decade. We expect the quantum of increases to rise dramatically over FY16-21 (which is the term over which the 14th FC recommendations apply) for two sets of reasons:
Given this historical pattern of multiple FCs diverting a greater share of Central Government resources to States, what is undisputable is the fact that the 14th FC also appears likely to recommend increasing States’ share in taxes
Firstly, increasingly there is a tendency amongst States to demand greater autonomy and flexibility in terms of defining their schemes (as opposed to these being thrust upon them by the Centre) as well as funding. The Centre too is known to be empathetic to this point of view as reflected by a range of recent developments (see the exhibit below).
January 22, 2015
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Economy & Strategy Exhibit 15: Subsequent Central Governments have been granting States greater resources Development
Rationale provided
Increasing states’ share in Central Government tax revenue collections Transfer of Central Plan Schemes related funds directly to the State Government
Every Finance Commission since independence has been recommending a higher share for States in Central Government tax revenues (see Exhibit 13 above for details). Historically, the Centre would transfer its share of funds for implementing a certain scheme (say Sarva Shiksha Abhiyan or SSA where the Central funding component is 50%) directly to the local body (such as the Panchayat) in each State, thereby bypassing the State Government entirely. Such expenditure would be classified as ‘Central Plan expenditure’ in the old scheme of things. From FY15 onwards the Centre’s share of funds for implementing a scheme such as SSA will now be directly transferred to the State and such expenditure will rightly be classified as ‘Central Assistance’. As a result of this change in budgeting practices, the ‘Central Plan’ component of plan expenditure as a percentage of GDP in FY15 has fallen to 1.8% of GDP vs 3.1% of GDP in FY14. Correspondingly, the ‘Central Assistance’ component of plan expenditure as a percentage of GDP has risen to 2.6% of GDP in FY15 vs 1.0% of GDP in FY14. The newly formed NITI Aayog calls The NITI Aayog calls for the creation of a 'Governing Council’ comprising the Chief Ministers of all the States and Lt. for the creation of a governing Governors of Union Territories. Also, it calls for the creation of regional councils which will be formed to address council comprising of State CMs specific issues and contingencies impacting more than one state or a region. Source: Budget Documents, Ambit Capital research
Secondly, there has been a significant increase in non-tax revenues of the Centre, particularly from the telecommunications sector and from disinvestments. Non-tax revenue as a percentage of GDP has increased from an average of 6.4% in FY98FY06 to 7.6% in FY07-FY15.
Non-tax revenue as a percentage of GDP has increased from an average of 6.4% in FY98-FY06 to 7.6% in FY07-FY15
In view of these dynamics, we expect the 14th FC to recommend a markedly higher share for States in Central Government tax revenues. Whilst States have been demanding a 50% share in Central Government taxes, we expect the FC to concede to a demand of a 10% increase, thereby increasing the share of States in Central revenue to 42% from 32% as recommended by the 13th FC. As a share of nominal GDP, ceteris paribus, this will translate into the total value of FC-mandated transfers rising to ~4.6% of GDP from FY16 onwards vs 3.6% of GDP in FY16. Interestingly, this expectation of a steep increase in FC-mandated transfers to States is also corroborated by media articles (refer to http://www.livemint.com/Politics/r0ICwUF1KH4JOSkaVSDQvI/Decentralization-to-bea-key-budget-theme.html for details). A footnote on ‘Horizontal Transfers’: The Government can influence horizontal transfers to benefit States that it rules Once the FC determines the vertical transfer from Centre to States, it then defines the formula used to arrive at the horizontal transfers i.e. the distribution of this amount among the States. The table below details the formulae used by the last three Finance Commissions to determine this amount. Exhibit 16: Different Finance Commissions look at different parameters for horizontal transfers 11th FC
12th FC
Population in FY71
10%
25%
25%
Area
7.5%
10%
As per the 13th FC report, area as a criterion in the devolution formula was first introduced by the 10th 10% FC on the grounds that a State with larger area has to incur additional administrative costs to deliver a comparable standard of service to its citizens.
Income distance
62.5%
50%
47.5%
Income Distance criterion works as a proxy for the distance between states in tax capacity as measured by the tax-GSDP ratios.
Fiscal discipline
7.5%
7.5%
17.5%
The index of fiscal discipline is arrived at by improvement in the ratio of the own revenue receipts of a State to its total revenue expenditure to average ratio across all the States.
5%
7.5%
7.5%
-
Criteria
Tax effort Index of infrastructure
13th FC Description The larger population States should get higher share of the tax resource pool. Since the FY71 Census, FCs follow population estimates from the FY71 Census.
0% This variable is used to understand how efficient a State is in collecting taxes. - This variable is used to determine how developed is the infrastructure in the State.
Source: Finance Commission reports, Ambit Capital research
It is interesting to note that the 13th FC decided to increase the weightage of fiscal discipline in the horizontal share calculation formula, stating the following rationale: “Recent Finance Commissions have used equity and efficiency as the two guiding principles while recommending inter se shares of states in tax devolution. The principle of equity addresses the problem of differences in revenue raising capacity and cost
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The 13th FC decided to increase the weightage of fiscal discipline in the horizontal share calculation formula
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Economy & Strategy disabilities across states. When capacity is assessed on the basis of observed revenue collected there is the risk of moral hazard in making the states lax in terms of improving their revenue effort and managing their finances prudently. The principle of efficiency is intended to address this issue and to motivate the states to exploit their resource base and manage their fiscal operations in a cost effective manner. A combination of these two principles has found wide acceptability and addressed the concerns of reforming states. Our recommendations on horizontal sharing have been informed by these principles.”
Congress-ruled states benefitted by the change in formula for horizontal transfers prescribed by the 13th FC
It is interesting to note that Congress-ruled states benefitted by the change in formula for horizontal transfers prescribed by the 13th FC, thereby pointing to the possibility that the Government of the day can influence horizontal transfers to benefit States that it rules. Exhibit 17: Congress-ruled states benefitted by the change in formula for horizontal transfers prescribed by the 13th FC State Winners (out of 12 winners, 8 states had a Congress or Congress+ Ally Govt)
Arunachal Pradesh, Assam, Goa, Himachal Pradesh, Jammu & Kashmir, Madhya Pradesh, Maharashtra, Punjab, Rajasthan, Uttar Pradesh, Uttarakhand, West Bengal
Losers (out of 10 losers, 3 states had a Congress or Congress+ Ally Govt)
Andhra Pradesh, Bihar, Chhattisgarh, Gujarat, Haryana, Jharkhand, Karnataka, Kerala, Odisha, Tamil Nadu
Source: Finance Commissions, Ambit Capital research, Note: States with a Congress Govt. or Congress+Ally Govt. in FY10 are highlighted in BOLD.
January 22, 2015
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Economy & Strategy
Force#2: Replacement of the Planning Commission by the NITI Aayog On 15 August 2014, the newly elected PM made a critical announcement from the ramparts of the Red Fort saying, “…within a short period, we will replace the Planning Commission [PC] with a new institution having a new design and structure”. Following up on this announcement, the Cabinet passed a resolution on 1 January 2015 calling for the creation of a body christened the National Institute for Transforming India (NITI) Aayog. PM Modi then decided to appoint Arvind Panagariya as the vice chairman of this new policy-making institution that will now replace the PC. The ideological direction that the NITI Aayog is likely to focus on: High GDP growth focus even at the cost of fiscal discipline It is clear that the main function that the NITI Aayog will undertake is to provide an ideological direction to the NDA Government. The NDA’s existing sources of economic ideology are limited, with its PM proving to be an astute CEO (but not a visionary Chairman; refer to our note on August 26, 2014 for details) and with the RSS largely being a source of religious ideology. The Vice Chairman of the newly formed NITI Aayog, Dr Panagariya, is therefore likely to be the main source of this sort of ideological firepower that the NDA currently lacks.
It is clear that the main function that the NITI Aayog will undertake is to provide an ideological direction to the NDA Government
In a bid to predict the likely ideology that Dr. Panagariya is likely to recommend, in the section below (on the basis of our reading of Dr. Panagariya’s body of published work, public addresses and our own discussions with the economist), we expect a ‘Single-minded focus on higher growth, even at the cost of a higher fiscal deficit’ to be the NITI Aayog’s main goal. Our discussions with Dr. Panagariya (pre-dating his announcement as the NITI Aayog Vice Chairman) reinforce this view - it is clear that his prime focus will be to propel India’s GDP growth to a higher trajectory. Dr. Panagariya believes that higher growth alone is the solution to India’s economic as well as social woes. He cites in ‘India’s Tryst with Destiny’ (which has been published in the US under the title of ‘Why growth matters?’) that during India’s high growth phase spanning FY04-11 the decline in poverty too was the greatest. Higher growth, according to this economist, is beneficial to the rural masses of India as well, since it leads to faster growth in rural wages besides providing the Government with higher tax revenue collections, which can be spent on various social sector schemes. Furthermore, Dr. Panagariya has argued for loosening India’s fiscal deficit to boost capital spending and to revive growth. Likely fiscal impact of Force#2: Share of plan expenditure in total expenditure to be increased at a faster pace
We expect a ‘Single-minded focus on higher growth, even at the cost of a higher fiscal deficit’ to be the NITI Aayog’s main goal
Dr. Panagariya believes that higher growth alone is the solution to India’s economic as well as social woes
With Dr. Panagariya at the helm of the NITI Aayog, the Government’s focus is likely to move to reviving growth even at the cost of maintaining fiscal targets. This view has takers in the Ministry of Finance as well, as the mid-year analysis report of the Ministry of Finance published in December 2014 said, “…consideration should be given to address the neglect of public investment in the recent past and also review mediumterm fiscal policy to find the fiscal space for it” (see the exhibit below for more details). Exhibit 18: Statements made in the mid-year economic analysis of the Central Government point to its increasing tendency to spend more on capex Topic
Quote
“..this reflects low and declining corporate profitability as more than one-third firms have an interest coverage ratio of Over indebtedness of corporate less than one (borrowing is used to cover interest payments). Over-indebtedness in the corporate sector with median sector debt-equity ratios at 70 per cent is among the highest in the world.” Need for greater public “..It seems imperative to consider the case for reviving public investment as one of the key engines of growth going investments forward, not to replace private investment but to revive and complement it.” Source: Mid-year Economic analysis 2014-15 Government of India, Ambit Capital research
January 22, 2015
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Economy & Strategy It is important to note that more than 80% of the Union Government’s non-plan expenditure is accounted for by non-capex-intensive expenditure categories such as interest payments and subsidies (see the exhibit below).
Others, 17%
Interest Payments , 31%
Police , 4%
R² = 0.1624
4.5%
4.0%
3.5%
3.0%
Defence , 19%
Source: CEIC, Ambit Capital research
Thus, in a bid to increase the Government’s share in investment, the Government is likely to increase the pace of plan expenditure growth in India and revise its mediumterm fiscal deficit targets upwards for FY16 and FY17 from 3.6% of GDP by FY16 and 3% of GDP by FY17. Plan expenditure as a percentage of total expenditure has been increasing at the pace of 0.04% per annum for the past decade. We expect this pace to rise to 0.3% of GDP per annum for the next two years in FY16-17 and then be phased down to 0.2% of GDP in FY18-19, as the Government starts handing over this responsibility to the private sector, which in two years should be in a better position to take on the responsibility of infrastructure creation (see the exhibit below for details). If the Government decides to phase-out the plan and non-plan expenditure classification in the medium term, this inference still holds, as the Government will correspondingly increase a capex-related category.
0.2%
0.20%
0.15%
0.15%
0.2%
0.10% 0.04%
0.00% 10 yr FY14-15 FY16-17 FY18-19 average (BE) E E
Source: CEIC, Ambit Capital research
January 22, 2015
0.0% 0.0%
-0.2%
-0.1% -0.1% -0.1%
-0.4% -0.6%
-0.5% FY19 E
0.25%
FY18 E
0.30%
0.1%
FY17 E
0.3%
10 yr average
0.35%
0.05%
Exhibit 22: The Central Government is likely to cut plan support to States to offset the increase in FC transfers
Change in Central increment in plan exp. (as a % of GDP)
Average annual increment in plan exp. (as a % of GDP)
Exhibit 21: The Central Government is likely to increase the quantum of plan expenditure over FY16-17
In a bid to increase Government share in investment, the Government is likely to increase the pace of growth of plan expenditure in India and revise its medium-term fiscal deficit targets upwards for FY16 and FY17 from 3.6% of GDP by FY16 and 3% of GDP by FY17
FY16 E
Source: CEIC, Ambit Capital research
FY14
Subsidies , 23%
5.0%
FY01 FY02 FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15 (BE)
Pensions , 7%
Exhibit 20: Plan expenditure as a percentage of nominal GDP has been increasing at 0.04% per annum
Plan Exp. (as a share of nominal GDP)
Exhibit 19: 83% of non-plan expenditure is accounted for by non-capex-intensive expenditure categories
Source: CEIC, Ambit Capital research
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Economy & Strategy Furthermore, the 14th FC is likely to direct the Central Government to offset the increase in States’ share in Central Government taxes by reducing Central funding to States. The Centre currently provides more than 40% of plan expenditure to States in the form of funding state plan schemes, central plan schemes, centrally sponsored schemes and special plan schemes. The erstwhile Planning Commission played a pivotal role in defining this sum and this currently amounts to about 2% of GDP, which is a subset of the Central Government’s total plan expenditure which is likely to amount to 4.4% of GDP in FY15.
The 14th FC is likely to direct Central Government to offset increase in States’ share Central Government taxes reducing Central funding States
the the in by to
Given that we expect the 14th FC to recommend an increase in States’ share in Central Government taxes (which is likely to amount to an increase of 1.1% of GDP in Central transfers to States) and given that the NITI Aayog appears likely to play a minimal role in terms of fund allocations to states, the Central Government will likely be advised to offset this increase in FC-recommended transfers by a reduction in States’ share in Central plan expenditure. However, given that cutting expenditure is always more challenging than increasing transfers, we expect the Centre to be able to reduce this component (which currently amounts to ~2% of GDP) by 0.5% of GDP in FY16 and 0.1% of GDP in subsequent years (see the exhibit above).
January 22, 2015
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Economy & Strategy
Force#3: Creation and use of the DBT infrastructure for transfer of subsidies Within a fortnight of assuming office as the PM of India, Modi was working on the ‘Prime Minister’s Jan Dhan Yojana (PMJDY)’ scheme, as is evident by the fact that Arun Jaitley, the Finance Minister (FM), alluded to this in his budget speech on July 10, 2014 (see the exhibit below).
PMJDY is going to be the flagship programme of the NDA Government
Exhibit 23: The PM Jan Dhan Yojana appears to be the core deliverable that Modi will focus on over the next five years Source of statement
Statement
Arun Jaitley, Budget Speech on “To provide all households in the country with banking services, a time-bound programme would be launched as July 10, 2014 the Financial Inclusion Mission on 15 August this year. It would particularly focus to empower the weaker sections of the society, including women, small and marginal farmers and labourers. Two bank accounts in each household are proposed to be opened which will also be eligible for credit.” Narendra Modi, Independence “Brothers and sisters, I have come here with a pledge to launch a scheme on this festival of freedom. It will be day speech on August 15, called Pradhanmantri Jan-Dhan Yojana (PMJDY). I wish to connect the poorest citizens of the country with the 2014 facility of bank accounts through this plan.” Narendra Modi at the launch of PMJDY on August 28, 2014
“If crores of Indians are outside the ambit of organised financial services because they do not have a bank account even after 68 years of independence, I call it financial untouchability. Gandhiji ended social untouchability; it is our mission to eradicate this kind of untouchability now to fight poverty.”
Raghuram Rajan on September 15, 2014
“Universal financial access is a national priority because if every household is connected to the financial system then we will have increased financial savings, less cash economy and a Direct Benefit Transfer (DBT) system in place which will reduce leakage and price distortion, leading to more empowerment of the masses.”
Source: Media, Ambit Capital research
What does the PMJDY entail? The following table summarises the key targets of this scheme based on the various announcements made. Exhibit 24: What does the PMJDY entail and over what time period? Targets of the scheme
Description
Bank accounts Two bank accounts for each of the estimated 75 million poor bank households are to be opened by August 14, 2015.
This implies opening 150 million bank accounts in less than12 months. As on 15 January 2015, 113.7mn accounts have been opened under PMJDY, of which 67.7mn are in rural areas and 46mn are in urban areas. Rupay Cards have been issued for 97.4mn accounts.
Payment services and credit Each bank account is to be provided with an overdraft facility of `5,000 and a Rupay debit card.
The Mor Committee Report envisages Ubiquitous Access to Payment Services by January 2016. As per the additional comments made by Shikha Sharma and SS Mundra, “While January 2016 can be an aspirational goal, given the scale of the task, a target date of January 2018 may be more realistic and implementable”. The overdraft facility will only be extended to Aadhar-enabled accounts after satisfactory operation of the account for six months. Assuming that this linkage is achieved, the banking system will have to extend credit of `750bn (i.e. 75mn households x 2 bank accounts per household x `5,000).
Insurance cover Each bank account will be provided with accident insurance cover of `100,000 and life insurance cover of `30,000
For life insurance cover, the Government has decided to set aside a sum of `500mn from the Social Security Fund (SSF) which was set up by the Government of India in 1988-89 and is managed by the Life Corporation of India (LIC). The National Payments Corporation of India (NPCI), promoted by public sector banks, will provide premium on the `0.1mn accident insurance cover on behalf of the customers.
Bank-based transfer of subsidies Each bank account will be linked to the Aadhaar card.
The linking of the Rupay debit card and the Aadhar card is critical, as this will allow the Government to transfer subsidies through banks and thereby allow banks to earn a fee income. Prime Minister Narendra Modi has directed the Unique Identification Authority of India (UIDAI) to ensure ‘universal coverage’ under Aadhaar by June 2015. From January 1, 2015, the entire LPG subsidy has been transferred on the DBT platform. More subsidies and transfers will follow soon.
Source: Media reports, Ambit Capital research
Given that PMJDY appears to be the flagship scheme that the Government of the day wants to implement over its five-year term and given that the DBT platform relies on PMJDY coverage, rapid progress has been made with respect to opening accounts under PMJDY and rolling out Aadhaar cards (see the exhibit below).
January 22, 2015
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Rapid progress has been made with respect to opening accounts under PMJDY and rolling out of Aadhaar cards
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Economy & Strategy Exhibit 25: There has been rapid progress in terms of opening accounts under PMJDY and rolling out Aadhaar cards Description Number of accounts opened under PMJDY to date RuPay Cards issued. Total number of accounts to be opened under PMJDY Aadhaar cards issued to date
Number
Unit
Source
113.7
Mn
PMJDY
97.4
Mn
PMJDY
150
Mn
PMJDY
730
Mn
UIDAI
Source: Various, Ambit Capital research. Note: Status as on 15 January 2015
Our sources suggest that once PMJDY has universal coverage and the bank accounts are seeded through Aadhaar cards, the Government eventually plans to route all transfers, including fertiliser subsidies, food subsidies, petroleum subsidies, pensions as well as scholarships through the Direct Benefits Transfer (DBT) platform. Note that the PM has announced the target date by which PMJDY has to meet its targets is 26 January 2015 and he has also said that the Aadhar rollout has to be complete by 30 June 2015.
Government eventually plans to route all transfers, including fertilisers subsidies, food subsidies, petroleum subsidies, pensions as well as scholarships through the Direct Benefits Transfer (DBT) platform
In the subsequent section we dive into the specifics of the savings that are likely to materialise as subsidies are routed through the DBT system (thereby plugging leakages and pilferage). Likely fiscal impact of Force#3: Transfer of subsidies on DBT platform will help Government plug the rampant leakages prevalent presently There are three major subsidies in India i.e. petroleum, food and fertilisers. These three subsidies together account for 15% of the total expenditure bill of the Central Government and as per FY15 budget estimates amount to 2.1% of GDP. Food subsidies likely to remain constant at 0.9% of GDP Food subsidies in India comprise subsidies to farmers through support prices and purchase operations of the Food Corporation of India (FCI), consumer subsidies through the public distribution system (PDS), and subsidies to FCI to cover all its costs. Food subsidies account for roughly 36% of the total subsidies in India and as a percentage of GDP the food subsidy has amounted to 0.9% of GDP since FY10. As the trend suggests, we assume that the food subsidy bill will continue to rise in absolute terms on account of the requirements to honour the Food Security Act (FSA) but its share in GDP will remain constant at 0.9% of GDP.
Food subsidies account for roughly 36% of the total subsidies in India and the food subsidy as a percentage of GDP has amounted to 0.9% of GDP since FY10
Exhibit 26: Food subsidies in India have averaged 0.9% of GDP for the past five years 1.2%
Food subsidy (in ` bn)
1200
1.0%
1000 800
0.8%
600
0.6%
400 0.4%
200 0
Food subsidy (as % of GDP)
1400
0.2% FY10
FY11
FY12
FY13
FY14
FY15 (BE)
Food subsidy (in INR bn, Left Scale) Food subsidy (as % of GDP, Right Scale) Source: Union Budget, Ambit Capita research Note: BE refers to Budget Estimates
January 22, 2015
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Economy & Strategy Fertiliser subsidies to remain constant at 0.6% of GDP In order to control the fluctuations in fertiliser prices, the Government of India regulates the fertiliser market by providing subsidies. The retail price of fertilisers is fixed and is uniform throughout the country. The difference between the retention price (adjusted for freight and dealer’s margin) and the price at which the fertilisers are provided to the farmer is paid back to the producer as subsidy. The share of fertiliser subsidies in total subsidies has also fallen from 43% in FY10 to 27% in FY15. Correspondingly, as a percentage of GDP this bill has declined from 1% of GDP in FY10 to 0.6% of GDP in FY15 (as per budget estimates; see the exhibit below). Despite the declining trend, for the sake of prudence we assume that the fertiliser subsidy will continue to grow in absolute terms but will be constant at 0.6% of GDP till FY19.
Fertiliser subsidies’ share in total subsidies has also fallen from 43% in FY10 to 27% in FY15; correspondingly, as a percentage of GDP, this bill has declined from 1% of GDP in FY10 to 0.6% of GDP in FY15
Exhibit 27: The share of fertiliser subsidies in total subsidies has declined from 43% in FY10 to 27% in FY14 1.2% 1.0%
700.0
0.8%
650.0
0.6% 0.4%
600.0
0.2%
550.0
Fertilizer subsidy (as % of GDP)
Fertilizer subsidy (in INR bn)
750.0
0.0% FY10
FY11
FY12
FY13
FY14
FY15 (BE)
Fertlizer subsidy (in INR bn, Left Scale) Fertlizer subsidy (as % of GDP, Right Scale) Source: Union Budget various years, Ambit Capital research. Note: BE refers to Budget Estimates
Petroleum subsidies likely to experience a dramatic reduction The Government regulates the retail price of kerosene and LPG to insulate consumers from the impact of international crude prices. This results in under-recoveries to stateowned oil marketing companies and is compensated by the Government partially, thereby resulting in the petroleum subsidy bill.
1200
1.2%
1000
1.0%
800
0.8%
600
0.6%
400
0.4%
200
0.2%
0
Petroleum subsidy (as a % of GDP)
Petroleum subsidy (in ` bn)
Exhibit 28: Petroleum subsidies as a percentage of GDP will continue to fall further
0.0% FY10
FY11
FY12
FY13
FY14
FY15 (BE)
Petroleum subsidy (in INR bn, Left Scale) Petroleum subsidy (as % of GDP, Right Scale) Source: Union Budget various years, Ambit Capital research. Note: BE refers to Budget Estimates
January 22, 2015
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Economy & Strategy As the average price of Brent crude increased from US$69.5/barrel in FY10 to US$110/barrel in FY13, the share of petroleum subsidies increased from 11% in FY10 to a peak of 38% in FY13. Correspondingly, the share of petroleum subsidies as a percentage of GDP also increased from 0.2% of GDP in FY10 to 1% of GDP in FY13. The combination of a reduction in the price of crude, deregulation of diesel prices as well as the shift in LPG to the DBT platform has helped the Government limit the size of this subsidy to 0.5% of GDP in FY15. Going forward we expect petroleum subsidies as a percentage of GDP to fall from 0.5% of GDP in FY15 to 0.07% in FY19. We have assumed that due to diesel price deregulation, the petroleum subsidy will fall from 0.5% of GDP to 0.1% of GDP or `133bn in FY16. Thereafter, the subsidies on account of kerosene and LPG will rise to `142bn by FY19. Post deregulation, LPG comprises 70% of the petroleum subsidy bill whilst kerosene accounts for 30%. We have assumed a 5% YoY increase in LPG subsidy outlay and a 5% YoY decline in kerosene subsidy outlay because historically consumption of kerosene has been declining YoY and consumption of LPG has been increasing. We assume that this trend will continue in the future (see the exhibit below).
The combination of a reduction in the price of crude, deregulation of diesel prices as well as moving LPG to the DBT platform has helped the Government limit the size of the petroleum subsidy to 0.5% of GDP in FY15 from 1% in FY10
Exhibit 29: Petroleum subsidy will fall to 0.07% of GDP by FY19 Petroleum subsidy (` bn)
Nominal GDP (` bn)
FY16 (E)
133
133,254
0.1
FY17 (E)
136
149,777
0.09
FY18 (E)
139
168,649
0.08
FY19 (E)
142
189,899
0.07
FY
Petroleum subsidy (as a % of GDP)
Source: Ambit Capital research
Transferring subsidies on the DBT platform could be a game-changer As mentioned earlier, the Government eventually plans to transfer all the subsidies onto the DBT platform. However, this will be done in a phased manner, with petroleum subsidies transferred first followed by food and then fertilisers. In this section we attempt to quantify the savings that will accrue to the Government if all the three major subsidies i.e. petroleum, food and fertilisers are transferred to the DBT platform in a phased manner. The transfer of subsidies from the Central Government to the final consumer is affected by leakages, and research in this area suggests that as much as 40% of the subsidies and transfers are wasted through leakages (Himanshu and Sen, 2013).
The transfer of subsidies from the Central Government to the final consumer is affected by leakages, and research in this area suggests that as much as 40% of the subsidies and transfers are wasted through leakages
Exhibit 30: Studies point out that there are leakages of 40-50% in the Public Distribution System Title
Key relevant finding
Authors
Performance Evaluation of Targeted Public Distribution System
“Leakages in India after the implementation of the targeted PDS concludes that illegal diversions of rice and wheat at the all- The Planning India level in 2003/2004 was 37% of the total supply of Commission of India subsidized grain meant for the BPL category”
Planning Commission, 2005
Public Distribution of Food in India: Coverage, Targeting and leakages
In1986/1987, 37% of the supply of subsidized rice and 38% of Deepak Ahluwalia the supply of subsidized wheat were illegally diverted
World Bank, 1993
In the year 2004-05, the per capita consumption of subsidized How can food subsidies work better? foodgrains was 1.03 kg per month while the per capita supply Shikha Jha, Bharat of subsidized food works out to be 2.27 kg per month. This Ramaswami Answers from India and Philippines works out to a leakage of 55% of subsidized foodgrains supply.
Source and year
Asian Development Bank, 2010
Source: Various Academic publications, Ambit Capital research
Based on these findings, we assume that the Government will be able to save 40% of every rupee spent on subsidies once the subsidies are transferred onto the DBT platform. Secondly, we assume that the Government will be able to transfer the subsidies on the DBT platform in a phased manner. Whilst subsidies on food and petroleum can be transferred to the DBT platform on a stage-by-stage basis, given that politically executing the same is likely to be a difficult decision for fertiliser subsidies we assume a slower rate for this constituent. January 22, 2015
Ambit Capital Pvt. Ltd.
Page 22
Economy & Strategy Exhibit 31: Assumptions made regarding the phased transfer of subsidies onto DBT
Government can save as much as 40% by plugging the leakages… in FY19 the Government could save 0.4% of GDP
Share of subsidies transferred to the DBT platform Petroleum subsidy
Food subsidy
Fertilizer subsidy
FY16E
20%
20%
10%
FY17E
40%
40%
20%
FY18E
60%
60%
30%
FY19E
80%
80%
40%
Source: Ambit Capital research
Combining the above-mentioned assumptions leads us to conclude that as the major subsidies are transferred to the DBT in a phased manner and assuming the Government can save as much as 40% by plugging the leakages, in FY19 the Government will be able to save up to `760bn or 0.4% of the GDP (see the exhibit below for details). Exhibit 32: The transfer of major subsidies to the DBT platform in a phased can save the Government as much as 0.4% of GDP by FY19 ` bn
Transfer to DBT platform (` bn)
Savings (as % of GDP)
Petroleum subsidies1
Food subsidies2
Fertiliser subsidies3
Petroleum subsidies
Food subsidies
Fertiliser subsidies
Petroleum subsidies
Food subsidies
Fertiliser subsidies
Total
FY16E
133
1,199
800
27
240
80
0.01%
0.07%
0.02%
0.1%
FY17E
136
1,348
899
54
539
180
0.01%
0.14%
0.05%
0.2%
FY18E
139
1,518
1,012
83
911
304
0.02%
0.22%
0.07%
0.3%
FY19E
142
1,709
1,139
114
1,367
456
0.02%
0.29%
0.1%
0.4%
Source: Ambit Capital research, Note: We have assumed a nominal GDP growth rate of 12.7% per annum from FY16 to FY19. 1 We have calculated the quantum of the food subsidy by assuming that this amounts to 0.9% of GDP. 2 We have calculated the petroleum subsidy by assuming these amounts to 0.1% of GDP in FY16, 0.09% of GDP in FY17, 0.08% of GDP in FY18 and 0.07% of GDP in FY19. 3 We have calculated the fertiliser subsidy by assuming these amounts to 0.6% of GDP.
January 22, 2015
Ambit Capital Pvt. Ltd.
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Economy & Strategy
Force#4: Deregulation of diesel prices The Government used the opportunity of falling global crude prices to deregulate domestic diesel prices completely on October 19, 2014. With petrol prices already deregulated, LPG and kerosene are the only items that create the petroleum subsidy. Post deregulation, LPG comprises 70% of the petroleum subsidy bill whilst kerosene accounts for 30%. We have assumed a 5% YoY increase in LPG subsidy outlay and a 5% YoY decline in kerosene subsidy outlay because historically consumption of kerosene has been declining YoY and consumption of LPG has been increasing. We expect this trend to continue in the future as well. This leads us to estimate that the petroleum subsidy as a percentage of GDP will fall from 0.5% in FY15 to 0.07% in FY19 (see the exhibit below for more details).
The deregulation of petrol and diesel will reduce the petroleum subsidy as a percentage of GDP from 0.5% in FY15 to 0.07% in FY19
Exhibit 33: The Government’s petroleum subsidy bill could fall to 0.07% of GDP by FY19 on account of diesel price deregulation Petroleum Assumptions made for subsidies(as % crude(US$/barrel) of GDP)
Kerosene (` bn)
LPG (` bn)
Total petroleum subsidy (` bn)
FY16
40
93
133
0.1%
65
FY17
38
98
136
0.09%
90
FY18
36
103
139
0.08%
90
FY19
34
108
142
0.07%
90
Source: Ambit Capital research
January 22, 2015
Ambit Capital Pvt. Ltd.
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Economy & Strategy
Section 3: Investment and macroeconomic implications Having articulated Modi’s goals and objectives as well as the impact of the resultant fiscal forces, we finally move to outlining the macroeconomic and investment implications of these forces. Select infrastructure stocks stand to benefit from the Government’s focus on infrastructure creation Given that we expect the Modi Government to increase the Centre’s involvement in the infrastructure sector, it seems likely that the Government is likely to play an active role in building roads, freight corridors and power plants. Once the cash inflows from these projects stabilise, the Government might then sell down the asset to the private sector. As stated its mid-year economic analysis, published on 19 December 2014, the Government says that, “It seems imperative to consider the case for reviving public investment as one of the key engines of growth going forward, not to replace private investment but to revive and complement it.” (Source: http://finmin.nic.in/reports/MYR201415English.pdf)
It seems likely that the Government is likely to play an active role in building roads, freight corridors and power plants
This points to a very different construct as compared to the PPP model that India has followed over the past 15 years. In the PPP model, the state was placing the construction risk on the private sector and given the weakness of India’s institutions (outdated laws pertaining to public infrastructure, venal politicians and civil servants, and a clogged up judicial system), the predictable result was incomplete projects and bankrupt project sponsors. In the new model, the Modi Government seems to be moving towards the Government taking on the onus of building the asset with the private sector largely providing EPC services. (For a lucid justification of why this altered model could work better than PPP, it is worth reading IDFC Chairman, Rajiv Lall’s column in the 3 January edition of the Business Standard: http://www.businessstandard.com/article/opinion/rajiv-lall-turn-the-ppp-model-on-its-head115010300622_1.html.) As a result of this dynamic, companies like Concor, Coal India and NTPC are likely to play starring roles in the next stage of India’s infrastructure development. Efficient road builders with reasonably healthy balance sheets like Ashoka Buildcon, Sadbhav Engineering and MBL Infrastructure are also well placed to benefit from the new wave of road building contracts (see the exhibit below for details). Exhibit 34: Infrastructure development - Stocks in focus Mcap (in US$ mn)
6M ADV (in US$ mn)
FY15 P/E
FY15 P/B
BUY
40,189
18.7
16.0
5.2
NTPC IN
SELL
19,213
13.4
12.5
1.3
PGCIL
PWGR IN
BUY
12,479
10.4
14.4
2
Concor
CCRI IN
NR
4,417
2.1
28
3.6
BEL
BHE IN
UR
4,094
8.1
25.4
3.1
Alstom T&D
ATD IN
NR
1,967
1.0
66.1
8.6
Sadbhav Engineering SADE IN
UR
709
1.1
NA
2.7
Techno Electric
TEEC IN
NR
385
0.7
21.9
2.6
Ashoka Buildcon
ASBL IN
NR
383
0.5
25.3
1.7
MBL Infrastructures
MBL IN
NR
149
0.3
10.4
1.4
Stock
Ticker
Coal India Ltd.
COAL IN
NTPC
Our Stance
Source: Bloomberg, Ambit Capital research. Note: UR indicates Under Review, NR indicates not rated.
Based on our discussions with policy experts over the past quarter, it is relatively clear that the Centre is also likely to step up spending on Defence, Transmission and Distribution as well as Railways. The contracts for supplying equipment for this kind of capital expenditure are likely to go to a mixture of public and private sector firms. Hence BEL, PGCIL, Alstom T&D as well as Techno Electric are well placed to benefit from the coming step-up in Government spending.
January 22, 2015
Ambit Capital Pvt. Ltd.
Page 25
Economy & Strategy Plugging of leakages in Government transfers can boost rural consumption As leakages in the subsidy mechanism are reduced and as the DBT mechanism becomes more ubiquitous, there is likely to be a redistribution of wealth in favour of the poorest deciles of society. Whilst it is challenging at present to discern the precise contours of this redistribution, the rural elite (which was the biggest beneficiary of leakages in the subsidy mechanism) is likely to suffer at the expense of the lowest strata of rural India. This in turn should provide a fillip to the consumption of the ‘bottom of the pyramid’ FMCG goods and could dent the type of aspirational consumption that better-off rural classes indulged in. This is an early hypothesis on our part and we will have to do more field work on this subject over the coming months to validate this hypothesis.
As leakages in the subsidy mechanism are reduced and as the DBT mechanism becomes more ubiquitous, there could be a redistribution of wealth in favour of the poorest deciles of society
FMCG companies classify higher income groups in rural area as socio-economic class or SEC A and B. Similarly they classify lower income groups as SEC C, D and E. As a result of the above state dynamic, SEC C, D and E are likely to spend more on consumption goods rather than SEC A and B. Our consumer analyst Rakshit Ranjan suggests that brands like HUL, Dabur and Colgate are set to gain in such a scenario as these companies source 40-50% of their revenues from rural India. Exhibit 35: Rural consumption - Stocks in focus Mcap (in US$ mn)
6M ADV (in US$ mn)
FY15 P/E
FY15 P/B
SELL
33,087
17.4
50.5
50.0
DABUR IN
SELL
7,136
6.2
41.0
13.3
CLGT IN
SELL
4,180
5.5
45.3
37.8
Stock
Ticker
Our Stance
HUL
HUVR IN
Dabur Colgate
Source: Bloomberg, Ambit Capital research. Note: UR indicates Under Review, NR indicates not rated.
Government’s stance on fiscal deficit crucial in deciding the quantum of rate cuts In the near term, the extra pressure on the fiscal deficit in FY16 (as highlighted above) could result in adverse impacts on the ten-year bond yield and on the INR if global macro sentiment worsens and/or India’s GDP growth fails to move towards 6% over the course of the next six months. History points to a positive relationship between the Indian ten-year bond yield (annual average) and the Central Government’s fiscal deficit as percentage of GDP (see the exhibit below).
In the near term, the extra pressure on the fiscal deficit in FY16 could result in adverse impacts on the ten-year bond yield and on the INR
Exhibit 36: There exists a positive relationship between the ten-year bond yield and the size of the India’s fiscal deficit as a percentage of the deficit
R² = 0.1589
Fiscal deficit (as % of GDP)
7% 6% 5% 4% 3% 2% 4%
6% 8% 10% 12% 10 year avg. Government's securities yield (in %)
14%
Source: CEIC, Ambit Capital research. Data pertains to FY98-FY14
Furthermore, history also suggests that the monetary policy cycle and fiscal policy cycle tend to offset one another (see the exhibit below). This is because the rise in fiscal deficit restricts the central bank’s power to reduce rates, as the combination of an expansionary monetary and fiscal policy can fan inflation.
January 22, 2015
Ambit Capital Pvt. Ltd.
Page 26
Economy & Strategy As is evident from the exhibit below, four years namely FY06, FY09, FY10 and FY12 saw India’s fiscal deficit expanding. Out of this, only one year i.e. FY09 (when the country was grappling with the aftermath of the global financial crisis of 2008) saw the expansion in the deficit being accompanied by monetary policy easing. Exhibit 37: Years in which the fiscal policy is supportive seldom see monetary policy being supportive as well 4% 2% 0% -2% -4% FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14 Change in fiscal deficit (%)
Change in repo rate (%)
Source: CEIC, Ambit Capital research
Therefore, the Government’s intention to expand the fiscal deficit in FY16 will be crucial for the extent of rate cuts to be administered. As mentioned in our note on 7 January (click here for the note), major slippage on the fiscal front could restrict the scope of monetary easing by the RBI. On 15 January when it administered a surprise 25bps cut in the repo rate, the RBI Governor clearly said, “Finally, the government has reiterated its commitment to adhering to its fiscal deficit target.” If the fiscal discipline that the RBI Governor hopes to see does not materialise, his credibility would also take a knock. Transfers to the States will be conditional on growth-centric policies followed by the States As highlighted in Section 1, even after adjusting for the reduction in the transfer of plan spends from the Centre to the States, a reasonably large sum of funds, amounting to 1.5% of GDP in FY16, will be available to the Centre in terms of discretionary sums that can be transferred to the State. It seems likely that the PM is going to follow a policy of ‘competitive federalism’ whereby States which embark on growth-friendly policies will be given greater transfers, thereby forcing states to move towards policies which promise higher growth and hence higher job creation.
States which deregulate land and labour markets quicker and follow more growth-centric policies are likely to get more transfers from the Centre
In this context, three BJP-ruled States (i.e. Rajasthan, Haryana and Madhya Pradesh) have already undertaken legislative labour reform. On 19 January, the Prime Minister’s Office (PMO) sent letters to the chief secretaries of all states asking them to reform the labour laws in line with the policies followed by the Rajasthan Government (Source: http://www.livemint.com/Politics/9t08SH138jCkGZ5jG4dZiM/NDA-nudgeto-states-on-labour-reforms.html). This policy of competitive federalism is likely to trigger heightened competition between states for investment inflows. The biggest beneficiary of such competition would be the manufacturing sector as various members of the Government, including the PM on his 15 August speech, have clearly said that they want to see more activity in sectors such as textiles, leather goods and electronics. If land and labour reforms are pushed through on a large scale then combined with the 35% depreciation of the INR against the USD over the past five years and India’s proven competitive advantage in light industrial manufacturing, we could see a range of well-managed manufacturing companies prosper mightily in the years to come. For more details on this megathemes, please refer to our thematic dated 30 September 2014 which has in-depth profiles of AIA Engineering, TVS Motors,
January 22, 2015
Ambit Capital Pvt. Ltd.
Page 27
Economy & Strategy Bajaj Auto, Bharat Forge, Balkrishna Industries, WABCO, Cummins India, TTK Prestige, VA Tech, Triveni Turbines, Elgi Equipments, PI Industries, Aarti Industries (see exhibit below). Exhibit 38: ‘Make in India’ - Stocks in focus Stock
Ticker
Our Stance
Mcap (in US$ mn)
6M ADV (in US$ mn)
FY15 P/E
FY15 P/B
Auto & Auto Ancillaries Bajaj Auto
BJAUT IN
SELL
11,496
14.6
20.5
6.2
Bharat Forge
BHFC IN
NR
3,814
14.3
34.6
7.3
TVS Motors
TVSL IN
BUY
2,319
14.4
46.7
9.7
WABCO
WIL IN
Balkrishna Industries BIL IN
NR
1,536
0.6
70.4
10.7
BUY
1,027
1.9
13.0
2.7
Light Engineering Cummins India
KKC IN
SELL
4,017
3.0
34.9
8.7
AIA Engineering
AIAE IN
BUY
1,696
2.1
25.8
5.0
TTK Prestige
TTKPT IN
BUY
681
1.1
33.8
6.1
VA Tech
VATW IN
BUY
683
1.5
29.0
4.4
Triveni Turbines
TRIV IN
NR
582
0.4
35.4
15.7
Elgi Equipments
ELEQ IN
NR
412
0.2
40.3
4.9
PI Industries
PI IN
BUY
1,092
1.3
28.5
7.6
Aarti Industries
ARTO IN
NR
395
0.5
11.9
2.4
Chemicals
Source: Bloomberg, Ambit Capital research. Note: UR indicates Under Review, NR indicates not rated.
January 22, 2015
Ambit Capital Pvt. Ltd.
Page 28
Economy & Strategy
Appendix: Impact of implementation of the Goods and Services Tax (GST) from April 1, 2016 GST will be a destination-based tax on the consumption of goods and services with an input credit mechanism across the value chain. It will subsume most indirect taxes (currently levied on both goods and services) under a single umbrella. Major taxes likely to be subsumed are Central Value Added Tax (CENVAT), VAT and service tax. Keeping in view the federal structure, GST will have a dual structure wherein it will comprise Central GST (CGST) and State GST (SGST). The Government is yet to set the revenue-neutral rate (RNR), which is a rate at which there will be no revenue loss to the States after adoption of GST. The Government to date not come up with an RNR which is acceptable to all the stakeholders. A subcommittee comprising Central and State Government officials recommended an RNR of almost 27% under the proposed GST regime. Whilst the SGST component is proposed to be 13.91%, the CGST component is proposed at 12.77%. However, the committee said that this rate is not final and if items like land, liquor and petroleum are included in the construct of the GST, the tax base would increase and this will bring down the RNR further. The structure of the GST is not clear yet, but in all probability it will be a dual GST where both Centre and States will have the power to tax all goods and services. Key impact of GST implementation: Expansion of the tax base by covering the unorganised sector The GST will boost the Government’s revenue by increasing the tax base, as the Indian unorganised sector will come under the purview of the GST. Given that 59% of the total output in India is produced in the unorganised sector, this can boost the Government’s revenue to a considerable extent if GST is able to bring even a part of the unorganised sector under its ambit. The table below captures the size of the unorganised sector in India across different sectors. Exhibit 39: 59% of the total output in India is produced in the unorganised sector As % of National Domestic Product Industry group Agriculture, forestry and fishing
Informal
Others Unorganised
Organised
Total
25.5
25.5
0.9
26.4
Mining and quarrying
0.2
0.2
1.8
2
Manufacturing
1.6
5.0
8.4
13.4
Electricity, gas and water supply
0.1
0.1
1.0
1
Construction
3.9
3.9
2.5
6.4
Trade, hotels, restaurants
9.3
2.5
11.9
3.8
15.6
Transport and communication Real estate, financial services and ownership of dwellings Community, social and personal services Total
3.3
0.6
3.9
2.8
6.7
2.6
2.9
5.4
7.6
13
1.3
1.3
2.6
12.8
15.4
47.7
10.7
58.5
41.5
100
3.4
Source: Kannan, K.P., et.al, 2008. Note: NDP refers to Net National Product
As shown above, nearly 58.5% of India’s Net Domestic Product (NDP) comes through the unorganised sector. Out of this, 25.5% is in the farm sector and 33% in the nonfarm sector. The Central Government cannot tax the agricultural income, and hence only the unorganised sector in the non-farm category can come under the ambit of the GST. Nevertheless, if 33% of India’s NDP comes under the purview of the GST, the net impact (after deducting compensation to the states) of GST implementation will be positive for the Central Government’s revenues.
January 22, 2015
Ambit Capital Pvt. Ltd.
Page 29
Economy & Strategy What about the fiscal impact of the need for the Centre to compensate States for revenue lost? The exact compensation to the states on account of the revenue loss due to the implementation of the GST will be clear only after a final structure of the GST is available. However, our discussions with a leading fiscal expert in India suggest that this amount will be approximately `200bn per annum. The Centre in all probability will define the GST in such a manner that at least in the initial years the compensation due to States is offset by the incremental revenue generated owing to GST implementation.
January 22, 2015
Ambit Capital Pvt. Ltd.
Page 30
Economy & Strategy
Notes:
January 22, 2015
Ambit Capital Pvt. Ltd.
Page 31
Economy & Strategy
Institutional Equities Team Saurabh Mukherjea, CFA
CEO, Institutional Equities
(022) 30433174
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Research Analysts
Industry Sectors
Nitin Bhasin - Head of Research
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(022) 30433241
Desk-Phone E-mail
[email protected]
Aadesh Mehta, CFA
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Achint Bhagat
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Aditya Bagul
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Deepesh Agarwal
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Ambit Capital Pvt. Ltd.
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Economy & Strategy
Stock price performance charts Coal India Ltd. (COAL IN, BUY)
NTPC (NTPC IN, SELL)
450 400 350 300 250 200 150 100 50 0
200 150 100 50
Jan-14
Apr-14
Jul-14
Oct-14
Apr-14
Jul-14
Oct-14
Jul-14
Oct-14
Oct-13
Jul-13
Jan-14
COAL INDIA LTD
Apr-13
Jan-13
Oct-12
Jul-12
Apr-12
Jan-12
Oct-14
Jul-14
Apr-14
Jan-14
Oct-13
Jul-13
Apr-13
Jan-13
Oct-12
Jul-12
Apr-12
Jan-12
0
NTPC LTD
Source: Bloomberg, Ambit Capital research
Source: Bloomberg, Ambit Capital research
Ashoka Buildcon (ASBL IN, NOT RATED)
Sadbhav (SADE IN, UNDER REVIEW)
180 160 140 120 100 80 60 40 20 0
300 250 200 150 100 50
ASHOKA BUILDCON LTD
Oct-13
Jul-13
Apr-13
Jan-13
Oct-12
Jul-12
Apr-12
Jan-12
Oct-14
Jul-14
Apr-14
Jan-14
Oct-13
Jul-13
Apr-13
Jan-13
Oct-12
Jul-12
Apr-12
Jan-12
0
SADBHAV ENGINEERING LTD
Source: Bloomberg, Ambit Capital research
Source: Bloomberg, Ambit Capital research
MBL (MBL IN, NOT RATED)
BHEL (BHE IN, UNDER REVIEW)
500
3,500 3,000 2,500
400 300
2,000 1,500 1,000 500
200 100
MBL INFRASTRUCTURES LTD Source: Bloomberg, Ambit Capital research
January 22, 2015
Apr-14
Jan-14
Oct-13
Jul-13
Apr-13
Jan-13
Oct-12
Jul-12
Apr-12
Jan-12
Oct-14
Jul-14
Apr-14
Jan-14
Oct-13
Jul-13
Apr-13
Jan-13
Oct-12
Jul-12
Apr-12
0 Jan-12
0
BHARAT ELECTRONICS LTD Source: Bloomberg, Ambit Capital research
Ambit Capital Pvt. Ltd.
Page 33
Economy & Strategy PGCIL (PWGR IN, BUY)
Alstom T&D (ATD IN, NOT RATED) 600
160 140 120 100 80 60 40 20 0
500 400 300 200 100
POWER GRID CORP OF INDIA LTD
Oct-14
Jul-14
Apr-14
Jan-14
Oct-13
Jul-13
Apr-13
Jan-13
Oct-12
Jul-12
Apr-12
Jan-12
Oct-14
Jul-14
Apr-14
Jan-14
Oct-13
Jul-13
Apr-13
Jan-13
Oct-12
Jul-12
Apr-12
Jan-12
0
ALSTOM T&D INDIA LTD
Source: Bloomberg, Ambit Capital research
Source: Bloomberg, Ambit Capital research
Techno Electric (TEEC IN, NOT RATED)
Triveni Turbines (TRIV IN, NOT RATED) 140 120
500 400
100 80 60 40
300 200 100
Apr-14
Jul-14
Oct-14
Jul-14
Oct-14
Jan-14
Oct-13
Jul-13
Apr-13
Apr-14
TECHNO ELECTRIC & ENGINEERIN
Jan-13
Oct-12
Jul-12
Jan-12
Oct-14
Jul-14
Apr-14
Jan-14
Oct-13
Jul-13
Apr-13
Jan-13
Oct-12
Jul-12
Apr-12
Jan-12
0
Apr-12
20 0
TRIVENI TURBINE LTD
Source: Bloomberg, Ambit Capital research
Source: Bloomberg, Ambit Capital research
Hind. Unilever (HUVR IN, SELL)
Dabur (DABUR IN, SELL)
1,000
300
800
250 200
600
150 400
HINDUSTAN UNILEVER LTD Source: Bloomberg, Ambit Capital research
January 22, 2015
Jan-14
Oct-13
Jul-13
Apr-13
Jan-13
Oct-12
Jul-12
Jan-12
Oct-14
Jul-14
Apr-14
Jan-14
Oct-13
Jul-13
Apr-13
Jan-13
Oct-12
Jul-12
0 Apr-12
0 Jan-12
50 Apr-12
100
200
DABUR INDIA LTD Source: Bloomberg, Ambit Capital research
Ambit Capital Pvt. Ltd.
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Economy & Strategy Colgate (CLGT IN, SELL)
AIA Engg (AIAE IN, BUY)
2,500
1,400 1,200
2,000
1,000 800 600
1,500 1,000
COLGATE PALMOLIVE (INDIA)
Oct-14
Jul-14
Apr-14
Jan-14
Oct-13
Jul-13
Apr-13
Jan-13
Oct-12
Jul-12
Jan-12
Oct-14
Jul-14
Apr-14
Jan-14
Oct-13
Jul-13
Apr-13
Jan-13
Oct-12
Jul-12
Apr-12
Jan-12
0
Apr-12
400 200 0
500
AIA ENGINEERING LTD
Source: Bloomberg, Ambit Capital research
Source: Bloomberg, Ambit Capital research
TVS Motors (TVSL IN, BUY)
Bajaj Auto (BJAUT IN, SELL)
350
3,000
300 250 200 150
2,500 2,000 1,500 1,000
100 50 0
500 Apr-14
Jul-14
Oct-14
Jul-14
Oct-14
Jan-14
Oct-13
Jul-13
Apr-13
Apr-14
TVS MOTOR CO LTD
Jan-13
Oct-12
Jul-12
Apr-12
Jan-12
Oct-14
Jul-14
Apr-14
Jan-14
Oct-13
Jul-13
Apr-13
Jan-13
Oct-12
Jul-12
Apr-12
Jan-12
0
BAJAJ AUTO LTD
Source: Bloomberg, Ambit Capital research
Source: Bloomberg, Ambit Capital research
Bharat Forge (BHFC IN, NOT RATED)
Balkrishna Inds (BIL IN, BUY)
BHARAT FORGE LTD Source: Bloomberg, Ambit Capital research
January 22, 2015
Jan-14
Oct-13
Oct-14
Jul-14
Apr-14
Jan-14
Oct-13
Jul-13
Apr-13
Jan-13
Oct-12
Jul-12
Apr-12
Jan-12
0
Jul-13
200
Apr-13
400
Jan-13
600
Oct-12
800
Jul-12
1,000
Apr-12
900 800 700 600 500 400 300 200 100 0 Jan-12
1,200
BALKRISHNA INDUSTRIES LTD Source: Bloomberg, Ambit Capital research
Ambit Capital Pvt. Ltd.
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Economy & Strategy WABCO (WIL IN, NOT RATED)
Cummins (KKC IN, SELL)
6,000
1,000
5,000
800
4,000
600
3,000
WABCO INDIA LTD
Oct-14
Jul-14
Apr-14
Jan-14
Oct-13
Jul-13
Apr-13
Jan-13
Oct-12
Jul-12
Jan-12
Oct-14
Jul-14
Apr-14
Jan-14
Oct-13
Jul-13
Apr-13
Jan-13
Oct-12
0 Jul-12
0 Apr-12
200 Jan-12
1,000
Apr-12
400
2,000
CUMMINS INDIA LTD
Source: Bloomberg, Ambit Capital research
Source: Bloomberg, Ambit Capital research
TTK Prestige (TTKPT IN, BUY)
VA Tech (VATW IN, BUY)
Apr-14
Jul-14
Oct-14
Jul-14
Oct-14
Jan-14
Apr-14
TTK PRESTIGE LTD
Oct-13
Jan-12
Oct-14
Jul-14
Apr-14
Jan-14
Oct-13
Jul-13
Apr-13
Jan-13
Oct-12
Jul-12
Apr-12
Jan-12
0
Jul-13
1,000
Apr-13
2,000
Jan-13
3,000
Oct-12
4,000
Jul-12
1,800 1,600 1,400 1,200 1,000 800 600 400 200 0 Apr-12
5,000
VA TECH WABAG LTD
Source: Bloomberg, Ambit Capital research
Source: Bloomberg, Ambit Capital research
Elgi Equipments (ELEQ IN, NOT RATED)
PI Inds (PI IN, BUY)
180 160 140 120 100 80 60 40 20 0
600 500 400 300 200 100
ELGI EQUIPMENTS LTD Source: Bloomberg, Ambit Capital research
January 22, 2015
Jan-14
Oct-13
Jul-13
Apr-13
Jan-13
Oct-12
Jul-12
Apr-12
Jan-12
Oct-14
Jul-14
Apr-14
Jan-14
Oct-13
Jul-13
Apr-13
Jan-13
Oct-12
Jul-12
Apr-12
Jan-12
0
PI INDUSTRIES LTD Source: Bloomberg, Ambit Capital research
Ambit Capital Pvt. Ltd.
Page 36
Economy & Strategy Aarti Inds (ARTO IN, NOT RATED) 350 300 250 200 150
Oct-14
Jul-14
Apr-14
Jan-14
Oct-13
Jul-13
Apr-13
Jan-13
Oct-12
Jul-12
Apr-12
Jan-12
100 50 0
AARTI INDUSTRIES LIMITED Source: Bloomberg, Ambit Capital research
January 22, 2015
Ambit Capital Pvt. Ltd.
Page 37
Economy & Strategy Explanation of Investment Rating Investment Rating
Expected return (over 12-month)
BUY
>5%
SELL
<5%
NO STANCE
We have forward looking estimates for the stock but we refrain from assigning valuation and recommendation
UNDER REVIEW
We will revisit our recommendation, valuation and estimates on the stock following recent events
NOT RATED
We do not have any forward looking estimates, valuation or recommendation for the stock
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January 22, 2015
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