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Using Bandaids

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With an economic slowdown and general elections both looming, political parties are vying to hand out sops to industry.
First, Parliament passed the 2008 Budget without a murmur. Then Finance Minister P. Chidambaram put on the same kinder, friendlier face he had on for the farm sector in February — when he wrote off $15 billion in small farmer loans — for India Inc. His speech in the Lok Sabha on Tuesday, marking the culmination of the debate on the Budget, handed out fresh sops and extended others nearing expiry.
Says Ficci Secretary General Amit Mitra, “The amendments to the Budget would curb inflation, which is a key concern for the government and the corporate sector right now.” Prime amongst the Finance Minister’s pacifiers is a one-year extension to the scheme granting tax-free status to information technology (IT) companies set up in software parks. (Also see ‘Help From Above’).
The tax relief, that enables savings of up to 10-15 per cent, was to expire next year based on the recommendations of key government panels.
Its critics have wondered why India’s mighty software industry needs tax breaks. But Chidambaram bravely defended his decision. “As things stand, the Budget for 2009-10 may not be presented in February, 2009 but only after the elections… to avoid any uncertainty as we draw close to March 31, 2009, it has been decided that… the exemptions continued until March 31, 2010,” the Finance Minister declared in the Lok Sabha.
Srikanth Balakrishnan, director at the Bangalore-based auditing and consultancy firm JCSS, agrees that the move will cheer the IT sector by helping “software units in tiding over losses in income due to the weakening dollar”.
The Finance Minister has also sought to help companies battling to insulate profits from the unfavourable macro-economic shifts occurring at home and abroad by slashing customs and excise duties of a host of key industrial inputs and products facing sluggish demand. Sectors that have benefited include newsprint, skimmed milk, steel and cement.

And yet, the corporate sector may not be the biggest beneficiary of Chidambaram’s sops. His parting shot could well turn out to be a political winner, says Mahavir Jain, director for taxes at JCSS. “It’s a master move of not taking a bold step of extending (the tax break to IT companies) for five or more years to make the industry truly happy,” says Jain. “If the next dispensation does not extend the tax exemption as recommended by various expert committees, Chidambaram will be in a position to take credit for being industry-friendly.”



The Reserve Bank of India (RBI) fired another salvo in its fight against inflation by hiking the cash reserve ratio (CRR) by another 25 basis points (bps) to 8.25 per cent. The latest hike is the third in a row and follows the 50 bps two-tranche hike announced on April 17.
The RBI’s move caught the financial markets by surprise as it was widely speculated that there could be hike in the repos rate with CRR remaining untouched. “The timing of the CRR hike is surprising because it is so soon after the 50 bps CRR hike announced on 17 April. This suggests that the RBI was contemplating a larger CRR hike earlier and decided to spread out the impact on banks. This was a prudent policy response, in our view, to the difficult challenge of slowing growth yet rising inflation,” says Lehman Brothers’ economist Sonal Varma.
There is also a technical reason for the latest CRR hike. While the two-tranche 50 bps CRR hike would have sucked out Rs 18,500 crore, there is an inflow of Rs 23,000 crore due on May 4 due to bond redemption. This would have negated the earlier increase of 50 bps in the CRR, and, therefore, the CRR hike of 25 bps.
Headline inflation eased marginally to 7.33 per cent during the week ended 12 April 2008 from 7.4 per cent as on 29 March 2008. The RBI said that in view of the lagged and cumulative effects of monetary policy on aggregate demand and assuming that supply management would be conducive, the policy endeavour would be to bring down inflation from the current high level of above 7 per cent to around 5.5 per cent in 2008-09 with a preference for bringing it as close to 5 per cent as soon as possible. And that means, the central bank can be expected to press ahead with another round of hikes if need be.
Ravikant Bhat, banking analyst at IDBI Capital Markets, is of the view that banks may take a call on deposit rates as the CRR hikes hurt banks’ margins; and they do not get any interest on them as well. “Given the risks associated with increasing lending rates, a deposit rate cut makes better sense for banks. However, banks will have to be cautious as low deposit rates two years back were not helping banks grow their deposits and the incremental lending took place through liquidation of excess SLR. It can be another year of margins remaining under pressure,” he says.
The RBI measures over the last year has seen the growth in non-food credit moderating to 22.3 per cent (Rs 419,425 crore) as compared to 28.5 per cent (Rs 418,282 crore) in the previous year. The incremental non-food credit-deposit ratio declined to 72.3 per cent during 2007-08 from 83.2 per cent in 2006-07 (109.3 per cent in 2005-06 and 130.0 per cent in 2004-05). This will lead to lower net interest income and spread, and lower profitability of banks over the medium-term.
Raghu Mohan

Amitabh Singh, a partner at Ernst&Young, also says that India Inc. will benefit from the Finance Minister’s decision to relax — with retrospective effect — the time available to companies for depositing with the tax department the tax they deduct at source (TDS) from payments made to suppliers and vendors.
If companies fail to deposit TDS in time, they are barred from factoring expenses on hiring the vendors into income for the calculation of their own tax dues. Chidambaram has given six months for depositing the tax deducted at source, relatable to payments in the month of March, with retrospective effect from assessment year 2005-06 (covers taxes to be paid for financial 2004-05). Effectively, it’s a three-year leash for companies on TDS.
The Finance Minister, however, disappointed the oil and gas exploration and production industry. In the Budget, Chidambaram had discontinued the seven-year 100 per cent tax exemption which refineries that had begun production after 2000-01 enjoyed. It affects all projects that would go into commercial production of “petroleum and natural gas” starting 1 April 2008.
The application of this tax break to the exploration and production industry is currently being contested in various courts.
Though it was being hoped that the Finance Minister would jump the gun and extend it, he has refrained saying the matter is sub-judice. Pending the courts’ verdicts, tax officers will have the leeway to issue notices for non-payment of taxes worth hundreds of crores to refineries.
“While incumbents would have much liked to know the intent of the government rather than face years of litigation, new entrants would specially rethink before putting in bids,” says Deepak Mahurkar, associate director for the sector at consultancy PwC.
Still, it is hard not to see Chidambaram, who aggravated corporate India with taxes such as the fringe benefit tax, is trying to project a softer side — as much in anticipation of the impending elections as responding to the need of the hour.
Says Ernst&Young’s Singh, “Using band-aids, Chidambaram has obtained the blessings of the corporate sector.”

Dream budgets, it would seem, have given way to budget dreams.
(Businessworld issue 6-12 May 2008)

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