Budget 0506

Union Budget - Analysis
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Contents
Foreword Economy Highlights Detailed economic analysis Industry Overall sectoral impact Overall company impact Auto ancillaries Capital goods Cars and utility vehicles Cement Chlor alkalies Cigarettes Commercial vehicles Consumer durables Cotton and cotton yarn Fertilisers Hotels Information technology Man-made fibres Non-ferrous metals Oil and gas Paints Paper Personal care and detergents Petrochemicals: Basic and polymers Petrochemicals: Downstream Pharmaceuticals Shipping Steel Sugar Tea and coffee Telecom cables 18 24 30 32 34 36 38 40 42 44 46 48 50 52 54 56 58 62 64 66 68 70 72 74 76 78 80 82
Continued...
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CRIS INFAC ANALYSIS, FEBRUARY 28, 2005
Contents
...continued
Telecom equipments Telecom services Tractors Two-wheelers Tyres Diversified companies Infrastructure Power Port Roads Other infrastructure Banking and financial sector Banking and financial sector Capital markets
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84 86 88 90 92 94
100 102 103 105
108
Debt markets Equity market
112 117
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Data notes
1) 2) 3) 4) All domestic prices are ex-factory prices, unless indicated otherwise. All international prices are cif prices, unless indicated otherwise. Wherever the domestic prices are ex-factory prices, the landed costs do not include CVD. Wherever the domestic prices are market prices, the landed costs include CVD. Landed costs, customs and excise duties for 2004-05 include the education cess of 2 per cent.
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Foreword
A delicate balance It was quite clear before the Budget that Mr Chidambaram would have to deal with a number of conflicting objectives. Increasing spending on rural development and infrastructure, in general, would have to be tempered by the need to adhere to the fiscal responsibility targets. Tax reforms would also be subject to the same constraint. The new awards by the Finance Commission would have to be factored into the calculation. When all of these limits were recognised, how much room would he actually have to manoeuvre? Obviously, not a lot, but as things turned out, the leeway was used with a reasonable degree of effectiveness. Tax reforms are something that are controlled by his ministry and are virtually certain to be implemented as presented in the Budget. The Budget has to be judged to a large extent by what has been done on this front. On direct taxes, there has been a significant streamlining of the personal tax regime. The anomalies have been ironed out, and the brackets have been re-structured. Section 88 exemptions, which gave a tax rebate for savings channelised into post office and public provident schemes and infrastructure bonds, have been eliminated. This is a very positive move, because other than the infrastructure bonds, these savings were not really going into any kind of capital formation. This elimination has been offset by a blanket exemption of Rs 100,000 on income for savings, presumably including pension and other long-term instruments, which are more likely to be deployed in the creation of fixed assets. The corporate tax rate has been reduced from 35 per cent to 30 per cent, without any elimination of exemptions. This is clearly good news in the short term for corporate earnings, but we must remember that the logic of tax rate reductions is tied to the phasing out of exemptions. Given the expected buoyancy in earnings this year, the rate reduction should not result in a large revenue loss, if any, but in the event of an economic downturn, the lower rates with persistent exemptions might upset the fiscal calculations significantly. It should be reasonable to expect that the exemptions will be eliminated sooner or later and, as a consequence, the long-term prospect is for the effective tax rate to go up rather than down for many corporates. Ultimately, an optimal tax rate for a zero exemption scenario has to be worked out and the whole transition accomplished as smoothly as possible. Better sooner rather than later. There are big spending initiatives on the social and infrastructure sectors, but clearly, the committed resources have not kept pace with the aspirations. In fact, aggregate plan spending in this Budget is actually lower than was budgeted last year, although it represents a Rs 6,000 crore increase over the revised estimates. The slack in spending plans is, ultimately, what gives the government some room to keep the deficit in check.
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Foreword
The one sector that is proven to have delivered is highways. The Budget has wisely committed an extra Rs 2,800 crore to this programme, taking the total government spending up to Rs 9,200 crore. This will clearly sustain the momentum to industrial demand and employment that the programme has provided over the last 3-4 years. It is sensible to place one's bets on tired and tested horses. Overall, this is a Budget that finds the balance between fiscal and political compulsions. On many fronts, it relies on the efficiency of various ministries and departments to deliver. But, that has always been the case and is a broader problem for the government as a whole to address. The finance minister cannot be expected to take the entire burden of the government on his shoulders. Dr Subir Gokarn Chief Economist, CRISIL
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Economy
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Highlights
Growth The performance of industry and services is expected to remain buoyant during 2005-06. The indications of a pick-up in the investment activity augur well for the growth prospects of industry in the coming year, and services are expected to continue with their high growth performance. Overall, we expect India's GDP to grow in the range of 6.75-7.00 per cent during 2005-06. Inflation This Budget will not have much impact on inflation. Indirect taxes have been estimated to be revenue neutral, so the prices of inputs, especially petroleum and diesel, will not be impacted much. Also, the inflation scenario is far more dependent on factors such as domestic capacity utilisation and global commodity prices. We expect the inflation rate to be at about 5 per cent during 2005-06. Fiscal scenario This remains the area of concern. The government has not been able to meet the rolling targets of 2005-06 presented in the last year's Budget and has put the Fiscal Responsibility and Budget Management Act (FRBM) on the back burner for the time being. In the 2005-06 Budget, the government expects the fiscal deficit to GDP ratio to be 4.3 per cent. Our assessment is that the revenue estimates for
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2005-06 are quite optimistic and we expect a revenue shortfall of around Rs 8,600 crore to Rs 12,400 crore. Consequently, we expect the fiscal deficit to be 4.5-4.7 per cent of GDP against the target of 4.3 per cent. Interest rates Driven by higher market borrowings of Rs 8,600-12,400 crore in conjunction with higher global interest rates, continuance of wider coverage of the service tax net, revenue from dividends and profits and interest cost savings, we expect the benchmark ten-year yield at 7.25 per cent by the end of March 2006. Equity markets Armed with tax rationalisation measures and the focus on infrastructure development, the Budget is clearly a reform-oriented one. Lowering of corporate tax and custom tariffs will boost the earnings of the corporates. This, together with the exemption on savings of Rs 100,000, will help channelise the savings to the markets and will, thus, add a fillip to the market sentiment. We thus see the Budget as substantially equipped to support the strong market sentiment.
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Highlights
Exchange rates While the Budget does not directly impact the exchange rate, the introduction of a special purpose vehicle (SPV), which will utilise foreign exchange reserves for funding infrastructure projects, may ease the pressure of appreciation on the rupee if the scheme increases the demand for forex. At current levels, however, it will only absorb $2 billion out of the reserve of $133 billion - which is of hardly any significance. More importantly, the reduction in import duties will increase the demand for forex and ease the upward pressure. The rupee is expected to be stable around the Rs 44/$ mark during 2005-06.
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Detailed economic analysis

I. Economic backdrop The economic setting for the making of Budget 2005-06 could not have been better. The year 200405 started with the spectre of drought, spiralling inflation and firming up of crude prices. But the scenario has completely changed towards the end of the year. With inflation down to 5 per cent and growth estimated at 6.9 per cent, the year is ending with good news on the growth and inflation fronts. After initial jitters, the Sensex too has zoomed, buoyed by strong growth and foreign institutional investor (FII) inflows. India's long-term currency rating has recently been notched up by S&P to BB+. Improved growth scenario The fears of the initial monsoon failure scaling down the overall GDP growth have been completely warded off by the robust performance of the industrial and services sectors, which grew at 7.8 per cent and 8.9 per cent, respectively, in 2004-05. Agriculture is the only sector to have witnessed growth deceleration. What is noteworthy is that the poor performance of agriculture had no perceptible impact on industrial activity, indicating a gradual insulation of industry from the vagaries of monsoons. Also, the high crude prices failed to dampen industrial activity. The indications of a pick-up in investment activity augur well for the growth prospects in the coming year. The overall GDP growth of 6.9 per cent over a high base of 8.5 per cent is quite commendable. Buoyed by the recent growth patterns, the Economic Survey notes a possible ratcheting up of the trend rate of growth of the economy,
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from around 6 per cent to about 7 per cent per year. Given that the current growth pick-up is accompanied by the upswing in saving and investment rates, the scenario is reminiscent of the growth performance during the boom phase of 1994-95 to 1996-97. Inflation moderates but interest rates firm Inflationary pressures started building up in the beginning of this year, and by July 2004 inflation had crossed 8 per cent. Inflation in the first 10 months of 2004-05 stood at 6.7 per cent. The price rise was spread across all the three major categories, namely primary articles, manufactured products and the fuel group. The recent downturn in inflation notwithstanding, the average inflation for 200405 is expected to be 6.5 per cent. The current bout of inflation was primarily a cost-push phenomenon led by a sharp upturn in petroleum and metal prices. Duty reduction and improvement in the agricultural scenario, supported by a favourable base effect, has tamed inflation to around 5 per cent now. The higher inflationary pressures translated into higher interest rates. The 10-year G-sec rates rose by 100 basis points in the current fiscal. External scenario Both exports and imports have maintained their buoyancy during April-January 2004-05. With exports growing at 25 per cent and imports at 35 per cent the trade deficit widened to over $22 billion. The ballooning of the import bill was on account of a sharp rise in crude prices and a genuine demand for non-oil imports stemming from a pick-up in industrial activity. The current account position is, however, comfortable due to a positive balance on trade in services. The foreign exchange reserves, at $132 billion in mid-February, can support 15.5 months of imports.
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Fiscal situation: No cause for alarm but stress evident As a result of high real growth and higher-than-expected average inflation in 2004-05, the nominal GDP has risen to 12.6 per cent. This, together with revenue buoyancy due to a pick-up in industrial activity, has almost contained the fiscal deficit/GDP ratio within the budgetary target in 2004-05. There is a marginal slippage of 0.1 percentage points in the revenue deficit and the fiscal deficit. In the last 2-3 years, the tax buoyancy has improved due to a sustained up-tick in industrial activity (which is a key source of revenue for the government) and increased coverage of service tax. Higher dividend from public sector undertakings (PSUs) and softening of the interest burden also helped in improving the fiscal scenario. These healthy trends are, however, not enough to guarantee the fiscal consolidation envisaged in the FRBM. Acknowledging this, the Survey categorically notes that "the outlook on the fiscal front very much depends on how the credibility of the budgetary process is enhanced. In the medium term, adherence to FRBM targets, given the limitation of expenditure compression, critically hinges upon the success in raising the tax/GDP ratio." Challenges The task before the Budget is to take steps to maintain the growth momentum and push reforms while fulfilling the promises made in the common minimum programme (CMP). In addition, the recommendations of the Finance Commission have increased the expenditure commitment of the Central government. And all this within the latitude provided by the FRBM. In what follows, we will examine how the Budget walks this tightrope and the implications of the budgetary proposals. II. 2004-05 estimates, Budget 2005-06 and FRBM targets
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The year 2004-05 was the first year of implementation of the FRBM. The revise estimated for 200405 shows that the targets have almost been achieved for fiscal deficit (the revised estimates exceed the Budget estimate by Rs 1,824 crore, equivalent to a slippage of 1.3 per cent). But there has been relatively higher overshooting in revenue and primary deficit of Rs 8,448 crore and Rs 5,419 crore respectively. Fiscal marksmanship has improved in the last 2-3 years. During 2003-04, the deficit figures were much below the budgeted target and in 2004-05 the overall marksmanship has been quite satisfactory. This is primarily due to revenue buoyancy on account of a sustained pick-up in industrial activity, a trend that has been sustained in 2004-05. Although the overall non-Plan expenditure went up by 10.9 per cent, the non-Plan revenue expenditure increased marginally by 0.9 per cent in 200405. Further there was a saving of Rs 3,595 crore on interest payments. On the Plan side, however, the government was unable to meet its targets. Overall Plan expenditure fell short of the Budget estimate by 5.6 per cent. What is worrying is the sharper fall in expenditure on the capital account, which was 11.2 per cent below the target in 2004-05. The gross tax revenue collections fell short of the budgetary estimate by Rs 11,712 crore as the targets set in the 2004-05 Budget were over optimistic to begin with. Our analysis of last year's
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Budget had pointed out a revenue shortfall of Rs 20,000 crore, which was later revised to Rs 12,000 crore in December.
Table 1: Fiscal marksmanship Fiscal Revenue Plan Non-plan Total Gross tax Industrial deficit deficit expenditure expenditure expenditure revenue growth 1999-00 2000-01 2001-02 2002-03 2003-04 2004-05 Note Figures for 2004-05 have been computed from revised estimates. Source: Budget 2005-06 31 6.8 21.2 -3.1 -19.8 1.3 24.8 10.1 27.1 13.1 -12.5 11.8 -1.1 -6.2 6.4 -1.8 1.1 -5.6 7.2 -3 -5.1 -2.7 9.8 10.9 5 -3.8 -3.4 -2.4 7.4 5.9 2.5 -2.5 -17.5 -8.3 1.1 -3.7 6.6 5 2.7 5.8 6.9 7.9
The deficit targets for 2005-06 have been specified a notch above what was anticipated in the FRBM, thereby implying some dilution of the original FRBM targets. Table 2 presents the key budgetary arithmetic for 2005-06.
Table 2: Budget at a glance 2005-06 (Rs crore) 2003-04 Actuals 1. Revenue receipts 263,878 2. Tax revenue (net to centre) 186,982 3. Non-tax revenue 76,896 4. C apital receipts (5+6+7) 207,490 5. Recoveries of loans 67,265 6. Other receipts 16,953 7. Borrowings and other liabilities 123,272 8. Total receipts (1+4) 471,368 9. Non-plan expenditure 349,088 10. On revenue account 283,502 of which Interest payments 124,088 12. On capital account 65,586 13. Plan expenditure 122,280 14. On revenue account 78,638 15. On capital account 43,642 16. Total expenditure 471,368 17. Revenue expenditure 362,140 18. C apital expenditure 109,228 19. Revenue deficit As a percentage of GDP 20. Fiscal deficit As a percentage of GDP 21. Primary deficit As a percentage of GDP Source: Budget 2005-06 98,262 3.6 123,272 4.5 -816 0
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2004-05 BE 309,322 233,906 75,416 168,507 27,100 4,000 137,407 477,829 332,239 293,650 129,500 38,589 145,590 91,843 53,747 477,829 385,493 92,336 76,171 2.5 137,407 4.4 7,907 0.3
2004-05 RE 300,904 225,804 75,100 204,887 61,565 4,091 139,231 505,791 368,404 296,396 125,905 72,008 137,387 89,673 47,714 505,791 386,069 119,722 85,165 2.7 139,231 4.5 13,326 0.4
2005-06 BE 351,200 273,466 77,734 163,144 12,000 151,144 514,344 370,847 330,530 133,945 40,317 143,497 115,982 27,515 514,344 446,512 67,832 95,312 2.7 151,144 4.3 17,199 0.5

Along with the Budget, and as required under the FRBM Act, the Central government has laid the following statements before Parliament: Medium-term Fiscal Policy Statement, specifying 3-year rolling targets for specified fiscal indicators. Fiscal Policy Strategy Statement, dealing with the fiscal strategy in the following year and rationale for deviation in fiscal measures related to taxation, subsidies and borrowings etc. Macroeconomic Framework Statement, containing an assessment of the growth prospects of the economy, along with underlying assumptions. Rolling revenue targets (2005-06 to 2007-08) The Medium-term Fiscal Policy Statement presented along with the Budget gives 3-year rolling targets for key fiscal indicators. These have been derived on the basis of assumptions on growth and the policy stance of the government. Tables 3a and 3b compare the rolling targets fixed last year. The 2005-06 Budget targets show a substantial variation over the projections of 2005-06 carried out with the 2004-05 budget. The rolling indicators set in the 2004-05 Budget had targeted the revenue deficit to fall to 1.8 per cent of GDP by 2005-06, but the 2005-06 Budget has a more realistic revenue deficit target of 2.7 per cent. Similar is the case with other deficit indicators. The fiscal deficit for 2005-06 has been targeted at 4.3 per cent of GDP in the 2005-06 Budget whereas the target was much lower at 4 per cent in the Budget presented last year. The gross tax revenue also could not match up with what the government anticipated last year. Based on last year's Budget, gross tax revenue as a proportion of GDP was expected to rise to 11.1 per cent during 2005-06. But the 2005-06 Budget has a gross tax revenue target of 10.6 per cent as a proportion of GDP. As far as the correction in the revenue deficit is concerned, the targets set in the FRBM last year have been pushed forward by one year.
Table 3a: Rolling fiscal indicators set in 2005-06 Revised estimates Budget estimates 2004-05 Revenue deficit as percentage of GDP Fiscal deficit as percentage of GDP Gross tax revenue as percentage of GDP Total outstanding liabilities at the end of the year as percentage of GDP for the year 2.7 4.5 9.8 68.8 2.7 4.3 10.6 68.6 Targets for 2 3.8 11.1 68.2 1.1 3.1 12.6 67.3 2005-06 2006-07 2007-08
Source: Medium-term fiscal policy statement, Union Budget 2005-06
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Table 3b: Rolling fiscal indicators set in 2004-05 Budget estimates 2004-05 Revenue deficit as a percentage of GDP Fiscal deficit as percentage of GDP Gross tax revenue as a percentage of GDP Total outstanding liabilities at the end of the year as a percentage of GDP for the year 2.5 4.4 10.2 68.5 Targets for 2005-06 1.8 4 11.1 68.2 2006-07 1.1 3.6 12.1 67.8
Source: Medium-term fiscal policy statement, Union Budget 2004-05
III. The revenue arithmetic The gross revenue targets in 2004-05 fell short of the Budget estimates by Rs 11,712 crore. Are the revenue targets set for 2005-06 achievable? Revenue targets in 2005-06 The Budget assumes a growth of 20.9 per cent in gross revenues in 2005-06BE over a high growth of 20.3 per cent in 2004-05. This translates into an increase in the tax/GDP ratio to 10.5 per cent in 2005-06 from 9.8 per cent in 2004-05. The implicit tax buoyancy is about 1.6. Table 4 documents the share of major taxes in the gross tax revenues, their performance in 2004-05 and expectation in
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2005-06BE.
Table 4: Tax revenues of the central government Tax heads Gross tax revenue % Share 100 32.9 27.1 18.4 16.6 4.6 0.3 73.8 20.3 11 30.6 15.7 23.1 79.3 -54 20.8 % Growth 20.9 20.7 33.2 -5.5 30.1 23.7 2.7 21.1 (2004-05) 04-05/03-04 05-06BE/04-05 Excise C orporate C ustoms Income tax Service Other taxes Net tax revenue (centre) Source: Budget 2005-06
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The revenue buoyancy projected in 2005-06 relies heavily on the performance of corporate and income tax. Significant increases of 33.2 per cent and 30.1 per cent have been budgeted in corporate and income tax during 2005-06. The overall revenue receipts (net to the Centre) are budgeted to grow by 21.1 per cent in 2005-06 as against the observed growth of 20.8 per cent in the previous year. No target has been set for disinvestment receipts. The overall tax buoyancy has improved significantly in the last 2-3 years. An important reason for this is the revival of industrial growth on which the tax collections of the government critically depend. 10 Box 1 examines the recent shifts in tax buoyancy and its relation to the industrial growth patterns.

Box 1: Tax buoyancy and industrial growth While reviewing the patterns in the overall tax buoyancy in the last couple of years, this section attempts to examine the relationship between the buoyancy in tax collection and the industrial activity. The following figure charts the changes in tax buoyancy (ratio of growth in tax collection to GDP growth) against industrial growth based on Index of Industrial Production (IIP). We have divided the period since 1993-94 into three sub periods: 1993-94 to 1996-97 (period of high growth) followed by 1997-98 to 2001-02 (period of downturn) and ending with another recovery phase, 2002-03 to 2004-05.
Figure 1: Tax buoyancy and industrial growth
1.8 1.5 1.2 0.9 0.6 0.3 0.0 93-94 to 96-97 97-98 to 01-02 Tax Buoyancy 02-03 to 04-05 Industrial Growth 1.2 0.7 1.5 10 9 8 Indsutrial growth 7 6 5 4 3 2 1 0
Tax Buoyancy
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Source: CRISIL estimates
The overall tax buoyancy moved more or less in tandem with the industrial performance. It dipped during the period of downturn and shot up again during the recovery period. However, the overall tax buoyancy hit a high of 1.5 during period III, a sharper acceleration than dictated by the acceleration in industrial growth. What had contributed to such an improvement in tax collection? As we looked into performance of specific tax groups, buoyancy in direct taxes turned out to be much higher than buoyancy in indirect taxes and direct tax buoyancy did not see a dip even during the lean phase of 1997-98 to 2001-02. However, the trend over time reveals that the performance of indirect taxes (consisting of customs and excise) is very closely related to industrial performance - buoyancy in industry tends to improve the customs and excise duty collection. But the relatively high growth in tax collection during the past couple of years actually came about because of surge in corporate tax collection. Corporate tax buoyancy has improved substantially during the ongoing industrial recovery - buoyancy in corporate taxes has moved up from 1.5 during 1997-98 to 2001-02 to 2.8 during 2002-03 to 2004-05. Income tax buoyancy, on the other
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hand, does not show any linkages with the industrial performance. The income tax buoyancy was 1.5 during the first high growth phase, went up slightly to 1.6 during the following lean phase and came down to 1.4 during the industrial recovery onset since 2002-03.
Table 5: Tax buoyancy Tax buoyancy Gross tax 1993-94 to 1996-97 1997-98 to 2001-02 2002-03 to 2004-05 1.2 0.7 1.5 1.4 1.5 2.8 Direct tax 1.5 1.6 1.4 Indirect tax 1.1 0.6 0.9 Corporate tax Income tax Custom + Excise
Source: CRISIL estimates
The other important factor behind the high tax buoyancy is the widening of the tax base by inclusion of new services into the tax net. The buoyancy in gross tax collection would fall to 1.4 during 2002-03 to 2004-05 from 1.5, if we exclude services tax from it. Though still contributing a very small amount to total tax collection, the services tax elasticity with respect to services sector GDP stood at 6.4 during 2002-03 to 2004-05. This shows that despite the recent attempts at widening
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the tax base there is excessive reliance of the exchequer on industry. To sum up, there is no denying that tax collection is linked to the industrial performance, as the overall tax buoyancy tends to pick up during high industrial growth phase. And the ongoing recovery has witnessed much higher tax buoyancy than during 1993-94 to 1996-97. Part of this can be explained by the structural change in tax collection - though still around 4.5 per cent of the overall gross tax collection, services tax revenue has improved over the years (the share was not even 1 per cent during the mid-1990s).
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To examine the veracity of tax revenues, we link it with the implicit GDP growth for industry in the Budget. Growth assumptions The Budget assumes a nominal GDP growth of 13.6 per cent for 2005-06. Under the assumption of 5.0-5.5 per cent inflation, this translates into a high real growth of over 8.0 per cent. Given the buoyancy in the industrial and services sector, and under the assumption of normal monsoons, this could be achieved. We expect real GDP growth at 6.9 per cent in 2005-06 if the monsoons are normal. Is the growth target set in the Budget over-optimistic? Neither the Budget nor the three accompanying documents provide sectoral growth patterns. It is important 12 to know the sectoral estimates of GDP to take a call on the revenue buoyancy in 2005-06. Given

growth deceleration in agriculture in 2004-05, growth in agricultural GDP in 2005-06 can be assumed at 3 per cent. Assuming that the buoyancy in services will continue, 8.3 per cent growth is feasible. The industrial growth required to deliver 8 per cent real GDP growth would be around 11 per cent. Table 6 documents the expected shortfall in gross tax revenues under alternate assumptions of industrial growth. The estimates of gross tax revenues (except the revenues from the services sector) have been computed using the ratio of tax collections to nominal industrial GDP observed during 2003-04 and 2004-05. The service sector revenues have been assumed at the same level as budgeted. If the average tax/industrial GDP observed in 2004-05 is assumed, we get a revenue shortfall of Rs 12,439 crore and Rs 8,689 crore for industrial growth of 7 per cent and 8 per cent, respectively. The revenue shortfall factors in the positive revenue impact of direct tax proposals of Rs 6,000 crore. Assuming the expenditure targets are met, the revenue shortfall will lead to a slippage of the fiscal deficit from 4.3 per cent to 4.5-4.6 per cent of GDP.
Table 6: Tax revenues and industrial growth 2005-06 Industrial Industrial growth inflation 2005-06 Gross Expected Nominal Gross tax shortfall industrial tax growth revenue revenue (EST) (BE) 12.5 13.7 15 357,586 361,336 365,399 370,025 370,025 370,025 12,439 8,689 4,626
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7 8 9
5.5 5.7 6
Source: CRISIL Simulations

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IV. Expenditure drivers Expenditure patterns A higher rise in Plan expenditure (4.45 per cent growth) vis--vis non-Plan expenditure (0.66 per cent) has been budgeted in 2005-06. The overall expenditure (Plan and Non-Plan) on health and education has gone up by more than 22 per cent and 36 per cent, respectively, in 2005-06 BE. While Plan allocations have increased sharply (by 38 per cent), non-Plan expenditure has gone up by only 3 per cent on health and education. As per the National Common Minimum Programme (NCMP), the spending on education and health is to be raised to at least 6 per cent and 2-3 per cent of GDP, respectively, over the next few years. Though the overall expenditure on health and education has increased, it is still less than what was promised in the NCMP. It was also mentioned in the NCMP that subsidies are not to be reduced but targeted better, with immediate effect. Defence expenditure, another important item under non-Plan expenditure, has been budgeted to increase by only 8 per cent.
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As per the Twelfth Finance Commission recommendations, the share of the states in the net proceeds of shareable central taxes shall be 30.5 per cent during 2005-10, inclusive of additional excise duty in lieu of sales tax. The total outgo to the states on this account works out to Rs 6,13,112 crore as compared with the last Finance Commission where it was Rs 3,76,318 crore. The share of the states in central tax increased by only 2.9 per cent and 8.5 per cent in 2001-02 and 2002-03, respectively. In the present Budget, the share has increased to 21 per cent. The gross hit to the Central government has been estimated at Rs 26,000 crore in 2005-06. One important and new aspect of expenditure in the present budget is the value added tax (VAT), which has been proposed to be introduced with effect from April 1, 2005. The Central government has agreed to compensate the states, according to an agreed formula, (Central government will provide 100 per cent compensation to the states in 2005-06, 75 per cent in 2006-07 and 50 per cent during 2007- 08 for the loss, if any, on account of the introduction of VAT) in the event of any revenue loss. However, no provision for the same has been made in the Budget. The government has increased allocation for the national food for work programme, mid-day meal scheme, Sarva Shiksha Abhiyan, etc.
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Plan outlay The NCMP aimed at increasing expenditure on agriculture and rural development, infrastructure, social sectors and employment generation. To fund the Plan outlays, there has been higher reliance on internal and extra budgetary resources (IEBR) than on budgetary support. At the aggregate level, the IEBR for the above-mentioned areas has been increased by 62 per cent as compared to a 33 per cent rise in the budgetary allocation to Plan outlays. The Plan expenditure for economic services and social services has been raised by 33 per cent and 35 per cent, respectively. As per NCMP, the public investment in agriculture, rural infrastructure and irrigation will be increased. Within economic services, Plan expenditure for agriculture and allied activities, rural development, irrigation and flood control has been increased sharply, along with the Plan expenditure for industry & minerals, communication, science, technology and environment, and general economic services. Increased Plan expenditure in agriculture and allied activities, rural development and irrigation & flood control reflects the government's intention to fulfil promises made in the NCMP. The Plan expenditure on social services has risen by a faster rate than economic services. Plan expenditures for education and health have been budgeted to increase by 47 per cent and 25 per cent, respectively. The central Plan outlay for infrastructure has been budgeted to increase by 52 per cent. Within infrastructure, the sharpest rise of about 200 per cent has been witnessed in road transport and shipping.
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Table 7. Plan expenditure by key heads of development Rs crore 2003-04 2004-05 RE 2005-06BE Economic services Agriculture and allied activities Rural development Irrigation and flood control Energy Industry and Minerals Transport C ommunication Science, technology and environment General economic services Social services Education art and culture Health and family welfare Water supply, sanitation, housing and urban development Welfare of SC /ST and other backward classes Labour and labour welfare Social welfare and nutrition Source: Budget documents 43,426 3,519 11,369 271 4,323 2,850 14,701 224 4,170 1,999 28,021 7,839 5,564 6,802 1,128 118 2,173 46,704 4,775 8,589 365 4,402 3,472 17,020 276 5,294 2,511 35,404 10,106 6,944 7,930 1,250 157 2,423 62,152 6,361 11,494 524 5,197 4,841 21,614 507 7,075 4,539 47,665 14,820 8,711 9,029 1,490 208 3,819 Growth 2004-05 RE 2005-06BE 7.55 35.69 -24.45 34.69 1.83 21.82 15.77 23.21 26.95 25.61 26.35 28.92 24.8 16.58 10.82 33.05 11.5 33.08 33.21 33.82 43.56 18.06 39.43 26.99 83.7 33.64 80.76 34.63 46.65 25.45 13.86 19.2 32.48 57.61
V. Debt sustainability A marginal slippage in fiscal deficit in 2004-05 is attributable to a number of factors - high industrial growth, rise in corporate taxes due to a surge in corporate profits, and expenditure compression (on the Plan account), together with a high base of national income. Another welcome development has been the stabilisation or relatively slow growth in the debt/GDP ratio in the last 2 years. The internal liabilities of the Central government increased sharply from 49.7 per cent of GDP in 1999-2000 to 60.9 per cent of GDP in 2002-03. They remained at 61.7 per cent and 62.3 per cent of GDP in 2003-04 and 2004-05, respectively. For 2005-06, the internal debt/GDP ratio is budgeted at 61.7 per cent. The stabilisation of the internal debt ratio (albeit at a high level) is due to positive differential of growth rates over interest rates since 2003-04. While the average cost of Central government debt has come down from 10 per cent in 99-20/02-03 to 8.8 per cent in 03-04/04-05, nominal GDP growth has gone up from 9.1 per cent to 12.3 per cent in the corresponding period. This, together with the low deficit on the primary account, has permitted the stabilisation of the internal debt/GDP ratio, which is budgeted at 61.7 per cent in 2005-06. The declining trend of external liabilities in relation to GDP has continued in 2004-05 and the same is expected in 2005-06. The stabilisation of debt/GDP, together with decreasing interest cost, has moderated the growth in interest burden. Interest payments have come down from 4.8 per cent of GDP in 200102 to 4 per cent in 2003-04. As a percentage of revenue receipts, they have come down from 73 per cent to 66 per cent in the corresponding period.
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The above positive developments, however, do not call for complacency. Although the ills associated with high deficits have not manifested themselves in terms of rising interest rates, inflation and preemption of private investment, now that private investment has perked up, the need to keep debt and deficit under check gains significance. The Economic Survey notes that in 2004-05 there has been a significant deceleration in investments in government securities by commercial banks following a pick-up in demand for credit from the commercial sector and lower market borrowings by the Central government. Between April 2004 and January 2005 the investments of commercial banks in Central and state government securities increased by 4.9 per cent as against 20.1 per cent during the corresponding period of the previous year. Thus, a scenario of high government borrowing can result in pre-emption of private investment in future. Further, high deficits and debt have reduced the ability of the government to spend in priority areas like infrastructure, health, education and employment guarantee. Without a concerted effort, the gains in terms of a relatively better fiscal situation in 2003-04 and 2004-05 will prove to be shortlived. The FRBM Act was enacted and fiscal policy rules were notified to put a legislative ceiling on deficits. The FRBM targets have not been belied by the fiscal outcome of 2004-05. The proposed trajectory of debt suggests that government will have to generate a primary surplus to bring down the debt/GDP. The trajectory of primary deficit/surplus has, however, not been explicitly stated in the Medium Term Fiscal Policy Statement.
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Industry
Overall sectoral impact

Industry Auto ancillaries Effect Marginally positive
The reduction in the peak customs duty from 20 per cent to 15 per cent will reduce the input costs of auto ancillary companies who import sub-components for use in their final products, such as MICO and Sona Koyo Steering Systems. The reduction in the peak duty on aluminium will marginally reduce the input costs of auto ancillary and casting & forging companies such as Bharat Forge and Rico Auto, which is likely to be passed on to original equipment manufacturers (OEMs). The reduction in the customs duty on copper will marginally reduce the input cost of companies manufacturing electrical components such as wire harnesses; for e.g., Motherson Sumi. The reduction in the customs duty on lead from 15 per cent to 5 per cent will reduce the input costs of automotive battery manufacturing companies such as Exide and Amara Raja Batteries. The extension of 150 per cent deduction on in-house R&D till March 2007 will benefit companies such as MICO, PRICOL and Sundaram Brake Linings.
Banking Positive
The proposed amendment to the Banking Regulation Act, allowing banks to issue preference shares, is a positive, as it will provide them with another source of capital, which will help them in meeting obligations under Basel II.
U N I O N
The proposed removal of floor and caps on SLR and CRR requirements will give more autonomy to the Reserve Bank of India in effective management of the banking system. Allowing banks to appoint micro finance institutions (MFI) as banking correspondents will provide transaction services will help banks in increasing credit flow to small sectors and meet priority sector targets. The proposal to levy a 0.1 per cent tax on withdrawal of cash on a single day of Rs. 10,000/- or more will not have any significant impact. The amendment to the definition of `securities' under the Securities Contracts (Regulation) Act, 1956 to include legal framework for trading of securitised debt will help deepen the securitisation market (asset-backed securitsation & mortgage-backed securitisation) in India. This is likely to benefit HFCs and NBFCs. The proposal to allow deduction of up to Rs 1 lakh on repayment of principal amount of housing loan will positively affect housing finance.
Capital goods Neutral
B U D G E T
18
The cut in peak duty from 20 per cent to 15 per cent will translate into higher competition from imports. The cut in customs duty on textile machinery from 20 per cent to 10 per cent will affect domestic players like LMW. The budgetary allocation of Rs 11 billion for rural electrification programmes will benefit transformer manufacturers; however, an expected lag in implementation will not result in immediate benefits. The cut in customs duties on copper, aluminium and alloy steel from 15 per cent to 10 per cent will have a marginal positive impact. The rise in excise duty on steel, from 12 per cent to 16 per cent, will not have any impact, as it is modvatable. Overall, the impact of these measures will be neutral on the sector.

Industry Cars and utility vehicles Effect Marginally positive
The reduction in peak customs duty, from 20 per cent to 15 per cent, will lower the prices of imported components. This reduction will bring down the prices of premium segment cars, which have higher import content. The cut in the customs duty on aluminium, from 15 per cent to 10 per cent, will marginally decrease the cost of production for cars and utility vehicle manufacturers. These measures will increase the margins of players, as the savings in costs will be retained. The extension of 150 per cent deduction, in terms of in-house R&D expenses, upto March 31, 2007, will benefit companies such as M&M and Tata Motors.
Cement Marginally positive
The cement industry is set to benefit from the government's focus on irrigation, urban infrastructure and roads. The cut in the customs duty on pet coke will encourage the use of alternative fuels. Shree Cements and Gujarat Ambuja have a headstart in the use of alternative fuels and are set to benefit the most. Mini-cement plants will be affected more by the hike in the excise duty on clinker. However, the larger players (who purchase clinker) pay a higher excise duty on cement, and hence, will be able to offset the increase. The proposal to allow deduction of up to Rs 1 lakh on repayment of principal amount of housing loan will boost housing demand and thereby cement consumption.
Chlor alkalies Marginally negative
U N I O N
The cut in peak customs duty rates, from 20 per cent 15 per cent, will marginally affect the caustic soda and soda ash industry. Although the current domestic prices of both products are at a discount to the landed cost, prices are expected to fall marginally. As a large number of caustic soda manufacturers use captive power plants, which primarily use furnace oil as fuel, the cut in customs duty from 20 per cent to 10 per cent on FO/LSHS will lower their manufacturing costs marginally. Overall, the impact of the above measures is marginally negative for the industry.
Cigarettes Neutral
B U D G E T
An additional excise duty has been imposed on cigarettes at specific rates ranging from Rs 15 to Rs 180 per thousand cigarettes. The increase is unlikely to affect cigarette companies, as they will be able to pass on the hike to consumers.
Commercial vehicles Neutral
The reduction in the excise duty on tyres will reduce the operating costs of transport operators in terms of lower tyre prices in the replacement market. The reduction in the peak duty on aluminium is likely to marginally reduce the input costs for commercial vehicle OEMs. The extension of 150 per cent tax deduction in in-house R&D expenses till March 2007 will benefit companies such as Eicher Motors, Tata Motors and Ashok Leyland.
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Industry Consumer durables Effect Positive
The expected rise in the disposable income of consumers (following the change in tax brackets and norms) is expected to induce consumer durable demand. The reduction in the customs duty on CPTs is expected to lower input costs which is likely to have a marginally positive impact on CTVs (particularly the flat and large-sized CTV segments). Players are expected to pass on a part of the cost benefits to consumers. Mirc Electronics, LG and Samsung will benefit owing to increased demand. AC players are expected to pass on the reduction in excise benefits to consumers. This will result in higher demand, as ACs have displayed significant price elasticity in the past. The reduction in the customs duty on consumer durables will have a negligible impact on the domestic industry.
Cotton and cotton yarn Positive
U N I O N
The CENVAT exemption route has been maintained for natural fibres, including cotton, which is a positive for the industry. The customs duty on specific textile machinery has been cut from 20 per cent to 10 per cent; this will benefit the entire cotton textile sector. The de-reservation of 30 textile products, including hosiery, from among 108 items, will boost the cotton knitwear sector. The textileprocessing sector will also benefit from the 10 per cent capital subsidy. The Rs 250 billion Technology Upgradation Fund (TUF) scheme has been continued with an additional allocation of Rs 4.35 billion, which will benefit the cotton yarn industry.
Fertilisers Marginally positive
B U D G E T
Although the budget contained no direct provisions relating to the fertiliser industry, the increased thrust on irrigation, higher farm sector credit and various other measures for the agricultural sector augur well for the industry. The Budget has provided an allocation of Rs 162.5 billion as the fertiliser subsidy for 2005-06 as against the provision of Rs 126.62 billion for 2004-05. This increase is expected to cover the subsidy arrears for 2004-05.
Hotels Neutral
No impact on the sector.

Information technology
Software Neutral
The government has introduced the National Urban Renewal Mission, to renew the infrastructure of seven mega cities with a population of over 1 million. The deteriorating infrastructure in most Tier 1 and Tier 2 cities has been a cause for concern for various players within the IT and ITeS industry. The above initiative is expected to benefit the IT sector in the long term.
20

Industry Information technology
Hardware Marginally positive
Effect
The reduction of customs duties on all Information Technology Agreement (ITA)-bound per cent from the current 10 per cent, as well as the abolition of customs duties on and inputs required to manufacture these items will benefit assemblers, domestic hardware such as HCL Infosystems, Wipro, Zenith Computers, and players such as Dell, IBM
items to zero capital goods manufacturers and HP.
This benefit is, however, partially offset by the imposition of a CVD of 4 per cent on all imports of ITA-bound items and their inputs, which attract zero duty. Credit for the CVD is available against payment of excise duty.
Man-made fibres Marginally negative
The reduction in excise duty on polyester filament yarn (PFY) from 24 per cent to 16 per cent will be positive for the industry, as it will help revive PFY demand, which had turned uncompetitive vis-vis cotton yarn. There has been no rationalisation of excise duties on other man-made fibres. The cut in customs duties on POY and PSF will bring down the landed costs and force domestic producers to lower prices to match the landed costs. The overall negative impact on margins will, however, be offset to some extent, as the duties on the feedstocks, PTA, DMT and MEG, have also been brought down to 15 per cent. The duty cut on synthetic fabrics from 20 per cent to 15 per cent will lead to increase in synthetic fabric imports. The overall impact will be marginally negative for the industry.
Non-ferrous metals Marginally negative
U N I O N
The budget measures will have a negative impact on the non-ferrous metal (NFM) industry as the import duties on aluminium, copper and zinc have fallen to 10 per cent from 15 per cent. However, in the case of copper and zinc, the impact on margins in 2005-06 will be neutralised by the favourable changes in global demand-supply dynamics. However, the margins of aluminium players are expected to decline by 300 basis points. Hindalco will be affected the most, with overall operating margins expected to decline by around 270 basis points. Nalco will be the least affected, because it has a high share of alumina sales in its product mix.
Oil and gas Negative
B U D G E T
The customs duty cut in crude oil (from 10 per cent to 5 per cent) and peak customs duty cut on petroleum products (20 per cent to 10 per cent) has resulted in lower tariff protection for the refining players (from 3.1 per cent to 2.6 per cent). The resultant lower gross refining margins will result in oil marketing companies (oil marketing companies - OMCs, such as IOC, BPCL and HPCL) seeing their operating profits take a hit of Rs 6.6 billion. The decline in customs duty on products will have a positive impact on MS/HSD marketing margins (Rs 24 billion) and subsidy under-recovery on LPG/SKO (Rs 11.3 billion). The zero excise duty on LPG (down from 8 per cent) and SKO (down from 12 per cent) would result in lower subsidy under-recovery for the OMCs, to the extent of Rs 17 billion. However, the increase in excise duty on MS and HSD would have a major negative impact on the marketing margins on these products, as these are not likely to be passed on to the end consumers. We estimate that the OMCs will take a collective hit of Rs 75 billion. Overall, the three major integrated OMCs are estimated to take an annual hit of Rs 29.4 billion while ONGC will see its operating profits take a hit of Rs 1.5 billion.
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Industry Other infrastructure Effect Positive
The Union Budget 2005-06 lays significant thrust on the overall development of infrastructure. The Budget proposes to set up a special purpose vehicle (SPV) to the extent of Rs 100 billion, to fund roads, ports, airports and tourism projects, which will be governed by the inter-institutional group. In addition to this, foreign exchange reserves will be used to fund infrastructure projects. The government's continued commitment to provide equity (Rs 140.4 billion) and debt support (Rs 35.54 billion) to public sector enterprises in 6 infrastructure sectors, including railways and aviation, will benefit these sectors. The passage of the proposed bill for regulating SEZs could boost private investment and help in the speedy implementation of SEZ projects.
Paints Marginally positive
The reduction in peak import duty would improve operating margins by about 30 basis points.
Paper Marginally negative
The reduction in the import duty on paper, from 20 per cent to 15 per cent, will adversely affect higher-end coated paper manufacturer, BILT. Other paper manufacturers are likely to be marginally affected owing to the reduced differential between landed costs and domestic prices.
Personal care and detergents
U N I O N
Positive
The reduction in peak import duty on raw materials will benefit the industry. The magnitude of the impact would differ across players, depending on the extent of imports. The increase in disposable income, following change in the direct tax structure, will aid more penetration and upgradation to more value-added products.
Petrochemicals: Basic and Polymers Negative
B U D G E T
The customs duty on naphtha has been retained at 5 per cent, while the duties on basic petrochemicals and polymers have been reduced to 5 per cent and 10 per cent, respectively. Thus, the effective duty protection (naphtha-polymer) for integrated polymer producers (RIL, IPCL, Haldia Petrochem and GAIL) has come down from 10 per cent to 5 per cent. For non-integrated producers (Finolex, Chemplast and DCW), though the duty differential is maintained, margins will be impacted negatively, as the reduction of the duty on raw materials will not completely offset the impact of the duty cut on higherpriced end products. Domestic producers will also face greater competition from cheaper imports. Further, the reduced duty differential between naphtha and basic products (not converted into polymers and sold domestically, such as benzene and toluene) will also affect player margins negatively. Overall, the duty cuts will have a negative impact on the industry.
Petrochemicals: Downstream Marginally negative
22
The government has cut customs duty from 20 per cent to 15 per cent on downstream petrochemical products. However, it has also reduced customs duty on raw material (benzene, ethylene, naphtha) from 10 per cent to 5 per cent. Although the duty differential is maintained at 10 per cent, the reduction in raw material duty will not completely offset the decline in duty on higher priced end products. It will thus have a marginally negative impact on downstream petrochemical companies like Thirumalai Chemicals (phthalic anhydride), Tamilnadu Petroproducts (LAB), HOCL and Schenectady Herdillia (phenol/ acetone), PCBL (carbon black) and Vinyl Chemicals (VAM). Domestic producers will also face higher competition from imports. However, end user industries like paints, plasticisers, detergent and tyre manufacturers are expected to benefit with reduction in duties and hence, product prices.

Industry Pharmaceuticals Effect Marginally positive
The government has increased its focus on healthcare by increasing the allocation from Rs 84.2 billion to Rs 102.8 billion under the National Rural Health Mission. The focus is on increasing the supply of medicines and training medical personnel. The last date to avail of 150 per cent tax deductions for research companies as well as 100 per cent deduction of profits of companies carrying on scientific research and development and approved by the Department of Scientific and Industrial Research has been extended to March 31, 2007. Besides, the government has announced reduction in imports duty on a list of nine capital goods. It has announced formation of a corpus fund of Rs 5 billion called the SME Growth Fund through the Small Industries Development Bank of India (SIDBI) to provide equity support for small and medium units in pharmaceuticals and biotech firms. Thus the overall impact has been marginally positive.
Ports Neutral
The budget contains no specific measures for the ports sector. The establishment of a special purpose vehicle to finance infrastructure projects such as ports will, however, serve to boost investments in the sector. The imposition of service tax on dredging services will result in a marginal increase in capital and operating costs for ports.
Power Marginally positive
U N I O N
The government has indicated that in 2005-06 it will provide equity support to the tune of Rs 140.40 billion and loans amounting to Rs 35.54 billion to central public sector undertakings in select sectors, including power. This will help companies such as NTPC, NHPC and PGCIL in their capacity augmentation plans. The reduction of customs duties on capital goods would primarily benefit medium and smallscale power projects through lower project costs. The government has announced a budgetary support of Rs 11 billion for 2005-06 under the Rural Electrification Distribution Backbone programme for installing at least one 33/11KV substation in every block, for electrification of 1,25,000 villages in the next 5 years. This is a positive indicator of the government's overall commitment to reform the sector. The cess of Rs 1.5 per litre on light diesel oil would increase generation costs by around 8 per cent for captive power plants that consume the same.
Roads Positive
B U D G E T
The Union Budget 2005-06 has provided a significant fillip to the roads sector, given its higher focus on the infrastructure sector. The rise in allocations for the National Highway Development Programme (NHDP) from Rs 65.14 billion in FY05 to Rs 93.20 billion in FY06 will result in more funds for the programme. The focus on NHDP phase III will result in speedy implementation of the project. An outlay of Rs 55 billion under the National Urban Renewal Mission, a special purpose vehicle (SPV) to finance infrastructure projects with Rs 100 billion borrowing limit and a provision of Rs 15 billion for viability gap funding for infrastructure projects, will boost the roads sector.
Shipping Neutral
No impact on the sector. 23


Industry Steel Effect Marginally negative
The excise duty on steel products has been increased to 16 per cent from 12 per cent. The excise duty on steel is cenvatable for a majority of the steel consumers of flat products and will, hence, will be passed on. Thus the impact on margins will be neutral. However, the increase will be difficult to pass on in case of GP/GC steel and long products. SAIL, Tata Steel (for long products) and GP/GC manufacturers will be partially affected; the least impact will be on JISCO. Lower duties on stainless steel will have a neutral impact because the landed cost (after the duty reduction) is higher than the current domestic prices. One factor that will mitigate the negative impact is the reduction in the duties on coking coal (with more than 12 per cent ash content), refractories and ferro alloys, which will marginally lower the input costs for the industry.
Sugar Positive
U N I O N
The proposed financial package for the revitalisation of the sugar industry, entailing a moratorium of 2 years on the payment of both principal and interest, is expected to largely benefit those mills in Maharashtra and South India, that are in financial distress. For the stronger mills, which have availed of loans from the Sugar Development Fund (SDF), the reduction in the rate of interest on all outstanding SDF loans is viewed as a positive. The reduction in the basic customs duty on molasses and industrial alcohol from 15 per cent to 10 per cent is expected to be marginally negative for the industry.
Tea and Coffee Positive
B U D G E T
The removal of surcharge of Re 1 per kg of tea will benefit the industry. The proposal to reframe the price stabilisation fund and improve replantation and rejuvenation activity will benefit the industry in the long term.
Telecom cables Negative
The abolition of the basic customs duty on jelly-filled telecom cables (15 per cent in 2004-05) and optical fibre cables (20 per cent in 2004-05) under the Information Technology Agreement (ITA) is a negative for the industry. Price realisations will decline, as competitive pressures will force Indian producers to lower prices to compete with cheaper imports. The reduction in the customs duty on raw materials like copper and optic fibre partly offsets the zero duty on finished products. The pressure on the margins of domestic producers is expected to increase.
Telecom equipment Marginally negative
The customs duty on specified finished products and the capital goods required to manufacture these products have been abolished; earlier a customs duty of 10-15 per cent was levied on these items. The change in the customs duty on finished products will have a negative impact on domestic players, although the abolition of duties on capital goods will mitigate the negative impact.
24

Industry Telecom services Effect Negative
The continuation of the exemption presently available to telecom service providers for the import of specified telecom network equipment and parts thereof is a positive for the sector. Zero import duty on mobile and fixed wireless handsets to lower entry cost for customers. The benefits under section 80 IA, wherein a telecom operator was entitled to 100 per cent exemption on taxable profit for 5 years and 30 per cent exemption for the next 5 years during the initial 15 years from the date of commencement of commercial operations, have not been extended. This will reduce the return on future capital investments in the industry.
Tractors Marginally positive
The overall thrust of the government on the agricultural sector, in terms of irrigation, agricultural credit, crop insurance and schemes for the agri-marketing sector, augurs well for the long-term demand growth in the industry. The increase in the excise duty on steel from 12 per cent to 16 per cent is likely to be passed on by the tractor manufacturers as the excise duty on inputs is not cenvatable for tractors (since the agricultural tractors are exempt from excise duty). The imposition of a 16 per cent excise duty on road tractors (of engine capacity more than 1,800 cc) for road trailers is not expected to impact the industry, considering its miniscule volumes when compared with agricultural tractors.
Two-wheelers Marginally positive
U N I
The reduction in personal tax rates will increase household disposable income, which is a positive for two-wheeler demand.
Tyres Positive
O N
B U D G E T
Customs on tyres and its raw materials - synthetic butadiene rubber, poly butadiene rubber and carbon black - has been reduced from 20 per cent to 15 per cent. The domestic prices of raw materials are aligned with landed costs, thus reducing the material costs. So the operating margins may improve from 7.5 per cent to 10 per cent. The customs duty cut on tyres will not intensify the import threat from China and South Korea, as they already enjoyed a preferential 15 per cent duty under the Bangkok Agreement. The abolition of the specific excise duty of 8 per cent on tyres would have a neutral impact, as the benefits are expected to be passed on.
25
Overall company impact

Company ABB Ltd. AC C Ltd. Aksh Optifibre Ltd. Alfa Laval (India) Ltd. Andhra Pradesh Paper Mills Ltd. Apollo Tyres Ltd. Arvind Mills Ltd. Ashok Leyland Ltd. Asian Hotels Ltd. Asian Paints India Ltd. Aurobindo Pharma Ltd. Bajaj Auto Ltd. Bajaj Hindusthan Ltd. Ballarpur Industries Ltd. Balrampur C hini Mills Ltd. Bannari Amman Sugars Ltd. Berger Paints India Ltd. Bharat Forge Ltd. Bharat Heavy Electricals Ltd. Bharat Petroleum C orpn. Ltd. Bharat Sanchar Nigam Ltd. Bharti Televentures Ltd. Bhushan Steel & Strips Ltd. Biocon India Ltd. Birla Ericsson Optical Ltd. Bombay Dyeing Ltd. Bongaigon Petrochemicals Ltd. C arrier Aircon Ltd. C eat Ltd. C entury Enka Ltd. C entury Textiles Ltd. C hambal Fertilisers & C hemicals Ltd. C hemplast Sanmar Ltd. C hennai Petroleum C orpn. Ltd. C ipla Ltd. C olgate-Palmolive (India) Ltd. C oromandel Fertilizers Ltd. C rompton Greaves Ltd. Dabur India Ltd. DC W Ltd. D-Link(India) Ltd. Dr Reddy's Laboratories Ltd. Eicher Motors Ltd. EID Parry Ltd. EIH Ltd. Escorts Ltd. Essar Shipping Ltd. Essar Steel Ltd. Impact Industry C apital goods C ement Telecom cables C apital goods Paper Tyres C otton textiles C ommercial vehicles Hotels Paints Pharmaceuticals Two wheelers Sugar Paper Sugar Sugar Paints Auto ancillaries C apital goods Oil and gas Telecom services Telecom services Steel Pharmaceuticals Telecom cables Diversified Oil and gas C onsumer durables Tyres Man-made fibres Diversified Fertilisers Petrochemicals: Basic and Polymers Oil and gas Pharmaceuticals Personal care and Detergents Fertilisers C apital goods Personal care and Detergents Petrochemicals: Basic and Polymers Information technology Pharmaceuticals C ommercial vehicles, Tractors Sugar Hotels Tractors Shipping Steel
Continued...
U N I O N
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...continued
Company Finolex C ables Ltd. Finolex Industries Ltd. Garden Silk Mills Ltd. Gas Authority of India Ltd. George Williamson (Assam) Ltd. GlaxoSmithkline Pharmaceuticals Ltd. Godfrey Phillips India Ltd. Goetze India Ltd. Goodlass Nerolac Paints Ltd. Goodricke Group Ltd. Goodyear India Ltd. Grasim Industries Ltd. Great Eastern Shipping C o Ltd. GTN Textile Ltd. Gujarat Alkalies and C hemicals Ltd. Gujarat Ambuja C ement Ltd. Gujarat Heavy C hemicals Ltd. Gujarat Narmada Valley Fertilizers C ompany Ltd. Gujarat State Fertilisers C ompany Ltd. Haldia Petrochemicals Ltd. Harrisons Malayalam Ltd. HC L Infosystems Ltd. Hero Honda Motors Ltd. Himachel Futuristic C ommunications Ltd. Hindalco Industries Ltd. Hindustan C opper Ltd. Hindustan Lever Ltd. Hindustan Motors Ltd. Hindustan Organic C hemicals Ltd. Hindustan Petroleum C orpn. Ltd. Hindustan Zinc Ltd. Hitachi Home & Life Solutions (India) Ltd. Honda SIEL C ars India Ltd. Hotel Leelaventure Ltd. Hutchison Max Telecom Ltd. Hyundai Motors India Ltd. IBP C o. Ltd. IC I India Ltd. India C ement Ltd. India Glycols Ltd. Indian Hotels C ompany Ltd. Indian Oil C orpn. Ltd. Indian Petrochemicals C orpn. Ltd. Indian Rayon & Industries Ltd. Indo Gulf Fertilisers Ltd. Indo Rama Synthetics (India) Ltd. Infosys Technologies Ltd. Ispat Industries Ltd.
Impact Industry Telecom cables Petrochemicals: Basic and Polymers Man-made fibres Oil and gas Tea and C offee Pharmaceuticals C igarettes Auto ancillaries Paints Tea and C offee Tyres Diversified Shipping C otton textiles C hlor alkalies C ement C hlor alkalies Fertilisers Fertilisers Petrochemicals: Basic and Polymers Tea and C offee Information technology Two wheelers Telecom equipment Non-ferrous metals Non-ferrous metals Personal care and Detergents C ars and Utility vehicles Petrochemicals: Downstream Oil and gas Non-ferrous metals C onsumer durables C ars and Utility vehicles Hotels Telecom services C ars and Utility vehicles Oil and gas Paints C ement Petrochemicals: Downstream Hotels Oil and gas Petrochemicals: Basic and Polymers Diversified Fertilisers Man-made fibres Information technology Steel
continued...
U N I O N
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27

...continued
U N I O N
B U D G E T
Company ITC Ltd. ITI Ltd. JBF Industries Ltd. Jindal Stainless Ltd. JISC O/JVSL JK Industries Ltd. Kalyani Brakes Ltd. Kesoram Industries Ltd. Kochi Refineries Ltd. Lakshmi Machine Works Ltd. Madras C ements Ltd. Madras Refineries Ltd. Mahavir Spinning Mills Ltd. Mahindra & Mahindra Ltd. Malwa C otton Spinning Mills Ltd. Maruti Udyog Ltd. Matrix Laboratories Ltd. Mercator Lines Ltd. Mahanagar Telephone Nigam Ltd. MIRC Electronics Ltd. Moser Baer India Ltd. Motor Industries C o. Ltd. MRF Ltd. Munjal Showa Ltd. Nahar Exports Ltd. National Aluminium C o. Ltd. National Hydro Electric Power C orp. Ltd. National Thermal Power C orp. Ltd. Nicholas Piramal India Ltd. Nirma Ltd. Numaligarh Refinery Ltd. Oil and Natural Gas C orpn. Ltd. Oswal C hemicals and Fertilisers Ltd. PC S Technologies Ltd. Pfizer Ltd. Philips C arbon Black Ltd. Power Grid C orporation of India Ltd. Pudumjee pulp and paper Ltd. Punjab Alkalies and C hemicals Ltd. Punjab Tractors Ltd. Ranbaxy Ltd. Rashtriya C hemicals and Fertilisers Ltd. Raymond Ltd. Reliance Energy Ltd. Reliance Industries Ltd. Reliance Infocomm Ltd. Sanghi Polyester Ltd. Satyam C omputer Services Ltd.
Impact Industry C igarettes Telecom equipment Man-made fibres Steel Steel Tyres Auto ancillaries Diversified Oil and gas C apital goods C ement Oil and gas C otton textiles C ars and Utility vehicles, Tractors C otton textiles C ars and Utility vehicles Pharmaceuticals Shipping Telecom services C onsumer durables Information technology Auto ancillaries Tyres Auto ancillaries C otton textiles Non-ferrous metals Power Power Pharmaceuticals Personal care and Detergents Oil and gas Oil and gas Fertilisers Information technology Pharmaceuticals Petrochemicals: Downstream Power Paper C hlor alkalies Tractors Pharmaceuticals Fertilisers Diversified Power Diversified Telecom services Man-made fibres Information technology
continued...
28

...continued
Company Schenectady Herdillia Ltd. Seshasayee Paper and Boards Ltd. Shipping C orporation of India Ltd. Shree C ements Ltd. Shyam Telecom Ltd. Sona Koyo Steering Systems Ltd. Southern Petrochemical Industries C orporation Ltd. Steel Authority of India Ltd. Sterlite Industries (India) Ltd. Sterlite Optical Technologies Ltd. Sundaram Fasteners Ltd. Supreme Petrochem Ltd. TAFE Ltd. Tamil Nadu Newsprint & Papers Ltd. Tamil Nadu Petroproducts Ltd. Tata C hemicals Ltd. Tata C offee Ltd. Tata Iron & Steel C o. Ltd. Tata Motors Ltd. Tata Power C ompany Ltd. Tata Tea Ltd. Tata Teleservices Ltd. Thirumalai C hemicals Ltd. TVS Motor C ompany Ltd. Ultratech C ement Ltd. Videocon Appliances Ltd. Videocon International Ltd. Videsh Sanchar Nigam Ltd. Vindhya Telelinks Ltd. Vintron Informatics Ltd. VST Industries Ltd. West C oast Paper Mills Ltd. Whirlpool of India Ltd. Wipro Ltd. Wockhardt Ltd. Zenith C omputers Ltd. Zuari Industries Ltd. Source: CRIS INFAC
Impact Industry Petrochemicals: Downstream Paper Shipping C ement Telecom equipment Auto ancillaries Fertilisers Steel Non-ferrous metals Telecom cables Auto ancillaries Petrochemicals: Basic and Polymers Tractors Paper Petrochemicals: Downstream Diversified Tea and C offee Steel C ars and UVs, C ommercial vehicles Power Tea and C offee Telecom services Petrochemicals: Downstream Two wheelers C ement C onsumer durables C onsumer durables Telecom services Telecom cables Information technology C igarettes Paper C onsumer durables Information technology Pharmaceuticals Information technology Fertilisers
U N I O N
B U D G E T
29
Auto ancillaries
Domestic growth to slow down, surge in exports to continue in 2005-06 The auto ancillary industry is estimated to have grown by around 20 per cent in the first 9 months of 2004-05 in terms of value of production as compared with the same period last year. The growth was led by the strong domestic growth posted by almost all the segments of the automobile industry and high growth in exports. The passenger cars and utility vehicles segment grew by 27 per cent, commercial vehicles by 30 per cent, twowheelers by 14 per cent and tractors by 40 per cent in the first 9 months of 2004-05. For the full year of 200405, the auto ancillary industry is expected to grow by 18-20 per cent, while exports are seen growing by 25-30 per cent. In 2005-06, the auto ancillary industry is likely to post a relatively lower growth of 12-13 per cent. The lower growth will be due to the reduced growth rate in almost all the automobile segments. However, exports are expected to continue the strong growth momentum in 2005-06 at 20-25 per cent. This will be led by the continued thrust on exports by domestic manufacturers as well as increase in outsourcing of components from India by global OEMs and Tier-I vendors. Operating profit margins slipped marginally in the first 9 months of 2004-05, owing to a rise in input costs; the margins are expected to remain under marginal pressure in 2005-06 as well, as CRIS INFAC expects average steel prices to remain firm in 2005-06. But net profits of players have risen, on account of higher growth in net sales and lower capital charges in the first 9 months of 2004-05; the net profits are expected to improve further in 2005-06.
U N I O N
Auto ancillaries: Tariffs (per cent) Parts of four-wheelers Parts of two-wheelers Parts of IC engines IC engines Transmission shafts, gears and gear boxes Auto gaskets/brake linings C atalytic convertors GP/GC steel HR steel Aluminium C opper Lead Nickel Source: CRIS INFAC Customs 2004-05 2005-06 20.4 20.4 20.4 20.4 20.4 20.4 5.1 5.1 5.1 15.3 15.3 15.3 5.1 15.3 15.3 15.3 15.3 15.3 15.3 5.1 5.1 5.1 10.2 10.2 5.1 5.1 16.3 16.3 16.3 16.3 16.3 16.3 16.3 12.2 12.2 16.3 16.3 16.3 16.3 Excise 2004-05 2005-06 16.3 16.3 16.3 16.3 16.3 16.3 16.3 16.3 16.3 16.3 16.3 16.3 16.3
B U D G E T
HR: Hot rolled; GC : Galvanised coil; GP: Galvanised plate; IC : Internal combustion
30
Auto ancillaries
Budget measures marginally positive for the auto ancillary sector
Company Bharat Forge Ltd. Goetze India Ltd. Kalyani Brakes Ltd. Motor Industries C o. Ltd. Munjal Showa Ltd. Sona Koyo Steering Systems Ltd Sundaram Fasteners Ltd. Source: CRIS INFAC Impact Impact factors D B, D B, D A, D A A, D A
Impact factors A. The reduction in the peak customs duty on components will benefit companies that import sub-components for manufacturing their final product, such as MICO and Sona Koyo Steering Systems. B. The reduction in the peak customs duty on aluminium will marginally reduce the input costs of auto ancillaries in terms of lower prices. The cut in the peak customs duty on copper will marginally reduce the input costs of companies manufacturing electrical components such as wire harnesses. The reduction in the customs duty on lead to 5 per cent will reduce the input costs of automotive battery manufacturing companies such as Exide and Amara Raja Batteries. The benefit of the above measures will be passed on to the original equipment manufacturers. C. The increase in the excise duty on steel will not have any impact on the costs of auto ancillary manufacturers, as the same is modvatable. D. The extension of the 150 per cent tax benefit for in-house R&D will marginally benefit auto ancillary companies undertaking research and development.
31
Capital goods
Demand to remain robust in medium term The demand growth momentum in capital goods is expected to continue in 2005-06, driven by pick-up in industrial activity, fresh investments in sectors like power equipment, metals, oil and gas and petrochemicals and the continued spending thrust on infrastructure. Over the past 2 years, the demand for capital goods has risen due to a rise in corporate profitability, leading to greater investment activity in the industry. Unlike the negative growth rates seen in 2001-02, the sector grew by over 13 per cent in 2003-04 and 14 per cent in 2004-05, driving industrial growth. The Index of Industrial Production (IIP) averaged 2.7 per cent in 2001-02, 6.9 per cent in 2003-04 and 8.1 per cent in the first half of 2004-05. This is evident in the bulging order book for companies catering to these sectors. The players' export thrust, to weather the downturn in domestic markets, has continued and the contribution of export revenues has been steadily improving. We expect this trend to continue in the medium term. There are substantial capex plans outlined by major players (ABB, Seimens, BHEL), due to the need to expand capacities to meet these orders (the asset turnover ratios reflect higher capacity utilisation levels). Competition in this sector is expected to intensify since the reduction, in January 2004, of peak customs duty to 20 per cent, which has made imports cheaper. Capital goods imports grew by 31 per cent in 2003-04 vis--vis 24.7 per cent in 2002-03. The profitability of domestic manufacturers has improved over the past 2 years after having hit a low in 200102. We expect margins to be marginally affected in 2004-05 before stabilising in 2005-06 in spite of the improved
U N I O N
demand outlook on account of the increased competition from imports and rise in the prices of raw materials, namely steel, aluminium and copper
Capital goods: Tariffs (per cent) General machinery Textile machinery Textile machinery (Specified items) Machine tools C NC systems Milking and dairy machinery High speed steel/alloy steel Steel plates Seamless steel tubes Project imports Fertilisers 5.1 Refining of crude petroleum 5.1 C oal mining 5.1 C aptive power plants of 5 MW and above 20.4 Power generation project 5.1 (excluding captive power plants) Power transmission projects of 66 KV and above 5.1 LNG regassification plants 5.1 Other industrial plants or projects, including oil and gas 20.4 C VD: C ountervailing duty Note 1) C ustom duty on steel plates revised from 10 to 5 per cent Source: CRIS INFAC Customs 2004-05 20.4 20.4 5.1 20.4 20.4 20.4 15.3 5.1 20.4 + + + + + 10 10 10 16 10 2005-06 15.3 10.2 5.1 15.3 15.3 15.3 10.2 5.1 15.3 10 10 10 16 10 C VD C VD C VD C VD C VD Excise 2004-05 2005-06 16.3 16.3 16.3 16.3 16.3 16.3 16.3 16.3 16.3 16.3 0.0 0.0 12.2 16.3 12.2 16.3 16.3 16.3 -
B U D G E T
C VD 5.1 + C VD 5.1 + C VD 5.1 + C VD 15.3 + C VD 5.1 +
+ 10 C VD 5.1 + 10 C VD + 10 C VD 5.1 + 10 C VD + 16 C VD 15.3 + 16 C VD
32
in August 2004
Capital goods
Customs duties cut on product and raw materials
Company ABB Ltd. Alfa Laval (India) Ltd. Bharat Heavy Electricals Ltd. C rompton Greaves Ltd. Lakshmi Machine Works Ltd. Source: CRIS INFAC Impact Impact factors A,B,C,D A,B,C A,B,C,D A,B,C,D A,B,C
Impact factors A. The reduction in the peak customs duty from 20 per cent to 15 per cent will result in increased competition from imports. This will have a marginally negative impact on domestic companies; but domestic companies with strong technology platforms and relationships will be able to weather increased competition to an extent. The reduction in the customs duty on specified textile machinery from 20 per cent to 10 per cent will have a negative impact on domestic textile machinery manufacturers. B. The reduction in customs duty from 15 per cent to 10 per cent on alloy steel, aluminium and copper will have a marginally positive impact on raw material prices.
U
C. Increase in excise duty on iron and steel from 12 per cent to 16 per cent will not have any impact, as it will be modvatable. D. The budgetary allocation of Rs 11 billion for rural electrification programmes will benefit transformer manufacturers; however, with an expected lag in implementation, we do not expect immediate benefits.
N I O N
B U D G E T
33
Cars and utility vehicles

Growth to be lower in 2005-06 Domestic passenger car sales rose by 22 per cent, while domestic utility vehicle (UV) sales increased by 20 per cent in the first 9 months of 2004-05. Passenger cars and UVs are expected to grow at 17-18 per cent and 16-17 per cent respectively in 2004-05. The strong growth in sales was due to strong growth in family incomes, higher aspiration levels of customers, price reductions and new models/variants launched by companies, lower EMIs due to stable interest rates and higher tenures. The cut in EMIs also spurred tour operators to replace old vehicles in their fleet. The growth of passenger cars is likely to be lower at 10-11 per cent in 2005-06, due to increase in prices of cars (owing to rise in input price), Euro III norms, and stable interest rates. The mid-size segment and compact segment will continue to see growth, while the mini segment may see a fall in sales. Similarly, the growth in utility vehicles is likely to be lower, at 4-5 per cent, mainly due to expectations of stable consumer finance interest rates, which drove growth in the previous fiscal. The operating margins of car and UV manufacturers have improved marginally, owing to strong demand growth and higher capacity utilisation. Going forward, the operating margins are expected to increase slightly in 2005-06, on the back of higher realisations, due to change in product mix in favour of compact and mid-size segment cars. Net profits have grown substantially in the first 9 months of 2004-05, on account of higher volumes and lower interest cost, and are expected to improve further in 2005-06.
U N I O N
Cars and utility vehicles: Tariffs (per cent) New cars -C KDs -SKDs -C BUs Second hand cars Utility vehicles -6-12 seater 1 -12 seater and above Steel items Other components C BUs: C ompletely built units
1 1
Customs 2004-05 2005-06 20.4 61.2 61.2 107.1 20.4 20.4 5.1 20.4 20.4 15.3 61.2 61.2 102.0 15.3 15.3 5.1 15.3 15.3
Excise 2004-05 2005-06 24.5 24.5 24.5 24.5 24.5 16.3 12.2 16.3 16.3 24.5 24.5 24.5 24.5 24.5 16.3 16.3 16.3 16.3
B U D G E T
Engines and engine parts
C KDs: C ompletely knocked down units; SKDs: Semi-knocked down units; Excluding driver Source: CRIS INFAC
34
Cars and Utility vehicles

Cost savings for cars & UV manufacturers to improve margins
Company Hindustan Motors Ltd. Honda SIEL C ars India Ltd. Hyundai Motors India Ltd. Maruti Udyog Ltd. Tata Motors Ltd. Mahindra & Mahindra Ltd. Source: CRIS INFAC Impact Impact factors B, D, E B, D, E B, D, E B, D, E B, D, E B, D, E
Impact factors A. The cut in the import duty on used cars and utility vehicles from 105 per cent to 100 per cent will not have any impact on the industry. B. The reduction in the peak customs duty on components from 20 per cent to 15 per cent will lower the prices of imported components. This reduction will bring down the prices of premium segment cars, which have a higher import content. In addition, the cut in the customs duty on aluminium from 15 per cent to 10 per cent will marginally lower the cost of production of cars and utility vehicles. The above measures will have a positive impact on cars and utility vehicle manufacturers, as these benefits are likely to be retained by auto original equipment manufacturers (OEMs), thereby increasing their margins. C. The increase in the excise duty on steel from 12 per cent to 16 per cent and cut in the excise duty on tyres from 24 per cent to 16 per cent will not affect OEMs, as the excise on inputs are modvatable against the excise paid by companies on their final product. D. The extension of 150 per cent deduction up to March 31, 2007 in terms of in-house R&D expenditure will benefit automobile OEMs. E. The reduction in personal tax rates will increase household disposable income, which is a positive for car demand.
U N I O N
B U D G E T
35
Cement
Infrastructure development and housing to drive future demand growth In April-December 2004-05, cement demand increased by 6.7 per cent over that in the corresponding period of the previous year. CRIS INFAC expects cement demand to grow by 8 per cent over the next 2 years. While the housing sector will continue to be the key growth driver on the back of housing sops, infrastructure spending (particularly roads, urban infrastructure, ports and airports), will provide further impetus to the growth. This apart, industrial projects that are expected to pick up after 2005 will further aid demand growth in the domestic market. Industry to witness firming up of prices and higher consolidation The first 9 months witnessed price increases across all regions (barring the East), on account of higher operating rates and increased consolidation. In 2005-06, prices will increase steeply in the South on the back of strong demand, followed by the North, West and East, owing to robust growth in cement demand and high operating rates. Given the limited greenfield capacity additions expected over the next 2-3 years and the strong growth in cement consumption, operating rates will continue to improve and thereby translate into firm prices. Also, the acquisition of smaller players will result in greater consolidation in the industry over the next 5 years.
U N I O N
Cement: Tariffs Customs (per cent) 2004-05 Portland cement White cement Limestone
1
Excise (Rs/tonne) 2004-05 408 16.3 255 16.3 2005-06 408 16.3 357 16.3
Abatement rate (per cent) 2004-05 35.0 2005-06 35.0 -
2005-06 15.3 15.3 15.3 15.3 15.3 5.1 10
20.4 20.4 20.4 15.3 15.3 5.1 20.4
C ement clinker Gypsum Non coking coal Pet coke 1

1
B U D G E T
Excise duty for white cement and pet coke is in per cent
Source: CRIS INFAC
36
Cement
Focus on infrastructure and reduction in customs duty on pet coke positive for cement industry
Company AC C Ltd. Gujarat Ambuja C ement Ltd. India C ement Ltd. Madras C ements Ltd. Shree C ements Ltd. Ultratech C ement Ltd. Source: CRIS INFAC Impact Impact factors C, E A, C, E C, E C, E A, C, E C, E
Impact factors A. The customs duty on pet coke has been slashed to 10 per cent from 20 per cent. This will encourage the use of alternative fuels. Among the cement players, Shree Cements and Gujarat Ambuja have a headstart in the use of pet coke and will benefit the most. B. The excise duty on clinker has been increased to Rs 350 per tonne from Rs 250 per tonne. As mini-cement plants pay an excise duty of Rs 250 per tonne of cement, they will not be able to avail of cenvat credit for the rise in the excise duty. Larger cement players, on the other hand, pay an excise duty of Rs 400 per tonne of cement. Therefore, they will be able to avail of cenvat credit for the rise in the excise duty on clinker and hence, will not be affected. C. The budget provides significant fillip to the infrastructure sector. While the allocation for irrigation has been stepped up, the outlay for national highway development has been increased from Rs 65 billion in 2004-05 to Rs 93 billion in 2005-06. This apart, an outlay of Rs 55 billion has been provided for, under the National Urban Renewal Mission, which includes projects such as Mumbai Western Expressway sea-link, etc. The above initiatives will provide a fillip to cement consumption. D. The customs duty on cement has been reduced from 20 per cent to 15 per cent, in line with the cut in the peak customs duty. However, despite the reduction, the landed cost of cement will be much higher than the domestic price. Thus, imports will pose a minimal threat and domestic players will not be affected by the cut in the customs duty. E. The proposal to allow deduction of up to Rs 1 lakh on the repayment of principal amount of housing loan (u/ s 80 C of the Income Tax Act), will boost housing demand and thereby cement consumption.
37
Chlor alkalies
Caustic soda ECU realisations surge Consumption of caustic soda rose by a moderate 3 per cent in 2003-04 after the huge growth witnessed in 2002-03. Chlorine demand fell on account of lower demand from the EDC segment. ECU realisations of producers surged by around 4.5 per cent in 2003-04, led by caustic soda prices, which shot up by 23 per cent. Over the medium term, the demand for caustic soda is expected to increase by a moderate 4 per cent. In 2004-05, ECU realisations are estimated to have risen by 5.5 per cent and are expected to rise by around 8 per cent in 2005-06, led by an upturn in caustic soda prices, while chlorine prices are expected to remain fairly firm. Rising caustic soda prices have been supported by higher international prices, which are expected to prevail over the medium term, and improvement in the domestic demand-supply balance. Operating margins are expected to improve in spite of higher power and fuel costs, as the rise in ECU realisations would completely offset the impact of the same. Soda ash Margins to be under pressure Demand in the soda ash industry grew by around 6 per cent in 2003-04, led by the rise in offtake from the glass
U N I O N
segment. Prices rose marginally towards the end of 2003-04 by around 4.5 per cent, chiefly to offset the impact of the rise in coke prices. Over the medium term, demand is expected to continue its moderate growth trend of 4-5 per cent, as the demand from the glass segment continues to be high. Domestic prices are expected to remain firm after the rise in the second half of 2004-05, supported by strong international prices. The anti-dumping duties imposed on imports of soda ash from China were under review in the current year and no decision on the same was taken up to January 2005. In case the duties are abolished, imports are expected to rise in the second half of 2005-06. With coke prices expected to remain strong and the low pricing flexibility, the operating margins of the industry are expected to remain under pressure over the medium term.
Chlor alkalies: Tariffs, prices and landed costs Tariff (per cent) Customs C austic soda Soda ash 20.4 20.4 15.3 15.3 Excise 16.3 16.3 16.3 16.3 Prices (Jan 2005) ($/tonne) 335 150 24,061 13,124 22,979 12,534 Landed cost (Rs/tonne) Domestic International Pre-Budget Post-Budget 21,000 9,015
B U D G E T
2004-05 2005-06 2004-05 2005-06 (Rs/tonne)
Source: CRIS INFAC
38
Chlor alkalies
Customs duty cut - marginally negative for the industry
Company Gujarat Alkalies and C hemicals Ltd. Gujarat Heavy C hemicals Ltd. Punjab Alkalies and C hemicals Ltd. Source: CRIS INFAC Impact Impact factors A, B A A, B
Impact factors A. The cut in peak customs duty rates from 20 per cent to 15 per cent will marginally affect the caustic soda and soda ash industry. Although, at present, the domestic prices of both products are at a discount to the landed cost, prices will remain under pressure and are expected to fall marginally. B. As a large number of caustic soda manufacturers use captive power plants, which primarily use furnace oil as fuel, the cut in customs duty from 20 per cent to 10 per cent on FO/LSHS will lower their manufacturing costs marginally.
U N I O N
B U D G E T
39
Cigarettes
Volume growth and strong pricing flexibility bolsters profitability The domestic cigarettes industry has been facing pressures in the spheres of taxation, and regulation of consumption and communication. The ban on smoking in public places, restrictive cigarette advertising, and the increasing health awareness among consumers resulted in a decline in cigarette consumption to around 86 billion sticks in 2001-02. However, the absence of further increase in duty rates since 2002-03 has helped consumption improve to 90 billion sticks in 2002-03 and further to 95 billion sticks in 2003-04 (not considering contraband). In the medium term, cigarette consumption is expected to grow by 3-5 per cent annually on account of higher disposable income in the country, the growing proportion of the younger populace in the overall population composition, the shift of smokers from bidis to cigarettes and the policy of certain state governments banning "gutkha" and other forms of chewing tobacco. The industry is one of the highly taxed sectors in the economy, and amongst the tobacco segments. The domestic cigarette industry is also increasingly under threat from smuggled brands, although the sector is characterised by moderate competition on account of the strong brand loyalty. However, the cigarette manufacturers enjoy good pricing flexibility due to the strong product dependence and brand loyalty, and hence, have been able to pass on the increase in excise duties.
Cigarettes: Tariffs
U N I O N
Customs (per cent) 2004-05 Filter > 85 mm 75-85 mm 70-75 mm < 70 mm Non-filter 60-70 mm < 60 mm Note 30.60 30.60 30.60 30.60 30.60 30.60 30.60 30.6 30.6 30.6 30.6 30.6 30.6 30.6 2005-06
Excise (Rs per '000 cigarettes) 2004-05 1,816 1,479 1,112 683 459 138 2005-06 2,000 1,627 1,224 754 505 153
B U D G E T
The increase in excise duty for 2004-05 is on account of levy of 2 per cent education cess Source: CRIS INFAC
40
Cigarettes
Increase in excise duty will be passed on to the consumer
Company Godfrey Phillips India Ltd. ITC Ltd. VST Industries Ltd. Source: CRIS INFAC Impact Impact Factors A A A
Additional excise duty has been imposed on cigarettes at specific rates, ranging from Rs 15 to Rs 180 per thousand cigarettes. However, cigarette companies will be able to pass on this increase to the final consumer. Thus, the profitability of cigarette companies will not be affected.
U N I O N
B U D G E T
41
Commercial vehicles
Cyclical pressures to drag commercial vehicles market into slowdown phase The domestic commercial vehicles (CV) industry recorded sales growth of around 25.5 per cent during the first 9 months of 2004-05. Large buying due to attractive interest rate scenario, aggressive push by financiers and strong economic and industrial growth propelled sales of commercial vehicles. We expect sales to grow at 2022 per cent in 2004-05. However, in 2005-06, CRIS INFAC expects that cyclical pressures may result in the growth slowing down to around 5 per cent. Overbuilding of transport capacity due to excessive buying, increase in vehicle prices due to high steel prices and implementation of emission norms, and completion of fleet renewal programmes by fleet operators may dampen growth in the CV market. Despite the robust volume growth in commercial vehicle sales, operating margins of CV manufacturers have dipped in the first 9 months of 2004-05, as manufacturers have faced the brunt of high steel prices. We expect operating margins to remain stable, as average steel prices are expected to remain firm in 2005-06. Net profits have grown substantially in the first 9 months of 2004-05, on account of higher volumes and lower interest cost, and are expected to improve moderately in 2005-06.
Commercial vehicles: Tariffs (per cent) LC Vs M&HC Vs Steel items Engines and engine parts Other components Source: CRIS INFAC
B U D G E T
Customs 2004-05 2005-06 15.3 15.3 5.1 15.3 15.3 20.4 20.4 5.1 20.4 20.4
Excise 2004-05 16.3 16.3 12.2 16.3 16.3 2005-06 16.3 16.3 16.3 16.3 16.3
U N I O N
LC V: Light commercial vehicles; M&HC V: Medium and heavy commercial vehicles
42
Commercial vehicles
Industry to remain unaffected by budget measures
Company Ashok Leyland Ltd. Eicher Motors Ltd. Tata Motors Ltd. Source: CRIS INFAC Impact Impact factors A, C A, C A, C
Impact factors A. The reduction in the peak customs duty on components, from 20 per cent to 15 per cent, will not have any impact on commercial vehicle manufacturers, owing to the high indigenisation levels in the industry. The reduction in the customs duty on aluminium is likely to lower the input costs of OEMs marginally. B. The increase in the excise duty on steel, from 12 per cent to 16 per cent, and the reduction in the excise duty on tyres, from 24 per cent to 16 per cent, will not affect OEMs, as the excise on inputs will be modvatable against the excise paid on the final product. However, the reduction in the excise duty on tyres will lower the operating costs of transport operators in terms of lower tyre prices in the replacement market. C. The extension of the 150 per cent deduction on in-house R&D expenses, upto March 31, 2007, will benefit commercial vehicle OEMs.
U N I O N
B U D G E T
43
Consumer durables
Burgeoning Indian middle class to drive demand. India has a huge middle class population with rising income levels and growing aspirations. This, along with easy availability of consumer finance, will drive the demand for consumer durables. In the medium term, CTVs and ACs are expected to continue to grow in double digits, while refrigerators and washing machines are likely to record a moderate growth of 5-10 per cent. While CTV prices are expected to decline marginally, prices of white goods will remain stable or increase marginally due to rising input costs. Air conditioners The demand for ACs is expected to grow stupendously at a compounded rate of 20 per cent during 2003-04 to 2005-06. Refrigerators After a flat growth in 2003-04, the industry grew by 10 per cent Y-o-Y during April-December 2004. The aggressive focus by Korean MNCs (particularly on the frost-free segment) will result in an 8-10 per cent growth in the medium term. Colour televisions
U N I O N
CTV demand surged by 21 per cent Y-o-Y during April-December 2004 to cross 6 million units, and is expected to grow by 10-15 per cent in the medium term. Growth will be substantial in the flat CTV segment, which is expected to account for 30-35 per cent of CTV sales in 2005-06 (up from about 25 per cent in 2004-05). Washing machines The washing machines segment is expected to end the year at about 1.4-1.5 million units, and is expected to
B U D G E T
grow by 5 per cent in the medium term.
Consumer durables: Tariffs (per cent) Customs Excise 2004-05 2005-06 2004-05 2005-06 B/W TVs 20.4 15.3 16.3 16.3 C olour TVs 20.4 15.3 16.3 16.3 Refrigerators 20.4 15.3 16.3 16.3 Room AC s 20.4 15.3 24.5 16.3 Washing machines 20.4 15.3 16.3 16.3 C olour picture tubes 20.4 15.3 16.3 16.3 Glass parts for C PTs 20.4 15.3 16.3 16.3 C ompressors 15.3 15.3 16.3 16.3 Thermostat, copper tubes 15.3 15.3 16.3 16.3 Alloy steel 15.3 10.2 12.2 16.3 C R steel sheets 5.1 5.1 12.2 16.3 Polymers (ABS/HIPS) 15.3 10.2 16.3 16.3 ABS: Acrylonitrile butadiene styrene; HIPS: High impact polystyrene Source: CRIS INFAC
Abatement rate 2004-05 2005-06 35.0 35.0 40.0 40.0 35.0 30.0 40.0 40.0 -
44
Consumer durables
Marginally positive for CTVs, ACs
Company C arrier Aircon Ltd. Hitachi Home & Life Solutions (India) Ltd. MIRC Electronics Ltd. Videocon Appliances Ltd. Videocon International Ltd. Whirlpool of India Ltd. Source: CRIS INFAC Impact Impact factors B, C, D B, C, D A, C, D B, C, D C, D C, D
Impact factors A. The reduction in the import duty on consumer durables will not affect the domestic industry, as domestically manufactured consumer durables will continue to remain price-competitive even at the revised duty levels. However, players concentrating on the premium end / higher capacity segments (such as LG, Samsung and Sony) will benefit, as these products are mostly imported. B. The removal of the special excise duty (SED) of 8 per cent on ACs, along with a corresponding reduction in the abatement rate to 30 per cent (35 per cent last year), will result in an effective excise duty of 11.2 per cent (15.6 per cent). This will lead to a Rs 700-900 decline in AC prices, which will lead to a corresponding rise in demand, as ACs have displayed significant price elasticity in the past. C. The decline in the import duty on colour picture tubes (CPTs), along with the fall in the duty on glass components used for manufacturing CPTs, will result in a Rs 100-300 decline in CPT prices. While the decline will be partially passed on to consumers, the quantum of the fall will be higher in the flat and large size CTV prices. Overall, this will have a marginally positive impact on CTV sales. LG, Samsung, and Mirc will be the key beneficiaries. In case of Videocon, the impact of CPT price decline will be more than offset by the corresponding fall in duty of glass shells. The reduction in import duty on alloy steel, copper, zinc and polymers (ABS/HIP) will be marginally positive for the refrigerators, washing machines and the air-conditioner segments. D. The expected rise in disposable income of consumers (following the change in the tax brackets and norms) is expected to induce demand.
U N I O N
B U D G E T
45
Cotton and cotton yarn

Quota removal to provide strong demand boost The Multi-Fibre Agreement (MFA), which permitted developed countries like the US to impose restrictions in the form of quotas on imports of textile goods from developing countries like India, China, Pakistan etc, ended on January 1, 2005. With the end of the MFA, textile exporter countries now have unrestricted access to developed markets. The quota removal augurs well for the Indian cotton yarn industry, as it will benefit from higher derived demand from rising garment exports. CRIS INFAC expects the demand for cotton yarn to increase at 6 per cent in the medium term (against a negative growth of around 2 per cent between 2000-01 and 2003-04). Cotton yarn exports are also expected to rise at 6 per cent due to higher offtake from non-quota countries like Bangladesh, Sri Lanka, Korea, Hong Kong, Italy, China and Japan, which import yarn and re-export value-added fabrics and garments. The margins of spinning companies are expected to improve in the second half of 2004-05 and 2005-06 as cotton prices are expected to soften due to higher cotton production (20 per cent higher than the previous season) in the October 2004-September 2005 cotton season. The Union Budget 2004-05 provided a strong boost to the industry by removing the mandatory CENVAT, and allowing all cotton textile manufacturers (at the yarn, fabric and garment stage) to opt for complete excise exemption. The excise duties on polyester filament yarn (a substitute for cotton yarn) and polyester staple fibre (a substitute for cotton) were left unchanged and attract excise duties of 24 per cent and 16 per cent, respectively.
U N I O N
Cotton and cotton yarn: Tariffs, prices and landed costs Tariff (per cent) Customs C otton yarn 20.4 10.2 15.0 10.2 Excise 4.1 0.0 4.1 0.0 2004-05 2005-06 2004-05 2005-06 (34s) C otton n.a.: Not available
1
Prices (Feb 2005) Domestic (Rs/tonne) 89,200 43,000

1
B U D G E T
Market prices of H-4 variety
Source: CRIS INFAC
46
Cotton and Cotton yarn

Continuity of CENVAT exemption route and de-reservation of knitwear sector augurs for cotton textiles industry
Company Arvind Mills Ltd. GTN Textile Ltd. Mahavir Spinning Mills Ltd. Nahar Exports Ltd. Malwa C otton Spinning Mills Ltd. Source: CRIS INFAC Impact Impact factors A,B,C A,B,C A,B A,B,C A,B
well
Impact factors A. The 100 per cent cenvat exemption provided in the Union Budget 2004-05 to the cotton textiles sector, including cotton yarn, fabrics and garments has been maintained. The price competitiveness of polyester (substitute for cotton) is likely to improve by 10 per cent as the duties on polyester filament yarn (PFY) have been brought down from 24 per cent to 16 per cent, and the customs duty from 20 per cent to 15 per cent. Cotton yarn producers, however, have the flexibility to reduce prices and remain competitive due to lower cotton costs (key raw material) on account of higher cotton production, while polyester producers are reeling under the pressure of high feedstock costs and thus have limited pricing flexibility. B. The Rs 250 billion Technology Upgradation Fund (TUFs) is being continued, with an enhanced allocation of Rs 4.35 billion. This will marginally benefit cotton yarn producers as they are the larger beneficiaries of the funds availed under the scheme. C. The knitwear sector has been de-reserved from the small-scale industry category, which earlier had a cap of Rs 50 million on plant and machinery. This will encourage spinning companies to forward integrate.
U N I O N
B U D G E T
47
Fertilisers
Stellar financial performance despite pressure on margins In the first 9 months of 2004-05, the sales volumes of fertilisers registered a healthy growth over the corresponding period of the previous year, despite a deficient monsoon. Sales of urea increased by around 5.3 per cent, while those of DAP rose by 12.9 per cent during the year. The industry's financial performance has been excellent on account of a healthy volume growth and a sharp reduction in interest costs. CRIS INFAC estimates urea consumption to grow by 4-5 per cent, while DAP consumption is likely to maintain double-digit growth for 2004-05. The current fiscal marks the completion of a year since the transition in the governments subsidy policies for urea and DAP. The government's policy on subsidies was changed from unit-specific retention price to groupbased concession for urea and from an adhoc concession scheme to group concession for DAP in 2003-04. The new subsidy schemes have resulted in lower player margins with the level of the decrease in margins depending on the efficiency of players. The operating margins of players are expected to remain under pressure on account of the government policies aimed at weeding out inefficiencies and the higher volatility in input costs (especially for complex manufacturers). Government policies will continue to influence the structure and the profitability of the industry. The Union Budget 2004-05 had provided Rs 126.62 billion towards fertiliser subsidy. However, in the absence of an increase in the farmgate price of fertilisers, the overall fertiliser subsidy for 2004-05 has overshot
U N I O N
provisions due to higher offtake and the steep increase in input prices.
Fertilisers: Tariffs, prices and landed costs Tariffs (per cent) Customs Urea DAP MOP
2 2
Prices (Jan 2005) ($/tonne)

1 1 1
Landed costs (Rs/tonne)
Excise 5.1 5.0 5.1 5.1 5.1 5.1 5.1 5.1 16.3 16.3 16.3 16.3 -
Domestic International Pre-Budget Post-Budget 4,830 9,350 4,455 NT 3,918 NT 19,005 10,345 225 231 228 240 403 90 49 352 167 11,773 13,168 10,694 11,257 18,891 4,222 3,236 16,986 9,535 11,773 13,168 10,694 11,257 18,891 4,222 3,236 16,986 8,727
2004-05 2005-06 2004-05 2005-06 (Rs/tonne)

B U D G E T
5.1 5.0 5.1 5.1 5.1 5.1 5.1 5.1 20.4

3
Ammonia Sulphur
Phosphoric acid Rock phosphate Naphtha Fuel oil / LSHS (for non-feed) LNG
10.2 5.1
5.1
DAP: Di-ammonium phosphate; LNG: Liquefied natural gas; LSHS: Low sulphur heavy stock; MOP: Muriate of potash; NT: Not traded
1 2 3
Farmgate price from March 12, 2003 Landed costs excluding freight Price per kilo litre
Source: CRIS INFAC
48
Fertilisers
Fertiliser consumption to be boosted by the thrust on irrigation and other agriculture-friendly measures
Company C hambal Fertilisers & C hemicals Ltd. C oromandel Fertilizers Ltd. Gujarat Narmada Valley Fertilizers C ompany Ltd. Gujarat State Fertilisers C ompany Ltd. Indo Gulf Fertilisers Ltd. Oswal C hemicals and Fertilisers Ltd. Rashtriya C hemicals and Fertilisers Ltd. Southern Petrochemical Industries C orporation Ltd. Zuari Industries Ltd. Source: CRIS INFAC Impact Impact factors A,B,C A,B,C A,B,C,D A,B,C,E A,B,C A,B,C A,B,C,D A,B,C A,B,C
Impact factors A. The imposition of a 10 per cent service tax on gas transporting agencies is not expected to affect the industry given that the supply of gas is undertaken under the administered price scheme and increases in input costs are recovered as subsidies. B. The budget contained no announcements that specifically concern the fertiliser industry. However, a greater thrust on agricultural credit, an increase in the area under irrigation, agricultural diversification, continuation of farm insurance scheme, national horticulture mission and the scheme for strengthening agricultural infrastructure are likely to boost farm incomes and thereby support fertiliser consumption in the long run. C. The enhanced allocation of Rs 162.5 billion for the fertiliser subsidy for 2005-06 as against a provision of Rs 126.62 billion for 2004-05 is expected to cover the subsidy arrears for 2004-05. D. The reduction in the customs duty on methanol, from 20 per cent to 15 per cent, is likely to exert a downward pressure on realisations and therefore, on margins. E. The reduction in the customs duty on caprolactum from 20 to 15 per cent, will lead to a reduction in the unit realisations of the product. The reduction in the customs duty on benzene, from 10 per cent to 5 per cent, will only partially offset the decline. As a result, the overall margins for caprolactum are expected to shrink.
U N I O N
B U D G E T
49
Hotels
Good times to continue After an upturn in 2003-04, the industry has sustained its growth momentum in the first 9 months of 2004-05. Demand jumped by over 16 per cent, increasing occupancy rates from 65 per cent to 71 per cent. Average room rates (ARRs) increased by 13 per cent, from Rs 4,104 to Rs 4,630, thereby increasing operating margins from 16 per cent to approximately 25 per cent. In 2004-05, CRIS INFAC expects tourist inflows to increase to around 3.5 million arrivals, propelled by both business and leisure travellers. While a strong economy and higher FII and FDI inflows will propel demand from business travellers, demand from the leisure segment will be driven by the continued promotion of India as a tourist destination. Average room demand in the premium segment is expected to increase by 13 per cent, driven largely by business travellers. Across the four metros, room availability is expected to go up by around 475 rooms in the last quarter of 200405. Chennai and Delhi are to have room additions; room availability in Kolkata and Mumbai is expected to remain unchanged. With increasing occupancies and higher tariffs, RevPARs are likely to increase considerably. Higher RevPARs are expected to expand operating margins. The absence of any major capex plans will lower the interest costs of players, thereby improving profitability in 2005-06.
U N I O N
(Note: The four metros account for over 60 per cent of the total rooms, and for over 60 per cent of the total revenues of the premium segment in India.)
B U D G E T
50
Hotels
No impact on the hotels industry
Company Asian Hotels Ltd. EIH Ltd. Hotel Leelaventure Ltd. Indian Hotels C ompany Ltd. Source: CRIS INFAC Impact Impact factors -
U N I O N
B U D G E T
51
Stable billing rates and healthy volumes to drive revenue growth CRIS INFAC expects the export revenues of the Indian IT services industry to touch $15.6 billion in 2005-06, registering a growth of 31 per cent over 2004-05. The export revenues of the IT-enabled services (ITES) sector, on the other hand, are expected to increase by around 41 per cent to reach $7.1 billion in 2005-06. The increased IT spending and the growing preference for offshoring IT services to India will drive growth. Over the past 3-4 quarters, billing rates have been stable with an upward bias. However, we do not expect any significant rise in billing rates unless it is backed by a corresponding change in service line mix. In the ITES sector, the captive units of global corporations continue to dominate the scene. The share of captives in ITES exports for 2004-05 is estimated to be 56 per cent. The disparity in growth rates of large Indian third party vendors (TPVs) and other players in the industry is also significant. While large Indian players have grown exponentially over the past 2 years, other players within the industry have registered a CAGR of 13 per cent over the 2-year period. The domestic IT market is expected to register higher growth on the back of increased IT investments by corporations across the country and sustained IT spending by the banking, financial services and insurance segments. Contrary to the situation in developed economies, IT spending in the domestic market is focussed on hardware. According to Nasscom (National Association of Software and Service Companies), the domestic hardware industry is estimated to reach $6 billion in 2004-05, up from $4.8 billion in 2003-04, registering a growth of 21
U N I O N
per cent. Computer systems and servers contribute to a major chunk of the revenues of the hardware industry, followed by peripherals and networking equipment. Lower PC prices and increased bundling of peripherals with PCs by various vendors is expected to drive growth in this segment.
IT: Hardware tariffs (per cent)
B U D G E T
52
Application and system software C omputers accessories (excluding PPC Bs) C omputers and peripherals Monitor, keyboard, mouse, printer FDD, HDD, C D-ROM drive and other storage drives Ink cartridges with print head assembly Integrated circuits and micro assemblies Microprocessors Routers and other networking equipment Other units of automatic data processing machines Storage devices C omputer parts other than ink cartidriges, PPC Bs, motherboards Digital video disc drive C Ds & C D writers 0.0 0.0 16.3 16.3 Speakers 20.4 15.3 16.3 16.3 Printed circuits (PPC Bs) 10.0 0.0 16.3 16.3 Key switches for key boards 10.0 0.0 16.3 16.3 Others, including modems, routers, ISDN terminals,etc 10.2 0.0 16.3 16.3 FDD: Floppy disk drive; HDD: Hard disk drive; C D-ROM: C ompact disk-read only memory; Note: A C VD of 4.08 per cent (4 per cent C VD plus 2 per cent educational cess) has been imposed on all ITA bound items and their inputs that attract nil customs duty. IT software has, however, been exempt from the C VD. Source: CRIS INFAC
Customs 2004-05 2005-06 0.0 0.0 10.2 0.0 10.0 0.0 10.0 0.0 0.0 0.0 5.1 0.0 0.0 0.0 0.0 0.0 10.2 0.0 10.0 0.0 5.0 0.0 0.0 0.0
Excise 2004-05 2005-06 0.0 0.0 16.3 16.3 0.0 0.0 16.3 16.3 0.0 0.0 16.3 16.3 16.3 16.3 0.0 0.0 16.3 16.3 8.2 8.2 16.3 16.3 16.3 16.3
Customs duty exemption augurs well for the IT industry
Company D-Link (India) Ltd. HC L Infosystems Ltd. Infosys Technologies Ltd. Moser Baer India Ltd. PC S Technologies Ltd. Satyam C omputer Services Ltd. Vintron Informatics Ltd. Wipro Ltd. Zenith C omputers Ltd. Source: CRIS INFAC Impact Impact factors A A C B C A,C A
Impact factors A. Reduction in the customs duty on imports of Information Technology Agreement (ITA) items is a positive for both the domestic hardware manufacturers, such as HCL Infosystems and Zenith Computers, as well as players such as HP, Dell and IBM. This measure will significantly reduce the price differential between the grey market and the branded goods. Since the credit for countervailing duty (CVD) will be available against payment of excise duty, imposition of CVD will have a minimal impact on domestic manufacturers.
U
B. Reduction in import duty on polycarbonates from 20 per cent to 15 per cent, a key raw material used to manufacture CD ROMs and DVD ROMs is a positive for Moser Baer. C. Reduction in withholding tax on technical services from 20 per cent to 10 per cent will benefit Indian IT service providers. However, since consultancy fees constitute 1.5-2.5 per cent of the software development expenses of large players, the impact is expected to be small.
N I O N
B U D G E T
53
Man-made fibres
Margins under severe pressure The polyester industry is in the grip of a tight feedstock (PTA and MEG) supply, which has caused an upsurge in feedstock prices. In February 2005, prices of PTA (purified terephthalic acid) and MEG (mono ethylene glycol) were 23 per cent and 28 per cent higher, respectively, on a year-on-year basis. The margins of polyester producers are under severe pressure at these high price levels. We expect the pressure on margins to continue up to 2005-06. The tight supply situation in feedstocks is a result of the rapid growth in China's polyester capacities, which has outpaced the growth of global feedstock capacities. Most of the global capacity expansions in feedstocks will come on stream only by end-2005, which will keep the supplies of these feedstocks extremely tight until 2005-2006. The Union Budget 2004-05 reduced the mandatory CENVAT duty on cotton yarn, fabrics and garments allowing them the option of opting for complete excise exemption. However, duties on polyester were maintained at higher levels - partially oriented yarn (POY) at 24 per cent and polyester staple fibre (PSF) at 16 per cent. The duty on blended yarn was decreased from 12 per cent to 8 per cent, while the duties on nylon filament yarn (NFY) and viscose filament yarn (VFY) were increased from 12 per cent to 16 per cent. The increase in polyester prices (driven by a cost push from high feedstock costs), combined with the impact of the duty cuts on cotton textiles and a softening of cotton prices, have made POY and PSF more expensive than cotton yarn and cotton, thus eroding their price competitiveness. This is likely to lead to lower sales
U N I O N
growth for polyester producers over the medium term. We expect the demand for polyester filament yarn (PFY) and PSF to grow at a CAGR of 5.6 per cent and 4.2 per cent, respectively, over the medium term.
Man-made fibre & intermediates: Tariffs, prices and landed costs Tariff (per cent) Prices (Feb 2005) Landed cost (Rs/tonne) Customs Excise Domestic International Pre-Budget Post-Budget 2004-05 2005-06 2004-05 2005-06 (Rs/tonne) ($/tonne) PSF 1.2d 20.4 15.3 16.3 16.3 80,300 1 1,220 79,594 76,209 1,820 113,173 108,360 AF 1.5d 20.4 15.3 16.3 16.3 112,500 1 VSF 1.5d 20.4 15.3 16.3 16.3 91,893 1,450 90,165 86,331 1,460 93,163 83,368 POY 126d 20.4 15.3 24.5 16.3 91,000 1 NFY 20sd 20.4 15.3 16.3 16.3 255,000 1 n.a. n.a. n.a. n.a. n.a. n.a. VFY 120d 20.4 15.3 16.3 16.3 214,000 1 PV 30s count 70-30 20.4 15.3 8.2 8.2 115,000 1 n.a. n.a. n.a. n.a. n.a. n.a. DMT 20.4 15.3 16.3 16.3 53,391 1 PTA 20.4 15.3 16.3 16.3 53,623 1 860 53,477 51,212 1,050 65,292 62,526 MEG 20.4 15.3 16.3 16.3 65,023 1 C aprolactam 20.4 15.3 16.3 16.3 136,676 1 2,200 136,802 131,007 1,300 74,436 67,916 AC N 15.3 5.0 16.3 16.3 70,955 1 RGWP 5.1 5.0 0.0 0.0 n.a 820 38,265 38,265 Paraxylene 5.1 5.0 16.3 16.3 n.a 930 50,481 50,481 AC N: Acrylonitrile; AF: Acrylic fibre; DMT: Di methyl terephthalate; MEG: Mono ethylene glycol; NFY: Nylon filament yarn;PC : Polyester cotton; POY: Partially oriented yarn; PSF: Polyester staple fibre; PTA: Purified terephthalic acid; PV: Polyester viscose; RGWP: Rayon grade wood pulp; VFY: Viscose filament yarn; VSF: Viscose staple fibre n.a.: Not available 1 Market prices Source: CRIS INFAC
B U D G E T
54
Man-made fibres
Overall negative impact due to customs duty cuts
Company name C entury Enka Ltd. Garden Silk Mills Ltd. Indo Rama Synthetics (India) Ltd. JBF Industries Ltd. Sanghi Polyester Ltd. Source: CRIS INFAC Impact Impact factors A, B, D A, B, D A, B, C, D A, B, D A, B, D
Impact factors A. The excise duty on polyester filament yarn (PFY) has been slashed from 24 per cent to 16 per cent. The customs duty on PFY has also been brought down from 20 per cent to 15 per cent. This will lower the landed costs of POY and will force domestic manufacturers to reduce prices. This will improve the price competitiveness of POY vis--vis cotton yarn and provide a fillip to demand. POY producers will, however, continue to face the disadvantage of a high duty differential with cotton yarn, which continues to be allowed the option of 100 per cent excise exemption. B. The margins of POY producers are likely to decline following the customs duty cuts, although the negative impact will be partially offset by the cut in the customs duties on feedstocks, PTA, DMT and MEG. C. There is no change in the excise duty on polyester staple fibre (PSF). PSF producers will also be under pressure to reduce prices (to match the lower landed costs following the reduction in the customs duty from 20 per cent to 15 per cent); as a result, margins are likely to decline slightly.
B U N I O N
D. The imports of synthetic fabrics are likely to increase, following the cut in the customs duty on fabrics (including synthetic fabrics) from 20 per cent to 15 per cent. Synthetic fabric imports have been on the rise, particularly by garment exporters, which will lower the derived demand for POY and PSF.
U D G E T
55
Non-ferrous metals
Profitability to remain stable Aluminium The Indian aluminium market has grown by over 10 per cent in the first 9 months of 2004-05 and the prospects for the electrical, construction and transportation sectors look promising. The production of aluminium in April-December 2004 increased by 6 per cent over the same period of 2003-04. Average prices have increased by 6 per cent during April-February 2004-05 over the corresponding period of the previous year. Higher realisations, moderate demand growth and cost reduction through increased efficiencies led to an improvement in the operating profit margins of domestic aluminium manufacturers. Domestic demand is expected to grow by 8-10 per cent in 2005-06. Average domestic prices are expected to decline after the customs duty cut given the stable global price outlook. With no significant increase in input costs, the profitability of domestic players is expected to remain stable. Copper Domestic consumption increased by 10 per cent in calendar year 2004 as demand continued to be buoyant from user segments such as winding wire, power cables and transformers. Average prices of copper in the domestic market have increased by over 41 per cent during April-February 2004-05 over the corresponding period of the previous year due to a nearly 51 per cent increase in international prices.
U N I O N
The copper concentrate market has moved from an extreme deficit in the first quarter of 2004 to a surplus now. Hence, with an improvement in global demand, prices and concentrate availability, the treatment charges and refining charges (TC/RC) are expected to remain high in the medium-term. Zinc
B U D G E T
Domestic demand for zinc is estimated to increase by 9-10 per cent in 2004-05 driven by growth in the galvanising sector. Average prices in the Mumbai market have increased by 6 per cent during April-February 2004-05 over the corresponding period of the previous year, with the increase in international prices. Margins have remained stable during the period. In 2005-06, CRIS INFAC expects domestic prices to remain stable even after the customs duty cut, owing to the continuation of firm international prices. A stable cost base will result in steady margins. The domestic demand supply gap had been met through imports. With capacity expansions in the pipeline, imports are likely to decline in 2005-06. Lead Average prices in the Mumbai market have increased by 27 per cent during April-February 2004-05 over the corresponding period of the previous year, with the increase in international prices. The increase in demand for automobile batteries will result in higher lead consumption.
56
Non-ferrous metals
Non-ferrous metals: Tariffs, prices and landed costs Tariff (per cent) Customs Aluminium ingots Aluminium products Aluminium scrap Non-coking coal C austic soda C alcined petroleum coke C opper C opper scrap C opper ore and concentrates Nickel 1 Nickel ore and concentrates Lead Lead ore and concentrates Zinc Zinc ore and concentrates Tin 1 Tin ore and concentrates
1
Prices (Feb 2005) ($/tonne) 1,847 3,213 14,505 984 1,288 7,736 -
Landed cost (Rs/tonne)
Excise 16.3 16.3 16.3 0.0 16.3 16.3 16.3 16.3 16.3 16.3 16.3 16.3 16.3 16.3 16.3 16.3 16.3 16.3 16.3 16.3 0.0 16.3 16.3 16.3 16.3 16.3 16.3 16.3 16.3 16.3 16.3 16.3 16.3 16.3
Domestic International Pre-budget Post-budget 102,000 209,000 736,000 51,000 80,000 468,000 113,267 194,367 792,409 62,008 80,061 465,290 108,257 185,770 792,409 56,522 76,519 U
2004-05 2005-06 2004-05 2005-06 (Rs/tonne) 15.3 15.3 15.3 5.1 20.4 20.4 15.3 15.3 5.1 5.1 5.1 15.3 5.1 15.3 5.1 15.3 5.1 10.2 10.2 10.2 5.1 15.3 10.2 10.2 10.2 5.1 5.1 5.1 5.1 5.1 10.2 5.1 10.2 5.1
444,709 -
N I O N
Prices are for January 2005 Notes 1) Domestic prices are Mumbai market prices. 2) International prices are LME cash prices. Source: CRIS INFAC
B U D G E T
57
Non-ferrous metals
Negative impact on aluminium; impact on copper and zinc to be neutralised by favourable changes in global demand-supply dynamics
Company Hindalco Industries Ltd. Hindustan C opper Ltd. Hindustan Zinc Ltd. National Aluminium C o. Ltd. Sterlite Industries (India) Ltd. Source: CRIS INFAC Impact Impact factors A & B B C A B
Impact factors A. The reduction in the basic customs duty on aluminium to 10 per cent from 15 per cent will result in a drop in the landed cost of imports by around Rs 5,000 per tonne. Consequently, the operating margins of domestic aluminium manufacturers are expected to slip by around 300 basis points. Nalco will be the least affected, as it has a 25 per cent share of alumina in its revenues. B. The landed cost of copper is expected to fall by around Rs 8,500 per tonne following the reduction in import duty on copper to 10 per cent from 15 per cent, resulting in a 422 basis points decline in margins. However,
U N I O N
increasing TC/RC margins will neutralise the impact on margins in 2005-06. However, the same benefit will not be available to Hindustan Copper; hence, its margins will be hit. C. A fall of 325 basis points in margins is expected as a result of the decline in the landed cost of zinc by Rs 3,500 per tonne, due to reduction of import duty to 10 per cent from 15 per cent. However, the impact will be neutralised by an expected 4 per cent rise in average global prices of zinc for 2005-06.
B U D G E T
58
Oil and gas

High subsidy under-recovery and lower marketing margins affect profits in 2004-05 The industry's overall profitability declined in 2004-05 on account of lower marketing margins and a subsidy under-recovery burden. High international crude oil prices buoyed the realisations of oil producers in 2004-05. On the product front, demand growth outstripped supply. The resultant increase in international product prices enabled a sharp rise in domestic refining margins in 2004-05. We estimate gross refining margins (GRMs) at $6.5 per barrel in 200405, as against $5.25 per barrel in 2003-04. Although the increase in refining margins proved to be beneficial to the profitability of standalone refining players, the drop in marketing margins and higher subsidy under-recovery on LPG and SKO lowered the profitability of integrated companies in 2004-05. The decrease in marketing margins on retail auto fuels, from Rs 1,500/kl in 2003-04 to 1,200/kl in 2004-05, was on account of the non-revision of MS and HSD prices, even as international prices increased substantially during the year. Public sector oil marketing companies (OMCs) have also been bearing losses on LPG and SKO, on account of the under-recovery of subsidies. With international prices ruling high, the total subsidy under-recovery on these two products is likely to be substantially high, at Rs 150 billion in 2004-05 (as against Rs 67 billion in 2003-04). The total demand for petroleum products will increase by 3 per cent in 2005-06, driven by the rise in the demand for LPG, MS and HSD. While MS demand is expected to grow by 11 per cent, HSD demand is expected to increase by 5 per cent, largely due to sustained growth in industrial activity and higher rural demand, boosted by a growth in agricultural production. While overall refinery capacity utilisation is expected to dip marginally due to capacity expansions in 2005-06, we forecast a 5 per cent growth in the overall supply of petroleum products. CRIS INFAC estimates annual average crude oil prices (North Sea Brent) for 2005-06 to be lower at $39-41 per barrel, as against an expected $41-42 per barrel in 2004-05. Prices are expected to soften on account of a marginal improvement in demand-supply. While the incremental growth in demand is expected to be lower, OPEC capacity is expected to increase. Despite lower crude prices, GRMs are expected to remain strong in 2005-06 owing to strong international demand. However, they would be tempered to an extent by the reduction in duty protection from 3.1 per cent to 2.6 per cent in the 2005-06 Budget. With the government still actively involved in determining the prices of retail auto fuels, the marketing margins of OMCs will be affected in 2005-06 if prices are not aligned (in time) with the changes in international product prices. However, the subsidy under-recovery on cooking fuels is set to decrease significantly in 200506 on account of the reduction in customs and excise duties and drop in international prices. No revisions are expected in the domestic prices of cooking fuels and the government is expected to continue to share the subsidy burden at the same levels in 2005-06.
U N I O N
B U D G E T
59
Oil and gas

Oil and gas: Tariffs, prices and landed costs
Ta riffs (pe r c e nt) Customs 2004- 05 2005- 06 Exc ise 2004- 05 2005- 06 P ric e s (Ja n 2 0 0 5 ) La nde d c osts (Rs/ tonne ) Dome stic Inte rna tiona l P re - Budge t P ost- Budge t (Rs/ tonne ) ($ / tonne )
Motor spirit (MS)1 Aviation turbine fuel (ATF)1 Naphtha Superior kerosene oil (SKO)1 - Industrial use - Domestic use High speed diesel (HSD)1 Fuel oil1 Liquefied petroleum gas - Industrial use - Domestic use Bitumen C rude oil
U N I O N
15.3 20.4
10.2 10.2
23.5 8.2
8.2 8.2
18,690 18,030
384 369
20,258 20,355
19,362 18,631
5.1
5.1
16.3
16.3
19,005
352
16,986
16,986
20.4 5.1 15.3 20.4
10.2 0.0 10.2 10.2
12.2 12.2 8.2 16.3
0.0 0.0 8.2 16.3
19,580 7,107 19,756 10,345
361 361 333 167
19,911 17,381 17,647 9,535
18,224 16,537 16,867 8,727
5.1 5.1 20.4 10.2 10.2 5.1 -
5.1 0.0 10.2 5.1 10.2 5.1 -
8.2 8.2 16.3 0.0 0.0 16.3
0.0 0.0 16.3 0.0 0.0 16.3
26,800 15,218 n.a. n.a. 2,850 -
366 366 174 278 -
18,587 18,587 14,158 -
18,587 17,685 13,503 -
Natural gas2 LNG C NG n.a.: Not available

1
Price per kl, Notes
Price per thousand scm
1) International prices are fob Arab Gulf prices . 2) Domestic price of petroleum products are ex-storage point prices. 3) Excise and C ustoms duty on MS was reduced to 23 per cent from 26 per cent and 15 per cent from 20 per cent in August, 2004 respectively. 4) Excise duty and C ustoms duty on HSD was reduced to 8 per cent from 11 per cent and 15 per cent from 20 per cent in August, 2004 respectively. 5) Excise duty and C ustoms duty on SKO was reduced to 12 per cent from 16 per cent and 5 per cent in 10 per cent in August, 2004 respectively. 6) C ustoms duty on LPG was reduced to 5 per cent from 10 per cent in August, 2004. 7) Prices of LPG for domestic use revised on November 2004 from Rs. 14,032 per tonne to 15,218 per tonne. 8) C ustoms duty on Naphtha was reduced to 5 per cent from 10 per cent in October 2004. 9) Road cess increased from 1.5 to 2.0 Rs per litre on MS and HSD. 10) Additional excise duty on MS increased from Rs 6 to Rs 11. 11) Additional excise duty of Rs.1.25 per litre levied on HSD 12) Additional excise duty of Rs 2.50 per litre levied on LDO. Source: CRIS INFAC
B U D G E T
60
Oil and gas

Reduction in tariff protection, increase in excise duty on MS and HSD negative for the industry
Company Bharat Petroleum C orpn. Ltd. Bongaigon Petrochemicals Ltd. C hennai Petroleum C orpn. Ltd. Gas Authority of India Ltd. Hindustan Petroleum C orpn. Ltd. IBP C o. Ltd. Indian Oil C orpn. Ltd. Kochi Refineries Ltd. Madras Refineries Ltd. Numaligarh Refinery Ltd. Oil and Natural Gas C orpn. Ltd. Source: CRIS INFAC Impact Impact factors A, B,C A,C A,C B,D A, B,C B,C A, B,C A,C A,C A,C A, B
Impact factors A. The cut in the customs duty on crude oil (from 10 per cent to 5 per cent) and petroleum products (20 per cent to 10 per cent) has resulted in lower tariff protection for the refining players (from 3.1 per cent to 2.6 per cent), negatively affecting the gross refining margins. The cut in crude oil duty will also hit ONGC's operating profits to the extent of Rs 9 billion. B. The favourable impact of the import duty cut on petroleum products has a positive impact on MS/HSD marketing margins and subsidy under-recovery on LPG/SKO. The cut in excise duty on LPG/SKO will help reduce subsidy under-recovery. The public sector oil marketing companies will benefit, as will ONGC and GAIL. C. However, the increase in the effective excise duty on MS and HSD by levying a specific rate of excise duty (along with advalorem duty) will negate the positive impact of the import duty and excise duty cuts. The overall hit on the three public sector oil marketing companies is to the tune of Rs 29 billion. Standalone refining and standalone marketing companies also stand to lose. D. The service tax on product transportation through pipelines will not affect gas marketing/transportation companies, as they will be able to pass it on to the customers.
U N I O N
B U D G E T
61
Paints
Margins to remain intact despite increasing input costs Between 2003-04 and 2007-08, the demand for paints is expected to grow at a steady rate of around 7 per cent in volume terms and 10 per cent in value terms. While the high growth in the auto sector, for the second consecutive year, is expected to drive the demand for industrial paints, higher demand from fresh housing constructions and steady growth in housing repaint demand is likely to boost the volumes of decoratives in the short term. The paint industry is raw material intensive and about 50 per cent of the inputs used are petroleum-based. The industry imports around 30 per cent of its total raw material requirements, primarily titanium dioxide. While the unexpected spurt in crude oil prices in the first half of 2004-05 led to an increase in the cost of production of paints, the pressure on margins was eased by the flexibility to pass on input cost increases. CRIS INFAC is of the opinion that the productivity-related benefits, an increased focus on premium products and the flexibility to pass on any further sharp change in input prices will continue to ensure stability in operating margins in 2004-05.
Paints: Tariffs (per cent) Paints

U N I O N
Customs 2004-05 2005-06 20.4 20.4 20.4 20.4 15.3 20.4 20.4 15.3 15.3 15.3 15.3 15.3 15.3 15.3
Excise 2004-05 2005-06 16.3 16.3 16.3 16.3 16.3 16.3 16.3 16.3 16.3 16.3 16.3 16.3 16.3 16.3
Dyes Varnishes Inks Orthoxylene Phthalic anhydride Titanium dioxide Source: CRIS INFAC
B U D G E T
62
Paints
Reduction in peak customs duty on raw materials to affect positively
Company Asian Paints India Ltd. Berger Paints India Ltd. Goodlass Nerolac Paints Ltd. IC I India Ltd. Source: CRIS INFAC Impact Impact factors A,B A,B A,B A,B
A. The reduction in peak customs duty on raw materials from 20 per cent to 15 per cent would benefit the companies positively, as around 20 per cent of the raw materials are imported and most of them currently attract peak duty. B. Continuation of housing sops will aid demand growth in the industry.
U N I O N
B U D G E T
63
Paper
Operating margins affected by surge in raw material costs Despite price hikes, a significant increase in raw material costs has led to lower operating margins in the industry. During the 9 months ended December 2004, operating margins fell by more than 170 bps. Surging raw material prices have driven the increase in paper prices in 2004-05. Average writing and printing paper prices (maplitho grade) increased by 3 per cent in April-February 2004-05, over the corresponding period last year. During the same period, kraft paper prices rose by 4 per cent and duplex board prices increased by 1 per cent. Demand growth is pegged at 6.3 per cent in 2004-05. Copier paper has been driving volume growth in the writing and printing paper segment, while strong growth in industrial production and a shift from film packaging to paper packaging has ensured a 7 per cent growth in the packaging paper segment. Excise duty on non-wood based paper was cut from 16 per cent to 12 per cent in September 2004, benefiting small and unorganised mills, which manufacture paper largely from wastepaper. Margins are likely to be under pressure in the next 1-2 years with raw material prices, particularly those of domestic wood, unlikely to decrease; product prices also cannot be increased significantly due to an expected growth in supply.
Paper and paperboards: Tariffs, prices and landed costs

Tariff (per cent)
U N I O N
Prices (Jan. 2005) ($/tonne) 570

1 1 1
Customs Newsprint Maplitho Duplex board C oated paper Wood pulp (hard) Wood pulp (soft) Waste paper (OC C ) n.a.: Not available NT: Not traded
1 2 2
Excise 5.1 0.0 16.3 16.3 16.3 0.0 0.0 0.0 0.0 16.3 16.3 16.3 0.0 0.0 0.0
Domestic International Pre-Budget Post-Budget 25,200 38,307 31,500 47,715 NT NT 5,500

1
2004-05 2005-06 2004-05 2005-06 (Rs/tonne) 5.1 20.4 20.4 20.4 5.1 5.1 5.1 15.3 15.3 15.3 5.1 5.1 5.1
26,209 50,549 n.a. 56,684 28,049 28,943 9,868
26,209 48,408 n.a. 54,283 28,049 28,943 9,868
825 n.a 925 610 629 185
B U D G E T
Market prices include excise duty and are net of trade discounts. C VD of 16% has been levied on wastepaper (except for that used in the printing of educational text books)
Source: CRIS INFAC
64
Paper
Marginally negative impact for the industry; coated paper segment severely hit by duty cut
Company Andhra Pradesh Paper Mills Ltd. Ballarpur Industries Ltd. Pudumjee pulp and paper Ltd. Seshasayee Paper and Boards Ltd. Tamil Nadu Newsprint & Papers Ltd. West C oast Paper Mills Ltd. Source: CRIS INFAC Impact Impact factors A A A A A A
Impact factors A. The peak customs duty has been reduced from 20 per cent to 15 per cent. Mills operating in the uncoated and industrial paper segments are likely to be marginally affected, due to the reduction in the price difference between domestic prices and landed costs. However, the prices of high-end coated paper move in line with the landed costs and so are expected to decline. As around 28 per cent of BILT's paper production comprises high-end coated paper, the duty cut will have a considerably negative impact on the company, due to increased pricing pressure and competition from imports.
U N I O N
B U D G E T
65

High competition and increasing penetration to limit industry growth The personal care and detergents segment in India has grown at a CAGR of 7-8 per cent in the past 3 years. While the premium products of the industry, consisting of cosmetics, skin care products, fragrances, deodorants and antiperspirants, and shaving products, are growing at above 10 per cent due to low penetration levels, the mass market segments like detergents, oral care products, hair care products and toilet soaps have already achieved high penetration levels and are registering a slowdown in demand growth. The latter segments also compete with the price- competitive unorganised segment, which also restricts value growth. The oral care market, which grew by 10 per cent in the past, has slowed down in recent years, due to high penetration levels. Demand in this segment is expected to grow at about 8 per cent, driven by rural demand. Value growth is likely to be under pressure due to penetrative pricing for the rural market and slow growth in urban demand. The hair care industry, which was growing at 8-9 per cent, is also expected to register a slower growth of 6-7 per cent in future, due to high penetration levels and competition from unbranded hair oils. Value growth in the segment is expected to be derived largely through the sale of value-added products. The demand for toilet soaps will be restricted to 5 per cent over the medium term, as current penetration levels are already high. However, since the growth will occur on a higher base, the quantum of increase will remain stable. Value growth in the industry is likely to be driven by the migration of consumers from low-end products to upper segments.
U N I O N
The demand growth for detergents has slowed down in the past few years from historic levels of 7-8 per cent, due to high penetration rate. Future demand growth is estimated at 4-5 per cent. However, since the growth would occur on a higher base, the quantum of increase would remain stable. Value growth is likely to be driven by the migration of consumers from lower-end products to the upper segments.
B U D G E T
Personal care and detergents: Tariffs Customs 2004-05 2005-06 Personal care and household products Hair oils Beauty, make-up or skin-care preparations Pre-shave, shaving or after shave preparations1 Personal deodorants and anti-perspirants1 Shampoos Toothpaste Toilet soaps Detergents Laundry soaps C austic soda Soda ash Linear alkyl benzene (LAB) 1 Non-alcohol Note The excise duty is applied on the maximum retail Source: CRIS INFAC 20.4 20.4 20.4 20.4 20.4 20.4 20.4 20.4 20.4 20.4 20.4 20.4 15.3 15.3 15.3 15.3 15.3 15.3 15.3 15.3 15.3 15.3 15.3 15.3 Excise 2004-05 2005-06 16.3 16.3 16.3 16.3 16.3 16.3 16.3 16.3 16.3 16.3 16.3 16.3 16.3 16.3 16.3 16.3 16.3 16.3 16.3 16.3 16.3 16.3 16.3 16.3 Abatement rate 2004-05 2005-06 40.0 40.0 40.0 40.0 40.0 35.0 35.0 35.0 35.0 40.0 40.0 40.0 40.0 40.0 35.0 35.0 35.0 35.0 -
price, after reducing the abatement rate.
66

Reduction in peak customs duty and increase in disposable income to benefit the industry
Company C olgate-Palmolive (India) Ltd. Dabur India Ltd. Hindustan Lever Ltd. Nirma Ltd. Source: CRIS INFAC Impact Impact factors A,B A,B A,B A,B
Impact factors A. The reduction in peak customs duty from 20 per cent to 15 per cent is likely to positively affect players in the industry, depending upon the proportion of imports in their total raw material cost. Accordingly, while the impact is likely to be moderate on Nirma and HLL, the benefit for Dabur is likely to be negligible. B. The increase in disposable income level, brought about by the changes in direct taxes, is likely to aid more penetration and upgradation to more value-added products.
U N I O N
B U D G E T
67
Petrochemicals: Basic and polymers

Domestic prices and margins to remain strong in 2004-06; polymer demand will be low Global petrochemical product prices and margins witnessed a sharp increase in 2004, driven mainly by lingering worries over crude oil supply, lower capacity additions and healthy demand growth (especially from China). In 2004, the average price of naphtha was around $390 per tonne ($196 per tonne in 2003), ethylene was $910 per tonne ($466 per tonne in 2003) and hdPE was $955 per tonne ($630 per tonne in 2003). High prices, and the producers ability to pass on high feedstock costs, expanded cracker margins to $502 per tonne ($134 per tonne in 2003, touched an all-time high of $914 per tonne in September 2004). CRIS INFAC forecasts that prices will remain strong over the next 15-18 months. Domestic product prices will increase in line with global prices in the medium term. In the medium term, any increase in regulated natural gas prices will affect the profitability of gas-based producers (IPCL and GAIL). The reduction in customs duty and the implementation of the Asean Free Trade Agreement, will strain margins in the medium-to-long term. In 2004-05, CRIS INFAC expects polymer demand to increase by 2.5-3.0 per cent, as against the industry's earlier prediction of around 10 per cent. A sharp jump in petrochemical product prices is expected to lead to higher usage of recycled plastics and fillers, thus lowering polymer offtake. In 2005-06, CRIS INFAC expects a marginal recovery in polymer demand owing to expectations of lower petrochemical product prices, led by lower crude oil prices and polymer duty cuts. Among polymers, PP and lldPE are expected to register healthy growth rates. Most domestic polymer markets are characterised by significant overcapacities. Moreover, the expected entry of new players like IOC, ONGC, and CPCL will augment the surplus in the long run. Existing players also plan to expand capacities. Capacity additions will increase the dependence on exports. As a result, corporate profitability will be affected, to some extent, over the long term. Moreover, new capacity additions, expected in the Middle East in 2-3 years, will have the advantage of low-cost feedstock, intensifying the competition.
U N I O N
B U D G E T
Basic petrochemicals and Polymers: Tariffs Tariff (per cent) Prices (Jan 2005) Landed cost (Rs/tonne) Customs Excise Domestic International Pre-Budget Post-Budget 2004-05 2005-06 2004-05 2005-06 (Rs/tonne) ($/tonne) 989 3 59,017 56,406 hdPE (IM) 15.3 10.2 16.3 16.3 58,464 1 1 1,195 3 71,324 68,169 ldPE 15.3 10.2 16.3 16.3 68,750 1,041 3 62,150 59,401 lldPE 15.3 10.2 16.3 16.3 60,088 1 985 3 58,790 56,189 PPHP (IM) 15.3 10.2 16.3 16.3 59,972 1 PVC 15.3 10.2 16.3 16.3 53,360 1 860 3 51,329 49,059 1,138 3 67,892 64,889 PS (GP) 15.3 10.2 16.3 16.3 80,040 1 ABS 15.3 10.2 16.3 16.3 82,200 1,303 3 67,017 64,053 91,338 87,469 SBR (1502) 20.4 15.3 16.3 16.3 92,000 1,700 3 PBR (1220) 20.4 15.3 16.3 16.3 81,000 1,600 3 85,966 82,324 515 2 32,801 31,283 EDC 10.2 5.1 16.3 16.3 26,000 1 VC M 10.2 5.1 16.3 16.3 44,000 1 820 2 50,200 47,876 1,055 2 63,605 60,662 Styrene 10.2 5.1 16.3 16.3 71,000 1 Ethylene 10.2 5.1 16.3 16.3 51,400 980 2 50,652 48,308 43,153 41,156 Propylene 10.2 5.1 16.3 16.3 46,500 828 2 Butadiene 10.2 5.1 16.3 16.3 58,300 1,160 2 59,504 56,750 45,061 42,975 Benzene 10.2 5.1 16.3 16.3 43,500 856 2 Toluene 10.2 5.1 16.3 16.3 35,000 698 2 36,799 35,096 19,112 19,112 Naphtha 5.1 5.1 16.3 16.3 19,005 408 4 1 Market prices, 2 Fob prices, 3 C &F Far East Asia, 4 C &F Japan. Note Anti-dumping duties on PS and SBR have not been included in the landed cost, as they vary by country. Source: CRIS INFAC
68
Petrochemicals: Basic and Polymers

Budget aligns polymer duties to ASEAN rates
Company C hemplast Sanmar Ltd. DC W Ltd. Finolex Industries Ltd. Haldia Petrochemicals Ltd. Indian Petrochemicals C orpn. Ltd. Supreme Petrochem Ltd. Source: CRIS INFAC Impact Impact factors A A A,B A A A
Impact factors A. The customs duty on polymers has been reduced from 15 per cent to 10 per cent. The margins of integrated producers (RIL, IPCL, Haldia Petrochem and GAIL) will be adversely affected since the duty differential between naphtha and polymers will come down to 5 per cent. IPCL's earlier net profit estimate for 2005-06 is expected to go down by Rs 2.3 billion. Higher exports will, to some extent, offset the negative impact on RIL and Haldia Petrochem. The impact of these measures on non-integrated producers (Finolex, Chemplast, and DCW) will be marginally negative, as the reduction of the duty on raw materials (basic and intermediates, where duty has been reduced to 5 per cent) will not completely offset the impact of the duty cut on higherpriced end products. Supreme Petrochem is expected to gain marginally, as it exports a substantial portion (30-40 per cent) of its finished products. The polymer duty cut will provide a breather to downstream plastic processors (Cosmo Films, Nilkamal Plastics, Supreme Industries, and VIP Ind) in terms of lower polymer prices. B. The Union Budget 2005-06 has laid an emphasis on accelerating irrigation and micro irrigation programmes. The government has announced a sum of Rs 48 billion as part of an Accelerated Irrigation Benefit Programme (AIBP) and Rs 4 billion for promoting micro-irrigation for 2005-06. We expect these measures to have a positive impact on the manufacturers of PVC pipes and fittings (Finolex Ind and Jain Irrigation).
U N I O N
B U D G E T
69
Petrochemicals: Downstream
Customs duty cut on feedstocks leads to higher margins The demand for downstream petrochemicals is expected to go up by 4-5 per cent in 2005-06, over the past year. The growth in demand will be in line with the increased offtake from consumer sectors such as paints and pigments, formaldehyde, and soaps and detergents. The cut in the customs duty on feedstocks, such as benzene, naphtha, and ethylene in October 2004, widened the duty differential between products and raw materials. This, coupled with soaring international prices increased the margins of most downstream petrochemical producers in 2004-05. With overcapacity prevailing in some products, such as linear alkyl benzene (LAB) and carbon black, and the expected softening of international prices in 2005-06, the prices of these products will witness some correction. Margins will also be affected by the narrowing of the duty differential.
Downstream petrochemicals: Tariffs, prices and landed costs Tariff (per cent) Customs LAB PAN MAN Methanol
U N I O N
Prices (Jan 2005) Domestic International ($/tonne) 1,250 910 1400 308 1,500 900 985 785 971 675 190
1 1 1 1 1 1
Landed cost (Rs/tonne) Pre-Budget Post-Budget 67,161 48,893 75,220 16,548 83,816 51,579 52,923 40,390 50,209 36,120 10,208 64,316 46,822 72,034 15,847 80,266 49,395 50,681 36,817 47,886 34,449 9,776
Excise 15.3 15.3 15.3 15.3 15.3 15.3 15.3 5.1 5.1 5.1 15.3 16.3 16.3 16.3 16.3 16.3 16.3 16.3 16.3 16.3 16.3 16.3 16.3 16.3 16.3 16.3 16.3 16.3 16.3 16.3 16.3 16.3 16.3
2004-05 2005-06 2004-05 2005-06 (Rs/tonne) 20.4 20.4 20.4 20.4 20.4 20.4 20.4 10.2 10.2 10.2 20.4 65,900 43,500 69,500 15,200 69,000 51,000 52,000 43,000 51,400 43,500 9,550
Phenol Acetone VAM Orthoxylene Ethylene Benzene C BFS
B U D G E T
LAB: Linear alkyl benzene; MAN: Maleic anhydride; PAN: Phthalic anhydride; VAM: Vinyl acetate monomer
1
Fob prices
Source: CRIS INFAC
70
Petrochemicals: Downstream
Duty differential maintained, marginally negative for players
Company Hindustan Organic C hemicals Ltd. India Glycols Ltd. Philips C arbon Black Ltd. Schenectady Herdillia Ltd. Tamil Nadu Petroproducts Ltd. Thirumalai C hemicals Ltd. Source: CRIS INFAC Impact Impact factors A A A A A A
A. The customs duty on downstream petrochemical products has been brought down from 20 per cent to 15 per cent. The customs duty on raw materials (benzene, ethylene, naphtha) has also been cut from 10 per cent to 5 per cent. Although the duty differential has been maintained at 10 per cent, the reduction in raw material duty will not completely offset the decline in duty on higher-priced end products. It will thus have a marginally negative impact on downstream petrochemical companies.
U N I O N
B U D G E T
71
Pharmaceuticals
Regulatory uncertainty may affect domestic industry, but exports to regulated markets to drive growth The Indian pharmaceutical industry is expected to grow at around 11 per cent, from Rs 396 billion in 2003-04 to Rs 600 billion in 2007-08, driven primarily by exports to regulated markets like the US and Europe. With around $65 billion worth of drugs going off patent by 2008-09, exports are expected to grow at around 18 per cent, from about Rs 155 billion in 2003-04 to about Rs 294 billion in 2007-08. The share of exports in 200304 was around 38 per cent and is expected to touch around 50 per cent in 2007-08. Thus, large companies focussing on these generic markets are expected to benefit. Other Indian companies, which enjoy the advantage of lower research and manufacturing costs vis--vis their international counterparts, are also expected to consider the generics and contract manufacturing businesses. With the implementation of the product patent regime from January 1, 2005, the domestic formulations market will see a slowdown in growth, as the introduction of new products through the reverse engineering route will become difficult. In the domestic formulations market, the growth rate for the first 9 months in 2004-05 slipped to 5.5 per cent from 14.5 per cent in the corresponding period of 2002-03. The slowdown in growth can be attributed to increased regulatory uncertainty in terms of excise duty payments and the implementation of VAT, which has reduced the offtake of medicines in Q3 2004-05. Besides, decreasing prices, owing to competition among domestic formulations market players, has also put pressure on the growth rates. CRIS INFAC expects the growth rate to stabilise at 5-6 per cent till 2006-07. This growth is expected to be sustained through the
U N I O N
increase of prescription share in the market, though pricing is expected to be flattish to downwards. Thus, players focussing only on the Indian markets are expected to lose out in the race.
Pharmaceuticals: Tariffs (per cent) Drug intermediates Bulk drugs Formulations Life saving bulk drugs and formulations Source: CRIS INFAC Customs duty 2004-05 20.4 20.4 20.4 5.1 2005-06 15.3 15.3 15.3 5.1 Excise duty 2004-05 16.3 16.3 16.3 0.0 2005-06 16.3 16.3 16.3 0.0
B U D G E T
72
Pharmaceuticals
Pharmaceuticals further fillip to R&D initiatives
Company Aurobindo Pharma Ltd. Biocon India Ltd. C ipla Ltd. Dr Reddy's Laboratories Ltd. GlaxoSmithkline Pharmaceuticals Matrix Laboratories Ltd. Nicholas Piramal India Ltd. Pfizer Ltd. Ranbaxy Ltd. Wockhardt Ltd. Source: CRIS INFAC Impact Impact factors A A A A A
A. The import duty on nine equipment used in pharmaceutical and biotechnology research has been reduced from 20 per cent to 5 per cent. This cut is expected to benefit companies like Ranbaxy, Cipla, Biocon, Matrix and Wockhardt, which are involved in biotechnology and AIDS research. The government has increased its focus on healthcare by increasing allocation under the National Rural Health Mission from Rs 84.2 billion to Rs 102.8 billion. The focus is now on increasing the supply of medicines and training medical personnel. The last date to avail of 150 per cent tax deductions for research companies, deductions of profits of new industrial undertakings in Jammu & Kashmir and the 100 per cent deduction of the profits of companies undertaking scientific research and development and approved by the Department of Scientific and Industrial Research has been extended to March 31, 2007. It has announced the formation of a corpus fund of Rs 5 billion called the SME Growth Fund through the Small Industries Development Bank of India (SIDBI) to provide equity support for small and medium units in the pharmaceutical and biotechnology sector. Thus, the overall impact of budget measures has been marginally positive.
U N I O N
B U D G E T
73
Shipping
Favourable demand-supply scenario up to CY 2007 The increase in global oil demand by 5 per cent and the strong growth of the Chinese economy by 9 per cent kept the demand for raw materials robust, fuelling greater demand for tankers and dry bulk carriers and strengthening freight rates. In CY 2004, freight rates remained volatile, and increased in the October-December 2004 quarter. Freight rates of active oil fleet rose by 3.8 per cent in 2004, while utilisation rates went up from 89 per cent to 91.3 per cent. Freight rates of dry bulk fleets increased by 4.5 per cent in 2004, while utilisation rates rose from 92 per cent to 97 per cent. Freight rates are expected to remain firm over the next 2 years, given the current high rates, an ageing fleet, and tightening regulations (leading to higher scrappage). Demand-supply is expected to remain favourable, as significant fleet replacements are due for single hull tankers in line with mandated safety norms, and fresh supply is expected to hit the markets by around 2007. We expect the freight rates to correct post-2007 as fresh supply hits the market. Introduction of tonnage tax has improved the profitability of shipping companies In the Union Budget 2004-05, the government introduced the tonnage tax, which has lowered the incidence of taxation for shipping companies. Under the tonnage tax regime, shipping companies will have to pay a flat rate of income tax on net tonnage unlike the earlier practice of corporate tax rate of 35 per cent levied. Under the
U N I O N
earlier practice, these companies had exemptions under Section 33 AC of the Income Tax Act; as a result, their effective taxation rate was around 10-14 per cent. However, under the tonnage tax regime, the effective tax rates are expected to drastically fall to around 2 per cent.
B U D G E T
74
Shipping
No impact on the shipping industry
Company Essar Shipping Ltd. Great Eastern Shipping C o Ltd. Mercator Lines Ltd. Shipping C orporation of India Ltd. Source: CRIS INFAC Impact Impact factors -
U N I O N
B U D G E T
75
Steel
Profitability of players to increase in 2004-05 Higher price realisations and increased volumes led to healthy operating profits and an improvement in the margins of domestic steel manufacturers. Restructuring and repayment of debt, with better accruals, led to a reduction in interest costs and, consequently, higher net margins. In the first 7 months of 2004-05, apparent consumption of steel increased by around 6 per cent, compared to the previous year. The domestic demand for steel is expected to be 7-8 per cent in 2005-06. The demand for steel in the domestic markets will be driven by sectors like automobiles, construction and tubes and pipes. The domestic demand-supply balance is expected to remain favourable with operating rates continuing to remain high. Growth in domestic prices was curtailed due to stiff user resistance and an unfavourable government stance with respect to frequent price hikes, resulting in weakening linkage between domestic and international prices. CRIS INFAC expects the average domestic prices of steel to remain stable despite the softening of prices in the international market. Even at the reduced international prices of $550 per tonne of HR coil, the landed cost at the current duty levels will be comparable to the current domestic prices. The industry's operating profit margins will come under pressure in 2005-06, due to the sharp increase in the cost of raw materials, mainly iron ore and coking coal, while the cost of sponge iron, coke and scrap will remain at high levels.
U N I O N
Steel: Tariffs, prices and landed costs Tariff (per cent) Customs 2004-05 2005-06 GP/GC CR coils HR coils Structurals Bars and rods Alloy steel Billets/Slabs Pig iron Ferro alloys Steel melting scrap 2 Iron ore Coking coal (< 12% ash content) Coking coal (>12% ash content) Metallurgical coke Non-coking coal
1 2 1
Prices (Feb 2005) ($/tonne) 730 650 588 490 340 310 250 -
Excise 5.1 5.1 5.1 5.1 5.1 10.0 5.1 5.1 10.2 10.2 0.0 0.0 0.0 5.1 5.1 5.1 12.2 12.2 12.2 12.2 12.2 12.2 12.2 12.2 12.2 12.2 12.2 16.3 16.3 16.3 16.3 16.3 16.3 16.3 16.3 16.3 16.3 16.3 -
Domestic International Pre-Budget Post-Budget 38,000 35,000 30,500 24,500 24,000 25,000 14,500 14,000 15,000 41,275 37,095 33,856 28,736 21,004 19,331 15,570 42,764 38,433 35,077 29,772 21,762 20,029 16,132 -
2004-05 2005-06 Rs/tonne)
5.1 5.1 5.1 5.1 5.1 15.3 5.1 5.1 10.2 15.3 0.0 0.0 0.0 15.3 5.1 5.1
B U D G E T
HBI/Sponge iron
Prices are for January 2005
Prices are for Decemebr 2004 Notes 1) International prices are fob prices. 2) Prices are average prices for the month. Source: CRIS INFAC
76
Steel
Excise duty changes to hit long product segment and GP-GC manufacturers
Company name Bhushan Steel & Strips Ltd. Essar Steel Ltd. Ispat Industries Ltd. Jindal Stainless Ltd. JISC O/JVSL Steel Authority of India Ltd. Tata Iron & Steel C o. Ltd. Source: CRIS INFAC Impact Impact factors B,C,D C,D B,C,D A,C,D B,C,D B,C,D B,C,D
Impact factors A. Duty on alloy steel products (including stainless steel) has been reduced from 15 per cent to 10 per cent. It will lower the landed cost of stainless steel HR coils by Rs 6,500-7,000 per tonne. However, domestic prices will not drop, as they will still be at a significant discount to landed cost. B. The import duty on zinc has been cut from 15 per cent to 10 per cent. This is likely to have a marginally positive impact on GP/GC producers. CRIS INFAC estimates that GP/GC costs will drop by Rs 175-190 per tonne. C. A 10 per cent drop (from 15 per cent to 5 per cent) in the import duty on coking coal that has an ash content of more than 12 per cent will not have a significant impact, since the industry largely uses coking coal with less than 12 per cent ash content. The 5 per cent (from 15 per cent to 10 per cent) decline in the import duty on refractories and ferro alloys will have only a marginally positive impact on the industry. D. The excise duty on steel products has been increased from 12 per cent to 16 per cent, implying a duty increase of Rs 1,000-1,200 per tonne.CRIS INFAC expects domestic flat product manufacturers to pass on the incremental duty since most buyers claim credit on excise duty paid on inputs. However, in case of long products or galvanised sheets used for roofing, the duty increases will be difficult to pass on to consumers. Long products account for 45-47 per cent of finished steel consumption and GP/GC sheets account for 5-6 per cent. RINL, JSPL (for long products), Tisco and SAIL (for long products and GP/GC) and other GP/GC players have been adversely affected. Jisco will be the least affected owing to the higher share of exports in its GP/GC sales.
U N I O N
B U D G E T
77
Sugar
Sugar deficit for the second consecutive year The sugar industry is in the midst of a cyclical upturn. Sugar prices have bounced back sharply from historic lows, as the industry is facing a production deficit for the second consecutive year during the 2004-05 sugar season (October-September). We expect the upturn to continue for the next 2 years. Sugar prices are expected to remain firm over this period. The sugar industry faced a deficit for the first time in 6 years during the 2003-04 sugar season. Production during the year, at 13.8 million tonnes, was a whopping 31 per cent lower than the record production of 20.1 million tonnes in 2002-03. During the current sugar season, 2004-05, production is expected to slip by a further 9 per cent to around 12.5 million tonnes. Meanwhile, domestic sugar consumption is expected to continue to rise by around 4 per cent annually. Consumption during the 2004-05 SS is forecast at 19 million tonnes. As a result of 2 successive years of low output and rising domestic consumption, sugar inventory levels have depleted rapidly. From 12.5 million tonnes at the end of the 2002-03 SS, sugar stocks are estimated to have come down to around 8.6 million tonnes by the end of 2003-04. Inventory levels are expected to slide further in 2004-05, and substantial imports will take place in order to meet domestic demand. Over the course of the current sugar season, 2004-05, and 2005-06, sugar imports of around 6 million tonnes (refined value) are expected to take place. The sugar industry has recorded an impressive surge in profitability in 2004-05 on the back of higher sugar
U N I O N
prices and a spurt in realisations from the sale of by-products such as molasses and bagasse. The improvement in financial performance is likely to be sustained over the medium term, as sales realisations are expected to remain firm. But the extent of profitability of individual mills in the sector will be determined by sugarcane availability and the price paid for sugarcane procured.
Sugar: Tariffs, prices and landed costs Tariff (per cent) Customs Imported sugar - Raw sugar - Refined sugar Domestic sugar - Levy sugar - Free-sale sugar Molasses
1
B U D G E T
Prices (Jan 2005)

1
Excise
Domestic International Pre-Budget Post-Budget ($/tonne) 227 258 20,828 23,052 20,828 23,052 -
2004-05 2005-06 2004-05 2005-06 (Rs/tonne) 61.2 61.2 15.3 61.2 61.2 10.2 928.2 928.2 591.6 928.2 510.0 928.2 928.2 591.6 928.2 1020.0 13,500 18,860 5,000
Excise duty is in Rs per tonne and it includes a cess of Rs 200 per tonne levied under the Sugar C ess Act, 1982.
Source: CRIS INFAC
78
Sugar
Budget positive for the sugar industry
Company Bajaj Hindusthan Ltd. Balrampur C hini Mills Ltd. Bannari Amman Sugars Ltd. EID Parry Ltd. Source: CRIS INFAC Impact Impact factors A,B,D,E A,B,D,E A,B,D,E A,B,D,E
A. The reduction in the basic customs duty on molasses and industrial alcohol from 15 per cent to 10 per cent is expected to be marginally negative for the industry. B. The hike in the excise duty on molasses from Rs 500 per tonne to Rs 1,000 per tonne (excluding education cess) is expected to result in a corresponding increase in molasses prices. C. The proposed financial package for the restructuring of sugar mills that were operational in the 2002-03 sugar season will mainly benefit mills located in Maharashtra and South India. The package provides for a moratorium of 2 years on the payment of both principal and interest, and the drawing up of a new schedule of payment, taking into account the commercial viability of each unit.
U
D. The rate of interest on loans from the Sugar Development Fund (SDF), including outstanding loans as of October 21, 2004, has been reduced to 4 per cent from 9 per cent previously. This is expected to result in a reduction in the interest cost of mills which have availed of loans or wish to obtain funds from the SDF. The stronger sugar mills are expected to be the main beneficiaries of this move. E. In addition, the Indian Banks' Association and the National Bank for Agricultural and Rural Development have been asked to work out a scheme, under which individual sugar factories may renegotiate the interest rate on their past loans.
N I O N
B U D G E T
79
Tea & coffee

Prices to remain firm Tea CRIS INFAC expects tea auction prices to remain firm in 2005 (calendar year). Considering the limited potential to increase supply and the increasing domestic consumption, stock levels are likely to fall further, leading to firming up of prices. Tea production fell by around 4.5 per in 2004, due to excessive rains and pest attacks. While exports grew in the first half of the year, the cancellation of a large order by Iraq led to their decline in the second half of the year, thereby posting flat growth over the previous year. However, the steady growth in domestic consumption caused demand to exceed production, thereby reducing stock levels and pushing up auction prices. The continuous slide in auction tea prices in the past few years led to mushrooming of unorganised players in the packaged tea segments, who raised their share to 30-40 per cent of the domestic tea market. However, the increase in auction prices in 2004 is likely to have led to a decline in their presence. We expect prices to remain firm over 2005, thereby resulting in a further moderate decline in the share of unorganised players. Coffee The coffee industry started looking up in 2003, on account of the substantial decline in Brazilian production, which reversed the oversupply situation in the global coffee industry. CRIS INFAC expects the coffee industry to maintain the increasing price trend in 2005 too, on account of an expected decline in global production.
U N I O N
As the industry is dependent on exports for around 70 per cent of the production, Indian coffee prices follow the global trend. Hence, domestic prices may maintain the increasing trend. While the global short-supply will augur well for India's exports, the constraints on its supply are likely to restrict growth in exports. Corporates largely involved in roasting and selling in final form are likely to increase product prices in line with auction prices. For the Indian merchant exporters, margins will remain unaffected due to the maintenance of the premium commanded by Indian exports over international prices. Hence, we expect corporate profitability or credit profile not to be affected by the expected increase in prices.
Tea: Tariffs and prices (Rs/tonne) Customs (per cent) 2004-05 2005-06 Excise (Rs/kg) 2004-05 2005-06 Domestic prices Dec-2004
B U D G E T
Tea (C TC ) 102.0 102.0 0.0 0.0 64,730 Instant Tea 30.6 30.6 16.3 16.3 C TC : C rush, Tear & C url Note A surcharge of Re 1, which was applicable in 2004-05, has been removed in 2005-06. Source: CRIS INFAC
Raw coffee: Tariffs and prices (per cent) C offee-Arabica C herry AB C offee-Robusta Parchment AB Customs 2004-05 2005-06 102.0 102.0 102.0 102.0 30.6 30.6 Excise 2004-05 2005-06 0.0 0.0 0.0 0.0 16.3 16.3
80
Instant C offee Source: CRIS INFAC
Tea & coffee

Abolition of surcharge to affect the tea industry positively
Company George Williamson (Assam) Ltd. Goodricke Group Ltd. Harrisons Malayalam Ltd. Tata C offee Ltd. Tata Tea Ltd. Source: CRIS INFAC Impact Impact factors A,B A,B A,B C A,B
Impact factors A. Removal of surcharge of Re 1 per kg of tea will have a favourable impact on the industry. B. It has been announced that the government will examine ways to initialise a massive replantation and rejuvenation programme for tea plantations. While this would affect the industry positively, the benefit will be visible only over the long term.
U N I O N
B U D G E T
81
Telecom cables
Competition to intensify; margins under pressure Over the next 3 years, the demand for optical fibre cables (OFCs) is expected to grow at a CAGR of 17 per cent to 1.8-2.4 mfkm. Fibre optic producers are reporting healthy order book positions on the back of increased demand for broadband deployment. OFC demand is being driven by 'last mile' (access) networks. In the medium term, higher OFC offtake will depend on the success of broadband services in various pilot cities. Although a number of technology and affordability issues could hold up the expansion of broadband services in the country, measures initiated by the Central and state governments seem conducive to the growth of broadband in India. Although demand is expected to improve in the OFC segment, price realisations will decrease owing to competition from global players, as customs duties have been abolished under the IT agreement with effect from April 1, 2005. The outlook for the jelly-filled telecom cables (JFTCs) industry remains bleak over the medium term. Largescale deployment using wireless services is expected to limit the demand for wireline services, thus adversely affecting JFTC demand. The demand for JFTC is expected to decline at a compounded annual rate of nearly 11 per cent between 200304 and 2006-07 and will eventually be restricted to replacement and maintenance demand. Intense competition will continue to strain the margins of JFTC producers over the medium term.
U N I O N
Telecom cables: Tariffs, prices and landed costs Tariffs (per cent) Customs 2004-05 2005-06 Jelly-filled telecom cables Optical fibre cables * C opper Preform Optical fibre Polyethylene 15.3 0.0 15.3 15.3 0.0 @ 0.0 @ 0.0 @ 0.0 @ 0.0 @ 16.3 16.3 16.3 16.3 16.3 16.3 # 16.3 # 16.3 # 16.3 # 16.3 # 208,333 644 58,464 61,306
2
Prices (Jan 2004) (Rs/tonne) 700 2,520

1
Landed costs (Rs/tonne)
Excise 2004-05 2005-06 16.3 16.3 16.3 # 16.3 #
Domestic International Pre-Budget Post-Budget ($/tonne) 3,170 n.a. 11 989 1,018 192,783 657 59,017 60,730 149,904 511 45,890 47,222
15.3 20.4
0.0 0.0
B U D G E T
Polypropylene 15.3 n.a.: Not available

1 2 3
Weighted average prices (in terms of Rs/ckm) of BSNL's tender for 2003-04 including increase in copper prices Market prices, in terms of Rs/km Market price, in terms of $/km
* Optical fibre cables is considered under ITC code 8544 70 (not under 9001 10), which is a part of the ITA agreement. # Clarification is awaited on the excise duty as the CVD on these products have been reduced to 4 per cent @ All goods imported for the manufacture of ITA bound items have been exempted from customs duty. Source: CRIS INFAC
82
Telecom cables
Prices to drop; margin pressures to continue
Company name Aksh Optifibre Ltd. Birla Ericsson Optical Ltd. Finolex C ables Ltd. Sterlite Optical Technologies Ltd. Vindhya Telelinks Ltd. Source: CRIS INFAC Impact Impact factors A, B A, B A, B A, B A, B
Impact factors A. The abolition of the customs duty on JFTC and OFC will have a negative impact on domestic producers. The resulting increase in competition will lower price realisations and exert pressure on margins. B. The reduction in the customs duty on raw materials like copper, polyethylene and polypropylene will partially offset the decrease in the duties on finished goods.
U N I O N
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83
Telecom equipment
Foreign equipment vendors expected to capture bulk of the orders The slowdown in the deployment of wireline networks has severely affected domestic telecom equipment manufacturers, as their capabilities are largely on the wireline side. BSNL and MTNL together added 4.50 million capacity to serve additional wireline subscribers in 2002-03 and just 0.45 million in 2003-04, as compared with additions of 7.10 million and 6.70 million in 2000-01 and 2001-02, respectively. On the wireless side, where demand has been strong over the last couple of years, foreign vendors have captured most of the demand. Foreign vendors have proven capabilities in undertaking large turnkey contracts and building wireless networks. They also finance service providers and have technological capabilities, which the Indian vendors lack. Over the next 5 years, the total capital expenditure of telecom services industry is expected to be about Rs 1,000 billion, of which Rs 650-700 billion is expected to be on mobile networks. The total capital expenditure on wireline networks is expected to drop from Rs 400-450 billion in the last 5 years to about Rs 110 billion in the next 5 years (2004-05 to 2008-09). The foreign vendors are likely to continue to capture majority of the total equipment demand.
Telecom equipment: Tariffs Tariffs (per cent) Customs

U N I O N
Excise 0.0 0.0 0.0 0.0 0.0 0.0 16.0 16.0 16.0 16.0 0.0 16.0 16.0 16.0 16.0
2004-05 2005-06 2004-05 2005-06 C ellular phones Fixed wireless terminals Microwave equipment (excluding BTS 1) Transceivers/Lasers Parts of Transmission Equipments (excludin
1
5.1 15.3 10.2 15.3 5.1
B U D G E T
Basic Duty on Base Transceiver Station (BTS) is Zero per cent
Source: CRIS INFAC
84
Telecom equipment
Customs duty cut on finished products to have a negative impact on the industry
Company Himachel Futuristic C ommunications Ltd. ITI Ltd. Shyam Telecom Ltd. Source: CRIS INFAC Impact Impact factors A,B A,B A,B
Impact factors A. The customs duty on specified items (parts of transmission equipment and microwave equipment) has been abolished, which is a negative for the sector. B. The customs duty exemption currently available on specified capital goods has been extended to some more capital goods, which is a positive for the sector.
U N I O N
B U D G E T
85
Telecom services
Strong growth in mobile subscriber base; slowdown in fixed services space The telecom services industry is currently in a high-growth phase. From 4.3 per cent at the end of March 2002, Indias teledensity has doubled to 8.6 per cent by December 2004, driven largely by the stupendous growth in the mobile services space. The mobile subscriber base increased seven-fold from 6.5 million at the end of 2001-02 to 47.5 million by the end of December 2004, buoyed by a sharp decline in tariffs, intense competition among service providers, lower handset prices, lowering of entry barriers, and the implementation of the calling party pays and the unified access service licence regime. The mobile subscriber base is expected to grow at a healthy pace over the medium-term. Growth will be driven by the increasing affordability of mobile services (due to rising income levels and falling tariffs) and by supply-side factors such as an increase in coverage by operators in semi-urban and rural areas and the strengthening of marketing and distribution networks. In contrast to mobile services, the growth in the demand for fixed services has been rather tepid. The number of fixed service subscribers increased by just one per cent to 42.8 million in 2003-04. In the first half of 200405, the subscriber base for fixed services increased by around 1.1 million, driven by increased penetration of and higher demand for fixed wireless services. We expect fixed wireless services to continue to witness healthy growth; fixed wireless will account for the bulk of the net subscriber additions in the fixed services segment over the medium-term.
U N I O N
National and international long distance call volumes are expected to increase in line with the growth in the telecom subscriber base. The demand for international bandwidth is also expected to increase substantially, driven by higher demand from the information technology services and IT-enabled services sectors, higher usage of Internet services and the growing connectivity needs of Indian corporates. Telecom tariffs have fallen quite sharply over the last few years, due to increased competition and the falling cost of service. Further tariff declines are expected over the medium-term. Mobile tariffs are expected to fall by 15-20 per cent annually over the next 2 years, driven by a decline in regulatory costs, greater economies of scale as a result of a further increase in the subscriber base, and keen competition among operators to garner a larger share of a growing market. In the long-distance segment, decreasing access deficit charges, competition and technological advancements will lower tariffs.
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86
Telecom services
Removal of Section 80 IA benefits to adversely affect players
Company Bharti Televentures Ltd. Bharat Sanchar Nigam Ltd. Hutchison Max Telecom Ltd. Mahanagar Telephone Nigam Ltd. Reliance Infocomm Ltd. Tata Teleservices Ltd. Videsh Sanchar Nigam Ltd. Source: CRIS INFAC Impact Impact factors B,C B,C B,C B A,B,C A,B,C
Impact factors A. The import duty on mobile handsets and fixed wireless terminals, which was 5 per cent and 15 per cent, respectively, has now been abolished. This will lower handset prices and thus, bring down the entry barrier for subscribing to telecom services. B. The customs duty on microwave equipment and parts of transmission equipment has been abolished. The duty exemption currently available on specified telecom network equipment and parts thereof, when imported by telecom service providers, has been continued. This move will reduce the capital costs of telecom operators. C. Section 80 IA benefits, whereby a telecom operator was entitled to 100 per cent exemption on taxable profit for 5 years and 30 per cent exemption for the next 5 years during the initial 15 years from the date of commencement of commercial operations, has not been extended. This is viewed as a negative for the industry. D. Mobile services have been removed from the one-by-six criterion for filing income tax returns. We do not expect this move to have a significant impact on demand.
U N I O N
B U D G E T
87
Tractors
Stupendous growth and continued focus on agriculture brings cheer to players The tractor industry has been on a growth trajectory since the second half of 2003-04, after going through a trough for 4 consecutive years. The key factors driving this growth are increasing farm incomes, aggressive financing resulting in easy availability of low-cost credit, sharp inventory correction and strong export growth. The tractor industry ended the 9 months of 2004-05 on a buoyant note, with sales growing by 39.5 per cent over the corresponding period of the previous year. On account of pumped-up sales volumes, the industry has registered a stellar financial performance. Government policies have been extremely favourable for the industry. The Union Budget 2004-05 announced an excise duty exemption for tractors (earlier an excise duty of 16 per cent was levied) and tractor parts that are meant for captive consumption. The industry is entitled to a 150 per cent deduction in expenditure on inhouse research and development. CRIS INFAC estimates that tractor volumes will grow by 25-30 per cent in 2004-05 and 8-10 per cent in 2005-06.
Tractors: Tariffs (per cent) Agricultural tractors Road tractors Steel items
U N I O N
2 1
Customs 2004-05 20.4 20.4 5.1 20.4 20.4

2 2 2
Excise 2004-05 2005-06 2 2 2
2005-06 20.4 20.4 5.1 15.3 15.3
16.3 16.3 16.3 16.3
12.2 16.3 16.3
Engines and engine parts Other components

1
Excise duty of 16% has been imposed on road tractors (of engine capacity more than 1800 cc) for road trailers. Excluding countervailing duty
Source: CRIS INFAC

B U D G E T
88
Tractors
Continued focus on agriculture positive for tractor industry
Company Eicher Motors Ltd. Escorts Ltd. Mahindra & Mahindra Ltd. Punjab Tractors Ltd. TAFE Ltd.
1 1
Impact
Impact factors A,B,C,D A,B,C,D A,B,C,D A,B,C,D A,B,C,D
Not withstanding the recent annoucement to sell its tractors division to
TAFE, which will take time to come into effect. Source: CRIS INFAC
Impact factors A. The hike in the excise duty on steel is likely to result in an increase in tractor prices, as cenvat credit cannot be availed on inputs since agricultural tractors are exempt from excise duty. B. The extension of the 150 per cent deduction on R&D expenditure up to March 31, 2007, will benefit the industry in terms of new product development. C. The cut in the peak customs duty on components as well as the cut in the excise duty on tractor front tyres is not expected to have a significant impact, given the high levels of indigenisation and the low value of tractor front tyres. D. The budget has announced various agriculture-friendly measures: Greater thrust on agricultural credit through 30 per cent increased flow of credit in 2005-06 and an increase in the number of borrowers by 5,000,000. Increase in the area under irrigation under the Bharat Nirman Project and the micro irrigation scheme. Road connection for all villages. Schemes for agricultural diversification. Continuation of farm insurance scheme. The commission of National Horticulture Mission to cover research, production, post harvest management, processing and marketing in an integrated manner. Scheme for strengthening agricultural marketing infrastructure. National project for repair, renovation and restoration of water bodies. In the long run, these measures are likely to boost farm incomes and thereby boost tractor demand.
B U D G E T
U N I O N
89
Two-wheelers
Robust demand to continue After an 11.4 per cent growth in 2003-04, two-wheeler sales surged by over 17 per cent year-on-year (Y-o-Y) for the first 10 months of 2004-05. Sales growth, led by the sales of motorcycles, escalated consistently during the April to January period due to increasing household incomes, easy availability of finance, and the success of certain new models launched during the period. Two-wheeler demand is expected to grow at a healthy rate of 11-12 per cent from 2004-05 to 2005-06. Rising household incomes, frequent new model launches and the increasing penetration of finance and distribution will act as key growth drivers. The motorcycle segment witnessed stupendous growth in 2004-05 (20.3 per cent Y-o-Y) after a moderate performance (growth of 13.7 per cent Y-o-Y) in 2003-04. The buoyant growth in this segment will be maintained on account of the entry of global players like Honda Motors and Suzuki (entry expected in 2005) and the domestic players growing focus on motorcycles. The segment is expected to grow by 12-13 per cent in 200506. Led by the ungeared segment, scooter sales are likely to grow by 8 per cent, while moped sales are expected to stagnate or decline marginally in 2005-06.
Two wheelers: Tariffs (per cent)

U N I O N
Customs 2004-05 2005-06 61.2 5.1 20.4 20.4 61.2 5.1 15.3 15.3
Excise 2004-05 2005-06 16.3 12.2 16.3 16.3 16.3 16.3 16.3 16.3
Two wheelers Steel items Engines and engine parts Other components Source: CRIS INFAC
B U D G E T
90
Two-wheelers
Marginally positive impact on the two-wheeler segment
Company Bajaj Auto Ltd. Hero Honda Motors Ltd. TVS Motor C ompany Ltd. Source: CRIS INFAC Impact Impact factors A, B, C, D A, B, C, D A, B, C, D
Impact factors A. The reduction in the import duty on used two-wheelers will not affect the industry. B. The hike in the excise duty on steel will not affect the industry, as cenvat credit can be availed for the same. C. The extension up to March 2007 of 150 per cent deduction on R&D expenditure will marginally benefit domestic two-wheeler players, such as TVS Motors, Bajaj Auto and Kinetic. D. The reduction in personal tax rates will increase household disposable income, which is a positive for twowheeler demand.
U N I O N
B U D G E T
91
Tyres
Long-term demand growth to stabilise at 6-7 per cent; operating margins to remain low During April-December 2004, sales volumes grew by around 10 per cent (Y-o-Y). However, with replacement demand slowing down, the annual growth for 2004-05 is likely to be lower at 8-9 per cent. The long-term demand growth is expected to settle at 6-7 per cent, on account of the slowdown in replacement demand. In January 2005, average tyre prices across categories rose by 5 per cent, over those in March 2004, driven by the surge in raw material prices. Average prices of natural rubber, which accounts for 35 per cent of raw material costs, increased by nearly 23 per cent (Y-o-Y) during the first 9 months. The first half of 2004-05 saw operating margins reel under pressure. This is because manufacturers were unable to pass on a major portion of the increase in raw material costs, owing to stiff competition and the threat of cheaper imports. Lower priced imports from China and South Korea pose a threat for the domestic tyres industry, as these two countries enjoy a preferential customs duty of 15.3 per cent, as against the standard duty of 20.4 per cent, under the Bangkok agreement.
Tyres: Tariffs, prices and landed costs Tariffs (per cent) Customs Excise Prices (January 2005) Landed costs (Rs/tonne) Domestic International Pre-budget Post-budget
U N I O N
B U D G E T
2004-05 2005-06 2004-05 2005-06 (Rs/tonne) ($/tonne) New tyres (for replacement) Truck and bus 20.4 15.3 24.5 16.3 9,073 1 Light truck 20.4 15.3 24.5 16.3 2,865 1 C ar cross ply 20.4 15.3 24.5 16.3 n.a. 1 C ar radials 20.4 15.3 24.5 16.3 1,022 1 Tractor front 20.4 15.3 24.5 16.3 1,403 1 Tractor rear 20.4 15.3 16.3 16.3 5,725 1 Tractor trailor 20.4 15.3 24.5 16.3 4,069 1 Moped 20.4 15.3 16.3 16.3 354 1 Scooter 20.4 15.3 16.3 16.3 431 1 Motorcycle 20.4 15.3 16.3 16.3 500 1 Used/retreaded tyres Truck and bus 20.4 15.3 24.5 16.3 C ar cross ply/ 20.4 15.3 24.5 16.3 radials Natural rubber 20.4 15.3 51,875 n.a SBR (1958) 20.4 15.3 16.3 16.3 92,000 1,560 97,495 PBR (1220) 20.4 15.3 16.3 16.3 78,680 1,600 99,995 NTC fabric 20.4 15.3 16.3 16.3 220,000 4,050 227,247 C arbon black 20.4 15.3 16.3 16.3 42,100 n.a. n.a. (N220) NTC : Nylon tyre cord; PBR: Polybutadiene rubber; SBR: Styrene butadiene rubber 1 Average Delhi Market Wholesale prices of leading players in terms of Rs/tyre. Notes 1) For natural rubber, there is a cess of Rs 1.50 per kg in lieu of excise duty. 2) For NTC fabric, an additional excise duty of Rs.10 per Kg is chargeable. 3) C hina and South Korea enjoy preferential rate of customs duty of 15.3 per cent on tyres in 2004-05. Source: CRIS INFAC
93,366 95,760 218,211 n.a.
92
Tyres
Customs duty cut on raw materials may boost operating margins
Company Apollo Tyres Ltd. C eat Ltd. Goodyear India Ltd. JK Industries Ltd. MRF Ltd. Note Factors A and C have a neutral impact on the companies. Source: CRIS INFAC Impact Impact factors B B B B B
Impact factors A. The reduction of the customs duty on tyres, from 20 per cent to 15 per cent, is not expected to intensify the import threat significantly. This is because China and South Korea already enjoy a preferential rate of 15 per cent under the Bangkok Agreement. B. The customs duty cut on raw materials like natural rubber, PBR, SBR and carbon black, from 20 per cent to 15 per cent, will cut down raw material costs, as the domestic prices of these raw materials are aligned with landed costs. Accordingly, operating margins may improve from 7.5 per cent to 10 per cent. C. The impact of the abolition of the SED on tyres will be neutral, as the benefit of the same is expected to be passed on, owing to the stiff competition posed by cheaper imports.
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B U D G E T
93
Diversified companies
Diversifled companies: Budget impact
Company name Reliance Industries Ltd. Indian Rayon & Industries Ltd. Grasim Industries Ltd. Bombay Dyeing Ltd. C entury Textiles Ltd. Kesoram Industries Ltd. Raymond Ltd. Tata C hemicals Source: CRIS INFAC Impact
Reliance Industries Limited Duty cuts to have a negative impact on RIL Overall: Negative: Net profit estimate for 2005-06 to decrease by Rs 3.5 billion. Refining: Positive: Net profit estimate for 2005-06 to increase by Rs 3 billion. Petrochemical: Negative: Net profit estimate for 2005-06 to decline by Rs 3.5 billion. Polyesters and fibre intermediates: Negative: Net profit estimate for 2005-06 to decline by Rs 2.8 billion.
U N I O N
Others (LAB): Negative: By Rs 185 million Overall, CRIS INFAC expects a negative impact on RIL. Benefits in refining segment will be overshadowed by the petrochemical and polyester segment. Refining: The company will benefit from the crude oil and petroleum product duty cuts. The import duty cut on crude oil from 10 per cent to 5 per cent and the drop in peak import duty on petroleum products to 10 per cent will have a positive impact on RIL. The duty cut on crude will benefit RIL as it imports 100 per cent of its requirement. On the product side, Reliance does not suffer a major hit, as it already exports about 40 per cent of its production, on which amount it does not enjoy any duty benefit. About 75 per cent of the total exports is accounted by MS and HSD, which are high-value products. As a result, the negative impact of petroleum product duty cuts has been restricted. The refining segment constitutes around 56 per cent of total turnover. Petrochemicals: The customs duty on polymers has been reduced from 15 per cent to 10 per cent. The duty differential between naphtha and polymers will come down to 5 per cent, thus negatively affecting the margins and bottomline. Higher exports of petrochemical products (mainly polypropylene) will lower the negative impact of the polymer duty cut. However, any variation in discounts to landed costs (which range from Rs 500-2,500 per tonne), owing to future domestic demand and supply situation, will change the impact of the polymer duty cut on the bottomline. The petrochemical segment constitutes around 18 per cent of total turnover. Polyesters and fibre intermediates: The customs duty cut on polyesters and fibre intermediates, from 20 per cent to 15 per cent, will have a negative impact on RIL. The duty differential between paraxylene and fibre intermediates has come down from 15 per cent to 10 per cent. The customs duty on paraxylene
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has been maintained at 5 per cent. Following this, margins from the fibre intermediates will be lower. Though the 0 per cent duty differential between fibre intermediates and polyesters has been maintained, the reduction in duties (on both polyesters and fibre intermediates by 5 per cent) will have a marginally negative impact, as the reduction will be on high-priced polyesters. Polyesters and fibre intermediates constitute around 21 per cent of total turnover. Indian Rayon Marginally negative impact due to customs duty cut on VFY and carbon black Indian Rayon derives 25 per cent of its sales from garments, 21 per cent from VFY, 21 per cent from fabrics and flax yarn, and 23 per cent from carbon black. There will be no impact on the company's garments, fabrics and flax yarn segments. The customs duty cut on VFY from 20 per cent to 15 per cent will exert downward pressure on prices and lower the profitability of the division. The customs duty on carbon black will bring down landed costs and force the company to lower prices. The negative impact on margins will, however, be partially offset by the duty reduction on carbon black feedstock (CBFS) from 20 to 15 per cent. Grasim Industries Overall positive impact due to improved prospects for the cement division Grasim derives 48 per cent of its revenues from the cement sector, 32 per cent from VSF and the rest from sponge iron. The company will benefit from the positive outlook for the cement sector, on account of the following: The customs duty on pet coke has been slashed to 10 per cent from 20 per cent. This will encourage the use of alternative fuels. The excise duty on clinker has been increased to Rs 350 per tonne from Rs 250 per tonne. As mini-cement plants pay an excise duty of Rs 250 per tonne of cement, they will not be able to avail of cenvat credit for the rise in the excise duty. Larger cement players, on the other hand, pay an excise duty of Rs 400 per tonne of cement. Therefore, they will be able to avail of cenvat credit for the rise in the excise duty on clinker and hence, will not be affected. The budget has provided a significant fillip to the infrastructure sector. While the allocation for irrigation has been stepped up, the outlay for national highway development has been raised from Rs 65 billion in 2004-05 to Rs 93 billion in 2005-06. This apart, an outlay of Rs 55 billion has been provided under the National Urban Renewal Mission, which includes projects such as the Mumbai Western Expressway sea-link, among others. The above initiatives will provide a fillip to cement consumption. The customs duty on cement has been cut from 20 per cent to 15 per cent, in line with the cut in the peak customs duty. However, despite the reduction, the landed cost of cement will be much higher than the domestic price. Thus, imports will pose a minimal threat and domestic players will not be affected by the cut in the customs duty.
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The proposal to allow deduction of up to Rs 1 lakh on repayment of principal amount of housing loan (u/s 80 C of the Income Tax Act) will boost housing demand and thereby cement consumption. The customs duty on VSF has been reduced from 20 per cent to 15 per cent. However, imports are not a threat, as Grasim is one of the least-cost producers of VSF and is also the only producer of VSF in India. Bombay Dyeing DMT customs duty cut to negatively affect the company DMT sales contributed to around 60 per cent of Bombay Dyeing's revenues in 2003-04. The reduction in the customs duty on DMT from 20 per cent to 15 per cent will lower the landed costs of DMT, forcing the company to reduce DMT prices. This will exert severe pressure on the company's margins. Century Textiles Marginal pressure on margins due to customs duty cuts on VFY and paper Cement contributes to 44 per cent of CTIL's revenues, VFY 15 per cent, textiles 17 per cent and paper to 17 per cent of CTIL's revenues. While the company benefits from the positive outlook for the
U N I O N
cement sector, and paper.
it is likely to face an overall pressure on profitability, due to duty cuts on VFY
The positive outlook for the cement sector is on account of the following factors: The excise duty on clinker has been increased to Rs 350 per tonne from Rs 250 per tonne. As mini cement
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plants pay an excise duty of Rs 250 per tonne of cement, they will not be able to avail of cenvat credit for the rise in the excise duty. Larger cement players, on the other hand, pay an excise duty of Rs 400 per tonne of cement. Therefore, they will be able to avail of cenvat credit for the rise in the excise duty on clinker and hence, will not be affected. The budget has provided a significant fillip to the infrastructure sector. While the allocation for irrigation has been stepped up, the outlay for national highway development has been increased from Rs 65 billion in 200405 to Rs 93 billion in 2005-06. Also, an outlay of Rs 55 billion has been provided under the National Urban Renewal Mission, which includes projects such as the Mumbai Western Expressway sea-link, among others. The above initiatives will provide a fillip to cement consumption. The customs duty on cement has been reduced from 20 per cent to 15 per cent, in line with the cut in the peak customs duty. However, despite the reduction, the landed cost of cement will be much higher than the domestic price. Thus, imports will pose a minimal threat and domestic players will not be affected by the cut in the customs duty. The proposal to allow deduction of up to Rs 1 lakh on repayment of principal amount of housing loan (u/s 80 C of the Income Tax Act) will boost housing demand and thereby, cement consumption.
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The customs duty cut on VFY from 20 per cent to 15 per cent will exert downward pressure on prices and lower the profitability of the division. The customs duty cut on paper will also force Century to lower prices to meet landed costs, which will exert pressure on margins Kesoram Industries Improved profitability of the tyres division Kesoram Industries derives 46 per cent of its turnover from tyres and 35 per cent from cement. The overall outlook for the company is positive, due to improved profitability of the tyres sector and improved prospects for the cement sector. The reduction of the customs duty on tyres, from 20 per cent to 15 per cent, is not expected to intensify the import threat significantly. This is because China and South Korea (the main sources for imports) already enjoy a preferential rate of 15 per cent under the Bangkok Agreement. The customs duty cut on raw materials like natural rubber, PBR, SBR and carbon black, from 20 per cent to 15 per cent, will cut down raw material costs, as the domestic prices of these raw materials are aligned with landed costs. Accordingly, operating margins may improve from 7.5 per cent to 10 per cent. The impact of the abolition of the SED on tyres will be neutral, as the benefit of the same is expected to be passed on, owing to the stiff competition posed by cheaper imports. The positive outlook for the cement sector is on account of the following factors: The excise duty on clinker has been increased to Rs 350 per tonne from Rs 250 per tonne. As mini cement plants pay an excise duty of Rs 250 per tonne of cement, they will not be able to avail of cenvat credit for the rise in the excise duty. Larger cement players, on the other hand, pay an excise duty of Rs 400 per tonne of cement. Therefore, they will be able to avail of cenvat credit for the rise in the excise duty on clinker and hence, will not be affected. The budget has provided a significant fillip to the infrastructure sector. While the allocation for irrigation has been stepped up, the outlay for national highway development has been increased from Rs 65 billion in 200405 to Rs 93 billion in 2005-06. This apart, an outlay of Rs 55 billion has been provided under the National Urban Renewal Mission, which includes projects such as the Mumbai Western Expressway sea-link, among others. The above initiatives will boost cement consumption. The customs duty on cement has been reduced from 20 per cent to 15 per cent, in line with the cut in the peak customs duty. However, despite the reduction, the landed cost of cement will be much higher than the domestic price. Thus, imports will pose a minimal threat and domestic players will not be affected by the cut in the customs duty. 97
U N I O N
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The proposal to allow deduction of up to Rs 1 lakh on repayment of principal amount of housing loan (u/s 80 C of the Income Tax Act) will boost housing demand and thereby, cement consumption. Raymond Neutral impact; continuity of the 100 per cent excise exemption on woollen and cotton textiles is a positive The company derives more than 60 per cent of its total revenues from worsted fabrics and around 17 per cent from denim business. There is no direct impact of any measures announced in the Union Budget 2005-06. The 100 per cent excise exemption provided to natural fibres, including woollen and cotton textiles (including denim fabrics), has been maintained; this is a key positive for the company. Tata Chemicals In FY 2003-04, Tata Chemicals derived 57 per cent of its revenues from the fertiliser businesses (comprising of urea, DAP, NPK and SSP), 22 per cent from the soda ash business, 4 per cent from the cement business and 9 per cent from the salt business. The focus on agriculture and housing is positive for the fertiliser and cement businesses; the reduction in customs duty will affect the soda ash segment.
U N I O N
A. The budget contained no announcements that specifically concern the fertiliser industry. However, a greater thrust on agricultural credit, an increase in the area under irrigation, agricultural diversification, continuation of farm insurance scheme, national horticulture mission and the scheme for strengthening agricultural infrastructure are likely to boost farm incomes and thereby support fertiliser consumption in the long run. The imposition of a 10 per cent service tax on gas transporting agencies is not expected to affect the company, given that the supply of gas is undertaken under the administered price scheme and increases in input costs are recovered as subsidies. B. The cut in peak customs duty rates from 20 per cent to 15 per cent will marginally affect the caustic soda and soda ash industry. Although, at present, the domestic prices of both the products are at a discount to the landed cost, prices will remain under pressure and are expected to fall marginally.
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Infrastructure
Power
Reform measures to transform the sector over the long term The Electricity Act, 2003, acts as an enabler for the increased pace of reforms in the power sector by introducing competition across the generation, transmission and distribution (T&D) segments and encouraging greater private participation and captive power generation. CRIS INFAC believes that open access (in generation and distribution), power trading, retail competition and captive generation are the critical catalysts in introducing competition and attracting investments, to make the sector more viable and self-sustaining. Given the critical issues concerning the restructuring and unbundling of SEBs, tariff rationalisation and decreasing the gap between average cost of supply and revenue realised, we believe that initiatives to reform the sector will only bear fruits over the long term. The National Electricity Policy, announced in February 2005, aims to meet peak and energy shortages completely by 2012, besides improving the quality and reliability of power. It also emphasises rationalising of tariffs, rural electrification and encouraging higher private sector participation. The National Electricity Policy also seeks to speed up the reform process by laying down deadlines for various critical processes such as enabling open access in each state, completing metering requirements, initiating mandatory energy audits, establishing intra-state transmission tariffs by electricity regulatory commissions, and upgrading technology at regional load despatch centres. However, actual adherence to these deadlines remains a concern.
U N I O N
The National Tariff Policy, expected to be announced in March 2005, will provide clarity on a number of issues related to tariff and surcharge calculations. It will provide a basic framework to state regulators for fixing generation and distribution tariffs. We believe that the current financial health and poor creditworthiness of SEBs is a major obstacle in the transformation of the sector. Unremunerative tariffs and irregular payment of subsidies by state governments have prevented SEBs from investing in capacity additions and system upgradation, which is responsible for the poor state of the T&D infrastructure. By the end of December 2004, the country's installed power generation capacity was around 115 GW; the average plant load factor (PLF) in the April-December 2004 period was 73.4 per cent. During the same period, the average energy shortage was 6.8 per cent, while the peak shortage stood at 12.1 per cent. The demand for electricity is expected to grow by 6-7 per cent over the medium term. To meet the demand growth, a capacity augmentation to the tune of 100 GW is required by 2012. This amounts to an investment of Rs 9 trillion over the next 8 years. According to CRIS INFAC estimates, the total capacity additions during the Tenth Plan are expected to be around 32,282 MW, as against a target of 41,000 MW. Further, the total target for the Tenth and the Eleventh Plan is also expected to fall short by 20-25 per cent.
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Power
Lower project costs for small plants; central sector units to benefit from equity support
Company National Hydro Electric Power C orp. Ltd. National Thermal Power C orp. Ltd. Power Grid C orporation of India Ltd. Reliance Energy Ltd. Tata Power C ompany Ltd. Source: CRIS INFAC Impact Impact factors A, B A, B A, B A A
Impact factors A. The reduction of peak customs duties on capital goods will primarily benefit medium and small-scale power projects through lower project costs. B. The government has indicated that in 2005-06 it will provide equity support to the tune of Rs 140.40 billion and loans amounting to Rs 35.54 billion to central public sector undertakings in select sectors, including power. This will help companies such as NTPC, NHPC and PGCIL in their capacity augmentation plans. C. The service tax imposed on product transportation through pipelines will increase the fuel prices for gasbased plants. However, there will be no impact on gas-based players, as the incremental cost would be completely pass-through.
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Ports
Moderate growth in cargo handled by Indian ports In 2003-04, the Indian ports handled 446.2 million tonnes of cargo, representing an 8.3 per cent growth over the traffic handled in 2002-03. Of this, the major ports handled 77 per cent of the traffic, while the minor ports handled the remaining. In the first half of 2004-05, ports in India handled about 209 million tonnes, a 10 per cent increase from the 189 million tonnes in the first half of 2003-04. Of this traffic, major ports handled 175 million tonnes, while minor ports handled the remaining. We expect port traffic to continue to witness a moderate growth of 8-10 per cent over the medium-term. Over 80 per cent of the total volume of traffic handled by Indian ports is in the form of dry and liquid bulk, while the remaining traffic consists of general cargo. The major commodities contributing to traffic are petroleum products, iron ore and coal. The poor state of infrastructure, like road and rail links, has hindered the development of the ports sector over the years, especially minor ports. Given that the quantum of trade between India and its trading partners is expected to increase in the coming years, there is an urgent need for better port connectivity infrastructure. This will also serve to reduce the congestion levels at many ports. If the Sagar Mala project (announced in 2003), which envisages capacity expansion and modernisation of all maritime transport, including ports, shipping and waterways, is successfully implemented, it will provide a fillip to the development of the ports sector in India. Under the project, all major ports will be connected to the Golden Quadrilateral through high-speed expressways and rail connectivity to ports will also be strengthened.
U N I O N
The programme is expected to require investments to the tune of Rs 1,000 billion over a period of 8-10 years.
Impact factors Neutral impact on the ports sector The establishment of a special purpose vehicle (SPV) to finance infrastructure projects (such as ports) will boost investments in the sector. On the other hand, the imposition of a service tax on dredging services will lead to a marginal increase in the capital and operating costs of ports.
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Roads
After a lull in 2004, pace of implementation to pick up in second half of 2005 The National Highways Authority of India (NHAI) aims to complete Phase I (Golden Quadrilateral) of the National Highways Development Programme (NHDP) by December 2005 and Phase II (NorthSouth-East-West) by December 2007. However, we expect the NHDP Phase II may be delayed by 36 months, and will be completed only by December 2010. As of January 2005, the work on the NHDP Phase I (Golden Quadrilateral) was nearly 75 per cent complete, with the expenditure on the project touching Rs 231.86 billion by November 2004. Some of the key reasons for the delay are problems related to land acquisition, law and order, the lack of cooperation by certain states, and the non-performance of some contractors. The project was originally scheduled for completion in December 2003. After a 9-month lull, in December 2004, NHAI awarded six projects worth Rs 18 billion for the NHDP Phase II project (NSEW project). In the next 3-4 months, nearly 70-80 bids worth Rs 200 billion are expected to be open for the same project, for the East West corridor, coupled with a few projects in some of the southern states. Hence, we believe that the pace of construction will pick up only from the second half of 2005-06, resulting in further delay in project implementation. There is also some funding action taking place, by means of funds through the Asian Development Bank (ADB), which, in December 2004, approved a $400 million loan for upgrading key sections in the NHDP Phase II. The work on the NHDP Phase III (formerly called Pradhan Mantri Bharat Jodo Pariyojana) is progressing at a snail's pace. In the second quarter of 2004-05, NHAI invited bids for the second lot of 10 projects. However, the award of contracts was held up due to delays in Cabinet clearance. On the Rs 600 billion Pradhan Mantri Grameen Sadak Yojana (PMGSY) project, we expect a substantial delay in implementation, given the difficulty in raising funds faced by the Ministry of Rural Development (MoRD). Of the total funds required, about Rs 200 billion is expected to be available from the cess on diesel. The resource gap of Rs 400 billion is expected to be bridged by access to multilateral funds and funds raised from the domestic market. No visible progress has been made on this front till date. Further, the new government has drawn up more roads and highway projects such as NHDP Phase IV and the Accelerated North-East Road Development (ANERD). These projects, along with NHDP Phase I, II and III and PMGSY, entail a total cost of Rs 2,385 billion, of which NHDP Phase I, Phase II and Phase III account for nearly 50 per cent (Rs 1,196 billion). Till November 2004, only Rs 267.17 billion has been spent on the latter three projects.
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Roads
Although we feel that NHAI is better equipped to implement and manage these projects, we are cautious, owing to the concerns arising from various issues such as Availability of funds: To achieve scheduled completion targets, a majority of the contracts for the NHDP Phase II and Phase III projects will have to be awarded during the current year and resources for funding the NSEW project will need to be tied up. We expect some delays on both these fronts. However, with the expected increase in the cess on diesel, availability of funds through this could increase. Past experience: With respect to the delay in implementing and awarding NHDP Phase I and Phase II, respectively, further delay is anticipated, Impact factors Increased availability of funds and greater focus on roads to speed up implementation of projects The increase in allocations for NHDP from Rs 65.14 billion in 2004-05 to Rs 93.20 billion in 2005-06 will result in greater availability of funds. To take care of this additional allocation, the cess on both petrol and diesel has been increased by 50 paise per litre and the resources raised will be earmarked exclusively for national highways. CRIS INFAC anticipates that additional resources amounting to Rs 28 billion will be raised through the increase in fuel cess. The government's focus on NHDP Phase III will result in speedy implementation of the project. The Centre
U N I O N
has allocated Rs 14 billion in 2005-06 to four-lane 4,000 km of roads. A special purpose vehicle (SPV) to finance infrastructure projects (including roads, ports, airports and tourism), for which the borrowing limit has been fixed at Rs 100 billion, and a provision of Rs 15 billion for viability gap funding for infrastructure projects will provide a further boost to the roads sector. The National Urban Renewal Mission has been established, which covers 7 mega cities and all cities with a population of over a million. An outlay of Rs 55 billion has been allocated under this mission, which includes project such as the Mumbai Western expressway sealink.
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Other infrastructure
The Union Budget 2005-06 lays significant thrust on the overall development of infrastructure. The Budget proposes the creation of a special purpose vehicle (SPV), wherein Rs 100 billion will be set aside to fund roads, ports, airports and tourism projects. This will be governed by the interinstitutional group. In addition to this, foreign exchange reserves will be used to fund infrastructure projects. The government's continued commitment to provide equity (Rs 140.4 billion) and debt support (Rs 35.54 billion) to public sector enterprises in six infrastructure sectors, including railways and aviation, will benefit these sectors. The passage of the proposed bill for regulating special economic zones (SEZs) could boost private investment and help in the speedy implementation of SEZ projects. Railways The performance of the Railways with respect to addition of broad gauge (BG) lines has been good, with 1,400 km of BG lines added to the system in 2004-05. The target for 2005-06 is 1,692 km. The Railways is targeting 935 km of gauge conversion in 2005-06. This would improve rail connectivity. The Railways has been able to complete 307 km of line doubling in 2004-05, and is targeting 538 km for 2005-06. The electrification of 375 route km has been completed in 2004-05, with the target for 2005-06 being 350 route km. This would help improve traffic flows. The thrust of the Annual Plan 2005-06 for the Railways is towards enhancement of throughput, safety and development. The total Plan outlay for the year has been budgeted at Rs 153.49 billion, including Rs 35.22 billion for the Railway Safety Fund. In addition to this, in order to improve the productivity and efficiency of the Railways, the Planning Commission has been asked to allow the Ministry of Railways to access extra budgetary resources to the extent of Rs 30 billion for identifying and executing financially viable schemes. Market borrowings through the Indian Railways Finance Corporation (IRFC) are budgeted to be Rs 34 billion, and the balance is planned through internal accruals and budgetary allocation. Several public-private partnership initiatives are being taken to garner resources through non-traditional methods for the modernisation and development of the railways and to provide enhanced facilities for users. Prominent among these are private sidings, wagon investment scheme, container traffic, commercial utilisation of surplus railway land through construction of modern railway stations and logistics parks under the aegis of Rail Land Development Authority etc. The reduction in customs duty from 20 per cent to 10 per cent on railway locomotives, railway rolling stock and railway equipment and their parts will help the Railways in lowering costs. With a view to develop Indian Railways as a world class railway, an Integrated Railways Modernisation Plan spanning 5 years up to 2010, with a budgeted expenditure of Rs 240 billion, has been formulated. Its implementation would ensure better performance of the Railways.
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Other infrastructure
Aviation A comprehensive aviation policy is likely to be announced in March 2005. In December 2004, the government gave its consent to domestic private airlines (Jet Airways and Air Sahara) with a minimum of 20 aircraft in their fleet to operate scheduled services to other international destinations (includes Singapore, Malaysia, Thailand, Hong Kong, the UK and the USA). This has increased the competition between the existing public and private players. The two new international airports to be developed in Bangalore and Hyderabad via the private participation route have obtained the necessary clearance. The construction work on the Bangalore project is likely to begin from March 2005 and is expected to start its operations by the end of 2007. A concession agreement has recently been signed for Hyderabad airport, which will be completed by end-2008. The government plans to privatise Chennai and Kolkata airports once it has successfully privatised Mumbai and Delhi airports. In addition to this, the development of 80 airports has been planned over the next 5 years. Domestic air traffic has been increasing by around 20 per cent per annum and international traffic has risen by 17 per cent, on account of the fast growing economy, lower airfare and higher connectivity.
U N I O N
In the first 6 months of 2004-05, passenger traffic grew by 24 per cent. Cargo handled grew by 20.5 per cent during April-September 2004-05. All this puts pressure on the existing infrastructure. The exemption from tax on agreements to acquire aircraft or aircraft engines on lease for Air India and Indian Airlines has been extended up to September 30, 2005. This would give the public sector airlines some more time to upgrade their fleet. The reduction in customs duty on aviation turbine fuel from 20 per cent to 15 per cent will help lower costs and, if passed on, will aid the growth in passenger traffic. SEZs Total exports from operational SEZs increased to Rs 140 billion in 2003-04 as compared to Rs 100.5 billion in 2002-03. Out of a total of 27 SEZs approved, 8 are operational in the country. Of these 8, the Surat SEZ is in the private sector, while the other 7 have been converted from EPZs to SEZs. To improve investments in SEZs, the government has decided to include SEZs in the list of specified ports for imports and exports and treat supplies to SEZs as physical exports instead of deemed exports. However, the progress on other SEZs has been slow due to various regulatory issues. The passage of the proposed Bill for regulating SEZs could boost private investment and the speedy implementation of SEZ projects. Clarity on the regulatory authority and various exemptions would increase exports
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from various SEZs.

Banking
sector
U N I O N
& financial
B U D G E T
Banking and finance sector

Proposed amendments to regulation Act, increased deduction for housing loans positive for banks and HFCs Overall, we feel that the Union Budget is positive for the banking sector. The major announcements in the Budget include the increase in deductions for principal repayment of housing loans and the proposed amendment to the Banking Regulation Act, 1949. CRIS INFAC believes the Budget is a huge positive for housing finance. The increase in the deduction for repayment of principal amount of housing loans up to Rs 100,000 u/s 80C will give a strong boost to housing finance. The proposed amendment to the definition of securities under the Securities Contracts (Regulation) Act, 1956, to include securitised debt will help to deepen the securitisation market in the country. This amendment will enable pass-through certificates to be listed on any recognised stock exchange. The proposal to amend the Banking Regulation Act includes permission for banks to issue preference shares. This will give banks an additional source to raise their Tier-II capital and thus help them meet their Basel-II obligations. A second amendment proposed to the Act includes the removal of the floor and the cap on the statutory liquidity ratio (SLR) requirement for banks. In conjunction with this, it has also been proposed to introduce amendments to the Reserve Bank of India Act, 1934, to remove the upper and lower limits on cash reserve
U N I O N
ratio (CRR). We believe these measures will give greater autonomy to the RBI in effective management of banks Further, it has also been proposed to introduce specific provisions to enable RBI to also supervise the subsidiaries of banks. This measure will improve corporate governance in banks. The government has taken steps to promote micro-finance institutions (MFIs) in a big way by increasing the corpus under the Micro Finance Development and Equity Fund to Rs 2 billion from the present Rs 1 billion. The government has also proposed to allow banks to appoint MFIs as banking correspondents to provide transaction services to banks. We feel the measure is a win-win for both banks and NBFCs (MFIs). While the measure will strengthen MFIs and help them in terms of increased fee income, banks will be able to meet their priority sector lending targets and can widen their reach in rural areas. The Budget has proposed to impose a 0.1 per cent tax on cash withdrawals of Rs 10,000 or more per day per account from banks. We feel this measure is unlikely to have a significant impact on the sector. Guidelines on ownership and governance in private banks Banks are important financial intermediaries in the economic system with the dual responsibility of channelising the savings of the economy and deploying them for industrial development. The RBIs view of well-diversified ownership and control of private banks is reflected in the guidelines on ownership of private banks. With respect to the shareholding pattern of private banks, it has capped the stake holding of any
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single entity or group of related entities in a private bank at 10 per cent. Any further acquisition

over and above this would require prior approval from RBI. Banks and financial institutions are allowed to increase their ownership by up to an additional 5 per cent in a private bank and will have to take prior approval of RBI if they want to increase their ownership above this additional stake. The guidelines have maintained status quo on foreign (FDI, FII, NRI) investment in private banks. The overall cap on foreign investments has been maintained at 74 per cent. Individual FIIs can hold up to 10 per cent stake while total FII ownership can be increased to up to 49 per cent subject to corporate board approval. In cases where current shareholding patterns are not in compliance with the above-stated norms, banks will have to indicate a timetable to meet the RBI guidelines. CRIS INFAC believes that the RBI guidelines of not allowing any bank to own more than 5 per cent stake in any other bank in India will discourage flow of non-strategic investments. On the other hand, RBIs policy of allowing higher ownership, on a case-by-case basis, would allow serious players to increase ownership in private banks. There are several positive measures regarding the composition of bank boards, aimed at enhancing corporate governance. RBI has mandated that the members of the board should be true representatives of various sectors and that not more than one member of a family or a close relative should be on the board. RBI has also detailed a roadmap for the presence of foreign banks in India. Foreign banks have been allowed to operate in India through one of these three channels: branch, wholly owned subsidiary or subsidiary with aggregate foreign investment up to a maximum of 74 per cent in a private bank. In the first phase, i.e., up to March 2009, foreign banks have been permitted to establish a presence by setting up wholly owned subsidiaries or by conversion of branches into wholly owned subsidiaries. They will also be allowed to take over stressed private sector banks identified by RBI during this phase. In such cases, the voting rights of the foreign bank will be linked to its shareholding and the necessary amendments to the Banking Regulation Act are proposed to effect the same. Foreign banks can increase their branch networks by more than 12 per year with a greater focus towards under-banked areas. In the second phase, i.e., beyond April 2009, foreign banks are allowed to acquire up to 74 per cent in a private sector bank in India. The detailed policies for this phase would be designed and implemented by RBI after reviewing the experience of Phase I and after due consultation with all stakeholders in the banking sector.
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The current guidelines are positive for large private and public sector banks and also for weak/stressed private sector banks. The guidelines allow the entry of foreign banks in a very phased and controlled manner while giving enough time for domestic public and private sector banks to strengthen their systems and processes to face eventual competition.
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Capital
markets
Debt market
The Indian debt market was dominated by the themes of inflation, crude oil prices and global interest rate hardening during the fiscal year 2004-05. First, on the inflation front, higher commodity prices on the back of rise in Chinese demand, rise in crude oil prices and lower base resulted in a steady rise in the inflation rate to over 7 per cent during the second half of 2004. These developments resulted in mounting inflationary expectations as higher fuel and commodity prices were passed on to the domestic consumers. Domestic interest rates also moved in tandem with the global interest rates, particularly the hike in the Fed funds rate in the US markets. Since December 2004, however, plummeting inflation rates and easing global crude oil prices, in addition to ample liquidity, have together imparted much more stability to interest rates with movement within the range of 6.5-6.8 per cent (ten-year G-Sec yield). A positive factor during this period of hardening interest rates has been the amount of government borrowings from the market. The government not only borrowed (net) only 61.5 per cent of its 200405 budget target, it also cancelled four of its auctions during the course of the fiscal year. Box 1 analyses the reasons for lower borrowings and its implications.
Box 1: Lower market borrowings by the Centre - Permanent or transitory

U N I O N
Government market borrowings are an important determinant of interest rates as higher supply of government paper restrains liquidity and, hence, results in an increase in yields. Against a target gross market borrowing of Rs 149,817 crore set in the Union Budget of 2004-05, the government has completed borrowing of Rs 105,350 crore, i.e., about 70.3 per cent of the target. Further reflecting surplus cash availability, the government cancelled four borrowing programmes totalling Rs 21,000 crore during the course of the year, triggering a rally in the debt market after the announcements.
B U D G E T
A closer look at the government budget in 2004-05 illustrates that lower government market borrowings have been substituted by higher securities against small savings. Securities against small savings were Rs 34,015 crore, far greater than the budget target of Rs 1,350 crore. Since states repay high-cost debt with fresh market borrowings and special securities issued to the National Small Savings Fund (NSSF), this is the amount received by the Central government under the states' debt swap scheme.
Gross borrowing by centre and states Actual (2004-05) C entre** States'* Total ** Revised estimates. Source: Budget Documents, RBI. 105350 38668 144018 Budget Estimate (2004-05) % of target 149817 40371 190188 70.3 95.8 75.7
* Borrowings till February 28, 2005.
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Continued...
Debt market
...continued
Does this imply that lower borrowing by the Centre has been substituted with higher borrowing by the states? States borrowed Rs 38,668 crore from the market (Rs 22,665 crore towards repayment to the Centre and Rs 16,002 crore as state loans) as against a target of Rs 40,371 crore. Hence, on aggregate, the borrowings of the Centre and the states together were lower, at 75.7 per cent of their combined targets. A similar result emerges if one analyses the pattern in the Centre's fiscal deficit - it has been consistently below the budgeted amount between 2002-03 and 2003-04 with 1 per cent more than budgeted amount in 2004-05. The level of fiscal deficit is, however, not affected by the states debt-swap scheme as the amount received by the Centre through states' debt swap (recoveries of loans under capital receipts), is used by the former to swap its coupon special securities issued to the NSSF (on capital account under non-Plan expenditure). So, a reduction in fiscal deficit and market borrowings is an outcome of factors other than the debt swap. Central Government Net Market Borrowings
(Rs crore) 140,000 120,000 100,000 80,000 60,000 40,000 20,000 0 FY98 FY99 FY00 Actuals FY01 BE FY02 FY03 FY04 FY05 (per cent) 140 120 100 80 60 40 20 0
U N I O N
B U D G E T
Actual (as % of BE)
Source: Various Budget Documents. Historically, net market borrowings have displayed some volatility with both excess and lower market borrowings as compared to the budgeted amount. The period since 2002-03 has, however, witnessed a definitive decline in the amount of government borrowings from the market, with the steepest decline from 2003-04. Is this decline transitory or does this reflect a permanent fall in the borrowing requirements of the government? This differentiation is important because a permanent decline would result in a long-term reduction in pressure on interest rates and a transitory decline will lead to only short-term relief. Of course, the decline could be on account of lower expenditure or higher revenue stream.
continued...
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Debt market
...continued
Structural/Permanent Revenue Tax revenue - Swings in government borrowings coincide with the industrial growth momentum in each year. Periods of lower industrial growth (1998-99 and 200102) witnessed higher government borrowings from the market, while periods of high industrial growth (2002-03 onwards) coincided with lower market borrowings. This is due to the tax buoyancy of industrial growth. Further, there has been a wider coverage of service tax in recent years, a pattern that is expected to continue. Dividends & profits - Actual revenue from dividends and profits has overshot the budget target set by the government since 1998-99. In 2004-05, revenue from dividend and profit was Rs 20,779 crore against the budgeted Rs 18,875 crore.
Transitory Disinvestment proceeds Transitory revenue from disinvestment has exhibited volatility over the last 8 years. Surcharges Revenue from surcharge has been volatile as well, but with surcharge expected to continue in the future, this source could lead to additional revenue.
Cash drawdown - Positive drawdown for Rs 6,669 crore during April-December 2004 as compared to negative value of Rs 10,721 crore last year.
Draft on foreign savings of Rs 9,034 crore also helped in financing the fiscal deficit during 2004-05.
U N I O N
Structural/Permanent Expenditure Interest payments and debt servicingThere has been a noticeable decline in permanent expenditure on interest payments and debt servicing. Expenditure on interest payments and debt servicing increased at a C AGR of 5.4 per cent between 2001-02 and 2004-05, as compared to 14.8 per cent between 199798 and 2000-01. Hence, there has been an interest cost saving accruing to the government on account of lower interest rates. Looking ahead, even if the marginal interest rate stays constant, the average cost of borrowing for the government is likely to fall.
Positive cash drawdown and draft on foreign savings are transitory and related to the first nine months of 2004-05. Transitory Subsidies linked to supply shocks Subsidies have been higher than the budgeted amount from 1997-98 to 2002-03. A decline in fertiliser subsidy in 2003-04 had resulted in lower subsidies expenditure in this period. Higher naphtha prices in 2004-05 have, however, resulted in higher fertiliser subsidy in 2004-05. Similarly with higher oil prices, the subsidy is likely to be higher/lower this year.
B U D G E T
continued...
114
Debt market
...continued
To sum up, the higher level of government borrowing till 2001-02 resulted despite higher dividends and profits due to lower industrial growth (and, hence, lower tax revenues), lower coverage of service tax and non-existence of sources like disinvestment and surcharges. The period from 200203 onwards has, on the other hand, seen lower borrowings due to higher tax revenues from industry and services, dividends and profits and interest cost savings and the debt swap scheme. Transitory factors such as higher disinvestment receipts and surcharges also further boosted revenues. The year 2004-05 benefited from additional revenues from positive cash drawdown and a draft on foreign savings, which reduced the reliance on market borrowings. With the government expected to conform to the targets set in the FRBM Act, government borrowings are likely to be under control. However, with the recommendations of the Twelfth Finance Commission on increasing expenditure on health and education, the final impact on interest rates will depend on how the government strikes a balance in its revenue and expenditure mismatches.
The key numbers that the debt market was awaiting from the Budget were the market borrowings of the Centre in 2005-06, the level of fiscal deficit and the change in small saving interest rates. On interest rates on small saving scheme, the Budget has taken a neutral stance by leaving the rates unchanged. The level of net market borrowings at Rs 100,836 crore for 2005-06 is slightly above the market expectations of Rs 95,500 crore. With Rs 15,019 crore to be absorbed under the market stabilisation scheme, total liquidity absorption in 2005-06 as per the Budget is estimated at Rs 115,855 crore. This is likely to act as a dampener to market sentiments as the recent rally in the debt market was driven on lower government borrowing expectations - the ten-year yield had fallen to 6.47 per cent. The immediate impact of the Budget on the debt market has been a rise in yields across tenors with the ten-year G-Sec yield rising by 8 bps to 6.55 per cent. More importantly, the Budget has assumed a fiscal deficit target of 4.3 per cent in 2005-06. Taking into account the social spending focus of this government, our calculations indicate that the government has assumed very aggressive tax collection projections. Even after incorporating the additional tax collected through surcharges, we expect a shortfall of Rs 8,600-12,400 crore or a fiscal deficit at 4.5-4.7 per cent of GDP in 2005-06.
U N I O N
B U D G E T
115
Debt market
The key positive for the debt market over the long term comes from the fact that the buoyancy in structural sources continues in 2005-06. Even though the Budget does not expect any revenue from disinvestment this year, the wider coverage of the service tax net, revenue from dividends and profits and interest cost savings are expected to continue. In conjunction with the global rise in interest rates, the shortfall in revenue, if met through additional market borrowings, could pressurise domestic liquidity. Hence, we expect the benchmark ten-year yield at 7.25 per cent by the end of March 2006.
U N I O N
B U D G E T
116
Equity market
After a historic single-day crash on the Nifty by 194 points on May 17 due to fears of an anti-reform agenda of the new government, the Indian equity markets bounced back in July as the formation of a new government and announcement of the Union Budget assuaged fears and re-built investor confidence. The upsurge in the equity markets sustained till early January solely on the back of robust foreign inflows. Negative factors such as higher crude oil prices and high domestic inflation rate also did not have a long-term impact. The gains clocked in the Indian bourses were a part of the gains amongst the emerging market indices aided by risk diversification strategy by the FIIs (away from US markets). Since January 2005, however, the markets have been moving in a narrow range as fears of aggressive rate hike by the Fed, profit-booking after the sharp run-up and nervousness before the Budget have dominated market sentiments. Unlike the previous few years, the market has not witnessed any pre-Budget rally this year. Box 1 analyses the relationship between movements in equity indices and the Union Budget.
Box 1: Budget and the markets The domestic markets have, over the years, witnessed an interesting trend of markets undergoing a downslide when the Budget has been preceded by a rally. Further, the absence of any preBudget rally has resulted in a rally after the Budget. The recent Nifty data shows that the budgets of 2000, 2001 and 2002 were preceded by a rally as the index posted a gain of 7-12 per cent 2 months preceding the Budget. However, the rally was not sustained and the index fell by about 1-15 per cent within a month after the Budget. The fall was further strengthened up to 10-16 per cent within 3 months of the presentation of the Budget. On the other hand, the budgets of 2003 and 2004, which were led by a downturn in the markets, were followed by a significant rally, with the Nifty gaining significantly after the Budget. Figure 1: S&P CNX Nifty- Monthly Averages
U N I O N
B U
S&P Nifty
Strong FII investment
Robust FII Inflow, Healthy Monsoon
Political instability
G E T
2000 1800 1600 1400 1200 1000 800
bursting low inflation, of IT consumption

recovery
Political uncertainity, monsoon delay,
downbeat Budget
Continued...
117
Equity market
...continued
Plotting the monthly averages of the index we get an explicit picture of the market movement. The budgets of 2000, 2001 and 2002 were preceded by a pre-Budget rally. Both the 2000 and 2002 budgets were preceded by a favourable macro-economic scenario of high growth, low inflation and high consumption recovery. While the inability of the respective budgets to meet the market expectations was responsible for short-run losses of the market, over the longer term it was a different picture. Factors like bursting of the technology bubble during 2000-01 and political uncertainty, together with delay in monsoons and instability in world markets during 2002-03 resulted in the observed downslide of the index. The 2001 Budget, however, was led by the faltering state of the economy, with high inflation and low economic growth. Though the Budget was growth-oriented and also addressed market-friendly measures, it was unable to revive the languishing sentiments of the markets. The 2003 Budget was not preceded by a market rally; however, the markets strengthened significantly post-Budget. Besides a 4 per cent growth and a moderate inflation rate of 3.4 per cent during 2002-03, the Budget was greeted by disappointing monsoons and unstable world markets. However, a slew of measures for equity markets sparked the rally witnessed in May 2003.
U N I O N
The markets, however, did not follow any trend during the budgets of 1998 and 1999. The downslide observed prior to the budget of 1998, continued even after the budget on the back of political instability. The budget of 1999 was preceded by a high growth situation. A reform-oriented budget helped the pre-Budget rally continue after the Budget.
Table 1: Key Macro Parameters Budget Growth Inflation FII Inflows S&P CNX Nifty Budget Day 1 month 1 month Close % 1997 1998 1999 2000 2001 2002 2003 2004 2005^ 7.8 4.8 6.5 6.1 4.4 5.8 4 8.5 6.9 % mill USD 4.6 4.4 5.9 3.3 7.1 3.6 3.4 5.5 6.7 2,432 1,649 -386 2,339 2,160 1,846 562 9,949 9,388 998.7 1,053.8 981.3 1,654.8 1,351.4 1,142.1 1,063.4 1,518.2 2,103.3 972.7 1,185.2 966.2 1,546.2 1,371.7 1,075.4 1,041.9 1,505.6 2,057.6 968.3 942.3 1,078.1 1,528.5 1,148.2 1,129.6 978.2 1642.6 -before budget after budget S&P CNX Nifty- % change Budget 1 month 1 month Day Close % 0.6 -0.9 4.3 -3.9 4.3 -4 1 -3.1 2.1 before budget % 2.7 -11.1 1.6 7 -1.5 6.2 2.1 0.8 2.2 after budget % -3 -10.6 9.9 -7.6 -15 -1.1 -8 8.2 --
B U D G E T
* Growth (Advance Estimates), Inflation (till Jan 05) and FII Inflows (till Feb 05) correspond to the
financial year preceding the budget.

^ Indicators till February 2005 Source: CSO, Ministry of Industry, NSE
118
continued...
Equity market
...continued
Similar to the 2000 and 2002 budgets, the budget of 2004 was also led by a high-growth scenario in the economy. Further, key macro factors that typically lead to an upward correction in the market like favourable interest rates, manageable inflation, promising long-term growth prospects and improving margins were all in place before the budget of 2004. The Budget, thus, provided a trigger to the already buoyant market sentiments. The current year has also witnessed a pre-Budget rally but is significantly backed by strong fundamentals in the economy. With an average growth of 6.9 per cent, robust forex inflows and strong corporate sector results have helped the Nifty experience significant gains despite high inflation. However, the current exuberance in the market is accompanied by significant services and broadened manufacturing sector growth, which supports the case for a sustainable upward trend in the domestic markets for the year ahead. Since the markets have always had their share of pre-Budget rallies, or P Chidambaram was the finance minister keeps the hopes alive!
U N
the fact that in four of
the five years when the rally sustained itself a month after the Budget, either Dr Manmohan Singh
The news of furthering reforms in banking, infrastructure, taxation and duties have provided the market with a tailwind of good news and is expected to strengthen the market sentiment. Lowering of the corporate tax rate, along with reduction in customs tariffs, will help strengthen the bottomlines of the corporates and, thus, add a fillip to the market sentiment. On the personal income tax front, exemption on savings of Rs 1 lakh is a good step, as it will help channelising savings into the markets. Rationalisation of tax-structure, along with the continued focus on the development of roads, as reflected in increased outlay for national highway development highlights the continuation of policies and schedules for execution of promises made by the government, and this is expected to support the market. The increased commitment to the highway development programme can be expected to support the generation of industrial demand and employment opportunities in the economy. As a result of the tax reforms and concrete commitments to infrastructure development, we see the Budget having a positive impact on the domestic markets. Foreign exchange reserves - Impact analysis
I O N
B U D G E T
The Budget has come up with a roadmap for utilising the foreign exchange reserves for financing the 'financially viable' infrastructure projects by way of establishing a Special Purpose Vehicle (SPV). While the Budget will continue funding infrastructure projects, the use of forex resources will be made to fund large infrastructure projects. Some of the key infrastructure sectors to be positively impacted by the SPV are roads, ports, airports and tourism sectors. The SPV will lend funds, especially debt of longer-term maturity, directly to the eligible projects. While the borrowing limit will be notified at the beginning of each fiscal year, for 2005-06 the limit is set at Rs 10,000 crore.
119
Equity market
Table 2: Forex reserves and impact on money supply Indicator M3* (Rs crore) Money Multiplier Borrowing Limit (Rs crore) Increase in Liquidity in system (Rs crore) Share wrt total Money Supply in system (per cent) * as on 4 February 2005 Source: CRISIL Estimates.
th
Value 2,208,074 4.8 10,000 47,674 2.2
It is not yet clear whether the limit will be allowed to act as reserve money for lending to identified infrastructure projects or just provide a forex window for such projects. If there is a monetary implication to this scheme, Table 9 shows the impact of utilising forex reserves for infrastructure development on money supply. Usage of Rs 10,000 crore of forex reserves to fund infrastructure development will result in a 2.2 per cent increase in money supply in the system. While the SPV helps create an enabling environment of infrastructure development in the economy, the issue, however, is not just about the modality of funding infrastructure development in the country, but equally of effectiveness of delivery systems, execution of projects, availability of viable projects and underpinning of
U N I O N
sector specific reforms. As the total foreign exchange reserves in the economy as on February 18, 2005, stands at $133 billion, the introduction of the SPV is not expected to significantly ease the pressure of appreciation on the rupee at this level of operation. However, lower import duties, resulting in greater demand for forex, will contribute to an easing of the upward pressure on the rupee.
B U D G E T
The removal of lower and upper bounds to the statutory liquidity ratio (SLR) and cash reserve ratio (CRR) will provide extra flexibility to the Reserve Bank of India in managing the monetary situation in an environment of declining government indebtedness, as visualised by the FRBM.
120

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Union Budget - Analysis

About CRISIL Limited

100 102 103 105

Debt markets Equity market

Detailed economic analysis

Detailed economic analysis

Detailed economic analysis

CRIS INFAC ANALYSIS, FEBRUARY 28, 2005

Detailed economic analysis

Source: Medium-term fiscal policy statement, Union Budget 2005-06

Detailed economic analysis

Source: Medium-term fiscal policy statement, Union Budget 2004-05

Detailed economic analysis

Source: CRISIL estimates

Detailed economic analysis

Source: CRISIL estimates

Detailed economic analysis

Source: CRISIL Simulations

Detailed economic analysis

Detailed economic analysis

Detailed economic analysis

Overall sectoral impact

Overall sectoral impact

Overall sectoral impact

No impact on the sector.

Overall sectoral impact

items to zero capital goods manufacturers and HP.

Overall sectoral impact

Overall sectoral impact

No impact on the sector. 23

Overall sectoral impact

Overall sectoral impact

Overall company impact

Overall company impact

Overall company impact

Overall company impact

C VD 5.1 + C VD 5.1 + C VD 5.1 + C VD 15.3 + C VD 5.1 +

+ 10 C VD 5.1 + 10 C VD + 10 C VD 5.1 + 10 C VD + 16 C VD 15.3 + 16 C VD

Cars and utility vehicles

Engines and engine parts

Cars and Utility vehicles

Abatement rate (per cent) 2004-05 35.0 2005-06 35.0 -

2005-06 15.3 15.3 15.3 15.3 15.3 5.1 10

20.4 20.4 20.4 15.3 15.3 5.1 20.4

C ement clinker Gypsum Non coking coal Pet coke 1

Source: CRIS INFAC

2004-05 2005-06 2004-05 2005-06 (Rs/tonne)

Source: CRIS INFAC

LC V: Light commercial vehicles; M&HC V: Medium and heavy commercial vehicles

grow by 5 per cent in the medium term.

Cotton and cotton yarn

Prices (Feb 2005) Domestic (Rs/tonne) 89,200 43,000

Market prices of H-4 variety

Source: CRIS INFAC

Cotton and Cotton yarn

Prices (Jan 2005) ($/tonne)

Landed costs (Rs/tonne)

2004-05 2005-06 2004-05 2005-06 (Rs/tonne)

5.1 5.0 5.1 5.1 5.1 5.1 5.1 5.1 20.4

Source: CRIS INFAC

CRIS INFAC ANALYSIS, FEBRUARY 28, 2005

Landed cost (Rs/tonne)

Oil and gas