Economy Matters, August - September 2013


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Economy Matters is bi-monthly newsletter of CII on Economic Affairs.
Our major neighboring economies- Sri Lanka, Bangladesh, Pakistan and Nepal - too are facing the heat as both global slowdown and country specific factors have stunted their domestic economic growth. We discuss the major trends in these South Asian economies in the section on Global Trends in this month’s issue of Economy Matters.

In the section on Domestic Trends, we discuss the trends emanating out of the recent releases on GDP, IIP, Inflation and Trade during the month of August-September 2013.

In Corporate Performance, we examine the financial performance of larger sample of firms in the first quarter of the current year, in order to decipher the evolving trends.

The Sectoral spotlight for this issue is on Capital Goods, which is of strategic importance for the Indian economy. Being large and diverse in nature and playing a critical role in production process, the sector has high multiplier effect on the overall growth of the economy.

In the Special Article, we discuss various provisions of the Land Acquisition, Rehabilitation & Resettlement Bill 2013, which was recently passed by both the Houses of the Parliament. Industry has concerns on some of the provisions of the Bill.

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Economy Matters, August - September 2013

  1. 1. ECONOMYMATTERS Right to Fair Compensation and Transparency in Land Acquisition, Rehabilitation & Resettlement Bill, 2013 Volume 01 No. 08August - September 2013
  2. 2. Our major neighboring economies- Sri Lanka, Bangladesh, Pakistan and Nepal - too are facing the heat as both global slowdown and country specific factors have stunted their domestic economic growth. The Sri Lankan economy bounced back strongly after the end of the civil war, but has not been immune to the global headwinds. Bangladesh has been fast emerging as a manufacturing hub in view of its low labour cost. Pakistan, on the other hand, finds itself embroiled in the worst ever fiscal deterioration due to inefficient performance of various government sector enterprises and the mounting cost of maintaining internal security in the country. Nepal is facing the classic macroeconomic dilemma of low growth and high inflation. Going forward, the growth outlook in these economies will be contingent upon the pace of recovery of the advanced economies and theirinternaldomesticresilience. The domestic scenario looks equally challenging at present, with the first quarter GDP numbersconfirmingthatwearenotoutofthewoodsasyet.Withmonsoonsbeingnormal, a good agricultural performance coupled with rise in rural wages would help bolster rural demand. But, that by itself is not adequate, when the other indicators are all southward bound. There are no visible signs of investment pick up as investor sentiments continue to be very low. A weak rupee, tight liquidity, high cost of funds, procedural delays, etc are all cominginthewayofaninvestmentrevival.AcoordinatedeffortfromtheGovernmentand the RBI is required to ensure that this vicious cycle is broken. Hastening disinvestment of public sector units, ensuring coal supplies to the power sector, promoting competition in the mining sector and ensuring speedy implementation of Delhi Mumbai Industrial Corridor (DMIC), all of which require non-legislative action, would be seen as positive developments. The Right to Fair Compensation, Resettlement, Rehabilitation and Transparency in Land Acquisition Bill 2013 will be a milestone since it is the first ever attempt to combine Resettlement of Project Affected People and their Rehabilitation (R&R) along with land acquisition. Besides, the new Bill provides a prominent role for Government in land acquisition process for the Industry, which is a very welcome step. Industry however continuesto have apprehensionson some of the key provisionsof the Bill. These pertainto compensation package and R&R entitlements; Consent Clause; Acquisition of Irrigated Multi-Crop Land; Retrospective Applicability of the Bill; Return of Un-utilised Land etc. Besides, the process of land acquisition, as proposed in the new Bill is highly complex and time taking, stretching up to a minimum of 56 Months. While the objective should be improving quality of life of affected families post land acquisition, it is imperative to streamline the land acquisition mechanism in the country in a manner that balances the interestsofaffectedfamilieswithindustryaffordability. Chandrajit Banerjee Director-General, CII 1 AUGUST-SEPTEMBER 2013 FOREWORD
  3. 3. DISCLAIMER Copyright©2013byConfederationofIndianIndustry(CII),Allrightsreserved. Nopartofthispublicationmaybereproduced,storedin,orintroducedintoaretrievalsystem,ortransmittedinanyformorby any means (electronic, mechanical, photocopying, recording or otherwise), without the prior written permission of the copyright owner. CII has made every effort to ensure the accuracy of information presented in this document. However, neitherCII noranyofitsofficebearersoranalystsoremployeescanbeheld responsibleforanyfinancialconsequencesarising outoftheuse ofinformationprovidedherein.However,incaseofanydiscrepancy,error,etc., samemayplease be broughtto thenoticeofCIIforappropriatecorrections. Published by Confederation of Indian Industry (CII), The Mantosh Sondhi Centre; 23, Institutional Area, Lodi Road, New Delhi- 110003(INDIA), Tel:+91-11-24629994-7,Fax:+91-11-24626149;; 2ECONOMY MATTERS TheConfederationofIndianIndustry(CII)workstocreateandsustainanenvironmentconducivetothedevelopmentofIndia, partneringindustry,Government,andcivilsociety,throughadvisoryandconsultativeprocesses. CII is a non-government, not-for-profit, industry-led and industry-managed organization, playing a proactive role in India's development process. Founded over 118 years ago, India's premier business association has over 7100 members, from the private as well as public sectors, including SMEs and MNCs, and an indirect membership of over 90,000 enterprises from around257nationalandregionalsectoralindustrybodies. CII charts change by working closely with Government on policy issues, interfacing with thought leaders, and enhancing efficiency, competitiveness and business opportunities for industry through a range of specialized services and strategic globallinkages.Italsoprovidesaplatformforconsensus-buildingandnetworkingonkeyissues. Extending its agenda beyond business, CII assists industry to identify and execute corporate citizenship programmes. Partnerships with civil society organizations carry forward corporate initiatives for integrated and inclusive development across diverse domains including affirmative action, healthcare, education, livelihood, diversity management, skill development,empowermentofwomen,andwater,tonameafew. The CII Theme for 2013-14 is Accelerating Economic Growth through Innovation, Transformation, Inclusion and Governance. Towards this, CII advocacy will accord top priority to stepping up the growth trajectory of the nation, while retaining a strong focus on accountability, transparency and measurement in the corporate and social eco-system, building a knowledge economy,andbroad-basingdevelopmenttohelpdeliverthefruitsofprogresstoall. With63offices,including10CentresofExcellence,inIndia,and7overseasofficesinAustralia,China,Egypt,France,Singapore, UK, and USA, as well as institutional partnerships with 224 counterpart organizations in 90 countries, CII serves as a reference pointforIndianindustryandtheinternationalbusinesscommunity. ABOUT CII Research The CII Research team regularly tracks economic, political and business developments within India and abroad to comment on theemergingeconomicscenariofortheIndiancorporatesector.Ittrackspolicydevelopments,offerscomprehensiveanalysis of industries and comments on and analyzes the economic climate through its regular publications– Economy Matters, BusinessOutlookSurveyand,FortnightlyEconomicUpdates. Wehavein-houseexpertiseinprovidingthemostcomprehensive,in-depth,unbiasedandincisiveanalysisandforecastsonthe Indian economy and various sectors. CII Research is also well versed and well equipped to offer customized research based consultancy services on any theme. It has been catering to the needs of various stakeholders including industries, business houses and government providing meaningful insights about the prevailing trends, outlook on likely future trends, factors behind these trends, existing government policies and policy recommendations with an objective to help stakeholders in better understanding of the issues at hand. The objective of CII Research is to assist stakeholders in taking more informed and strategicdecisionswithduefocusontheattainmentofshorttermaswellaslongtermgoals. Formoredetailsandtoadvertise inourproducts,
  4. 4. CONTENT Cover Story The passage of Land Acquisition Bill by both Houses of Parliament has brought little cheer to the industry as there are concerns on some of its provisions.Cost of land acquisition is likely to increase by 3-3.5 times, making industrial projects unviable and raising costs intheoveralleconomy.Wediscuss the key provisions of the new Bill andhowitwouldbringoutabouta change in the existing scenario in thismonth’sSpecialArticle. 3 AUGUST-SEPTEMBER 2013 Inside This Issue Executive Summary.................................................................04 GDP Forecasts Scaled Down for 2013-14.......................07 T A X E S Global Trends 08 Deciphering Trends in the Major South Asian Economies Domestic Trends GDP, IIP, Inflation & External Sector 15 Taxation Draft Safe Harbour Rules - Do they Bridge or Widen the Taxpayer-Exchequer Divide? 22 Sector in Focus Capital Goods 27 Special Article Right to Fair Compensation and Transparency in Land Acquisition, Rehabilitation & Resettlement Bill, 201334 Corporate Performance Industry Under Pressure as Growth Dips Further 24 Economy Monitor ................................................................... 43 Special Feature Green Manufacturing: The Next Big Opportunity 40
  5. 5. GlobalTrends DomesticTrends CorporatePerformance ThelargeSouthAsianeconomies(ex-India),viz,SriLanka, Bangladesh, Pakistan and Nepal are facing varied sets of problems precipitated as a result of the global slowdown and country specific factors. The Sri Lankan economy has bounced back strongly after the end of the civil war, but has not been immune to global headwinds. Bangladesh has been fast emerging as a manufacturing hub in view of its low labour cost. Pakistan on the other hand is facing mounting difficulties in the wake of sharp increase in fiscal deficit coupled with internal security strife. The smallest economy of the region, Nepal on the other hand is facing the classic macroeconomic dilemma of low growth and high inflation. Going forward, the growth outlook in these economies will be contingent upon the pace of recovery of the advanced economies and their internaldomesticresilience. GDP growth moderated to its more than four-year low of 4.4 per cent in the first quarter GDP growth dropped to a four-year low of 4.4 per cent of the current fiscal as compared to 4.8 per cent in the quarter before. This is the lowest quarterly growth rate since March 2009, when the global financial crisis was at its peak. The downslide was drivenbyaweakindustrialperformance,whichslippedto a its multi-year low. Inflation on the other hand has continued to accelerate, rising to 6.1 per cent in August 2013mainlyduetohighfoodprices.Ontheexternalfront, improvementintheglobalscenariohasprovidedafillipto exports growth, which accelerated to 13 per cent in August 2013, while imports contracted due to subdued demandintheeconomyandimpactofaweakRupee. The deepening economic slowdown, rising interest rates, tight liquidity, declining investments and depreciating rupee are slowly taking a toll on India Inc's financial performance with majority of companies witnessing a decline in net profits for the past few quarters. The corporateresultsattheendoffirstquarter(April-June)of the current fiscal painted a rather gloomy picture as the financial performance of Indian companies deteriorated. While revenues plummeted sharply, corporate sector continued to pull expenses down against the backdrop of a clouded economic outlook. However, the reduction in expenditure costs was not large enough to provide to cushion the bottom-line of the firms. Consequently, there was de-growth witnessed in profit-after-tax (PAT) on an aggregate basis in the first quarter of 2013-14. Margins, bothnetandgrosssawandeteriorationinthequartertoo, reflecting the fall in profitability. Our analysis is based on the financial performance of balanced panel of 2,701 firms (extractedonAugust29,2013). Capital goods sector is of strategic importance for the Indian economy. Being large and diverse in nature and playing a critical role in production process, the sector has high multiplier effect on the overall growth of the economy. The sector not only determines the pace of economicexpansionbut also gets influenced by the same. However, the negative growth recorded by the capital goods sector over the last two years is a matter of concern. Declining production in the sector was reflected intheimportsofcapitalgoodstoo,whichwitnessedsharp increase over the last decade or so, supported by a relatively low rate of customs duty in the range of 0.0-7.5 per cent. Poor performance of the sector has much to do withthelowcostcompetitivenessofthesector,whichhas magnified in the face of the economic slowdown. While revival of manufacturing growth is critical for capital goods sector, healthy growth performance of capital goodssectortoocanhelptherevivalprocess. The passage of Land Acquisition bill by both Houses of Parliamenthasbroughtlittlecheertotheindustryasthere are concerns on some of the provisions of the Bill. Cost of land acquisition is likely to increase by 3-3.5 times, making industrial projects unviable and raising costs in the overall Indianeconomy.TheBillwouldalsoleadtomajordelaysin theprocessofLandAcquisitionastakingtheconsentof80 per cent of affected families for Private Sector and 70 per cent of affected families for Public Private Partnership (PPP) Projects under 'Public Purpose' in the Bill would make the process of obtaining consent a very long drawn out process. Further, retrospective applicability of the Bill would severely affect the on-going industry projects as re- starting the entire land acquisition process would lead to avoidable delays and consequent cost over-runs. CII however does appreciate the holistic nature of the Bill and role of government in acquiring land. However, at a time when major projects are stalled and India's global competitiveness is eroding, a more facilitative land acquisition process would have helped long-term growth andrestoreinvestorsentiments. Sector in Focus: Capital Goods SpecialArticle EXECUTIVE SUMMARY 4ECONOMY MATTERS
  6. 6. ECONOMYMATTERS n n n Keeps readers abreast of global & domestic economic developments Monthly Journal of top management of 8000 companies Read by CII Members, Thought Leaders, Diplomats, Policy Makers, MPs and other decision makers The Facts n n n n n n Domestic Trends Corporate Performance Sector in Focus Special Article Economy Monitor Global Trends The Coverage CII invites full-page* Advertisements for this flagship document at an attractive rate of Rs 50,000 per issue and Rs 5 lakh for 12 issues. For more details, Please Contact: Confederation of Indian Industry The Mantosh Sondhi Centre, 23, Institutional Area, Lodi Road, New Delhi- 110003 (INDIA) Tel : +91-011-24629994-7, Fax: +91-011-24626149; Email: Dr. Danish A. Hashim, Director- Economic Research
  7. 7. GDP FORECAST GDP Forecasts Scaled Down for 2013-14 (y-o-y%) Old Forecasts New Forecasts BNP Paribas 5.2 3.7 HSBC 5.5 4.0 Goldman Sachs 6.4 4.0 Standard Chartered 5.1 4.1 Nomura 5.0 4.2 JP Morgan 5.5 4.7 Macquarie 6.2 5.3 CRISIL 5.5 4.8 RBI 5.7 5.5 PM Economic Advisory Council 6.4 5.3 CII 6.0-6.4 5.3-5.8 7 AUGUST-SEPTEMBER 2013
  8. 8. Deciphering Trends in the Major South Asian Economies below trend performance by the agriculture and services sectors, which grew at 2 per cent and 4.3 per cent, respectively. Services sector is the most dominant sector of the Sri Lankan economy, having a share of above 50 per cent in the total GDP, followed by industry at around 30 per cent and agriculture constituting the remaining. The sharp deceleration witnessed in agriculture was due to the drop in production of rubber due to lower global prices and unfavourable rainfall for tapping activities. Amongst the services sector, transport & communication and hotels & restaurant sectors grew by 9.5 per cent and 18.6 per cent respectively. SriLanka S GDPGrowth ri Lanka's GDP in the first quarter (January-March) of the current year grew at 6.0 per cent as compared to 8.0 per cent in the same quarter of the last year. The subdued performance was underpinned by a GLOBAL TRENDS 8ECONOMY MATTERS (y-o-y%) 1Q:2011 1Q:2012 1Q:2013 Agriculture -4.4 12.0 2.0 Industry 11.1 10.8 10.7 Services 9.5 5.8 4.3 OverallGDP 8.0 8.0 6.0 Source: Department of Census & Statistics, Government of Sri Lanka Yearly GDP growth rate in Sri Lanka (January-December)
  9. 9. the same period last year. Looking ahead, inflation is expected to remain in single-digit during the remainder of 2013, and in mid-single digits in 2014. Considering the subdued inflationary pressures prevalent in the economy currently, the Monetary Board in its meeting, th heldon15 August2013,wasoftheviewthatthecurrent monetary policy stance is appropriate, and therefore, decided to maintain the Repurchase rate and the Reverse Repurchase rate of the Central Bank of Sri Lanka unchanged at 7.00 per cent and 9.00 per cent, respectively. Inflation The prudent demand management policies along with favourable supply conditions have resulted in a continued low inflation environment in Sri Lanka. Inflationhasremainedat singledigitlevels for4 and half years with headline inflation (year-on-year), as measured by the Colombo consumers' price index (base: 2006/07=100) CCPI for first seven months of 2013 standing at 7.5 per cent as compared to 6.7 per cent in 3.8 6.3 12 10 8 6 4 2 0 Jan-12 Mar-12 May-12 Jul-12 Sep-12 Nov-12 Jan-13 Mar-13 May-13 Jul-13 CPI Inflation in Sri Lanka (y-o-y %) Source: Department of Census & Statistics, Government of Sri Lanka On the exchange rate front, following the general trend of depreciation against the US dollar of the other major currencies in the region, the Sri Lankan Rupee too fell to a near 10-month low in August 2013 due to dollar demand by importers and capital outflows. The rupee has fallen around 4 per cent since June 7, 2013 as foreign investors pulled out of Sri Lankan bonds and other emerging market assets due to a rise in U.S. treasury yields. Trade Intheexternalsector,merchandiseexportsinJune2013 showed some turnaround, recording a positive year-on- year growth after the decline observed in the past 15 months. The cumulative performance in merchandise trade depicts a salutary 7.1 per cent decline in the trade deficit for the first six months of 2013. Earnings from tourism and workers' remittances have continued to improve, while the financial inflows have been substantialinthefirsthalfoftheyear. key factor behind this was slower growth in agriculture, which according to these provisional numbers has slowed from 3.1 per cent in 2011-12 to 2.2 per cent in 2012- 13. This was largely due to the base effect of two consecutive years of record growth, lower output due to the falling price of paddy/rice and also due to weather-related disruptions. Yet, the industrial growth, which is the sector most affected by access to timely credit,isestimatedat9.0percentin2012-13,higherthan the 8.9 per cent in 2011-12, driven in large part by faster growth of construction and small scale industries. On Bangladesh GDPGrowth In 2012-13 (July-June), Bangladesh economy was faced with the challenges of rising inflation and balance of payments pressures stemming largely from a sudden surgeinoilimports. Accordingly,theGDPfortheannual year came in lower at 6.0 per cent as compared to 6.2 per cent in the previous fiscal. Growth was also lower than the previous five-year average of 6.2 per cent. A 9 AUGUST-SEPTEMBER 2013
  10. 10. fiscal, Bangladesh Bank (Central Bank of Bangladesh) forecasts that the output growth is unlikely to deviate significantly from the last ten year average of 6.2 per cent. the other hand, growth of services sector marginally slowed down to 5.7 per cent in 2012-13 from 5.9 per cent in 2011-12 as the retail and wholesale trade sectors were particularly affected. Looking ahead to the current (y-o-y%) 2010-11 2011-12 2012-13(P) Agriculture 5.1 3.1 2.2 Industry 8.2 8.9 9.0 Services 6.2 6.0 5.7 OverallGDP 6.7 6.2 6.0 Source: Bangladesh Bank Note: P- Provisional GDP Growth Rate in Bangladesh in Fiscal Year (July-June) using the 1995-96 base. The risks to the inflation target stem partly from likely wage increases, in both the public and private sectors, which will further add to existing aggregate demand pressures. Consequently, the expected monetary stance of the Central Bank of Bangladesh for the second-half of the current fiscal (July-December 2013) states maintaining the repo rates and reserve requirement ratios unchanged following the 50 bps rate cut in January 2013, in addition to bringing down average inflation to 7 per cent (using the 1995-96base). Inflation Average inflation, using the 1995-96 base year, has been declining steadily over the past fifteen months, from a peak of 10.9 per cent in February 2012 to 7.7 per cent in June 2013. This decline was driven by a steady fall in point-to-point food and non-food inflation until October 2012 when food inflation bottomed out at 5.6 per cent. Since then, food inflation has begun to rise and in June 2013 came in at 8.5 per cent. For the current fiscal, the inflation target announced in the Budget is 7.0 per cent, 10.6 7.7 11 10 9 8 7 Jun-12 Jul-12 Aug-12 Sep-12 Oct-12 Nov-12 Dec-12 Jan-13 Feb-13 Mar-13 Apr-13 May-13 Jun-13 CPI Inflation in Bangladesh (y-o-y%) Source: Bangladesh Bank 2012-13, partly reflecting the significant fall in food import demand, lower petroleum imports as well as slower demand for imports related to manufacturing output. The capital account shows that foreign direct investment is projected to have increased from US$1.2 billion in 2011-12 to US$1.3 billion in 2012-13. Remittances remain an important source of foreign capital for the Trade In the external sector, the current account balance (CAB) continued to be in surplus of US$2004 million in 2012-13,onthebackofincreasinginflowsofremittances, continued buoyant export expansion, and declining imports. Import growth continued to remain sluggish in 10ECONOMY MATTERS
  11. 11. appreciated 2.6 per cent between January 1st-June 30th 2013 and real exchange rate data indicates a marginal impact on export competitiveness. However, Central Bank's interventions in the foreign exchange market have limited this loss significantly by slowing the appreciationoftheTaka. country. Remittances have been buoyed by larger numbersofBangladeshiworkersmovingabroadin2011- 12 as well as real wage growth in the Middle East followingthe'ArabSpring'events. The Central Bank has been also working to rein in the excessive volatility in the exchange rate. The Taka (US$million) 2010-11(Actual) 2011-12(P) 2012-13(Estimation) CurrentAccountBalance -1549 151 2004 CapitalAccount 642 469 535 FinancialAccount 514 785 2347 OverallBalance -656 494 4886 Source: Bangladesh Bank Note: P- Provisional Bangladesh's Balance of Payments growth rate for the past five years has remained as low as 3 per cent, which is alarming when compared to the 2.1percentgrowthinthepopulation.Performanceofall the three sub-sectors, viz, agriculture, industry and services remained subdued during the year. For the current fiscal, government is targeting 4.4 per cent GDP growth. Though the new government that came in May 2013 is expected to provide some clarity on the political front, power shortages and security conditions continuetobestrongimpedimentstogrowth. Pakistan GDPGrowth Embroiled in an acute energy crisis since the last many years, Pakistan economy continues to face challenges on all fronts. The data for the GDP in Pakistan, which is releasedonanannualbasis,showsthatfor2012-13(July- June),theGDPgrewbymerely3.6percentascompared to the annual plan target of 4.3 per cent. The average 2012-13 2011-12 Growth(y-o-y%) Shares(%) Contribution(%) Growth(y-o-y%) Agriculture 3.3 21.4 0.7 3.5 Industry 3.5 20.9 0.7 2.7 Services 3.7 57.7 2.1 5.3 OverallGDP 3.6 100 3.6 4.4 Source: State Bank of Pakistan GDP Growth in Pakistan (July-June) impactofthedepreciationofthePakistaniRupee.Inthe latest budget the government has announced an increase of 1 percentage point in the General Sales Tax (GST),from16percentto17percent,andchangesinthe tax structurefor some goods & services. In addition, the government is considering a phase-wise upward adjustment in electricity tariff. Therefore, there is a risk Inflation Inflation continues to remain high, with July 2013 CPI inflation reading coming at a 10-month high of 8.3 per cent as compared to 9.6 per cent in the same month of last year mainly due to rise in food prices and adverse 11 AUGUST-SEPTEMBER 2013
  12. 12. economy, the State Bank of Pakistan (SBP) chose to cut its policy rate by 50 bps, to 9 per cent in its policy review held on June 24th, 2013, thus giving more weight to the declininggrowthprospects. that average inflation for the current fiscal could exceed the announced target of 8 per cent for the year. Notwithstanding, the rising inflationary pressures in the FiscalDeficit Another significant challenge facing the economy is the rising fiscal deficit. The centre fiscal deficit for 2012-13 is estimated to be 8.8 per cent (of GDP), which is nearly twicetheinitialtargetof 4.7 per cent. The source of deviation is structural and well known - low tax revenues due to absence of meaningful tax reforms and continuation of untargeted subsidies without comprehensively addressing the energy sector problems. The high inefficiency of the public sector enterprises (PSEs) is worth highlighting in this context. For the current year, the federal government has announcedaprovisionalfiscaldeficitestimateof6.3per cent. 12.3 8.3 14 12 10 8 6 4 May-12 Jun-12 Jul-12 Aug-12 Sep-12 Oct-12 Nov-12 Dec-12 Jan-13 Feb-13 Mar-13 Apr-13 May-13 Jun-13 Jul-13 CPI Inflation in Pakistan (y-o-y%) Source: State Bank of Pakistan 12ECONOMY MATTERS 1980s 1990s 2000s FY11 FY12 FY13 E 7.0 6.8 4.7 6.6 8.5 8.8 Fiscal Deficit (as a % of GDP) in Pakistan Source: State Bank of Pakistan Note: E- Estimated Trade On the external front, the exports from Pakistan during 2012-13 stood at US$24.5 billion, marginally higher than US$23.6 billion recorded in 2011-12. Energy shortages and slow economic growth in developed world economieswerethemajorreasonsbehindtherelatively slow expansion in exports. Almost all the exports earnings originated from textile manufactures, as the country's exports are concentrated in a few items like cotton & cotton manufactures, leather, rice and few others. Imports in to the country were recorded at US$44.9 billion during 2012-13. The trade deficit, hence, during 2012-13 amounted to US$20.4 billion as against the US$21.3 billion deficit recorded during the same periodoflastyear. On the exchange rate front, the Pakistani Rupee continues to be battered against the US$. The Rupee droppedtoafreshall-timelowof103.47perUSdollaron August 21, 2013, a depreciation of over 9 per cent on an annual basis. The widening current account deficit,
  13. 13. slipped to 1.6 per cent in 2012-13 as compared to 3.0 per cent in the previous year. The services sector in 2012-13, however, expanded by 6.0 per cent, much higher than 4.5 per cent last year. Nepal's economy has been embroiled in a major political crisis, with the elections now being postponed to November 2013. The country has been without a parliament for more than a year now, after major political parties missed yet another deadline to write a constitution and reach a consensus on the structure of the government. The political paralysis has deeply affected the economy. The strong factor for Nepal's economy has been the remittances sent by its residents staying outside; which constitutes roughly 22 per cent of the country's gross domestic product. Nepal GDPGrowth According to the preliminary estimates of the Central Bureau of Statistics (CBS), the Real GDP is estimated to have grown by 3.6 per cent in 2012-13 compared, lower than 4.5 per cent in the previous year. The deceleration in growthwas underpinnedby subdued performanceby theagricultureandindustrialsector.Agriculturegrewby a tepid 1.3 per cent mainly due to unfavourable monsoonswhichledtodecreaseintheproduceofmajor crops. Due to various structural bottlenecks, including energy shortage, industrial labour relation and delay in adopting a full-fledged budget, industrial growth (y-o-y%) 2011-12 2012-13(P) Agriculture 4.9 1.2 Industry 3.0 1.6 Services 4.5 6.0 OverallGDP 4.5 3.6 Source: Nepal Rastra Bank Note: P- Provisional GDP Growth in Nepal (fiscal year starting mid-July) Inconclusion,fromtheanalysisofthemajorSouthAsian economies, it emerges that they too are facing headwinds emanating from the tough global macroeconomic scenario. Out of the four major economies of South Asia, Pakistan appears to be in the most precarious state, troubled by deteriorating law and order, energy deficiencies, high inflation and fiscal deficit, and dip in the external aid. The currencies of all the four economies have witnessed sharp depreciation in the last few months, in line with the evolving global developments. Going forward, the growth outlook in these economies will be contingent upon the pace of recovery of the advanced economies and their internal domesticresilience. Inflation Annual average inflation based on consumer price index wasestimatedat9.9percentin2012-13,comparedto8.3 per cent in the previous year. Additional pressure on inflation has emerged as a result of a number of factors such as decline in food production due to unfavorable weather, weak supply situation, energy crisis, devaluation of Nepalese currency, increase in the price of petroleum products and Indian inflation. The monetary policy formulated by the Central Bank of Nepal for the current fiscal, adopted an accommodative policy stance to facilitate higher economic growth of 5.5 per cent during the year by making adequate provisions ofcreditalongwithcontaininginflationat8percent. excessive government borrowing from State Bank, absenceofforeigninflows,increasingoilimports,lackof foreign investment and repayments to the International Monetary Fund are the prominent reasons behind the constantdepreciationofPakistaniRupee. 13 AUGUST-SEPTEMBER 2013
  14. 14. 14ECONOMY MATTERS OtherMajorGlobalDevelopmentsduringtheMonth 1. US GDP in the second quarter of 2013 was revised upwards to 2.5 per cent on an annualised basis as compared to initially estimated 1.7 per cent. Expansion in the second quarter - faster than the annualized growth rate in the first quarter of 1.1 per cent - was driven by gains in consumer spending, exports, private inventory investment,non-residentialfixedinvestmentandresidentialfixedinvestment. 2. In US, non-farm payrolls (NFP) increased by 169K in August 2013, lower than market expectations of an increase of 180K. Meanwhile, total job addition for July was revised lower from 162K to 104K, while that for Junewasrevisedfrom188Kto172K. 3. Real GDP in Euro Area posted a growth of 0.3 per cent on q-o-q basis in the second quarter of 2013, marking its first expansion since third quarter of 2011. In y-o-y terms though, GDP contracted 0.5 per cent, slower than a contractionof1.0percentinthepreviousquarter. 4. Real GDP in UK posted a growth of 0.7 per cent on q-o-q basis - revised up from previously estimated 0.6 per cent - in second quarter of 2013, as against a growth of 0.3 per cent in the previous quarter. In y-o-y terms also, GDPincreased1.5percentlastquarter,markingthehighestgrowthsincefirstquarterof2011. 5. Headline inflation softened in UK for the second consecutive month to 2.7 per cent in August 2013, as against 2.8 per cent in the previous month. Core inflation, on the other hand, was unchanged at 2.0 per cent last month.The deceleration in inflation was primarily due to lower contribution by 'transport' and 'clothing & footwear'sectors,whilearisein'furniture&householdservices'partiallyoffsetthedeceleration. 6. The Bank of England (BoE) kept its policy rate unchanged at 0.5 per cent and the quantum of Asset Purchase th Facility(APF)wasalsoretainedatGBP375billioninitsmonetarypolicymeetingheldon5 September2013. 7. Government's Purchasing Managers Index (PMI) in China increased to 51.0 in August 2013, up by 0.7 percentagepointmonth-on-month,andpositionedabovethethresholdfor11consecutivemonths.
  15. 15. DOMESTIC TRENDS GDP Slows Down to 4-Year Low unexpected, as the monthly index of industrial production (IIP) numbers had pre-empted this weakness by posting a contraction to the tune of 1.1 per centinthefirstquarter. Thefullyeargrowthinthelastfiscalwasatadecadelow of 5 per cent. At the beginning of this fiscal it seemed as though the economy had bottomed out and that there would be some recovery during the course of this year. However, the first quarter print has effectively dashed any such hopes and it does not seem as though the growthcycle hasseen the troughyet as the next quarter islikelytobeonaweakerfootingtoo. GDP growth dropped to a four-year low of 4.4 per cent in the first quarter of the current fiscal as compared to 4.8 per cent in the quarter before. This is the lowest quarterly growth rate since March 2009, when the global financial crisis was at its peak. The downslide was driven by a weak industrial performance, which slipped to multi-year lows. This was however not 5.4 5.2 4.7 4.8 4.4 1QFY13 2QFY13 3QFY13 4QFY13 1QFY14 Growth in GDP at Factor cost (y-o-y%) Source: CSO 15 AUGUST-SEPTEMBER 2013
  16. 16. 16ECONOMY MATTERS lows in March 2009. This is particularly worrying as it is a proxy of consumption expenditure and contributes more than 25 per cent to overall GDP. In contrast, community, social & personal spending which is regarded as a proxy for government spending grew at its highest pace since the September 2009 quarter. However, it might be difficult to sustain this high government spending as slowing growth is having an adverse impact on tax revenues and the depreciating rupee is raising the subsidy burden of the government. In the first quarter alone, the actual fiscal deficit was almost half of the budgeted deficit for the entire fiscal year. For the remaining quarters, it looks increasingly likely that the government will have to cut back expenditure sharply from budgeted levels to maintain itsfiscaldeficittarget(4.8percentofGDP). The area under cotton, another important kharif crop, has surged by 7.3 per cent to 108.5 lakh heactares (lh), and this bodes well for the textile industry. In 2012-13, domesticcottonoutputhaddeclinedfourpercentto34 million bales owing to a drought in the main cotton producing states of Gujarat and Maharashtra. This had also impacted cotton exports last year. Further, the coverage of coarse cereals went up by 20.1 per cent to 163.1 lh. This has positive implications for the domestic poultryindustry. Kharif crop output touched an all-time high of 131.3 million tonnes in 2011-12. But kharif production had fallen in 2012-13 because of the drought in Karnataka, Maharashtra, Gujarat and Rajasthan. Timely sowing this year will ensure crops get adequate time to mature. The higher kharif output this year is expected to cool food inflationaswell. From the supply-side, agriculture growth came in at a one-year high of 2.7 per cent in the first-quarter of the current fiscal as compared to 1.4 per cent in the previous quarter. The performance of the sector is expected to improve further in the coming quarters aided by a good monsoon this fiscal and expectation of record-high food grain production this year. In fact agriculture sector's performanceisexpectedtobekeycontributortooverall growth this year. In contrast, industrial sector growth slumped to a low of 0.2 per cent, the lowest point second only to contraction in March 2009. Amongst its sub-sectors, manufacturing sector contracted by 1.2 per cent, while mining & quarrying continued to remain in theredterritoryinthereportingquarter. Any meaningful revival cannot afford to by-pass the crucial manufacturing sector, given its importance in employment creation; hence bold steps by the policymakers to revive the sector's fortunes are the need of the hour. Growth in the labour intensive sector of construction was a mere 2.8 per cent in the June quarter. Second quarter is usually a seasonally weak quarter for construction and the trend is likely to continue. The sector is possibly reflecting the sharp cut in government's plan expenditure towards the end of last year and the near halting of private investment projects. Services sector grew at the same clip as last fiscal, at 6.6 per cent and has been almost flat for 3 consecutive quarters now. However, the dynamics within the services component has changed significantly for the worse. The trade, hotels, transport and communication sector came in at a low of 3.9 per cent next only to its (y-o-y%) 2QFY13 Q3FY13 Q4FY13 Q1FY14 GDP at factor cost 4.4 Agriculture 2.7 Industry 0.2 Services 6.6 -2.8 -1.2 2.8 3.7 3.9 8.9 9.4 5.2 4.7 4.8 1.7 1.8 1.4 1.3 2.5 2.7 7.6 6.7 6.6 Mining & quarrying 1.7 -0.7 -3.1 Manufacturing 0.1 2.5 2.6 Construction 3.1 2.9 4.4 Electricity, gas & water supply 3.2 4.5 2.8 Trade, hotels, transport & communication 6.8 6.4 6.2 Financing, insurance, real estate & business services 8.3 7.8 9.1 Community, social & personal services 8.4 5.6 4.0 Source: CSO GDP Break-Up from Supply-Side
  17. 17. providing the biggest boost to expenditure GDP was government spending, which came in at 10.5 per cent. But as mentioned earlier, this trend might not be sustained in the future. Exports and imports were fairly muted and clocked -1.2 per cent and 0.7 per cent respectively. It seems as though the government's export promotion measures will take some more time topanout. From the demand-side, the situation remains weak and GDP notched 2.4 per cent in the April-June 2013 quarter as compared to 3.0 per cent in the previous quarter. The primary source of concern was the sharp slowdown in consumption growth, which came in at a dismal 1.6 per cent, which is the lowest print on record for this GDP series. In corroboration of the fact that the investment cycle in the economy is faltering, gross fixed capital formation contracted by 1.2 per cent. The component Source: CSO GDP Break-Up from Demand-Side Outlook CII is disappointed with the dismal performance of the first quarter GDP data which showed further deceleration in the economic growth. In particular, the near stagnation in the manufacturing sector is worrying at a time when policy makers are keen to raise the share of this sector in the economy. In view of the downside risks to growth, we havenowrevisedourGDPgrowthforecastdownwardtoarangeof5.3-5.8percentforthecurrentfiscal.Inorderto lift the economy out of the current quagmire, that all policy levers should be used to drive a revival in the economy. Project clearances should be hastened, implementation of the manufacturing policy should begin by identifying specificzoneswhereindustrycaninvestandinterestratesshouldbereduced. improvementinIIPgrowthwasnotentirelyunexpected as core sector (which constitutes close to 38 per cent of the total index) had grown at 3.1 per cent during the month.The positivesequential momentumwas evident from the 3.8 per cent growth in the seasonally-adjusted month-on-month (SA m-o-m) series in July 2013. However, on a cumulative basis, for the first four monthsofthefiscal,IIPcontractedby0.2percent. In an encouraging sign, index of industrial production grew by 2.6 per cent in July 2013 after remaining in negative territory for two consecutive months. The turnaround was mainly driven by a positive trend in the manufacturing growth rate. The print for June has also been revised upward to -1.8 per cent from -2.2 per cent earlier. However, it should be noted that the Industrial Growth Picks Up in July 2013 Jul-12 Sep-12 Nov-12 Jan-13 Mar-13 May-13 Jul-13 -0.1 2.6 10 5 0 -5 y-o-y% SA m-o-m% IIP Growth Rebounds in July 2013 Source: CSO (y-o-y%) 2QFY13 Q3FY13 Q4FY13 Q1FY14 GDP at market prices 2.4 1.6 10.5 -1.2 -1.2 0.7 2.5 4.1 3.0 Private Consumption 3.5 4.2 3.8 Govt. Consumption 6.9 2.2 0.6 Fixed Investment 1.1 4.5 3.4 Exports 5.0 -3.5 -0.6 Imports 9.5 4.2 3.3 17 AUGUST-SEPTEMBER 2013
  18. 18. 18ECONOMY MATTERS the previous month. The sector recorded positive growth after remaining in the negative territory for threeconsecutivemonths.Consumergoodscontinueto remain in negative territory for the third consecutive month, primarily on account of consumer durables. Overall consumer goods sector showed de-growth to the tune of 0.9 per cent in July 2013 as compared to -1.9 per cent in the previous month. The continued poor performance by consumer durables in the last eight months, wherein it remained in the negative territory, is amatterofconcernasitiswidelyregardedasaproxyfor consumption growth. Non-durables on the other hand continued to show a robust performance, growing by 6.8 per cent in July 2013 as compared to 5.7 per cent in thepreviousmonth. On the sectoral front, manufacturinggrew at a relatively robust 3 per cent, as compared to two previous consecutive months of negative growth. As per the industry classification, of the 22 industries, 11 showed positive growth, mainly led by electrical machinery, wearing apparel, luggage & footwear and tanning of leather products. In contrast, regulatory and environmental issues continued to plague the mining sector, as it contracted by 2.3 per cent in July 2013. Electricity sector, meanwhile, showed a strong rebound of 5.2 per cent after the surprise stagnant growth last month. Ontheusebasedfront,themostsignificantsurprisewas onthecapitalgoodsfront,whichgrewbyaconsiderable 15.6 per cent in July 2013 as compared to -5.8 per cent in Apr-July Weight July-12 May-13 Jun-13 July-13 FY13 FY14 General 1000.0 -0.1 -2.8 -1.8 -0.2 -0.2 Manufacturing 755.3 0.0 -3.6 -1.7 -0.6 -0.2 Mining 141.6 -3.5 -5.9 -4.3 -2.0 -4.0 Electricity 103.2 2.8 6.2 0.0 5.5 3.9 Use-Based Basic 456.8 1.0 -0.9 -1.5 2.7 0.2 Capital 88.3 -5.8 -2.6 -5.8 -16.8 1.8 Intermediates 156.9 0.1 1.0 1.3 0.6 1.8 Consumer Goods 298.1 0.7 -7.1 -1.9 3.1 -2.0 -Durables 84.6 0.8 -18.4 -10.4 6.1 -12.0 -Non durables 213.5 0.6 3.0 5.7 0.6 6.8 2.6 3.0 -2.3 5.2 1.7 15.6 2.4 -0.9 -9.3 6.8 Source: CSO Sectoral Growth (y-o-y, %) Outlook CII is happy to note the return of industrial growth to the positive terrain in July 2013, which marks a break from the pasttwomonthsofnegativegrowth.Thisiswelcome,thoughitistooearlytopresumethatarecoveryisunderway. However, manufacturing sector has been performing below its potential for quite some time now, hence well- thought-outshortandmediumtermactionplansareneededtoacceleratethegrowthmomentumofthesector.
  19. 19. WPI Inflation Accelerates on Higher Food Prices High fruits & vegetable prices coupled with high inland- fish prices drove the primary food inflation sharply up to 18.2 per cent as compared to 11.9 per cent in the last month. Consequently, primary inflation increased to 11.7 per cent in the reporting month as compared to 9 per cent in the month before despite sharp deceleration in its non-food and mineral sub components. Fuel inflation on the other hand remained stable at 11.3 per cent in August 2013. Encouragingly, non-food manufacturing inflation, which is widely regarded as the proxy for demand-side pressures in the economy came down to 1.9 per cent from 2.4 per cent in the month before. Total manufacturing inflation too stood at 1.9 per cent during themonth. HeadlineWPI-basedinflationclimbedto6-monthhighof 6.1percentinAugust2013ascomparedto5.8percentin the previous month mainly on account of spiralling food prices. Total food inflation (primary + manufacturing) accelerated sharply to 12.4 per cent in August 2013 as compared to 9.5 per cent in the month before. The average inflation for the first five months of the fiscal stands at 5.3 per cent as compared to 7.6 per cent in the same period last year. The sequential momentum of seasonally-adjusted month-on-month series also showedpickup.CombinedCPIinflationforthemonthof August 2013 stood at 9.52 per cent as compared to 9.64 percentinthepreviousmonth. General 100.0 8.0 5.2 5.8 7.6 5.3 Primary 20.1 11.2 8.8 9.0 10.3 8.1 - Food 14.3 9.3 10.3 11.9 10.4 11.0 -Non-Food 4.3 14.1 7.7 5.5 8.8 5.3 -Minerals 1.5 18.1 1.3 -2.4 12.3 -4.1 Fuel 14.9 8.7 7.5 11.3 10.5 9.2 -Petrol 1.1 9.5 -6.9 1.2 10.5 -0.9 -High Speed 4.7 0.5 23.4 26.3 5.0 23.8 Diesel Manufacturing 65.0 6.4 2.9 2.8 5.6 2.9 -Food 10.0 9.3 6.4 5.0 6.9 5.4 -Non-food 55.0 5.8 2.2 2.4 5.4 2.4 April-Aug Weight Aug-12 Jun-13 July-13 Aug-13 FY13 FY14 6.1 11.7 18.2 1.1 -7.2 11.3 3.2 27.6 1.9 1.7 1.9 Source: Office of Economic Advisor Sectoral Components of Inflation Outlook While on the one hand, high food prices drove inflation higher during the month, non-food manufacturing (core) inflation subsided further. This has complicated the task of the Central Bank further as there is clear evidence of abatement of demand-side pressures, which makes the case for a rate cut to spur growth, but on the other hand, supply-side issues have driven total inflation higher. We would urge the RBI to cut rates as it is well known that monetarypolicyisnotaneffectivetoolforcurbinginflationcausedduetosupply-sidebottlenecks. 19 AUGUST-SEPTEMBER 2013
  20. 20. 20ECONOMY MATTERS Trade Deficit Narrows on Sharp Spurt in Exports Growth Meanwhile, the cumulative value of exports for the period April-August FY2014 came in at US$124.4 billion, higher than US$119.7 billion recorded during same period last year. Imports contracted by 0.7 per cent in August 2013, lower than a decline of 6.2 per cent in July 2013, mirroring the continued subdued domestic demand in the economy, impact of imports getting costlierinthewakeofdepreciatingrupeeagainsttheUS dollar and the curtailed imports of non-productive items like gold. Imports also contracted in month-over-month terms, printing US$37.1 billion in August as against USD$38.1billioninJuly. Exports stabilised further in August 2013, as global demand improved. Imports declined reflecting the slow domestic demand scenario, thus resulting in narrowing of the monthly trade deficit. However, these may be early days still to pass any judgement on the sustainability of the exports momentum in the months tocome. In August 2013, exports were valued at US$26.1 billion, up a robust 13 per cent as compared with same period last year. This is the highest monthly increase this fiscal and augurs well for the future economic prospects. 11.8 13.0 28.8 -0.7 40 30 20 10 0 -10 -20 Jan/12 Feb/12 Mar/12 Apr/12 May/12 Jun/12 Jul/12 Aug/12 Sep/12 Oct/12 Nov/12 Dec/12 Jan/13 Feb/13 Mar/13 Apr/13 May/13 Jun/13 Jul/13 Aug/13 y-o-y% Exports Imports Source: Ministry of Commerce External Sector Performance Oil imports were higher by 17.9 per cent on a y-o-y basis. Non-oil imports declined by 10.4 per cent-standing at US$21.9billionduringthemonth. As exports rose and imports fell during the month, the tradedeficitnarrowedtoUS$10.9billionfromadeficitof US$12.3 billion in July. On a cumulative basis, trade deficit came in at US$73.4 billion in April-August FY14, slightly lower than a deficit of US$74.7 billion during the sameperiodinFY13. Within imports, oil and related products accounted for US$15.1 billion worth of imports in August 2013 as compared to US$12.7 billion in the previous month. The higher oil import bill is attributable to the high international oil prices during the month due the ongoing geopolitical tensions in Syria. The Indian crude oil basket price rose to US$110.1/bbl in late August as comparedtoUS$105/bblinJulyandUS$101.0/bblinJune. Outlook Going ahead, exports are likely to find some support amidst signs of economic recovery in both the US and the Euro zone. Besides, a weaker Rupee is also likely to aid exports. However, on the negative side, elevated crude oil prices poseriskstotheoilimportbill.
  21. 21. v v v v v v Services projected to grow at 6.6 per cent in 2013-14 asagainst7.1percentin2012-13. WPI inflation by end March 2014 will be around 5.5 percentasagainsttheaverageof7.4percentin2012- 13and5.7percentatendMarch2013. Current Account Deficit projected at US$70 billion (3.8 per cent of GDP) in 2013-14 against an estimated US$88.2billion(4.8percentofGDP)in2012-13. NetCapitalflowsprojectedatUS$61.4billion(3.4per cent of GDP) in the current year against an estimated US$89.4 billion in the last fiscal, the second highest leveltodate. Investment and Savings rate projected at 34.7 per centand31percentofGDPrespectivelyin2013-14. Some of the measures suggested by the council to improve economic conditions in the medium to long term include improving manufacturing capabilities, lowering current account deficit and encouraging foreigninvestmentamongstothermeasures. Initsrevisedeconomicforecastforthecurrentfiscal,PM Economic Advisory Council (PMEAC) lowered its GDP forecast from 6.4 per cent to 5.3 per cent. Though growth has been revised downwards, it is still higher than the 5 per cent growth posted last year. As per the council, the main reasons for the higher forecast in the current year is the sharp increase in agriculture output coupled with expected pick-up in growth of other sectors also in the second half of the year owing to slew of policy measures announced in the last couple of months. Following are the key highlights from the council'sotherforecasts: Agriculture projected to grow at 4.8 per cent in 2013- 14 as against 1.9 per cent in 2012-13 owing to a good monsoon which had a huge positive impact on sowingactivity. Industry projected to grow at 2.7 per cent in 2013-14 as against 2.1 per cent in 2012-13. Manufacturing sectorprojectedtogrowat1.5percentinthecurrent fiscalasagainst1percentinthelastfiscal. v v PMEAC Cuts GDP Forecast to 5.3 per cent Dr. Raghuram Rajan Takes Over as the New RBI Governor view that it is mainly the supply constraints that have unleashed the forces of inflation, especially in food. As the governor has appropriately emphasized on a policy that will promote inclusive growth and development, it is even more critical to address the supply bottlenecks throughawellcoordinatedmonetaryandfiscalpolicy. With a view to encourage investors to take positions domestically and provide depth and profits to our economy, CII welcomes the intention of the new RBI governor to steadily liberalize the domestic market, and ease the restrictions on investment and positions taking. This will also help the country by way of boosting confidenceofforeigninvestorsintheIndianeconomy. CII is also happy that the new governor will be taking several steps to help the households, who remain vulnerable to the vagaries of the market. Among these important measures, the decision of RBI to issue Inflation Indexed Savings Certificates linked to the CPI New Index to retail investors by end-November 2013, is welcomeandisinlinewith CIIrecommendations. CII welcomes the new governor and is confident that he will take the necessary pro-reform measures in the months to come in order to re-invigorate growth in the economyandkeeptheinflationaryexpectationslow. Dr. Raghuram Rajan assumed charge as rd the 23 Governor of the Reserve Bank of India on September 4, 2013. Prior to this, he was the Chief Economic Advisor, Ministry of Finance, Government of India and the Eric J. Gleacher Distinguished Service Professor of Finance at the UniversityofChicago'sBoothSchool.Between2003and 2006, Dr. Rajan was the Chief Economist and Director of Research at the International Monetary Fund. The new governor takes over at a very critical stage for the economy which saw Rupee touching historic lows in addition to the perceived fiscal dominance over monetary policy in recent times. Covering these critical areas in his maiden speech, Dr. Rajan, expressed confidence that monetary policy, in coordination with fiscal policy, will not only be able to address the macro economic issues facing the country currently but will also provide platform for sustaining the high growth withinclusivenessinmediumtolongterm. Dr. Rajan rightly recognized the need for taming inflationary expectations by taking measures based on the understanding of the dynamics of originating sources like the value of currency, supply-side constraints and demand pressures. CII has been of the 21 AUGUST-SEPTEMBER 2013
  22. 22. 22ECONOMY MATTERS Draft Safe Harbour Rules – Do They Bridge or Widen the Taxpayer-Exchequer Divide? The Safe Harbour rules (the rules) were released in draft form by the Central Board of Direct Taxes (the CBDT) on 14 August 2013. After considering comments from various stakeholders, the final rules have been issued on 18 September 2013. The rules cover the following categories/sectors of transactions and prescribe the belowmentionedsafeharbourmargins/prices: Software development and IT-enabled services - Cost plus mark-up of 20 per cent (provided the value of such transactions does not exceed INR 500 crores i.e. INR 5 billion); cost plus mark-up of 22 per cent mark in other cases, i.e. above INR 500 crores; the draft rules had proposed a threshold limit of INR 100 crores, i e taxpayers having transactions above INR 100 crores werenoteligiblefortheSafeHarbour Knowledge Processes Outsourcing (KPO services) - Cost plus mark-up of 25 per cent; in the draft rules the same was proposed as 30 per cent with an upper limit eligibilitythresholdofINR100crores. Contract Research & Development (R&D) relating to software development and generic pharmaceutical drugs - Cost plus mark-up of 30 per cent and 29 per cent respectively; same as the margins proposed in the draft rules Transfer Pricing (TP) has emerged as one of the key focal points of high-pitched tax litigation in India. While outsourcing/captive units have experienced significantTP adjustmentsto theirprofitmargins,Indian parent companies have suffered adjustments on their intra-groupfinancingarrangements. The Finance (No. 2) Act, 2009 had introduced Safe Harbour Provisions in order to reduce the uncertainty faced by the taxpayers in India. The provisions were also intended to provide clarity and guidance on the quantity of taxable profits that should be earned in India as per the arm's length principle. Safe Harbour is a mechanism under which the tax authorities accept the transfer prices declared by taxpayers without undertaking detailed audit, in certain circumstances. Safe harbour provisions generally intend to confer benefits like compliancerelief,administrativesimplicityandcertainty on the taxpayers and tax administrators. While this helps the tax payers in reducing compliance cost, tax authorities can focus their limited resources on bigger andmorecomplextransactions. T A X E S TAXATION
  23. 23. The rules have prescribed different margins for services viz., software development, ITeS, KPO, contract R&D, etc. A noteworthy aspect is that service providers bearing insignificant risk are only eligible to opt for the rules. The factors mentioned for identification of taxpayers with 'insignificant risk', inter-alia, includes performance of economically significant functions, provisionsoffunds/capitalandownershipofintangibles by foreign principal, etc. Hence, distinction in mark-up percentage between various services, presumably on the basis of high-end vs. low-end nature of activities, could lead to enhancing disputes on characterisation of taxpayers. The mark-up percentages prescribed in the rules may not meet the taxpayers' expectations (based on industry average margin trends and prevalent commercial rates) and opting for the prescribed margins under the rules may overshadow the expected benefits. Similarly, the safe harbour interest rate for loans would range from 11 per cent to 13 per cent (applying the SBI base rate as on 30 June 2013), which clearly is on a higher side. Also, the margin provided for auto components industry, which in particular has been going through a challenging phase, appears high. Since several rulings of the Income tax Appellate Tribunals have accepted lower percentage of mark-up or interest tobe atarm'slength,theratesspecified intherulesmay notfindfavourwiththetaxpayers. Whilst the step by the CBDT is a positive move, it is expected that the revenue authorities during audits, APA/MAP negotiations will not consider the safe harbor margins. An issuance of a binding circular clarifying that safe harbour rates should be strictly applied only to taxpayers who opt for the rules and should not be generically extended to other assessees (who do not opt for the rules) would provide a sense of relief to taxpayers.Thereisnodoubtthatthereleaseofthelong- awaitedSafeHarbourrulesisastepintherightdirection and the certainty and administrative convenience offered by the rules would be an additional incentive that will increase the attractiveness of India as an investmentjurisdiction. Manufacture and export of core and non-core auto components - Cost plus mark-up of 12 per cent and 8.5 percentrespectively;sameasthedraftrules Interest on loans sourced in Indian Rupees extended to Wholly-Owned non-resident subsidiaries (WOS) - State Bank of India (SBI) base rate plus 150 basis points for loans up to INR 50 crores and, SBI base rate plus 300 basis points for loans exceeding INR 50 crores i.e. INR 0.5billion. Guarantee fee on explicit corporate guarantees on behalf of WOS - 2 per cent per annum where the amount guaranteed does not exceed INR 100 crores i.e. INR 1 billion and 1.75 per cent in case the amount guaranteed exceeds INR 100 crores and the credit rating of the WOS is of adequate to highest safety as carried out by an agency registered with the Securities and Exchange BoardofIndia. The issuanceof detailed Safe Harbourrules is a welcome measure. The removal of upper threshold limits for eligibility of opting for safe harbour rules will give an opportunity to taxpayers at large to opt for the rules. As regards the period, application of the rules for five years (instead of 2 years as in the draft rules) is another positive development. It is expected that the rules would help overcome immense potential TP litigation andcreateanamicabletaxenvironment. However, the rules in final form also have certain issues aswereinthedraftrules.Therulesrequirethetaxpayers opting for Safe Harbour to comply with the detailed requirements relating to TP documentation. Such compulsion would defeat the key benefit of reduced compliance burden. Once a certain mark-up for a specified service is acceptable to the tax authorities, maintaining detailed documentation thereafter may, at bestbeofacademicimportance. The final rules only cover R&D for software developmentandgenericpharmaceuticaldrugs,leaving out other sectors such as R&D for active pharmaceutical ingredients, chemicals, agriculture, etc. Further, the rules only cover loans/guarantee provided by taxpayer to/for WOS and cover only rupee-sourced loans, thus, havingrestrictedapplicability. This articlehas beencontributedby Tarun Arora, Senior Director, Shuchi Ray, Director, DeloitteToucheTohmatsuIndia Pvt.Ltd. and Manmeet Vij, SeniorManager,DeloitteHaskins&Sells.ViewsexpressedinthearticlearethoseoftheauthorsandnotnecessarilyofCII. 23 AUGUST-SEPTEMBER 2013
  24. 24. 24ECONOMY MATTERS CORPORATE PERFORMANCE Industry Under Pressure as Growth Dips Further The analysis factors in the financial performance during the first quarter of 2013-14 of a balanced panel of 1664 manufacturing companies (excluding oil and gas companies) and 1037 service firms extracted from the th AceEquitydatabaseason29 August2013. Growth in net sales on an aggregate basis stood at a measly 4.8 per cent at the end of first quarter of the current year, as compared to a healthy 12.2 per cent in the same quarter a year ago. The growth of net sales for manufacturing firms moderated sharply to 0.2 per cent during the quarter as compared to 12.7 per cent in the same quarter a year ago. Firms in the services sector, on the other hand, fared somewhat better, with their net sales growing at a much higher pace of 12.6 per cent as compared to 11.4 per cent during the comparable time- period of last year. The low net sales of firms are reflectiveofthelackofampledemandintheeconomy,a scenario that has been persistent for quite some time now. The deepening economic slowdown, rising interest rates, tight liquidity, declining investments and depreciating rupee are slowly taking a toll on India Inc's financial performance with majority of companies witnessing a decline in net profits for the past few quarters.Thecorporateresultsattheendoffirstquarter (April-June)of the currentfiscal painted a rathergloomy picture as the financial performance of Indian companies deteriorated. A scanty 4.4 per cent GDP growth in the reporting quarter worsened the cause, even as the RBI tightened its purse strings in a bid to stem the downfall in Rupee. While the growth in expenditure costs stood somewhat curbed, fading growth of net sales and contraction in PAT added to the prevalentgloom.
  25. 25. the corresponding period of last year. Interestingly, growth in interest costs decelerated sharply to 10.0 per cent in the reporting quarter as against 29.0 per cent in the same quarter of 2012-13. In a reflection of slowing production, growth in raw materials cost contracted by 5.7 per cent in the reporting quarter as compared to a positivegrowthof10.5percentseeninthesamequarter oflastyear. Totalexpenditure,onanaggregatebasis,deceleratedto 3.5 per cent in the reporting quarter as against a growth of 16.5 per cent in the corresponding period of 2012-13. This came as a breather and fairly cushioned the severe impact of lower net sales growth during the quarter. Amongst the various components of total expenditure, the growth in wages & salaries stood at 14.7 per cent in thefirstquarterascomparedto15.1percentrecordedin GrowthinNetSales(y-o-y%) Aggregate Manufacturing Services FY13Q1 12.2 12.7 11.4 FY13Q2 9.9 8.8 11.8 FY13Q3 7.0 6.5 7.9 FY13Q4 4.5 2.1 9.1 FY14Q1 4.8 0.2 12.6 Source: Ace Equity database & CII calculations Growth in Net Sales (y-o-y%) Growth in Expenditure (y-o-y%) 10.5 -5.7 15.1 14.7 29.0 10.0 FY13Q1 FY13Q2 FY13Q3 FY13Q4 FY14Q1 FY13Q1 FY13Q2 FY13Q3 FY13Q4 FY14Q1 FY13Q1 FY13Q2 FY13Q3 FY13Q4 FY14Q1 Services & Raw Materials Wages & Salaries Interest Payments Source: Ace Equity database & CII calculations correspondingquarteroflastyear. On an aggregate basis, PAT declined by 5.9 per cent in the April-June 2013 quarter as compared to a growth of 3.2 per cent in the same quarter of last fiscal. Growth in operating profits (profits earned from a firm's core business operations excluding investments and the effects of depreciation, interest and taxes) on an aggregate basis saw moderation to 5.1 per cent in the April-June, 2013 quarter as compared to a growth 11.3 per cent in the first quarter of last year. PAT growth decelerated at a much faster rate than growth in operating profits due mainly to high interest rates prevailingintheeconomy. While moderation in growth of expenditure has to some extent mitigated the impact of the current bout of economic crisis characterized by falling growth in net sales, the reduction was not large enough to provide cushion to the bottom-line of the firms. Consequently, there was de-growth witnessed in profit-after-tax (PAT) on an aggregate basis in the first quarter of 2013-14. The sharpest contraction in PAT growth was seen in manufacturing sector firms, which saw its PAT declining by12.6percentinthefirstquarterofthecurrentfiscalas compared to a contraction of 14.5 per cent in the same quarter of last year. For the services sector, PAT growth moderated to 0.7 per cent in the reporting quarter as against a growth of 29.3 per cent seen in the 25 AUGUST-SEPTEMBER 2013
  26. 26. 26ECONOMY MATTERS Growth in PAT (y-o-y%) Manufacturing Services Aggregate Manufacturing Services Aggregate FY13Q1 FY13Q2 FY13Q3 FY13Q4 FY14Q1 Growth in PBDIT (y-o-y%) Source: Ace Equity database & CII calculations FY13Q1 FY13Q2 FY13Q3 FY13Q4 FY14Q1 3.2 20.1 9.9 -5.9 40 20 0 -20 -12.6 11.3 13.3 6.0 0.1 5.1 and thus also on aggregate basis in the reporting quarter. The fall in margins mirrored the sharp decline in profitability that the firms have had to confront in the reportingquarter. Our analysis shows that both net margin (ratio of PAT and net sales) and gross margins (ratio of PBDIT and net sales) fell across manufacturing as well as service firms, Gross Margin Net Margin Source: Ace Equity database & CII calculations Manufacturing Services Aggregate 20.3 20.6 19.4 19.9 20.4 FY13Q1 FY13Q2 FY13Q3 FY13Q4 FY14Q1 Manufacturing Services Aggregate FY13Q1 FY13Q2 FY13Q3 FY13Q4 FY14Q1 8.4 9.1 7.9 8.1 7.6 some moderation in expenditure costs. Net sales and PAT growth, however, continue to remain a sore point, indicating that there is still a long way to go before revivalinaggregatedemandgainstraction. Overall,theanalysisoftheresultsobtainedsofarreveals that there seems be no news to cheer for the India Inc amidst this weak macroeconomic scenario, except for 30 15 0 -15 40 20 0 20 10 0
  27. 27. Capital Goods Production Trend in Capital Goods Sector Analyzing the yearly performance of the capital goods segment, below table shows a sharp moderation in growthofthesectorsince2007-08(JulytoJune).Owing to the global financial crisis, the growth in capital goods sector plunged from 48 per cent in 2007-08 to 4 per cent in 2008-09. With the quick turnaround of the economy, growth prospects for the sector improved in the next two years. However, the sector went in for a sharp contraction in 2011-12 (-9 per cent) and 2012-13 (-2.2 per cent). The negative growth recorded by the sector over the last two years is a serious concern and its revival is crucial for the economy to resume its high growth trajectory. It is interesting to note that all sub-sectors of the capital goods segment have witnessed rapid deterioration in growth performance over the last two years. Machinery & equipment, which is an important indicator of the health of the other sectors of economy, has recorded contraction over two consecutive years. Given that it playsacrucialroleinupscalingthepaceoftheeconomy, directly and indirectly, every effort should be made to reversethedowntrendinthissector. Introduction apital goods sector is of strategic importance for the Indian economy. Being large and diverse in nature and playing a critical role in production process, the sector has high multiplier effect on the overall growth of the economy. The sector not only determines the pace of economic expansion but also gets influenced by the same. As the demand for the sector's output is derived from the demand for other sectors of the economy, its own performance provides an important clue to the future. By analyzing the recent trends in production and imports of lead components of capital goods sector, one can, therefore, explain the growthprospectsofrelatedsectorsoftheeconomyand alsocommentontheneedforpolicyintervention,ifany. While the performance of capital goods sector is generally considered as a barometer of the growth prospectsoftheeconomygoingforward,italsohelpsto assess the need for encouraging efficiency and production of the sector to encourage demand from its endusers. C SECTOR IN FOCUS 27 AUGUST-SEPTEMBER 2013
  28. 28. 28ECONOMY MATTERS automobile sector in slow track. While efforts can be made to revive the automobile production by direct policy intervention, it would also be helpful to enhance the cost competitiveness of "other transport equipment" to attract additional demand from its end users. Similarly, sharp growth deterioration witnessed by 'other transport equipment' signifies the downtrend in theautomobilesector,anotherengineofgrowthforthe economy. Slowing income growth, rising fuel prices, uncertainty relating to growth recovery and high credit cost have been among the major factors keeping the Year Machinery & Office, accounting & Electrical machinery Radio, TV and Other Capital equipment n.e.c. computing machinery & apparatus n.e.c. communication transport Goods equipment & equipment (Aggregate) apparatus 2007-08 19.6 6.3 183.8 87.5 -0.7 48.1 2008-09 -8.4 -11.3 33.0 15.7 4.9 4.1 2009-10 25.0 5.2 -0.6 18.4 31.4 10.4 2010-11 20.3 9.3 11.2 7.4 22.0 15.0 2011-12 -1.9 -3.8 -30.3 10.5 9.0 -9.1 2012-13 -7.4 -17.2 20.3 -2.9 1.1 -2.2 Average 7.9 -1.9 36.2 22.8 11.3 11.1 Source: CSO Average Annual Growth in IIP of Capital Goods Sector (July to June, y-o-y%) manufacturing sector plotted against the corresponding IIP for capital goods since June 2007. Production growth in capital goods sector, which constitutes less than 9 per cent share in overall weights in IIP, has moved in tandem with the overall growth of manufacturing index. Being the derived nature of demand for capital goods, its growth trend, in general, has preceded that of manufactured goods. In below figure, it can be seen that production growth of capital goods sector assumed a sharp downward spiral during June 2007 to Nov 2009, and the growth in manufacturingsectorfollowedsuitwithatimelag.After this, the capital goods sector exhibited a vigorous recovery till June 2011, albeit with a large volatility, coinciding with high growth performance of the manufacturing sector. Capital goods sector since July 2011haslargelystayedinnegativezones,bringingtohalt theexpansioninmanufacturingoutput. Sharp moderation in growth of 'Radio, TV and Communication equipment & apparatus' over the last two years is again the result of economic slowdown led by fall in demand. The fate of the sector largely depends upon the measures that could help in revival of demand for durables. The negative growth of 'office, accounting & commuting machinery' sector over the last two years is indicative of slowing business activities, and could mirrordecliningjobprospectsaswell. Interrelationship between Capital GoodsandManufacturingSectors The production performance of capital goods sector is directly linked to the growth performance of the manufacturing sector. Close relationship between the two sectors of the economy is discernible from the monthly Index of Industrial Production (IIP) for
  29. 29. especially true for the period of 2000s, when manufacturing sector recorded robust performance, supported by the elevated growth of capital imports. This is where there is a scope for domestic capital goods sectortofillthegap. Showing large dependence on imports of capital goods, the growth in manufacturing output has also moved closely with the growth in imports of capital goods (see below figure). Whenever there was high growth registered by the manufacturing sector, it was backed by large imports of capital goods and vice versa. This is Monthly Growth in Capital Goods and Manufacturing IIP since June 2007 70 56 42 28 14 0 -14 -28 Jun-07 Sep-07 Dec-07 Mar-08 Jun-08 Sep-08 Dec-08 Mar-09 Jun-09 Sep-09 Dec-09 Mar-10 Jun-10 Sep-10 Dec-10 Mar-11 Jun-11 Sep-11 Dec-11 Mar-12 Jun-12 Sep-12 Dec-12 Mar-13 Jun-13 Manufacturing Capital goods Source: CSO 50 40 30 20 10 0 -10 -20 -30 -40 1989-90 1990-91 1991-92 1992-93 1993-94 1994-95 1995-96 1996-97 1997-98 1998-99 1999-00 2000-01 2001-02 2002-03 2003-04 2004-05 2005-06 2006-07 2007-08 2008-09 2009-10 2010-11 2011-12 2012-13 Manf. Output Imports of Capital Goods Yearly Growth in Capital Goods Imports and Manufacturing Output since 1989-90 (%) Source: CSO billion in 2001 to US$79 billion in 2012. Even as the domestic production of capital goods sector has witnessed contraction in the last two years, imports of capital goods managed to maintain growth momentum and grew by an average of 12 per cent per year in the last twoyears.Relativelylowprotectionagainstimportsand growing pressure on the part of exporters to reduce prices in the wake of global slowdown could be among TrendinImportsofCapitalGoods In keeping with the pace of overall economic growth and lack of development of domestic capital goods sector, the imports of capital goods have witnessed sharpincreaseoverthelastdecadeorso,supportedbya relativelylowrateofcustomsdutyintherangeof0.0-7.5 percent.Theimportsjumpedupby10timesfromUS$7.9 29 AUGUST-SEPTEMBER 2013
  30. 30. 30ECONOMY MATTERS value of rupee against US dollar plunges to record new lows on regular basis. Further, the import duty could be raised to the WTO base rate to regulate unnecessary importslikehasbeendoneforgold. the major reasons that allowed imports to maintain its momentum. In the wake of widening current account deficit,whenthegovernmentandRBIaremakingallout effortstocurbavoidableimports,hugeimportofcapital goods is causing a drain on foreign reserves, even as the these two items together constitute less than 22 per cent of total imports, overall expansion in imports of capital goods continue to remain healthy. Three largest sub-sectors of capital goods imports - electrical equipment, telecommunication equipments, and industrial equipments - constituting half of the total importsofcapitalgoodsin2012-sawimportsgrowingin double-digits, which could mean good prospects of growthinendusersofthesesectors. Interestingly, majority of the capital goods sub-sectors haveshownconsistentandhealthygrowthinimportsin recent years; even over the last two years when economic growth in the country moderated substantially (see below table). The only sectors exhibiting poor growth performance in imports since 2007 are Railway/Tramway equipment (-5.7 per cent), and industry special machine (3.8 per cent). Given that 7.9 10.3 14.7 19.8 28.2 40.8 47.9 64.6 58.1 63.8 76.7 79.0 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 Trend in Imports of Capital Goods (US$, billion) Source: UN Comtrade Year Power Industry Metal Industrial Office/data Telecom Electrical Road Railway/ Total generating special working equipment proc ms etc equipment vehicles tramway Capital equipment machine machinery machines equipment equipment Goods 2007 3.1 6.9 2.5 6.8 4.2 9.9 6.5 1.9 6.1 47.9 2008 4.0 8.3 3.5 9.2 4.5 7.3 7.6 3.2 17.2 64.6 2009 3.9 6.8 2.5 7.7 4.3 11.6 9.9 2.7 8.7 58.1 2010 4.9 7.1 2.8 9.5 5.3 13.6 9.4 4.0 7.2 63.8 2011 6.1 8.9 3.6 12.2 6.8 14.6 14.1 5.0 5.2 76.7 2012 6.0 8.5 4.0 12.2 7.6 13.5 13.7 5.0 8.6 79.0 Avg 14.8 3.8 7.8 12.1 13.4 11.5 17.2 20.6 -5.7 9.3 Annual Growth (%) Source: UN Comtrade Trend in Imports of Major Components of Capital Goods Sector (US$, billion)
  31. 31. India's sources of capital goods imports are concentratedin just a few countries.This is evident from the fact that just the top ten sources contributed nearly 80 per cent of capital goods imports in 2012-13; of these, the top 5 countries - China, Germany, Japan, US, and Korea Rep. - accounted for 63 per cent of the total imports of capital goods. China is by far the largest exporterofcapitalgoodstoIndia. India is heavily dependent upon the imports of capital goods for meeting the domestic demand. This is evident from the fact that imports constituted 29 per cent of domestic demand for capital goods in 2010-11. Earth moving equipment, machine tools, metallurgical machinery and textiles machinery are sub-sectors that are particularly weak in self reliance with 48 to 87 per centdemandbeingmetbyimports. Electrical equipment 17.3% Telecomms etc equipment 17.1% Industrial equipment nes 15.4% Railway/tramway equipmnt 10.8% Industry special machine 10.8% Office/dat proc machines 9.6% Metalworking machinery 5.1% Road vehicles 6.3% Power generating equipmt 7.5% Sectoral Share of Capital Goods Imports (2012) Source: UN Comtrade China 31% Germany 9% Japan 8%United States 8% Korea, Rep. 7% Singapore 4% Italy 3% Malaysia 3% Thailand 3% France 3% Others 21% Composition of Imports of Capital Goods from Top-10 Countries (2012) Source: UN Comtrade 31 AUGUST-SEPTEMBER 2013
  32. 32. 32ECONOMY MATTERS This raises a pertinent question: why should we not make attempts to cut imports of capital goods by encouraging its domestic production, which would not only help in saving foreign exchange but also create much needed value addition and employment within the economy. This is especially critical in the context of sharperodingvalueofrupeeagainsttheUSdollarwhich is going to impact the imports of capital goods adversely. In order to ensure the sector's progressive development and to drive it to the next level of growth, there are numbers of measures that need to be taken, asmentionedinthefollowingsection. Measures to Boost Domestic Capital GoodsSector o Leverage domestic demand - To leverage large domestic demand that exists in India, there is a need for developing significant collaboration between usersandproducersofcapitalgoodssector. o Harmonize tax, duty structures, and FTAs - Indian capital goods manufacturers are affected by current duty structure that has created an unequal playing field between domestically manufactured goods and imported goods. Further, in certain cases, Free Trade Agreements (FTAs) are also being exploited to the disadvantage of domestic capital goods manufacturers.ExportsfromcountriessuchasChina are routed through these FTA countries to secure greater advantage over local manufacturers. There is, therefore, a need harmonize tax and duty structureandensurethatFTAsdon'tinflictinjuriesto thedomesticcapitalgoodssector. o Addressing the issue of inverted duty structure - In the current duty structure for intermediate and finished goods, there are certain anomalies, which at times, make the domestic capital goods costlier. At the same time, import duty on finished goods turns out to be lower in many instances, thereby creating an advantage for imports over domestic production. Such cases exist in various capital goods segments, callingforurgentpolicyattention. o Restricting imports of second hand machinery - There is a need to curb the large imports of second hand machinery in several sectors in India, including machine tools and textile machinery. Policy needs to be shaped to limit import of second hand equipment toprovideimpetustolocalmanufacturing. o Bridging the technology gap and increasing the depth of capabilities of domestic capital goods manufacturers-Indiancapitalgoodssectorneedsto plan and invest in developing the "next generation" products in order to shorten the prevailing technology gap between domestic manufacturers andforeignplayers. Imports Domestic Split of Demand between Imports and Domestic Production (2010-11) th Source: Report of the Working Group on Capital Goods & Engineering Sector for the 12 Five Year Plan, October 2011 9% 24% 26% 31% 35% 48% 51% 71% 87% 29% 91% 76% 74% 69% 65% 52% 49% 29% 13% 71% Process plant equipment Engineering Goods Heavy Electrical Equipment Dies, Moulds and Tools Plastic Machinery Textile Machinery Earth Moving Equipment Machine Tools Metallurgical Machinery Overall O demand met by imports ver 50 per cent
  33. 33. Conclusion The negative growth recorded by the capital goods sector over the last two years is a matter of concern. To blame the economic slowdown alone for the same would be incorrect as the imports of capital goods in the country have continued to remain buoyant. Poor performance, therefore, has much to do with the low cost competitiveness of the sector, which has magnified in the face of the economic slowdown. While revival of manufacturing growth is critical for capital goods sector, its healthy growth performance too can help the revival process. This is especially true in the backdrop of the sharp erosion in value of rupee against the US dollar, which is going to impact the importsofcapitalgoodsinthecountryadversely,besidesaddingtotheproblemofcurrentaccountdeficit. To make the domestic capital goods sector competitive, it is critical that we provide the right mix of fiscal incentives, infrastructure and skilled personnel and develop domestic capabilities across the value chain in the sector. Measures such as rationalizing the local tax structure, reducing the cost of credit, time bound fiscal incentives, putting check on avoidable imports of second hand machinery, addressing the issue of inverted duty structure, and facilitating skill development facilities for a competent workforce would go a long way in helping thesector. 33 AUGUST-SEPTEMBER 2013 Global Taxation Summit 2013 The topics to be deliberated at the Summit would broadly include: International & Domestic Tax Developments –Lessons and Learning for India Key Current and Emerging Transfer Pricing Audit Issues in India Alternate Dispute Resolution – Challenges & Way Forward BEPS – Emerging Trends in Developed and Emerging Markets Indirect Tax Issues including CENVAT, Service Tax and State VAT v v v v v Ms. Jessy Rajji Confederation of Indian Industry; 23 Institutional Area; Lodhi Road New Delhi 110 003. Tel : 91-11-24690715 /24629994 – 7; Fax : 91-11-24615693 Email : CII is organizing a day long Global Taxation th Summit 2013 on 20 November, 2013 at Hotel Taj Palace, New Delhi. Mr. Sumit Bose, Secretary - Revenue, Ministry of Finance, has kindly agreed to be the Chief Guest at the Summit. The Summit would also have the benefit of the views of senior government officers, tax experts from India and abroad and industry. You are invited to participate in the Summit. For registration and sponsorship opportunities, please contact:
  34. 34. 34ECONOMY MATTERS SPECIAL ARTICLE Right to Fair Compensation and Transparency in Land Acquisition, Rehabilitation and Resettlement Bill, 2013 Over a period of time, land acquisition has emerged as a critical constraint in India's industrialization, given pressures on limited land-mass for multiple uses. In order to remove the impediments to land acquisition, itisessentialthatitmusttakeplaceinamannerthatfully protects the interests of land-owners and also of those whose livelihoods depend on the land being acquired. Under our Constitution, land is a State subject but land acquisition is a Concurrent subject. So far, the basic law governing the land acquisition process has been the Land Acquisition Act, 1894. Although it has been amended from time to time, it is painfully evident that thebasiclawhasbecomearchaic.Againstthisbackdrop, review of the outdated Land Acquisition Act of 1894 in the country could not have come at a more appropriate time. After passage from both the Houses of the Parliament, the "Right to Fair Compensation and Transparency in Land Acquisition, Rehabilitation and Resettlement Bill, 2013" is currently awaiting the assent of the President of India and will become a new law within next three months. In this article we discuss the key provisions of the new bill and how it would bring aboutachangeintheexistinglandacquisitionscenario. Some of the key provisions of the new legislation, which hasbeenpassedbytheParliamenton6September,2013 arelistedbelow: TheBillprovidesforanexpandeddefinitionofpublic purpose that includes infrastructure projects, including: (i) all activities listed by the Government as infrastructure projects in its notification dated March 27, 2012, excluding private hospitals, private educational institutions and private hotels; (ii) projects related to agriculture, agro-processing, cold storage facilities; (iii) industrial corridors or mining activities, national investment and manufacturing zones as designated in the National Manufacturing Policy; (iv) Government administered or Government aided educational and research institutions; (v) sports, health care, transport or space program projects; and (vi) any other infrastructural facilities notified by the Central Government after tabling the notification in the Parliament. KeyProvisions vDefinitionofPublicPurpose -Key Provisions of the New Legislation
  35. 35. Further, public purpose also includes acquisition of land for use by: (a) Public-Private Partnership Projects (PPPs), where ownership of land continues to vest with the Government; and (b) private companies,forthepurposesmentionedabove. The new legislation requires the concerned Government to conduct a Social Impact Analysis (SIA) prior to every acquisition of land. The SIA has to be conducted in consultation with the Panchayat at the village level and at the Municipality or municipalcorporationattheurbanlevel. Further, the SIA has to be completed within six monthsfromthedateofitscommencementandwill take into account, amongst other factors, the social impact of the project on the overall costs of the project vis-a-vis the benefits of the project. The SIA report will be made available in the local language at the offices of the Panchayat, Municipality as the casemaybe. The SIA will be evaluated by an Expert Group, which has to look at whether the project serves any public purpose; or the social costs and adverse social impacts outweigh the potential benefits. It is required to submit its recommendation within two monthsofitsconstitution. The provisions of this Act relating to consent shall apply when the appropriate Government acquires landforthefollowingpurposes,namely:- (a) For public private partnership projects, where theownershipofthelandcontinuestovestwith theGovernment,forpublicpurposeand (b) for private companies for public purpose, provided that in the case of acquisition for- (i) Private companies, the prior consent of at lest eighty per cent of affected families; and (ii) Public Private Partnership projects, the prior consent of at least seventy per cent of affected families shall be obtained through a process as may be prescribed by the appropriate Government. The process of obtaining the consent shall be carried out along with the Social Impact Analysis(SIA)study. vSocialImpactAnalysis(SIA) vConsentforLandAcquisition vCompensationtoLandOwners vRehabilitation & Resettlement (R&R) Entitlements As per the new legislation, the market value of the acquiredlandshallbebasedonthe (i) market value specified in the Indian Stamp Act for the registration ofsaledeeds;or (ii) average of the top 50 per cent of all the sale deeds in the similar type of land situated in the vicinity; whichever is higher. Once the market value is computed, it shall be multiplied by a factor (1-2) for rural areas, based on the distance of the said land from urban areas. Once the total compensation is arrived at, the Collector shall impose a 100 per cent Solatium on it for both rural as well as urban areas. Further, the Collector shall award an amount at the rate of 12 per cent per annum on the market value from the period commencing from date of publication of the SIA till the date of the award of the Collector or the date of takingpossessionoftheland,whicheverisearlier. One of the key provisions of the new legislation is that families owning the land or whose livelihood is affected as a result of land acquisition shall be entitled for a specified R&R package, which has been elaborated in the Schedule II. Affected family insuchcaseswouldinclude- (i) A family whose land or other immovable propertyhasbeenacquired; (ii) A family which does not own any land but a member or members of such family may be agricultural labourers, tenants including any form of tenancy or holding of usufruct right, share-croppers or artisans or who may be working in the affected area for three years prior to the acquisition of the land, whose primary source of livelihood stand affected by theacquisitionofland; (iii) The Scheduled Tribes and other traditional forest dwellers that have lost any of their forest rights recognised under the Scheduled Tribes and Other Traditional Forest Dwellers (Recognition of Forest Rights) Act, 2006 due to acquisitionofland; (iv) Family whose primary source of livelihood for three years prior to the acquisition of the land is dependent on forests or water bodies and 35 AUGUST-SEPTEMBER 2013
  36. 36. 36ECONOMY MATTERS vAdditional Compensation to Original land Owner vProcessofLandAcquisition vReturnofUnutilizedLand vAcquisition of Irrigated Multi Cropped Land vLeasingofLand Bill stipulates that 40 per cent of appreciated land value (profit) should be shared with original land owners in cases where - Any land more than the threshold stipulated by the State Government which has been purchased through private negotiations on or after 5 September 2011 and acquired by the Government within three (3) years of commencement of this Bill; and whenever the ownership of any land acquired under this Act is transferred to any person for consideration, without any development having taken place on such land in proportion to the value at which the landwasacquiredwithinaperiodof5yearsfromthe date of acquisition. For both the cases, benefit shall accrue only on the first sale or transfer that occurs aftertheconclusionoftheacquisitionproceedings. The entire process of land acquisition, starting from Social Impact Analysis (SIA) to possession of land by the concerned Collector (after ensuring full payment of compensation as well as rehabilitation and resettlement entitlements are paid or tendered to the entitled persons) would take a minimum time of56months(see Table1). The New Bill stipulates that any acquired land, if not used for 5 years should be returned to owner or to the State Land Bank in case the land owner does not return the original compensation, as the case may be. The new legislation stipulates certain limits on acquisition of Multi-Cropped Land to be determined by the appropriate Government considering the relevantStatespecificfactorsandcircumstances. The new legislation permits the State Government to exercise the option of taking the land on lease insteadofacquiringtheland. includes gatherers of forest produce, hunters, fisher folk and boatmen and such livelihood is affectedduetoacquisitionofland; (v) A member of the family who has been assigned land by the State Government or the Central Government under any of its schemes and such landisunderacquisition; (vi) A family residing on any land in the urban areas for preceding three years or more prior to the acquisition of the land or whose primary source of livelihood for three years prior to the acquisition of the land is affected by the acquisitionofsuchland; The Bill provides that R&R will be mandatory in case of private purchase of land above a certain threshold, which shall be determined by individual State Governments after considering the relevant state specific factors. Further, it is also stipulated that it is mandatory to file an application with the concerned Collector before acquisition of such land, notifying him of - (a) intent to purchase; (b) purpose for which such purchase is being made; and (c) particularsoflandstobepurchased. No land use change shall be permitted in such cases if rehabilitation and resettlement is not complied withinfull. The proposed Bill has a provision of Retrospective in cases where - (i) notification has been issued but no award under Section 11 of the L.A. Act 1894 has been made; (ii) an award under Section 11 on the L.A. Act of 1894 has been made 5 years or more prior to the commencement of this New Bill but the physical possession of the land has not been taken or the compensation has not been paid; and (iii) more than 50 per cent of land owners have not accepted the compensation. vResettlement & Rehabilitation (R&R) in caseofPrivatePurchaseofLand vRetrospective Applicability of the New Bill
  37. 37. 37 AUGUST-SEPTEMBER 2013 Q.Do you think the proposed Bill will raise the cost of acquiringland?Ifyes,byhowmuch? Q. Apart from the cost, what is industry's view on the process of land acquisition as stipulated in the new Bill? A. As per the proposed provisions in the new Bill, CII estimates predict that cost of land acquisition in the countryislikelytoincreaseby3-3.5times. At a time when economy is trying to recover from the slowdown and National Manufacturing Policy (NMP) has set an ambitious target of creating 100 million jobs by 2025, enhanced cost of land acquisition could severely affect the viability of industrial projects acrosstheboardanderodecompetitivenessofIndian manufacturingsector. We in CII had suggested that since the proposed formula in the new Bill to calculate market value of thelandalreadyhas'Multiplier'totake careofunder- valuation of land, 'Solatium' should be dropped and if at all it has to be retained, it should be reduced from the proposed 100 per cent to 30 per cent. Similarly, R&R provisions should have been worked out separately for each category of affected families, depending upon their losses, with the ultimate objective of improving their quality of lives, post land acquisition. A. The process of land acquisition, starting from the Social Impact Analysis (SIA) up to the possession of the Land by the Collector, as proposed in the new Bill is highly complex and time taking, stretching up to a minimum of 56 Months. This elaborate process needs tobesimplifiedbyeithereliminatingfewprocessesor Q. Do you think the proposed Right to Fair Compensation and Transparency in Land Acquisition, Rehabilitation and Resettlement Bill, 2013 is a step in therightdirection? A. We in CII have always believed that India has and can have enough land for all its requirements - Agricultural, Industrial & Domestic, provided they are used judiciously and 'Supply' is managed efficiently. It is in this background that review of the archaic Land Acquisition Act of 1894 has come at a very appropriatetime. Right to Fair Compensation and Transparency in Land Acquisition, Rehabilitation and Resettlement Bill, 2013, which is currently awaiting President's formal approvalisamilestonesinceitisthefirsteverattempt to combine Resettlement of project affected people and their Rehabilitation (R&R) with land acquisition. Thisbecomesevenmoreimportantinthewakeofthe fact that last decade has witnessed several cases of land acquisition, especially in Government projects where compensation to the project affected people has not been fair and resettlement and rehabilitation measures for the affected people have not been proper. Besides, the fact that Government would continue to acquire land for the Industry, as proposed in the new legislation, is heartening as we have always maintained that Government should have a prominent role in land acquisition as agglomerating land from numerous owners is not a task which corporate sector can do effectively, especially in the absence of proper land records and small & scattered land-holdingsinthecountry. Mr B Muthuraman Chairman, CII National Task Force on Land Acquisition Past President, CII and Vice Chairman, Tata Steel Limited CII View Point LARR Bill: A Step Forward, Yet Industry Has Concerns
  38. 38. 38ECONOMY MATTERS adversely affect Industries that, by nature, grow in phases. Instead, we had suggested for a 'Land Use Plan' framework and align return of land with it, which can be monitored by the Chief Secretary of the concernedStateonacase-to-casebasis. A. Digitization of Land Records: Over decades, the land records have been maintained & upgraded manually onad-hocbasiswithhardlyanyfocusonaccuracyand authenticity. Archaic and un-authentic land records are the biggest pit-falls and road-blocks in land acquisition & disbursement of compensation. To streamline and bring transparency, CII strongly recommends speedy digitization of land records by state Government and the availability of these records on-line. The digitization of land records, across all States, over a specified time period, with comprehensive scrutiny would help make land records transparent, tamper-proof and facilitate detailed planning of land use for industrial, agricultureandresidentialdevelopment. Zoning of Land: Simultaneously with digitization, CII alsorecommendsex-antezoningoflandsoastohave aclearmapping,identificationandsegregationofthe land for various purposes, over a 100 - 150 year horizon. Updating, digitization and zoning of land records will be key for achieving success in the processofsystematicdevelopmentofindustrialland. Set up State Land Bank Corporations: CII recommends setting up of dedicated Institutions for acquiring fallow, barren and unproductive as well as other Lands, ex-ante, for Industrial purposes, as a transparent and viable solution to the problem. The job of these State Land Bank Corporations would be to scientifically acquire large tracts of non-cultivable and other lands, develop them as Land Banks for the future and have a transparent mechanism to pass themontotheprivatesector. Q.Does CII have other suggestions for successfully resolving the issue of Land Acquisition in the long run? making them simultaneous, with an objective to facilitate an acquisition within a minimum time line of 2years. A. Industry has specific concerns and suggestions on some of the key provisions of the proposed new Bill. First, though Government would continue to acquire land for Private Sector and PPP Projects, mandatory consent requirement from affected families - 80 per cent and 70 per cent for private sector & PPP respectively appears to be very high and continues to be a cause of concern. The process of obtaining consent as provided in the new Bill in itself is long drawn out, goes through various stages, taking up to several years. We in CII had suggested that consent provision should be limited to 60 per cent of the land owners. Second, providing for R&R entitlements to affected families in cases of direct acquisition of land from the owners above a certain threshold, to be determined bytheStates,couldalsohavebeenavoided.Assellers would have already bargained for the premium on land value in cases of direct purchase, we had suggested laying down of suitable R&R entitlements onlyforaffectedfamilieswholosetheirlivelihoodasa resultofsuchlandacquisition. Third, retrospective applicability of the new legislation under certain cases has also raised Industry apprehensions. To avoid delays and consequent cost escalation, CII had maintained right from the beginning that where land acquisition notification under section 11 of LA Act 1894 has already been issued and the process of award initiated, land acquisition process should be continuedandnotstartedafresh. Fourth, the provision as per the new Bill stipulating return of the unutilized land after 5 years to owner or totheStateLandBank(SLB),asthecasemaybecould Q.What are some of the other concerns regarding the newBill?
  39. 39. 39 AUGUST-SEPTEMBER 2013 Process (Sequential) Detail Minimum Stipulated Time Social Impact Analysis (SIA) Preparation of Social Impact Analysis(SIA) 6 Months in consultation with the concerned Panchayat, Municipality or Municipal Corporation Multi-disciplinary Expert Group Appraisal of SIA by an independent multi- 2 Months disciplinary Expert Group constituted by the appropriate Government Preliminary Notification Publication of Preliminary Notification along 12 Months with the details of land to be acquired and determination of market value of land Publication of Declaration Appropriate Government to publish the 12 Months declaration after Requiring Body deposits the amount & examining of any objections Award Collector shall make the award 12 Months Corrections to Awards Clerical or Arithmetical Corrections to 6 Months Awards by Collector Possession of Land Collector shall take possession of land 3 Months for the (after ensuring full payment of compensation compensation and a period as well as rehabilitation and resettlement of 6 Months for the entitlements are paid or tendered to the monetary part of R&R entitled persons) entitlements Table 1: Minimum Stipulated Time Frame under Various Processes