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Economy Matters, January 2014


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The world's second largest economy, China, is slowly recovering. Even more importantly, the latest forecasts by the World Bank suggest that high-income economies appear to be finally turning the corner. We cover this 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, trade, and monetary policy.

The Sectoral spotlight for this issue is on Manufacturing, which remains an important sector for realizing the higher growth potential of the economy.

The section on Taxation dwells on BEPS and carries an interview with Mr. Akhilesh Ranjan, Joint Secretary, Ministry of Finance, Government of India on some critical international taxation issues.

In the Special Article, we provide a snapshot of Central Government’s fiscal health along with a detailed Q&A of Mr. R. Seshasayee, Past President & Chairman Economic Policy Council, CII, on the subject.

The section on Special Feature carries an article titled “The Tradeoffs for Policy Makers in India Today”, by Dr. Pronab Sen, Chairman, National Statistical Commission, Government of India.

Published in: Business, Economy & Finance
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Economy Matters, January 2014

  1. 1. ECONOMY MATTERS Volume 19 January 2014 Rev e No. 01 nue Expe ndit ure Fiscal Situation Cover Story Inside This Issue China GDP Slows Down Review of IIP, Inflation & Trade data Interview with Mr Akhilesh Ranjan, Ministry of Finance Interview with Mr R Seshasayee, Past President, CII Corporate Performance for 3QFY14 Special Feature: Policy Trade-offs by Dr Probab Sen
  2. 2. FOREWORD The world's second largest economy, China is slowly recovering, though the pace of recovery has been rather lackadaisical. GDP for 2013 came in at 7.7 per cent- the lowest print in 14 years. In 2013, China tried to maintain strong growth while rebalancing its economy, by moving away from an investment-led growth model to one driven by domestic consumption. Firm recovery in China is very critical for the global economic prospects. The policy makers in China would need to adopt unconventional policy measures to stabilise GDP on higher growth trajectory in 2014, which the country has seen in the last many years. The rebalancing of economic growth in favor of domestic consumption will be crucial in order to achieve this. On the domestic front, the IIP numbers for the month of November 2013 were disappointing and reaffirmed our belief that signs of turn-around are sporadic and at best nascent. On a positive note, WPI inflation moderated to 5-month low in December 2013, driven by deceleration in food prices. RBI meanwhile, chose to hike interest rates again in its third quarter monetary policy review held on 28th January 2014. CII is disappointed with RBI's move as it is important for monetary policy to support growth at this crucial juncture especially when WPI inflation has shown signs of moderation. Low interest rates are the precursor for any meaningful recovery in both investment and consumption demand. Fiscal deficit has already widened to 95 per cent of the budgeted levels in the first nine months of the fiscal, thus raising red flags in the economy. Sluggish revenue growth due to weak GDP growth has been the main driver behind the widening deficit. Unfortunately, the options available in front of the government are clearly limited, given the fact that general elections are due soon. Any compression in plan expenditure in order to meet the fiscal target can be detrimental to growth. Consequently, CII has been advocating several unconventional sources of revenue for the government like utilizing the cash-pile of PSUs, monetising the surplus land lying with them, clearing up the funds held up in disputes and litigations etc time and again in its various dialogues with the government. Chandrajit Banerjee Director-General, CII 1 JANUARY 2014
  3. 3. CONTENT Inside This Issue Executive Summary .................................................03 Global Trends 04 Fiscal Situation Cover Story China GDP Slows Down to 14-year Low but Crosses Official Target Domestic Trends 08 With the fiscal deficit having reached 95 per cent of the budgeted estimates for the entire year in the first nine (AprilDecember) months already, the Finance Minister’s call of not breaching the red-line of fiscal target of 4.8 per cent this year looks increasingly difficult. In the Special Article, we provide an analysis of the fiscal situation so far and its impact on the overall growth prospects. GDP, IIP, Inflation, Trade, Balance of Payments, Monetary Policy Taxation Interview with Mr. Akhilesh Ranjan, MoF 16 BEPS Action Plan on TP Mr Ameya Kunte , Corporate Performance 20 Profitability Improves Sharply for Services, while for Manufacturing Remains Subdued in Q3 Sector in Focus 23 Manufacturing Special Article 30 Fiscal Situation Reining in the Fiscal Deficit Mr R Seshasayee , Past President, CII Subsidy Bill Bidisha Ganguly, Principal Economist, CII Special Feature 36 The Tradeoffs for Policy Makers Dr. Pronab Sen, Chairman, NSC Economy Monitor ................................................... 38 ECONOMY MATTERS 2
  4. 4. EXECUTIVE SUMMARY two quarters is encouraging, especially, since it comes at the back of a lackluster showing in the preceding several quarters. Global Trends China's economy, the world's second-largest, has shown signs of stabilising, as 2013's growth rate matched that for 2012. Gross domestic product (GDP) grew at an annual rate of 7.7 per cent in the October-toDecember period, down from 7.8 per cent in the previous quarter. With this, the full year GDP growth came in at 7.7 per cent, higher than the government's target rate of 7.5 per cent for the year. Coming to the global economies, the latest forecasts for the world economy released by the World Bank recently suggests that after several years of extreme weakness, high-income economies appear to be finally turning the corner, contributing to a projected acceleration in global growth from 2.4 per cent in 2013 to 3.2 per cent this year. Sector in Focus: Manufacturing Manufacturing sector has played a robust role in driving the GDP growth in the 2005-11 period, when it was growing at around 9 per cent CAGR. However, since then, industry has posted an overall slump, with manufacturing GDP growth at around 3 per cent in 201112 and at around 1 per cent in 2012-13. This is in sharp contrast to the over 10 per cent average annual growth that the sector needs in order to reach its aspiration of 25 per cent share in national GDP by 2022, as envisaged by the National Manufacturing Policy. However, multiple opportunities exist even in this environment; new avenues are still opening up. The depreciation of the currency in 2013 has lent optimism to Indian manufacturers as regards exports. A good monsoon has raised hopes of strong rural demand. Overall, industry is more confident of achieving a higher growth going forward as compared to previous years. Domestic Trends Industrial sector output contracted for the second consecutive month in November 2013, despite a supportive base effect. Industrial output declined to 2.1 per cent in November 2013, worsening from the -1.6 per cent print seen in the previous month. In a positive sign, WPI based inflation moderated to 5-month low of 6.2 per cent in December 2013 as compared to 7.5 per cent in the previous month on the back of cooling of primary food inflation and subdued manufacturing inflation. However, in an unanticipated move, Reserve Bank of India (RBI) in its third quarter monetary policy review held on 28th January 2014 chose to hike the repo rate by 25 bps to 8.00 per cent, citing stickiness in core CPI. Special Article With the fiscal deficit having reached 95 per cent of the budgeted estimates for the entire year in the first nine (April-December 2913) months already, the Finance Minister's firm call of not breaching the red-line of fiscal target of 4.8 per cent this year looks increasingly difficult. A challenging domestic and external economic environment has kept the revenue growth low, while expenditures have so far not shown any signs of abatement. Given that the general elections are due soon, the options available to the government to restrict the fiscal deficit within the budgeted levels of 4.8 per cent are clearly limited. The urgent task, therefore, is to prune expenditure while trying to boost government revenues, especially tax revenues. The axe is bound to fall on plan expenditure and that in turn will have a negative impact on the growth momentum. Under this scenario, it is best for the government to opt for getting revenue from unconventional sources. CII has suggested several innovative measures to prop up the government's revenue stream. Corporate Performance The analysis of the results of the firms in India, which have declared their results so far for the third quarter (Q3) of current financial year, suggests an improvement in their financial result at the aggregate level. It may recalled that the firms had recorded an improvement in their sales growth in the second quarter as well after disappointing previous few quarters as per the RBI analysis of 2,708 listed nongovernment non-financial (NGNF) companies. This improvement in corporate performance for the last 3 JANUARY 2014
  5. 5. GLOBAL TRENDS China GDP Slows Down to 14-year Low but Crosses Official Target was the lowest GDP print in 14 years. Consumer price inflation rose by 2.6 per cent in 2013, with the maximum increase coming from food articles. In 2013, China tried to maintain strong growth while rebalancing its economy, by moving away from an investment-led growth model to one driven by domestic consumption. Firm recovery in China is very critical for the global economic prospects. The policy makers in China would need to adopt unconventional policy measures to stabilise GDP on higher growth trajectory in 2014, which the country has seen in the last many years. The rebalancing of economic growth in favor of domestic consumption will be crucial in order to achieve this. C hina's economy, the world's second-largest, has shown signs of stabilising, as 2013's growth rate matched that for 2012. Gross domestic product (GDP) grew at an annual rate of 7.7 per cent in the October-toDecember period, down from 7.8 per cent in the previous quarter. With this, the full year GDP growth came in at 7.7 per cent, higher than the government's target rate of 7.5 per cent for the year. To be sure, this Moderate GDP Growth in 2013 y-o-y% 8.2 8.1 8 7.9 7.8 7.8 7.7 7.7 7.6 7.6 7.5 7.4 7.4 7.2 7 1Q12 2Q12 3Q12 4Q12 Source: National Bureau of Statistics ECONOMY MATTERS 4 1Q13 2Q13 3Q13 4Q13
  6. 6. GLOBAL TRENDS In 2013, Chinese policymakers took various steps to open up new avenues of growth. China announced dramatic new social and economic policies contemplating much greater reliance on market forces than it has in the past and inviting private-sector participation and foreign competition in industries, previously controlled by the central government. It also relaxed its one-child policy, opening the country and its people to vast new opportunities. In 2013, the total value added of the industrial enterprises above designated size was up by 9.7 per cent at comparable prices. Specifically, the year-on-year growth of the first quarter was 9.5 per cent, 9.1 per cent for the second quarter, 10.1 per cent for the third quarter and 10.0 per cent for the fourth quarter. Coming to the demand-side, investment in fixed assets (excluding rural households), a measure of government spending on infrastructure, grew by 19.6 per cent in 2013. Retail sales, a key indicator of consumer spending, gained 13.6 per cent on year-on-year basis in December 2013 and rose 13.1 per cent in 2013. Additionally, in order to boost trade, a free trade zone was launched in Shanghai recently. However, challenges are galore for the economy as it steps into 2014. One of the several concerns for the economy currently is the growth of shadow banking - lending by non-banking companies - in the country. Shadow banking makes credit less transparent and poses a major risk to China's economic growth. China is thought to be drafting rules calling for greater supervision and monitoring of the shadow banks. Banks have been told to publish data on 12 key indicators, including offbalance-sheet assets, to enhance their transparency. The total value of imports and exports in 2013 came at US$4,160.3 billion, which translates into an annual increase of 7.6 per cent. Out of this, the total value of exports stood at US$2,210.0 billion, up by 7.9 per cent on y-o-y basis; while the total value of imports was at US$ 1,950.3 billion, registering a y-o-y increase of 7.3 per cent in 2013. Consequently, the trade balance stood at US$259.75 billion for 2013. World Bank Upbeat about 2014 Global Growth The latest forecasts for the world economy released by the World Bank recently suggest that after several years of extreme weakness, high-income economies appear to be finally turning the corner, contributing to a projected acceleration in global growth from 2.4 per cent in 2013 to 3.2 per cent this year, 3.4 per cent in 2015, and 3.5 per cent in 2016, as the drag on growth from fiscal consolidation and policy uncertainty eases and private sector recoveries gain firmer footing. Highincome countries growth is projected to strengthen from only 1.3 per cent in 2013 to 2.2 per cent this year and 2.4 per cent in each of 2015 and 2016. This strengthening of output among high-income countries marks a significant shift from recent years when developing countries alone pulled the global economy forward. United States ticked up in response to expectations of the gradual withdrawal of quantitative easing. Other major headwinds included declining commodity prices for commodity exporters. Overall, growth in developing countries is projected to pick up modestly from 4.8 per cent in 2013 to 5.3 per cent this year, 5.5 per cent in 2015, and 5.7 per cent in 2016. However, it is pertinent to note that the developing-country GDP growth will be about 2.2 percentage points weaker than it was during the precrisis boom period. The developing countries will not cover the entire lost ground because growth in those years was unsustainably high, partly because of the global credit bubble. As per the report, India will see the strongest economic recovery among the major developing economies between 2013 and 2016. Its rate of expansion will go up by 2.3 percentage points, from 4.8 per cent in 2013 to 7.1 per cent in 2016. Interestingly, World Bank projections suggest that the gap between economic growth rates of India and China could narrow sharply by 2016. Chinese economic growth will remain at current levels while Indian growth will accelerate. There will be only a 0.4 percentage point gap in 2016 compared with the 3.1 percentage points gap in 2014. The latest edition of the Global Economic Prospects report published by the multilateral lender further adds that the activity and sentiment in developing countries have turned up since mid-2013, bolstered by strengthening high-income demand and a policyinduced rebound in China. These positive developments were partly offset by tighter financial conditions and reduced capital flows as long-term interest rates in the 5 JANUARY 2014
  7. 7. GLOBAL TRENDS World Bank's GDP Growth Forecast (y-o-y %) 8.0 7.7 6.5 6.2 3.2 3.0 2.8 2.8 1.1 0.9 Jun'13 Jan'14 Jun'13 World Jan'14 Jun'13 US Jan'14 Jun'13 Euro Area Jan'14 Jun'13 China Jan'14 India Source: Global Economic Prospects, January 2014- World Bank US Unemployment Rate Falls to 6.7 Per cent The unemployment rate in US declined from 7.0 per cent to 6.7 per cent in December 2013, the lowest since October 2008, as more people dropped out of the labor force. The labor force participation rate, which gauges the proportion of the working-age population in the labor force, slipped to 62.8 percent, down 0.8 percent from a year ago, and the lowest since February 1978. However, the U.S. economy added only 74K jobs in December, the smallest increase since January 2011. The unseasonably severe winter weather last month probably played a part in the disappointing December jobs number. November was revised to 241,000 from 203,000, while October's gain was unchanged at 200,000. Of the 74K jobs created in December, 55K were in retail, above its average of 32K in 2013. Health care was down 6K, a huge drop from its 2013 average of adding 17K jobs. Manufacturing added 9K jobs and construction jobs were down by 16K US Unemployment Rate Falls Sharply Thousand of Jobs 332 350 8 300 238 250 199 200 148 176 241 175 172 200 7 142 150 89 100 74 6 Source: US Bureau of Labour Statistics 6 Dec/13 Nov/13 Oct/13 Sep/13 Unemployment Rate (RHS) US NFP ECONOMY MATTERS Aug/13 Jul/13 Jun/13 May/13 Apr/13 Mar/13 Feb/13 Jan/13 50
  8. 8. GLOBAL TRENDS Other Global Developments During the Month The US v Federal Reserve in its meeting held on January 29th, 2014, reduced its asset purchase program further from US$75 billion/month in the month of January to US$ 65 billion month in February. Fed would trim its purchases of long-term Treasury bonds to US$35 billion/month (from US$40 billion) and mortgage-backed securities (MBS) to US$30 billion/month (from US$35 billion). This was Ben Bernanke's last policy meeting as the Fed Chairman. Jenet Yellen takes over as new Fed Chairperson from the next policy. The Consumer price Index (CPI) in the UK grew 2.0 per cent on y-o-y basis in December 2013, falling to its target v level for the first time since November 2009. The inflation has eased dramatically in the last quarter of 2013, averaging 2.1 per cent, in Q4, sharply lower from 2.7 per cent in September 2013. The largest negative contribution came from 'food and non-alcoholic beverages', wherein inflation eased from 2.8 per cent in November to 1.9 per cent last month, marking its lowest level since February 2010. On the other hand, the contribution of 'transport' items - especially petrol and diesel - increased in December 2013. U.K. unemployment fell to 7.1 per cent in the three months through November from 7.4 per cent in the quarter v through October 2013. The data will add pressure on BOE Governor Mark Carney to reassess his guidance policy, under which the Monetary Policy Committee has said it will consider raising interest rates once joblessness has fallen to 7 per cent. In an v update to its World Economic Outlook report, IMF predicted the global economy would grow 3.7 per cent this year, 0.1 percentage point higher than its October 2013 projection. It said it sees growth of 3.9 per cent in 2015. IMF highlighted the basic reason behind the stronger global recovery as the brakes to recovery being progressively being loosened. As per the Fund, United States is likely to be one of the bright spots, after a budget deal in Congress reduced some of the government spending cuts that had weighed on domestic demand. 7 JANUARY 2014
  9. 9. DOMESTIC TRENDS GDP, IIP, Inflation, Trade, Balance of Payments, Monetary Policy underpinned by robust performance by exports sector. Industry growth picked up to 2.4 per cent in Q2FY14 from a mere 0.2 per cent in the previous quarter. The revival in industry was led by an improvement in the construction and utilities sector. Manufacturing growth remained weak at 1.0 per cent, albeit it moved into the positive territory from the previous quarter. On the aggregate demand-side, though high interest rates in the economy continue to impact private final consumption expenditure growth, a vibrant rural economy helped to negate some of the ill-effect, thus pushing its growth to 2.2 per cent from 1.6 per cent in the previous quarter. Growth in gross fixed capital formation or investment moved into the positive territory in second quarter, clocking a growth of 2.6 per cent as compared to decline to the tune of 1.2 per cent in the previous quarter. G DP data released on 29th November, 2013 showed that growth increased to 4.8 per cent in the second quarter of the current fiscal (Q2FY14 henceforth) as compared to 4.4 per cent in the quarter before, mainly led by healthy performance by the agriculture sector and mild upturn in industry. With this the first-half growth stands at 4.6 per cent as compared to 5.3 per cent in the same period last year. From the demand-side, GDP picked up to its highest value since March 2012, Real GDP increases in 2QFY14 GDP at factor cost GDP at market prices 5.6 4.8 4.7 4.8 4.4 4.1 3.0 2.4 3QFY13 4QFY13 1QFY14 Source: CSO ECONOMY MATTERS 8 2QFY14
  10. 10. DOMESTIC TRENDS The CSO released the revised estimates for 2011-12 and 2012-2013 and final estimates for 2010-11. According to the revised estimates, the economy had grown by 4.5 per cent in 2012-13, compared with the earlier estimate of 5 per cent. Similarly, the growth for 2010-11 was revised downwards to 8.9 per cent from 9.3 per cent earlier. However, GDP growth in 2011-12 has been revised upwards to 6.7 per cent from 6.2 per cent. The major concern emerging from these estimates is the downward revision of growth in 2012-13, which is the lowest in a decade. Even more worryingly, the low growth continues to persist in the current year as well. CII has been for long highlighting that the heightened downside risks to growth will become more entrenched unless bold measures are taken by the policymakers. Even though GDP growth picked up in the 2QFY14, it continues to remain the below 5 per cent growth for the fourth consecutive quarter. We expect growth to pick up from the 4.6 per cent clocked in the first-half in the second-half of the current year and consequently expect GDP to come in a range of 5.3-5.8 per cent in the current fiscal. The RBI would need to take the lead and should start the monetary easing cycle at the earliest in order to ensure that growth picks up in the second-half. GDP for the third quarter is due to be released on 28th February, 2014. Outlook The second quarter GDP data has raised hopes that growth has bottomed out. However, although the worst may be over for the economy, a recovery will not be substantive. The overall growth this fiscal year would remain below 5 per cent. The positive signals from the second quarter data included higher-than-anticipated farm output growth and robust exports growth. Going forward, real risk to GDP growth will come from stalling consumption and investment demand which are holding up economic recovery. The prospect of fiscal squeeze by the government, by restraining capital expenditure, may also impact growth. The Bad News on the Industrial Growth Front Continues Industrial sector output contracted for the second consecutive month in November 2013, despite a supportive base effect. Industrial output declined to 2.1 per cent in November 2013, worsening from the -1.6 per cent print seen in the previous month. The decline in IIP during the month was underpinned by contraction in its sub-sectors such as manufacturing and consumer goods. The sequential momentum declined too as the seasonally-adjusted month-on-month series moved into the negative territory in during the month. On a cumulative basis, for the first eight months of the fiscal, industrial output has now contracted by 0.2 per cent. Dismal performance by industrial output growth was preceded by muted performance of the eight crucial sectors of the economy in November 2013, which expanded by mere 1.7 per cent. The eight core industries-coal, crude oil, natural gas, refinery products, fertilisers, steel, cement and electricity--have a combined weight of 37.9 per cent in IIP. The November core sector data revealed dismal performance in the natural gas, fertiliser and petroleum refinery sectors. Natural gas output fell 11.3 per cent on year-on-year basis during the month. IIP Contracts for Second Consecutive Month y-o-y% SA m-o-m% 10 5 0 -0.1 -2.1 9 Nov/13 Sep/13 Jul/13 May/13 Mar/13 Jan/13 Nov/12 Sep/12 Source: CSO Jul/12 -5 JANUARY 2014
  11. 11. DOMESTIC TRENDS On the use based front, the consistently volatile capital goods segment continued to remain in the positive territory, albeit growing at a lower rate as compared to October 2013. The sector's growth moderated to 0.3 per cent in November 2013 from 2.4 per cent in the previous month. Consumer goods remain a drag on overall IP growth primarily led by the continuing weakness in the durables goods sector. During the reporting month, consumer goods output declined for the second consecutive month to 8.7 per cent in November 2013 as compared to -4.9 per cent in the previous month. It's pertinent to note here that output of consumer durables, one of the sub-sectors of consumer goods, has now remained in red since the starting of the current fiscal. Such a poor performance by the sector is a matter of concern as it is widely regarded as a proxy for consumption growth. Non-durables on the other hand remained in the positive territory, albeit showing a flattish growth in November 2013 as compared to October 2013. Going ahead we expect recovery in this component as good agricultural GDP this year will support rural demand, which will prop up non-durables even if urban demand remains weak. On the sectoral front, manufacturing sector output, which constitutes over 75 per cent of the index, declined by 3.5 per cent in November as against a contraction of 0.8 per cent a year ago. This is the fifth negative data print of manufacturing output so far in this fiscal and has elevated the upside risks to growth. In terms of industries, ten (10) out of the twenty two (22) industry groups (as per 2-digit NIC-2004) in the manufacturing sector showed negative growth during the month of November 2013 as compared to the corresponding month of the previous year of manufacturing sector. The industry group 'Radio, TV and communication equipment & apparatus' showed the highest negative growth of (-) 42.2 per cent, followed by (-) 27.5 per cent in 'Office, accounting & computing machinery' and (-) 19.5 per cent in 'Furniture; manufacturing'. Mining sector output which has declined by 2.2 per cent in the year till date so far, moved into the positive territory, growing by 1.0 per cent in November 2013 as compared to contraction of 3.2 per cent in the previous month. Barring a few intermittent months, electricity sector growth has remained on a strong footing this fiscal, growing at an average 5.4 per cent in April-November 2013. Sectoral Growth (y-o-y, %) Apr-Nov Weight Nov-12 Sept-13 Oct-13 Nov-13 FY13 FY14 1000.0 -1.0 2.0 -1.6 -2.1 0.9 -0.2 Manufacturing 755.3 -0.8 0.6 -1.8 -3.5 0.9 -0.6 Mining 141.6 -5.5 3.3 -3.2 1.0 -1.6 -2.2 Electricity 103.2 2.4 12.9 1.3 6.3 4.4 5.4 Basic 456.8 1.1 5.3 -1.4 0.7 2.8 0.7 Capital 88.3 -8.5 -6.7 2.4 0.3 -11.3 -0.1 Intermediates 156.9 -1.4 4.2 2.2 3.3 1.8 2.7 Consumer Goods 298.1 -0.3 0.7 -4.9 -8.7 3.6 -2.6 84.6 1.1 -10.8 -12.1 -21.5 5.2 -12.6 213.5 -1.5 11.6 2.2 2.5 2.3 6.3 General Use-Based -Durables -Non durables Source : CSO Outlook The two consecutive negative data prints of industrial production is a worrying trend. It clearly conveys the message that much more needs to be done to revive investment. The government should ensure that projects getting cleared by the Cabinet Committee on Investment (CCI) are implemented on the ground. Government policies should be complemented with a shift towards an accommodative policy announcement by the RBI in its forthcoming monetary policy to revive investment and propel demand. ECONOMY MATTERS 10
  12. 12. DOMESTIC TRENDS Inflation Moderates as Food Prices Cool-Off on-month series slipped into the negative territory during the reporting month. To be sure, consumer prices based inflation (CPI) too slowed down, moving into single digits after a gap of two months. For the month of December 2013, it came at 9.87 per cent as compared to 11.2 per cent in the previous month. The moderation in food inflation in the month of December 2013 was expected due to seasonal factors and off-load of fresh vegetable supply in the market. WPI based inflation moderated to 5-month low of 6.2 per cent in December 2013 as compared to 7.5 per cent in the previous month on the back of cooling of primary food inflation and subdued manufacturing inflation. Amongst the primary food prices, vegetable prices which have been the main driver behind pushing overall WPI higher in the last few months, moderated to 57.3 per cent in December 2013 from record high of 95 per cent seen in the previous month. The momentum indicator indicated by the seasonally-adjusted month- Both WPI & CPI Inflation Moderate 12 10.3 10 9.9 8 7.5 6 6.2 4 WPI y-o-y% Dec/13 Oct/13 Aug/13 Jun/13 Apr/13 Feb/13 Dec/12 Oct/12 Aug/12 Jun/12 Apr/12 2 CPI (Combined) y-o-y% Source: Office of Economic Advisor Primary inflation decelerated to 5-month low of 10.8 per cent in December 2013 from 15.9 per cent in the previous month and average of 14.5 per cent seen in the last 4months. This was mainly attributable to the sharp slowing down of food inflation to 13.1 per cent as compared to almost 20 per cent a month ago. Amongst primary food inflation, vegetable prices declined by nearly 30 per cent on month-on-month basis in December 2013 led by massive decline in items such as onions and tomatoes. Encouragingly, the prices of products other than vegetables also witnessed healthy decline during the reporting month. Non-food inflation too moderated to 6.0 per cent as against 7.6 per cent in the previous month. Inflation in minerals to decelerated sharply to 2.1 per cent from 6.1 per cent in the previous month. Fuel inflation remained stable at 11.0 per cent in December 2013 as compared to the reading in the previous month. Though on month-on-month basis, it did show a 0.8 per cent increase, driven by rise in prices LPG, electricity and high speed diesel. High-speed diesel inflation rose to 17.0 per cent during the month as compared to 15.7 per cent in the previous month. Going forward, we expect fuel inflation to moderate due to stabilisation witnessed in global crude prices and the recent strengthening of the Rupee. Manufacturing inflation remained subdued and broadly unchanged at 2.6 per cent in December 2013, led by across the board correction in prices. Non-food manufacturing or core inflation which is widely regarded as the proxy for demand-side pressures in the economy too remained stable at 2.8 per cent during the 11 JANUARY 2014
  13. 13. DOMESTIC TRENDS month as compared to 2.7 per cent in November 2013. The stability in the core inflation since the last two quarters is an indication of weak pricing power of the corporate. In the coming months, we expect core WPI to remain at sub 3 per cent, RBI's comfort level for this inflation measure. Mirroring the sharp deceleration in primary food inflation, manufactured food products inflation also slowed down to 1.8 per cent in December 2013 from 2.5 per cent in the previous month. Sectoral Components of Inflation April-Dec Weight Dec-12 Oct-13 Nov-13 Dec-13 FY13 FY14 General 100.0 7.3 7.2 7.5 6.2 7.6 6.2 Primary 20.1 10.6 14.6 15.9 10.8 9.8 10.9 - Food 14.3 11.2 18.3 19.9 13.1 9.6 14.1 - Non-Food 4.3 13.6 7.1 7.6 6.0 10.4 5.8 - Minerals 1.5 5.6 4.6 6.1 2.1 10.7 0.8 14.9 10.2 10.5 11.1 11.0 10.7 10.2 - Petrol 1.1 3.4 5.3 4.4 5.4 7.4 2.3 - High Speed Diesel 4.7 14.6 14.6 15.7 17.0 8.7 20.5 65.0 5.0 2.8 2.6 2.6 5.7 2.8 - Food 10.0 8.7 2.3 2.5 1.8 8.1 3.9 - Non-food 55.0 4.3 2.9 2.7 2.8 5.2 2.6 Fuel Manufacturing Source: Office of Economic Advisor Outlook December month's inflation data print both at retail and wholesale level has been reassuring and conforms to RBI's expectation of a notable correction on account of decline in vegetable prices. Stability in core inflation is an indicator of weak demand conditions. Moreover, the lagged effects of effective monetary tightening since September 2013 would also exert an opposite force on inflation in the coming months. Consequently, we expect the RBI to cut rates in its forthcoming monetary policy review, in order to provide a fillip to falling growth. Inflation Control Finds Priority with RBI Reserve Bank of India (RBI) in its third quarter monetary policy review held on 28th January 2014 chose to hike the repo rate by 25 bps to 8.00 per cent. Citing concerns regarding the stickiness in core CPI and upward bias in core WPI inflation, the Central Bank made it aptly clear that only by bringing down inflation to a low and stable level that monetary policy can contribute to reviving consumption and investment in a sustainable way. The Central Bank also implicitly appears to have accepted Dr. Urijit Patel Committee's recommendations to strengthen the monetary policy framework and hence, ECONOMY MATTERS the hike is also in consonance with upside risks towards achievement of the 12-month target of 8 per cent for headline CPI inflation, the new nominal anchor. In its policy review, RBI mentioned that the GDP growth is expected to firm up from sub 5 per cent in the current fiscal to 5-6 per cent in next fiscal with support from exports, pick up in investment and expected decline in inflation levels. CPI inflation was expected to decline to close to 9 per cent by March-2014 and continue to fall in FY2015, though upside risks remain to the central forecast of 8 per cent 12
  14. 14. DOMESTIC TRENDS RBI Hikes Repo Rate (%) 10.00 9.00 8.00 8.00 7.00 7.00 6.00 5.00 4.00 4.00 Repo rate Reverse repo rate Jan-14 Aug-13 Mar-13 Oct-12 May-12 Dec-11 Jul-11 Feb-11 Sep-10 Apr-10 Nov-09 Jun-09 Jan-09 Aug-08 Mar-08 Oct-07 3.00 CRR Source: RBI CII is surprised by the RBI's decision to increase the repo rate, when all indicators were suggesting maintaining a 'status-quo'. While the overwhelming concern of the monetary authorities is to keep inflation under check, it is also expected that the RBI should have taken cognisance of the faltering investment and consumption demand which is preventing the economy from realising its growth potential. India has entered a cycle where higher interest rates are leading to subdued demand conditions resulting in lower growth and investment. This in turn is aggravating the supply bottlenecks and adding to inflationary pressure, thereby inducing the RBI to hold on to higher interest rates. This circularity can be broken only by a change in the monetary policy stance sooner than later. And this is an opportune time to accord precedence to growth over inflation especially as prices are trending downwards and inflationary expectations are not unduly high in view of a robust performance by the agriculture sector. Exports Growth Weakens for the Second Consecutive Month The pace of expansion of exports slackened for the second consecutive month in December 2013. Exports growth moderated to 3.5 per cent in December 2013 as compared to 5.9 per cent in the previous month. The slowdown was attributable primarily to decline in the shipments of petroleum products during the month. Exports of petroleum products fell 16 per cent to US$4.8 billion in December 2013. That was mainly due to an unexpected maintenance shutdown by energy giant Reliance Industries, India's biggest exporter of petroleum products and second-biggest company by market value. Exports had been growing at a doubledigit rate until October but lost momentum in the last two months, signalling that the worst might not be all over as yet for the Indian economy. Cumulative value of exports for the first nine months of the current fiscal (Apr-Dec) were valued at US$230.3 billion as against US$217.4 billion a year ago, thus registering a year-onyear growth of 5.9 per cent. Imports during December 2013 were valued at US$36.5 billion, posting a decline to the tune of 15.3 per cent over the same month last year, as weak domestic demand and restrictions on gold imports lowered non-oil imports by nearly 23 per cent on year-on-year basis. India imports almost all of the gold it consumes. The yellow metal is the country's second-biggest import after oil and was an important reason for driving the country's current account gap to a record high last year, pushing the rupee sharply lower. Oil imports rose slightly by 1.0 per cent reversing the fall seen last month. Going forward, consumption goods import may pick up as household consumption improves. A revival in household demand would be supported by higher farm incomes due to a good monsoon. 13 JANUARY 2014
  15. 15. DOMESTIC TRENDS External Sector Performance (y-o-y %) 20 10 3.5 0 -10 -15.3 Exports Dec/13 Oct/13 Aug/13 Jun/13 Apr/13 Feb/13 Dec/12 Oct/12 Aug/12 Jun/12 Apr/12 -20 Imports Source: Ministry of Commerce As the pace of decline of imports waned, without a commensurate rise in exports growth, trade deficit in December 2013 widened slightly to US$10.1 billion from US$9.2 billion in November 2013. On a cumulative basis, trade deficit came in at US$110.0 billion in AprilDecember FY14, lower than a deficit of US$146.8 billion during the same period in FY13. Outlook The economic conditions in the U.S. and the Euro Zone are not very favorable for exports and we hope the Indian government will help the exporters by providing help by way of including more products and countries for Focus Product Scheme and Focus market Scheme, where we have a comparative advantage. Also we need to relook at the duty drawback rates. These measures, if announced at the earliest will give the necessary push to the industry which can then benefit the industry and help them reach the export target. Current Account Deficit Improves Sharply in 2QFY14 The latest data released for the second-quarter of 201314 on December 3rd, 2013 shows that the current account deficit (CAD) narrowed sharply to 1.2 per cent of GDP from 4.9 per cent in the previous quarter. Narrowing of CAD was primarily on account of lower trade deficit on the back of sharp compression in gold imports and encouraging growth in exports. Merchandise trade deficit narrowed to US$33.3 billion in Q2 (7.9 per cent of GDP) due to the turnaround in export growth and decline in imports. In value terms CAD was recorded at a 16 quarter low of US$5.2 billion as compared to US$21.8 ECONOMY MATTERS billion in Q1FY14. On the capital account, foreign investment witnessed marginal inflows of US$0.3 billion as FDI net inflows (i.e. US$6.9billion) in Q2 were negated by portfolio outflows (US$6.6 billion). While the outflow on portfolio account was anticipated, sharp decline in banking capital inflows and other capital outflows worth US$6.9 billion led to a drawdown of US$10.3 billion on forex reserves. Correspondingly, BoP witnessed a deficit of US$10.4 billion in Q2 as against a deficit of US$0.3 billion in Q1. 14
  16. 16. DOMESTIC TRENDS Current Account Deficit Narrows Sharply in 2QFY14 35 8 6.7 30 5.4 6 25 4.9 32.6 3.6 20 4 15 21.8 12.6 18.1 1.2 10 2 5 5.2 0 0 2QFY13 3QFY13 3QFY13 1QFY14 2QFY14 CAD (as a % of GDP) RHS CAD (US$ billion) Source: RBI Outlook Continued improvement in export performance and expected traction in invisibles inflows are expected to support a lower reading on the current account deficit. The reduction in imports would further help ease pressure on CAD. Consequently, CAD during the current fiscal is expected to come down to 2.6 per cent, as predicted by the government. On the capital account, improving domestic growth outlook amid receding concerns on CAD are likely to partially counterbalance the concerns on taper and as such may improve the outlook on equity flows going forward. Know Your Facts: Banking Stability Index* The quality of assets in the Indian banking system has emerged as a cause of concern for the central bank in recent times. The asset quality has suffered due to a rise in the non-performing loans. It is also worrying for policymakers that a large portion of distressed assets in the banking system is concentrated in just a few sectors such as infrastructure, aviation, mining and textile. Concentration of bad assets in a handful of sectors increases the risk for the banking system as default in one sector can put significant pressure on the balance sheet of several banks. Further, since the banking and the financial system is highly interconnected, the failure of one bank, or some banks, is likely to affect the stability of other banks. This interdependence is measured by the Banking Stability Index. The Reserve Bank of India (RBI) defines Banking Stability Index (BSI) as "the expected number of banks that could become distressed given that at least one bank has become distressed". The Financial Stability Report (FSR), released by RBI on the 30 December 2013, highlighted that the BSI has gone up since August 2013. This means that more banks are expected to become distressed if one bank in the system is distressed. *Adapted from Mint dated January 02, 2014 15 JANUARY 2014
  17. 17. TAXATION Govt.'s View Point on Some Critical International Taxation Issues Guest Interview Q2: What is the current status of renewed dialogues with US Competent Authorities? Are you expecting any major cases to be closed? Ans 2: Renewed dialogue with the US is progressing along planned lines. There may be a meeting very soon and we sincerely hope that at least a few cases will be resolved by end-March. Mr Akhilesh Ranjan Joint Secretary (FT&TR-I) Department of Revenue, Ministry of Finance Government of India Q 3: The APA process has been very smooth so far. Are you expecting APA closure in the coming weeks? Any changes to be made in the APA process in coming months after first year learnings? Q1: The response to Transfer pricing safe harbour filings has not been encouraging. What would be the main reasons for the same and anything more that Government is contemplating to make safe harbour more acceptable? Ans 3: We are happy to note the public response to the APA process. We are certainly hoping that agreements will be reached in a few cases perhaps in February itself but the procedural aspects are likely to take some time and so the actual APAs may not start rolling out before March. Government is examining the issue of the possibility of bilateral APAs even where the relevant DTAA does not have Article 9(2) in it. Ans 1: Response has also not been discouraging. We gather that it was more of taxpayers not being sure how everyone else was responding to the rules! Also, there are probably some definitional issues that are creating uncertainties and we would shortly be going into them for the purposes of further clarifying Government intent. ECONOMY MATTERS Q 4: Is India looking at "Cyprus" like situation with more treaty partners to enforce effective exchange of information? 16
  18. 18. TAXATION Ans 4: Efforts are being made to resolve issues in this regard with some countries. We hope there will be no further occasion to take strong unilateral steps. What are the important "asks" put forward by India ? Ans 6: India is engaging quite closely with other G20 member countries in the BEPS process. We are involved in almost all of the different action points. India is also part of the BEPS Bureau Plus which is coordinating and guiding the work being done in all areas. We would request Indian industry, particularly through the CII, to carefully examine the BEPS discussion papers that have now started coming out for public consultation and forward to us their valued comments. The first paper on Transfer Pricing Documentation is already out. Q 5: There has been reorganisation in FT&TR. How will these changes affect delivery of services to taxpayers? Ans 5: The work distribution in FT&TR had become quite uneven. It is hoped that the redistribution will enable faster and more focused work in important areas. Q 6: Has the Indian Government provided its comments and feedback as part of the BEP's consultative process? ECONOMY MATTERS The Facts Keeps readers abreast of global & domestic n economic developments Monthly Journal of top management of 8000 n companies Read n by CII Members, Thought Leaders, Diplomats, Policy Makers, MPs and other decision makers The Coverage Global n Trends Trends n Corporate Performance n Sector in Focus Special Article n Special Feature n Economy Monitor n n Domestic CII invites full-page* Advertisements for this flagship document at an attractive rate of Rs 60,000 per issue and Rs 6 lakh for 12 issues. For more details, Please Contact: Dr. Danish A. Hashim, Director- Economic Research 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: 17 JANUARY 2014
  19. 19. TAXATION BEPS Action Plan on Transfer Pricing Changing Rules of the Game? intangibles and TP documentation are some of the significant action points, which are especially relevant in the current Indian context. Why TP in focus under BEPS? Tax treaties determine allocation of taxing rights between countries. Transfer pricing on the other hand determines quantum of allocation profits (and therefore the tax base) between countries arising out of transactions associated entities. OECD has found "arm's length" as solution to deal with transfer pricing. The arm's length principle is founded on the basis that profit allocation will follow "functions, assets and risks (FAR)". India too has adopted arm's length approach for its Transfer pricing law and it is a subject matter of great debate between taxpayers and Revenue authorities in last 5 years. Mr Ameya Kunte Executive Editor and Co-Founder BEPS in Brief OECD's ambitious Base Erosion and Profit Shifting project essentially arises out of concerns on double "non-taxation". BEPS behaviour arises because under existing international tax and treaty rules, MNCs are able to artificially separate allocation of their taxable profits from jurisdictions in which these profits arise. This has caused severe strain on Governments' resources in last few years as well as is harming individual tax payers. The G20 finance ministers called on the OECD to develop an action plan to address BEPS issues in a co-ordinated and comprehensive manner. OECD in July 2013, released a 15 points action plan addressing various issues arising out of BEPS behaviours. However, OECD now believes that arm's length creates an incentive to shift functions/assets/risks to jurisdiction where their returns are taxed more favourably. Out of the three, risk and ownership of assets (especially intangibles) is easier to shift to low tax jurisdictions. Thus, shifting of income using contractual arrangements has resulted in base erosion and profiting shifting behaviour. Also, the TP rules on risk and asset attribution within Group are applied on an entity-byentity basis. Thus, it was perceived that current TP Guidelines are putting too much emphasis on legal structures rather than on the underlying reality of economically integrated group. This resulted in BEPS. OECD has also acknowledged that media attention on transfer pricing especially intangibles has been one of the major reasons for its focus under BEPS. The approach in BEPS Action Plan involves coherence of taxation, realigning taxation with substance and bringing more transparency. The significance of BEPS project suggests change in the approach by OECD, from "Bottom Up" to "Top Down". OECD states that it is developing international policy to tackle BEPS with commitment first at highest political level within OECD and G20 Countries. The G20 Leaders endorsed BEPS Action Plan during their meeting in September 2013 at the Saint Petersburg Summit. It is relevant note that all non-OECD G20 countries (Argentina, Brazil, China, India, Indonesia, Russia, Saudi Arabia and South Africa) are participating in BPES project on an equal footing with OECD countries. BEPS Action Plan for TP Out of the 15 action points under BEPS, four specifically deal with transfer pricing. OECD states that the current transfer pricing system leads to serious BEPS concerns, but replacing arm's length principle is not the solution. The thrust of the OECD is now on assuring that transfer pricing outcomes are in line with "value" creation. In Addressing taxation issues from digital economy, preventing treaty abuse, transfer pricing (TP) aspects of ECONOMY MATTERS 18
  20. 20. TAXATION order to achieve this objective, OECD has initiated 3 specific actions, first dealing with intangibles (Action No 8), risk & capital (Action No 9) and high risk transactions that rarely occur between third parties (Action No 10). The fourth aspect deals with re-examining TP documentation (Action No 13). documentation rules, requiring MNEs to provide all relevant Governments, with needed information on their global allocation of the income, economic activity and taxes paid among countries according to a common template. For me personally, more than defining specific rules of profit allocation, transparency of information could be a 'game changer'. This will certainly provide a "big picture" & held identify value creation to the revenue authorities. OECD's outcome is expected to be in the form of recommendations regarding the design of domestic rules and it has set an aggressive deadline of September 2014. Action 9 states that OECD will develop special measures to ensure that inappropriate returns will not accrue to an entity, solely because it has contractually assumed risks or has provided capital. Action 10 pertains to providing circumstances for re-characterisation of high risk transactions, application of profit split in global value chains and provide protection against common types of base eroding payments, such as management fees and head office expenses. What does it mean for India? As a member of G20, India too has endorsed BEPS Action Plan. Indian revenue has welcomed BEPS initiative and is also participating in various working groups set-up under BEPS. Specifically in the area of Transfer pricing, India has stated that OECD or United Nations work on transfer pricing has ignored developing countries' perspective. India has also specifically expressed its reservations to UN Transfer Pricing Manual (2012 ) on areas such as risk allocation, location savings, intangibles (these issues are also part of BEPS). Specifically for risk, India has stated that it is unfair to give undue importance to risk in determination of arm's length price. India believes the risk is a by?product of performance of functions and ownership, exploitation or use of assets. India has also taken aggressive stand on compensation of market based intangibles. Many believe that acceptance of these issues by OECD, vindicates India's stand, particularly with respect to "source" (or market based) based taxation principles. Action Plan on Intangibles OECD proposes to develop special rules to prevent BEPS by moving intangibles within MNC Group members. This entails identifying and defining intangibles, ensuring profit allocation in line with (rather than divorced from) value creation, solutions for hard-to-value intangibles and cost contribution arrangements (covered under Action 8). Even before BEPS, OECD had already started work on TP aspects of intangibles since 2010 and has issued two discussion drafts, followed by two public consultations (last one was held in Paris in November 2013). In the second discussion draft on intangibles, OECD has proposed that no separate adjustment for "location savings" is warranted where reliable local comparables are available. Another significant proposal includes eligibility of full returns to legal owner of intangibles, only when he performs all important functions related to development, enhancement, maintenance & protection. The deadline for Phase 1 of this action step is September 2014 wherein OECD is expected to suggest changes to the Transfer Pricing Guidelines and possibly to the Model Tax Convention. OECD's Pascal Saint-Amans during January 2014 update has said that they are on track on 'ambitious' BEPS timelines. The next 24 months & BEPS "success" will shape the future of international taxation and also hopefully would address Indian revenue's concerns. Businesses too need to factor 'moral tax' issues on one hand and balancing compliance costs and business certainty on the other. It is therefore imperative that all the stakeholders including from India, actively participate in BEPS process & proactively get ready to face this "directional" change in international taxation. Action Plan on TP Documentation Improving transparency for tax administration is one of the focus areas under BEPS Action Plan. OECD is proposing under Action 13 re-examination of TP (Views are personal) 19 JANUARY 2014
  21. 21. CORPORATE PERFORMANCE Profitability Improves Sharply for Services, while for Manufacturing Remains Subdued in Q3 Our analysis of the firms in this section factors in the financial performance during the third quarter of 201314 using a balanced panel of 300 manufacturing companies (excluding oil & gas) and 148 services firms extracted from the Ace Equity database. T Growth in net sales, on an aggregate basis, rose to 15.1 per cent in the third quarter of 2013-14, as compared to 11.1 per cent in the same quarter of the previous fiscal. This can possibly be attributable to the signs of bottoming of the domestic economy along with the recovery in the global economies. While the net sales growth in services sector recorded a higher jump to 18.6 per cent in the third quarter of the current fiscal, as compared to a growth of 15.2 per cent in the comparable quarter last year, the growth in net sales in the manufacturing sector was relatively subdued at 13.5 per cent as compared to 9.4 per cent in the comparable quarter of 2012-13. he analysis of the results of the firms in India, which have declared their results so far for the third quarter (Q3) of current financial year, suggests an improvement in their financial result at the aggregate level. It may recalled that the firms had recorded an improvement in their sales growth in the second quarter as well after disappointing previous few quarters as per the RBI analysis of 2,708 listed non-government nonfinancial (NGNF) companies. This improvement in corporate performance for the last two quarters is encouraging, especially, since it comes at the back of a lackluster showing in the preceding several quarters. From the analysis of the results declared so far, profitability too has shown an uptick, despite an increase in the overall expenditure costs. ECONOMY MATTERS 20
  22. 22. CORPORATE PERFORMANCE Growth in Net Sales (y-o-y%) 15.1 Aggregate Q3FY14 11.1 Q3FY13 18.6 Services 15.2 13.5 Manufacturing 9.4 Source: Ace Equity database & CII calculations The expenditure costs of the firms, on an aggregate basis, witnessed an increase by 14.5 per cent in the reporting quarter, as compared to 9.9 per cent in the comparable time period last year. The increase in growth of expenditure costs was driven largely by an increase in the growth of raw materials cost , which stood at 13.1 per cent over 6.1 per cent in the same period last year. Growth in wages & salaries cost also showed an uptick. Amongst the broad categories, it is notable to point out that manufacturing firms showed the highest increase in interest costs in the third quarter at the rate of 36.3 per cent as compared to 20 per cent in the same period last year. For services sector, raw material costs registered the highest increase to the tune of 38.2 per cent in the reporting quarter as compared to 8.7 per cent in the comparable period last year. Growth in Expenditure on an Aggregate Basis (y-o-y%) 19.7 19.9 18.3 16.0 13.1 6.1 Q3FY13 Q3FY14 Raw Materials Q3FY14 Q3FY13 Wages & Salaries Q3FY13 Q3FY14 Interest cost Source: Ace Equity database & CII calculations On an aggregate basis, growth in Profit after Tax (PAT) increased to 20.8 per cent in the third quarter as compared to 15.0 per cent growth in the same quarter of last year. This was driven by a sharp rise in PAT growth of services sector to 34.3 per cent as compared to single- digit growth in the same quarter of the previous fiscal. However, across the manufacturing sector firms, PAT growth moderated to 10.4 per cent as compared to a growth of 24.5 per cent in the third quarter of previous year. Manufacturing sector has contracted by 0.1 per 21 JANUARY 2014
  23. 23. CORPORATE PERFORMANCE cent in the first-half of the fiscal so far and hence reflects in the poor performance of the PAT growth of the sector. Further, 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 too saw an increase to 19.6 per cent in the October-December, 2013 quarter as compared to a growth 14.0 per cent in the third quarter of last year. Growth in PAT (y-o-y%) 20.8 Aggregate Services Manufacturing Growth in PBDIT (y-o-y%) Aggregate 15.0 34.3 4.7 FY14Q3 Services FY13Q3 10.4 Manufacturing 24.5 19.6 14.0 26.9 11.5 FY14Q3 FY13Q3 12.8 16.5 Source: Ace Equity database & CII calculations will remain to be watched, given the fragile nature of the same. The political uncertainty before the next General Elections due in April 2014 along with high interest rates prevailing in the economy currently could also play spoilsport in the scheme of things. The corporate performance of the firms at aggregate level has been encouraging for the last two quarters. However, manufacturing firms have displayed a subdued performance so far in contrast to the sharp improvement in service sector firms' performance. Going forward, how far, this recovery will be sustained ECONOMY MATTERS 22
  24. 24. SECTOR IN FOCUS Manufacturing in recent years, the manufacturing sector growth slumped to around 3 per cent in 2011-12 and mere 1 per cent in 2012-13. This is in sharp contrast to 10-12 per cent average annual growth that the sector needs to clock in order to reach the aspirational 25 per cent share in national GDP by 2022, as envisaged by the National Manufacturing Policy (NMP). At 15 per cent currently, the share of manufacturing sector in India's GDP indicates significant potential, compared to corresponding figures of over 30 per cent share in China and 25-30 per cent share in many other emerging economies. M anufacturing sector has played a robust role in driving the GDP growth in the 2005-11 period, when the Indian economy registered an impressive average growth of around 9 per cent per annum. However, in the milieu of global and domestic slowdown Manufacturing Value Added as % of GDP in Select Economies (2012) 32 China* 24 Indonesia Philisppines 21 Japan 19 18 Sri Lanka 14 India 13 Brazil Source: World Bank Note: * Data is for 2010 23 JANUARY 2014
  25. 25. SECTOR IN FOCUS The monthly IIP figures for manufacturing sector reflects the consistent downward trend in the last several quarters. In the current financial year, it has stayed sluggish so far (April- Nov). A sub-sectoral look at the manufacturing GDP shows modest growth in just a few sectors, only to be offset by contraction in others. However, three sub-sectors - textiles/apparels, chemicals, and coke/refined petroleum products - have maintained a robust growth over the past two years. The sustained slowdown and lack of desired policy initiatives to counter it have derailed the growth momentum of the sector in the last few years. In the subsequent sections, we discuss, the drivers for manufacturing growth along with the challenges faced by the sector at present. Manufacturing Growth (y-o-y %) 20 15 14.5 10 5 0 -5 -3.5 Oct-13 Jul-13 Apr-13 Jan-13 Oct-12 Jul-12 Apr-12 Jan-12 Oct-11 Jul-11 Apr-11 Jan-11 Oct-10 Jul-10 Apr-10 -10 Source: CSO consecutive months of decline, Indian exports posted double-digit growth in the next four months, growing at an average 12.6 per cent. The growth was driven primarily by textiles, chemicals and petroleum exports. For instance, textile exports have maintained a strong growth trajectory in the current financial year. While a depreciated Rupee has helped, resurgence in demand from key developed markets has also been instrumental in driving exports growth for textiles. The recent increase in the rate of interest subvention from 2 per cent to 3 per cent is expected to further boost exports across several sectors, including textiles. Drivers of Manufacturing Growth Notwithstanding the continuing slowdown in domestic and global economies, ample scope exists for the manufacturing sector to return to high growth trajectory at the earliest. The sharp depreciation of the currency coupled with pick in growth revival of global economies in recent months has lent optimism to Indian manufacturing exporters. Some sectors like textiles and petrochemicals are already doing well. International markets are seen as essential components of Indian companies' business aspirations. The speedy clearances of some mega projects by the Cabinet Committee on Investments (CCI) in recent months lends further support to early revival of the sector. A good monsoon has raised hopes of strong demand for the sector from rural India. Overall, industry is more confident of achieving a higher growth going forward as compared to previous years. In this section, we touch upon some of the main opportunities to be tapped by the manufacturing sector. Rural Growth: This year, India has experienced one of the best monsoon seasons in recent history, with the southwest monsoon rainfall averaging at 106 per cent of normal. As observed in the past, favourable monsoons have a positive impact on agricultural as well as overall GDP growth in the same and the subsequent year. Hence, favourable monsoon this year is expected to spur rural demand. This is already evident in the robust growth of several industries in last few months, driven primarily by rural demand. For example, domestic tractor sales of Mahindra & Mahindra grew by 37 per cent in September 2013 over previous year. Similarly, Export Growth: Manufacturing companies have increased focus on exports, in comparison to previous year. After modest growth in April 2013 followed by two ECONOMY MATTERS 24
  26. 26. SECTOR IN FOCUS FMCG companies like Dabur and ITC have posted strong growth in sales and profit margins, driven by rural demand. The Committee is tasked with monitoring large as well as critical investment projects facing issues like lack of capital etc., in order to expedite resolution of any implementation bottlenecks and ensure timely completion. The initiative has started yielding results, having initiated the resolution of bureaucratic hurdles for nearly 125 stalled projects, accounting for Rs 4 lakh crore of investments as of December 2013. Investment Boost: The Cabinet Committee on Investments, constituted in January 2013, is an important step by the government towards restoring confidence in the country's investment environment. Shocks are Here to Stay Given the current context of slowing manufacturing growth and its consequent operational stresses, it is critical for industry to step back and ensure that the sweeping structural trends that it is witnessing are not dismissed as 'short term blips'. Most likely, these trends will be the driving factors that will determine the operating environment in the days to come. Indian manufacturing companies need to take into account the following two key challenges which distinguish current operating environment from the yesteryears, particularly considering that these are expected to continue going forward: I. Increased Volatility: We have entered what seems to be a prolonged period of unprecedented volatility and rapid change, both globally and in India. Volatility is fundamentally at two levels: firm's performance (for example, revenues, margins, market positions), and firm's input prices (for example, commodities, interest rates). Firm performance volatility has been on the increase globally over the last few decades, and continues to be a strong trend. In India too, the composition of the BSE reflects this volatility. Every four years; about half the top 30 companies in the BSE are replaced by new firms. Firm input volatility has also risen over the years. Volatility peaked in the years immediately following the crisis, and seems to be abating mildly in the last two years. Nevertheless, current volatility across inputs is at a higher level than seen historically. The new era of volatility will require manu-facturers to be far more nimble and resilient in the way they operate. II. Currency Shock: The Indian Rupee was largely stable for most part of the 2000s, ranging between 44 and 49 per USD during 2000-2007. However, the 2008 financial crisis saw a reversal in this trend, triggering a steady depreciation in the Rupee, reaching about 50-55 per USD by 2012. Additionally in 2013, the Rupee has seen sharper fluctuations and devaluation compared to most developing economies. The high recent volatility and depreciation of the Rupee has been driven by a weak do-mestic demand outlook coupled with a widening current account deficit, and several international concerns related to the U.S.'s 'tapering' and political tensions in Syria. While RBI's interventions like opening of a swap window to attract NRI funds have been welcomed, speculations around the imminent tapering by the U.S. and withdrawal of specific moves by the RBI - for instance, the oil swap window - will continue to test the Rupee in the near term. The Rupee is, therefore, expected to remain volatile as some of these global and local cues unfold. The implications of the depreciated and more volatile Rupee for Indian manufacturing companies are three-fold: 1. Exports will become increasingly attractive for sectors that have a high local value-added component, for example, textiles. 2. For sectors with a high proportion of dollar linked input costs, localization and alternate material development will be the key to enhance competitive advantage. 3. Contracting philosophies need to change. Wherever possible, firms may need to enter into back-to-back currency based contracts with suppliers and customers, to shield themselves against the adverse impact of the fluctuations. If such contracts are not possible, shorter contracting windows and price adjustments, for example, monthly instead of quarterly contracts, could help minimize exposure and should be explored. Source: Report on Powering Past Headwinds. Indian Manufacturing: Winning in an Era of Shocks, Swings & Shortages, CII & BCG, November 2013 25 JANUARY 2014
  27. 27. SECTOR IN FOCUS also the most vulnerable to the current trends of sustained volatility and growth slowdown. Overall, MSME health has declined in the last two to three years. Credit defaults are the highest for MSMEs amongst all credit classes, standing at around 5.3 per cent of advances as of 2012-13. NPA rates have grown by over 1 percentage point in the last two years. This creates a vicious cycle: on one hand, MSMEs need access to finance to overcome the slowdown; on the other, banks / financial institutions become wary of extending loans to this sector. This, in turn, creates significant supply challenges for larger manufacturers. A dipstick survey of the risk arising due to exposure of a large automotive manufacturer to MSMEs for supplies revealed that over 30 per cent of its MSME suppliers are exposed to significant financial or performance risks, largely due to their inability to handle the current volatility and growth slowdown. Challenges Facing the Manufacturing Sector The importance of a robust support system to aid strong manufacturing growth has been emphasized time and again. However, several fundamental challenges in the manufacturing support system for India still threaten to inhibit the country's manufacturing growth. We highlight two key shortages in this section. (1) Supply Chain Fragility Indian manufacturing continues to rely heavily on Micro, Small and Medium Enterprises (MSMEs). The MSME sector employs over 100 million people in around 45 million units across the country, contributes 45 per cent to the manufacturing output, and accounts for 40 per cent of the country's exports. However, MSMEs are MSME Gross NPA's Rise over the Past Two Years MSME Gross NPA (%) 100 bps 6 4 5.3 2 4.3 0 FY 2011 FY2013 Source: FIBAC Productivity Survey 2011, 2013 (2) Infrastructure and Regulatory Challenges The implications of this situation on Indian companies are two-fold: Indian infrastructure continues to trail global standards in terms of both soft (policy action) as well as hard (physical) infrastructure. For example, power deficits in India are as high as 25 per cent in states like Jammu and Kashmir and 21 per cent in even relatively more industrialized states like Himachal Pradesh. 1. Manufacturers need to be proactive in identifying areas of fragility in their supply chain - especially fragility arising out of MSMEs being exposed to volatility. 2. Supplier capability development activities need to shift from mere technical support to commercial / management skills infusion. ECONOMY MATTERS The proportion of delayed projects has been on an upward trend owing to policy bottlenecks. Two global steel makers recently shelved plans for setting up plants in India, chiefly due to delays arising out of regulatory hurdles. Delays in getting regulatory approvals and the 26
  28. 28. SECTOR IN FOCUS larger issue of project delays have also impacted cash flows for Indian infrastructure companies, leading to mounting debt burdens for these companies. This is an inherent structural flaw that needs to be addressed. years shows that out of leading Indian value creators, 49 per cent had diversified geographically with CAGR of over 15 per cent for revenues coming from overseas during 2008 to 2013. Further, companies having greater than 25 per cent of their revenues from international business delivered two to four per cent higher TSR per annum than peer companies having less than 25 per cent of their revenues from international business. Implications of this situation on companies are twofold: 1. Companies need to factor in higher costs due to infrastructure constraints. In tune with global swings, Indian manufacturers are also rebalancing their overseas revenue portfolios. As a result, the share of India's exports to non-U.S., non-EU companies over the last 10 years has increased from 57 per cent to 70 per cent. This trend is likely to continue as companies work towards exploring the rise of Africa and the shifting economic balance towards South East Asia and Latin America. 2. Companies may need to invest in captive infrastructure in the short to medium-term, especially in areas such as power generation. Looking Forward One of the key imperatives for Indian manufacturing enterprises in this era of shocks, swings and shortages is to build resilient business models. In other words, business models that will not cave in to the pressures of volatility/turbulence, will have in built mechanisms for recovery and will be able to take advantage of the shift in demand and supply patterns. Diversification of Manufacturing Centres Historically, Indian companies have been wary of using a large labour force within the same plant, for fear of handling large unions. They have more often than not gone for a distribut-ed manufacturing setup within the same region for this precise reason. However, of late, companies have also consciously started creating a diversified base from the perspective of de-risking their supply chain. Companies typically adopt two approaches to ensure resilience: 1 Diversification Companies have adopted different approaches for diversification. Many companies diversify at their 'front ends' (markets/customers/geographies). Other successful companies diversify at their 'back ends' (supply sources/manufacturing centers). Below we discuss both these levers in detail. Setting up capacity additions or new units in new geographies enables or even forces com-panies to focus on newer markets adjacent to the new unit. This improves their competitive-ness in the new markets, gives them a logistical cost advantage and reduces response time. Several players with lower market share or penetration in specific geographies, or those with stagnant growth rates have used this strategy to diversify and grow. Diversification of Markets/Customers Diversifying into export markets is one of the key ways to gain resilience. It's a well known fact that not all markets are facing a downturn. Whilst U.S. manufacturing is reviving and posing a threat, eastern markets are maturing. The Africa potential is becoming a reality. Hence, exposure to international markets helps create resilient business models. Diversification of Supply Sources Traditionally, manufacturing companies have focused on creating leaner supply chains. The key objective has been to create scale, efficiency and thereby reduce cost and complexity. However, with the increasing shocks and swings, companies have started diversifying their suppliers and prefer not to be dependent on a single supplier for one type of raw material or component. This diversification is by way of adding a new supplier or dispersing input requirements across multiple locations of the same supplier, thereby creating a natural hedge. This strategy may or may not improve bargaining power and has cost implications due to additional complexity; Historically, geographically diversified companies have performed better than their peers have. According to BCG's Value Creators Report, 58 per cent of global value creating companies (the top one-third as measured in terms of Total Shareholder Return (TSR) - from 1995 to 2008) had diversified geographically. A similar analysis of Indian manufacturing companies over the last five 27 JANUARY 2014
  29. 29. SECTOR IN FOCUS insights than ideating within the organization. Take the example of a manufacturer of consumer appliances that was trying to increase share in the North Indian rural market. Perennial low voltage in the North Indian villages was causing the company's refrigerators to malfunction. When this problem was shared with the supplier of compressor motors, they came up with a modified motor design that could continuously operate at lower voltages. This collaboration not only provided excellent consumer value, but boosted sales in North India as well. but it manages the risk of disruptions better. Hence, such diversification is applied selectively to critical inputs which have substantially high lead time for capacity creation in times of crisis. 2 Collaboration Collaboration with an external entity to tide over external challenges is a key driver of resilience, not just within the company, but also beyond. There are a couple of fundamental reasons why collaboration is an effective tool to combat external challenges. The first reason is that there is higher willingness to cooperate and explore new ideas during a downturn or an external challenge. Companies are typically more open to new ideas, including re-considering those that may have been shelved in the past, when they realize that their current plans alone will not be sufficient to reach their goals. The second is that resource allocation throughout the value-chain is more conducive for optimal results than that only within the company. Collaboration to reduce conversion costs due to better planning process. Collaboration across suppliers can not only increase customer value, it can also substantially reduce conversion costs. Collaboration to reduce raw material and inventory costs due to better planning and visibility. Collaboration across the value chain can generate significant advantage in terms of inventory and raw material costs, both upstream and downstream. For example, a manufacturer of consumer appliances successfully collaborated across three different groups of suppliers to develop 'composite' printed doors instead of steel doors for its refrigerators and successfully managed to combat the inflation in steel prices. There are two types of collaboration that have proven effective in the past: Collaboration within the value chain (with suppliers or customers). v Collaboration with a non-traditional partner (for instance, often with competitors). v Collaboration with Non-traditional Partners In addition to collaborating with suppliers, companies are also exploring several innovative non-traditional collaborations, even with competitors, so as to leverage their individual strength, manage risks and explore new avenues of growth at the same time. Some of the nontraditional collaborations that companies are exploring are as follows: Collaboration within the Value Chain Collaboration within the value chain typically occurs with suppliers and/or customers. While collaboration within the supply chain is an ongoing process in many companies, the winners see collaboration not as a oneoff initiative, but as an ongoing program with their core suppliers. They allocate specific resources in their procurement department towards supplier collaboration, devote senior management time, and ensure that promises about sharing of benefits arising out of a collaboration program are followed in letter and spirit. Collaborating to share supply chain. This type of collaboration focuses on leveraging economies of scale by sharing logistics, components and suppliers. For example, Mars and Nestle combine deliveries to TESCO, potentially saving over 100,000 kilometres of duplicate truck journeys every year. Though collaboration in various forms has been existing formally across businesses globally for a few decades now, the current Indian context is forcing companies to take up col-laboration initiatives more intensively than ever before. Collaboration today is being seen across three key dimensions: Collaboration to explore new markets. In this type of collaboration, companies come together to share the risks and rewards of entering new markets. The objective is to complement each others' strengths while charting new territory. For instance, Bajaj and Kawasaki have entered into a global alliance to market and brand their products jointly across developing countries, starting with Philippines and Indonesia. Collaboration to increase customer value through better design and/or delivery. Often, sharing a customer challenge with suppliers can provide greater ECONOMY MATTERS 28
  30. 30. SECTOR IN FOCUS productivity of manufacturing is higher than in agriculture, facilitating the shift of workers to the sector will result in better use of resources. Conclusion India's strong economic growth since 1990s has primarily been driven by the services sector, manufacturing at best has kept pace with the expansion of overall economy. Share of manufacturing in GDP has stagnated at around 16 per cent for the last two decades, greatly limiting the employment creation. This is undoubtedly a matter of great concern for India with its huge population size. According to an estimate, 650 million people in the country constituting around 61 per cent of the population are in the working age group of 15-59 years. It is estimated that an additional about 200 million Indians will enter the job market in next 15 years. Inclusive growth will be possible only if all workers have access to opportunities for employment and entrepreneurship. To be sure, a lot has changed in the Indian manufacturing sector. Turbulence has increased considerably. Product life cycle is shrinking as customers demand more. Shortages in terms of infrastructure have started to become a norm in some of the sectors. Exports have become radically more attractive for some sectors, marginally more in many others. Our approach in this era of turbulence needs to change. Companies need to be more adaptive and build their strategy and operations around three pillars of adaptiveness - Resilience, Readiness and Responsiveness. Resilience to make their businesses withstand shocks, Readiness to ensure their companies know how to react to changes, and Responsiveness to ensure speed. The adaptive companies have already started powering past the headwinds. Waiting in the hope that the sector will get back to the days of lesser turbulence and higher predictability may not be prudent. The time to change is now. As the share of agriculture shrinks, it is incumbent on the manufacturing sector to open up job opportunities for less skilled workers who cannot be easily absorbed in the services sector. Secondly, a healthy growth of manufacturing is critical for creating a large production and consumption base within the economy. Further, as (This article is based on the Report Powering Past Headwinds. Indian Manufacturing: Winning in an Era of Shocks, Swings & Shortages, published by CII & BCG in November 2013) 29 JANUARY 2014
  31. 31. SPECIAL ARTICLE Fiscal Situation a promise of a refund later, in order to boost the muted tax collections. Second option could be asking the PSU's to make interim payment of dividends for the year ending March 31, 2014, this year itself based on the projections for the entire year's profits. Dividend payment for a financial year is otherwise usually made in the first quarter of the following fiscal, after the declaration of profits. Recently, Coal India announced a special dividend which will fetch the government around Rs 18,000 crore. Thirdly, government could also cut the expenditures of many ministries in order to constrain fiscal deficit within the target, as it did in the last fiscal. Whichever of these options the government resorts to, however, one thing is certain, that it will be a tough balancing act for the Finance Minister. In this section, we provide an analysis of the fiscal situation so far and its impact on the overall growth prospects. W ith the fiscal deficit having reached 95 per cent of the budgeted estimates for the entire year in the first nine (April-December) months already, the Finance Minister's clarion call of not breaching the redline of fiscal target of 4.8 per cent this year looks increasingly difficult. A challenging domestic and external economic environment has kept the revenue growth low, while expenditures have so far not shown any signs of abatement. So what are the options available in front of the government to stick to its fiscal deficit target. Well, the first option could be to ask corporates to cough up higher advance payments, with ECONOMY MATTERS 30
  32. 32. SPECIAL ARTICLE Reining in the Fiscal Deficit Guest Interview Mr R Seshasayee Past President, CII, Chairman, CII Economic Policy Council and Vice Chairman, Hinduja Group Q1: How important, in your opinion, is it to consolidate our fiscal position? during April-December 2013, the same pace at which they were targeted to grow during the entire year. Ans: Containing the fiscal deficit is extremely important for India, as it will lead to higher credit rating and lower cost of borrowings not only for the government but also for the private sector. The challenge of containing the fiscal deficit has persisted with successive governments. The Finance Minister has articulated the problem arising out of the runaway fiscal deficit commendably. He has often said that the 'red line' for the fiscal deficit, which he set at 4.8 per cent of GDP, will not be breached. However, that may prove to be a daunting task in the light of the latest fiscal numbers released by the Controller General of Accounts (CGA), according to which the fiscal deficit in the first nine months (AprilDecember 2013) of the current fiscal had already reached 95 per cent of the budgeted estimates for the full year. The bright spot happens to be the non-tax revenue, which has remained relatively robust so far this fiscal at 67.5 per cent of the budgeted target as compared to 52.5 per cent in the comparable period last year. The robust non tax revenue collection is attributable to higher PSU dividends and receipts of user charges and licence fees from telecom companies. In contrast, due to the dismal PSU disinvestment scenario, non-debt capital receipts in April-December 2013 have remained lacklustre at only 20.3 per cent of the target. Proceeds from disinvestment have only reached Rs 5093 crore so far as compared to the target of Rs 40,000 crore for the year. Apart from the expected shortfall in tax revenue collections, the Union government may not be able to meet its disinvestment target, which in turn is going to result in overshooting of the fiscal deficit target for this year. Q2: What do you make of the latest fiscal numbers for the month of December 2013? Q3: Given that our fiscal deficit has already touched 95 per cent of the year's target in the first nine months, according to you what options exist in front of the government in order to adhere to the fiscal target for the year? Ans: It appears that the revenue collection has been sluggish given the growth slump. Net tax revenue stood at 58.6 per cent of the full year target as compared to 62.8 per cent a year ago. Amongst the various heads of tax revenue, on a gross basis, excise duty collections dropped by 6.9 per cent during April-December 2013. Custom duty and corporate tax collections did grow, but the growth was weak at 4.3 per cent and 9.6 per cent, respectively. The growth in services tax collection, too, appears weak at 19.8 per cent when compared to the robust 35.8 per cent growth budgeted for the year. It is only the income tax collections that are showing a growth trend as scheduled. These grew by 19.8 per cent Ans: Given that the general elections are due soon, the options available to the government to restrict the fiscal deficit within the budgeted levels of 4.8 per cent are clearly limited. The urgent task, therefore, is to prune expenditure while trying to boost government revenues, especially tax revenues. The axe is bound to fall on plan expenditure and that in turn will have a negative impact on the growth momentum. Between October and March last fiscal year, the Centre had forced massive contraction in expenditure to rein in the 31 JANUARY 2014
  33. 33. SPECIAL ARTICLE FY13 fiscal deficit to a creditable 4.9 per cent of the GDP. A similar policy prescription looks little difficult this year, since populist measures are expected to rule the roost, given that elections are due soon. Tax revenues are directly dependent on GDP growth. There again, with the economy unlikely to grow much above 5 per cent during the current year, the outlook for higher tax collections and hence a lower deficit is by no means positive. Liquidity Ratio (SLR) norms, hence they end up in monetising part of the deficit even though the automatic monetisation has been done away with. The effective monetary transmission mechanism of the Central Bank has been diluted due to the existence of high fiscal deficit in the economy, as evidenced by the fact that despite the cumulative 125 bps increase in the repo rate since March 2012 till April 2013, headline inflation (wholesale price index, WPI) had refused to abate and remained persistently high at an average of 7.5 per cent during the said period. To be sure, other supply-side factors also played a role in stepping up inflation, but expansionary fiscal policies too played a pivotal role - a fact which has been acknowledged by the Reserve Bank of India (RBI) in its various communications. Thus, inflation at times may become effectively a fiscal phenomenon, since the fiscal stance could influence significantly the overall monetary conditions in the economy. Hence, it's important to contain the fiscal deficit within sustainable limits every year, given the perverse consequences of high fiscal deficit on the efficacy of monetary policy. Under this scenario, it is best for the government to opt for getting revenue from unconventional sources. CII has suggested several innovative measures to prop up the government's revenue stream. Some of the measures like utilizing the cash-pile of PSUs, monetising the surplus land lying with them, clearing up the funds held up in disputes and litigations are needed to be pursued aggressively. Further, as I have discussed earlier too, the disinvestment target of Rs 40,000 crore will be difficult to achieve unless in the remaining months of the current fiscal, government makes a concerted effort to clear the backlog, especially since it had to postpone large stake sales like Indian Oil Corporation and Coal India due to poor market conditions and labour unrest earlier in the year. Spelling out strict timelines for carrying out disinvestment in the remaining period of current fiscal will be helpful. Q5: There have been talks of economy bottoming out, but the recent weak IIP data has raised serious doubts regarding that prognosis. What is CII's stand on the same? Ans: There are mixed signals coming out of the economy at present. While one set of indicators, such as GDP for the second quarter, exports growth, current account deficit suggest that the worst might be over for the economy, there is another group like the monthly industrial production numbers, non-oil imports which continue to paint a dismal picture. The latest industrial output numbers have, in fact, raised the red flags in the economy once again as the output has now contracted for two consecutive months. But I must also point out that the industrial production numbers have been very volatile, which makes the task of drawing any decisive inferences from the data difficult. This hypothesis gains currency particularly in view of the fact that the latest 85th round of CII Business Confidence Index rose sharply to 54.9 in the third quarter from 45.7 for the JulySeptember 2013 quarter. This has been the swiftest rebound ever seen in the index. But in the same vein, I must also add that there is still a case for cautious optimism, as recovery remains fragile. Hence, we at CII continue to remain guarded to any signs of distress or positive signal for the economy in the months to come. Q4: Fiscal policy is said to be dominant over monetary policy in India. The efficacy of monetary policy is reduced under the backdrop of a large fiscal largesse. What are your views on this pervasive issue? Ans: It is imperative that both fiscal and monetary policy complement each other to spur growth in India. However, under a case of excessive government borrowings, fiscal policy dominance over the monetary policy can lead to a situation in which a Central Bank is no longer able to use its instruments effectively for achieving the desired objectives. In India, even though the fiscal policy dominance through the automatic monetisation of fiscal deficit has been done away with over the years, the influence of fiscal deficit on the outcome of the monetary policy has continued to remain significant given its high level. High fiscal deficit, even if it's not monetised, can interfere with the monetary policy objective of price stability through its impact on aggregate demand and inflationary expectations. This is particularly true, given the fact that in India, the banks are captive holders of government securities due to their adherence to the Statutory ECONOMY MATTERS 32
  34. 34. SPECIAL ARTICLE Subsidy Bill: Reaching Dangerous Levels Bidisha Ganguly Principal Economist, CII The Indian central government's rising subsidy bill has been a cause for concern. Despite many attempts to control the situation, the expenditure on subsidies has been rising steadily. Although the 2013 Budget has set a target of reducing the expenditure from 2.6 per cent of GDP in 2012-13 to 2.0 per cent in 2013-14, it may not be met. In particular, there is concern that the plan to reduce the fuel subsidy by allowing higher prices of fuels such as petrol, diesel and LPG has not yet been successful in trimming the subsidy bill. This is because the rupee has depreciated by about 15 per cent against the dollar during the current year, making it necessary to raise the rupee price of fuels by higher amounts. Another practice that needs to be discontinued is carrying over subsidy payments from one financial year to the next. This is done in the hope of being able to control subsidies in the coming year so that actual payments can be smoothed. Expenditure on Subsidies (% of GDP) 3.0 1.3 1.3 2.4 2.6 2.0 1.4 2004-05 2007-08 1.4 1.5 2005-06 2.0 2.2 2010-11 2.5 2.2 2009-10 2.3 1.0 0.5 0.0 2013-14BE 2012-13RE 2011-12 2008-09 2004-05 Source: Budget documents Over the medium-term, there needs to be a debate on which subsidies can be done away with and which ones need to continue. Currently, economists favour continuing with the food subsidy while making it better targeted and phasing out the fuel and fertiliser subsidies. Given below is the amount spent on the three major subsidies - it is apparent that in the last five years the food and fuel subsidies have increased substantially. 33 JANUARY 2014
  35. 35. SPECIAL ARTICLE Expenditure on Subsidies (Rs crore) 2008-09 2009-10 2010-11 2011-12 2012-13 RE 2013-14 BE Food 43,751 58,443 63,844 72,823 85,000 90,000 Fertilisers 76,602 61,264 62,301 67,199 65,974 65,972 Fuel 2,852 14,951 38,371 68,484 96,880 65,000 Source: Budget documents Fuel petrol, diesel, kerosene and LPG has been inadequate. Fuel subsidies have become the major component of government expenditure on subsidies. The level of under-recovery has ballooned over the last few years on account of high crude oil prices prevailing in the international market and depreciation in the Indian rupee. Recently, the Government had taken several measures to contain the level of subsidies such as limiting the number of subsidized LPG cylinders to 9 per annum per household, deregulation of diesel price for bulk consumers and small monthly increases in retail prices. However, the level of under-recoveries continues to remain high as the increase in domestic prices of According to the Expert Group Report formed by the Government under Dr. Kirit Parikh, the actual underrecovery by oil marketing companies in 2013-14 are not likely to be much lower than last year. As a result, the fuel subsidy is likely to exceed Rs 65,000 crore budgeted for 2013-14 unless the government makes the upstream oil companies bear a larger share of the under-recovery or carries over the subsidy payment to the coming year. Any new government that comes to power in 2014 will have to deal with this issue on a priority basis. In fact, the government may consider a cap on the total expenditure on fuel subsidies on an annual basis. Under-Recoveries Reported by OMCs Rs crore 2012-13 2013-14 (April - December) Diesel 92,061 47,655 PDS kerosene 29,410 22,373 Domestic LPG 39,558 30,604 Total 161,029 100,632 Source: PPAC website this year's allocations. It has been reported that faced with severe financial crunch, the government may roll over a record 40,000 crore rupees of fertiliser subsidy to the next financial year starting April. Fertiliser The subsidy on fertilisers is also set to increase on account of a rise in the cost of imported fertilisers due to the rupee's depreciation against the US dollar. At the same time, an outstanding amount of Rs 32,000 crore was carried over from 2012-13, which has to be paid from Expenditure on Fertilizer Subsidy (Rs crore) 2010-11 2011-12 2012-13 RE 2013-14 BE Imported (urea) fertilizers 6,454 13,716 15,398 15,545 Indigenous (urea) fertilizers 15,081 20,208 20,000 21,000 Sale of decontrolled fertilizers with concession to farmers 40,767 36,089 30,576 29,427 Total 62,301 70,013 65,974 65,972 Source: Budget documents ECONOMY MATTERS 34
  36. 36. SPECIAL ARTICLE The Finance Ministry has approved a special banking arrangement for fertilizer companies which will allow them to raise short-term credit to the extent of Rs 9000 crore from banks in order to tide over the cash crunch in the industry. The principal will be repaid once the government makes the subsidy payments. This situation has made the fertilizer companies in the country unviable and unable to make any investments. times in the last ten. Record procurements in recent years, increasing cost of handling grains and widening difference between the procurement cost of grains and the central issue price have been the major factors leading to the ballooning food subsidy. With the implementation of the National Food Security Bill, the subsidy bill could go up further in coming years as the issue price has now been fixed by the legislation while procurement price will need to be revised upwards in order to provide incentive to farmers to increase production. Food The food subsidy has been on a rising trend, having more than doubled in the last five years and increased five Expenditure on Food Subsidy (Rs crore) 100,000 90,000 80,000 70,000 60,000 50,000 40,000 30,000 20,000 10,000 02 -0 3 20 03 -0 4 20 04 -0 5 20 05 -0 6 20 06 -0 7 20 07 -0 8 20 08 -0 9 20 09 -1 0 20 10 -11 20 11 -1 2 20 12 -1 3R E 20 13 -1 4B E 20 20 01 -0 2 0 Source: Budget documents currency could have an impact on the amount spent on subsidies. This would have long-term implications that are debilitating for the economy. In India, for example, interest rates have remained high even in a year of slowing growth due to fiscal excesses. And as the Finance Ministry has slashed expenditure in order to be able to meet its deficit target, the economy has found it difficult to recover. Conclusion When governments commit to spend on open-ended subsidies, there should also be a limit to the amount that can be spent. This limit could be in terms of percentage of GDP, as in the case of the fiscal deficit. Otherwise, unexpected events such as slowdown in economic growth, increase in oil prices or depreciation in the 35 JANUARY 2014
  37. 37. SPECIAL FEATURE The Tradeoffs for Policy Makers in India Today Guest Article inflation, especially inflation in food products, arguments have also been made for fiscal correction as a means of holding back the growth of food demand. In these circumstances, it may be desirable to understand some of the underlying features of the Indian economy which have led us to this pass. Dr. Pronab Sen The most underappreciated feature of what has happened in the Indian economy is the fairly substantial income redistribution that has occurred over the last several years. Due to a combination of factors, there has been a shift in terms of trade in favour of agriculture; and, within agriculture, in favour of agricultural labour. Three factors are of particular importance. First the rapid expansion of alternative work opportunities for rural labour triggered off by improved rural connectivity through the Pradhan Mantri Gram Sadak Yojana (PMGSY) and the spread of rural telephony. Second, the sharp increases in minimum support price for some agricultural products since 2004. Third, the role of Mahatama Gandhi National Rural Employment Guarantee Scheme (MNREGS) in providing a credible reservation wage which landless labour could use to bargain for higher wages. The main consequence of these redistributions was to shift relative incomes away from people with high savings propensities to those Chairman, National Statistical Commission The combination of high and persistent inflation and low growth that has characterized the Indian economy over the past two years has led to considerable anxiety about the nature of the policy responses that are required. Although the situation is by no means one of classic stagflation, the policy conundrum is pretty much the same. Any effort at taming inflation through the use of tighter monetary policies raises the risk of a further slow down in growth; while any effort at boosting growth runs the risk of a further acceleration in inflation. The classical prescription of a tight monitoring policy and expansionary fiscal policy runs aground on the fiscal stresses that are already being felt by the government. Moreover, given the structural causes of much of the ECONOMY MATTERS 36