Budget 2016-17: Implications for Trade and Investment

Budget 2016-17:
Implications for Trade and Investment
Rajat Kathuria
5th March 2016

Budget 2016-17: Implications for Trade and Investment
Global growth remains sluggish
Global growth is projected at 3.4 per cent and 3.6 per cent in 2016 and 2017, respectively.
According to IMF’s WEO January 2016, growth will pick up slower than the earlier forecast in fall 2015 especially
in emerging and developing economies.
• Modest and uneven recovery in advanced
economies and risks to the global outlook
remain tilted to downside.
• Emerging and developing economies are
expected to grow at 4.3 per cent in 2016 and at
4.7 per cent in 2017
 slow down and rebalancing of Chinese
economy
 Lower commodity prices
 Strains in some large emerging market
economies
Y-o-Y, % 2014 2015 2016
World 3.4 3.1 3.4
Advanced economies 1.8 1.9 2.1
Euro area 0.9 1.5 1.7
Emerging market and
developing economies 4.6 4.0 4.3
China 7.3 6.9 6.3
India 7.3 7.3 7.5
Japan 0.0 0.6 1.0
United Kingdom 2.9 2.2 2.2
United States 2.4 2.5 2.6
Recovery expected to be slower
Note: Forecasts after 2014
Source: International Monetary Fund, World Economic Outlook Database, January 2016

India’s GDP growth
• Economic survey projects India’s growth could
be in the range of 7-7.75 per cent in the
coming year
• The divergence between GDP growth and
other indicators such as export growth,
corporate sales growth and IIP is evident.
• Weak global demand may further impede
India’s growth
-2
0
2
4
6
8
10
12
14
16
18
2006-072007-082008-092009-102010-112011-122012-132013-142014-15
Percent
GDP growth new series GDP growth old series IIP
Source: RBI

Balance of Payments situation is comfortable
• Sharp decline in energy
prices has resulted in a
comfortable BoP
• Increase in foreign
exchange reserve and
decline in import bill has
improved the import
cover of reserve
• Significant increase in the
short term components in
the foreign exchange
reserve in recent years is
an area of concern
Average
2003-04 to
2007-08 (5
years)
Average
2009-10
to 2013-
14 (5
years)
2012-13 2013-14 2014-15
Balance of Payments
a) Merchandise Exports (% change) 25.3 12.2 -1.0 3.9 -0.6
b) Merchandise Imports (% change) 32.3 9.7 0.5 -7.2 -1.1
c) Trade Balance/GDP (%) -5.4 -8.9 -10.7 -7.9 -7.0
d) Invisible Balance/GDP (%) 5.1 5.7 5.9 6.1 5.7
e) Current Account Balance/GDP
(%)
-0.3 -3.2 -4.8 -1.7 -1.3
f) Net Capital Flows /GDP (%) 4.6 3.7 4.9 2.6 4.4
External Debt Indicators
a) External Debt Stock (US$ billion) 156.5 359.0 409.4 446.3 475.8
b) Debt-GDP Ratio (%) 17.7 20.9 22.3 23.6 23.8
c) Import cover of Reserves (in
Months)
14.0 8.5 7.0 7.8 8.9
e) Short-term Debt to Total Debt (%)
(residual maturity)
37.6^^ 41.9 44.2 39.6 38.9
Source: RBI Annual Report (2015)

Decline in Exports
• Sluggish GDP growth in export destination
• An income elasticity of 2.6, it implies that
Indian exports should have at least grown at
annual rate of about 5 percent in real terms.
• Prolonged overvaluation seems to have
played a major role in stymieing the exports
growth in post 2008 period
Period
Nominal
Export
Growth
Real
Export
Growth
GDP
Growth*
REER
2002-03 to
2007-08
24.52 15.03 3.5 101
2008-09 to
2014-15
10.58 1.17 1.9 109
Source: Estimated by ICRIER team
Note: *Export weighted average GDP growth of export destinations
Export destinations covered accounts for 68 percent of Indian exports
Income Elasticity of Indian Exports : 2.6
•Measurers announced in the budget to support export sector
• Government has widened and deepened the duty drawback scheme to include more
products and countries.
• Government has abolished the export duty on iron ore and chromium ores. Budget also
reduced the export duty on bauxite ores and concentrates.
• FM announced during his budget speech that profit-linked deductions will be available for
new units in SEZs commencing activity before March 31, 2020.

Competitive devaluation a major source of
uncertainty for trade and investment
 QE and currency depreciation in advanced economies
 Devaluation by few emerging economies to promote exports
 REER data shows Indian Rupee still overvalued
 Higher productivity growth in India is often cited as a factor which mitigates the REER
overvaluation
 However, a recent ICRIER Working paper finds that even the productivity adjusted
REER overvaluation averaged 7.6 percent between 2008 and 2013 ( Bhagwati et
al.2015).
Source: CEIC database

FII outflow
 Net FII withdrawal from Indian equity market was $ 6.5 billion in last seven months
 Currency risk: Investors are cautious about depreciating Rupee
 Safe haven: Uncertainty global financial market has made investors risk averse
 Stressed corporate balance sheets in India
 Uncertainty over growth numbers
 MAT for capital gains also created some uncertainty among FIIs
 MAT exemption in the budget – Exemption provided to foreign companies
retrospectively from AY 2001-2002 subject to the foreign company not having a PE in
India under the relevant DTAA or a place of business in India, by proposed
amendment to section 115JB of the ITA Act, 1961
-8000
-6000
-4000
-2000
0
2000
4000
6000
8000
Jan-11
Mar-11
May-11
Jul-11
Sep-11
Nov-11
Jan-12
Mar-12
May-12
Jul-12
Sep-12
Nov-12
Jan-13
Mar-13
May-13
Jul-13
Sep-13
Nov-13
Jan-14
Mar-14
May-14
Jul-14
Sep-14
Nov-14
Jan-15
Mar-15
May-15
Jul-15
Sep-15
Nov-15
Jan-16
Debt (net, ml $) Equity (net, ml $)

Decline in energy prices: Not all good for India
 Problems in major export destinations, particularly
middle east
 Large scale liquidation of funds by middle east sovereign
funds will result in outflows
 Adverse impact on employment and remittances
generated in energy rich economies
 Vulnerable global financial market due to large exposure
to energy companies

Policy uncertainty down, however, lack of
movement big ticket reforms a concern
 Policy uncertainty index is low
 Delay in GST
 Land acquisition bill
 Lack of major push in labor market reform
 Bankruptcy code
Source: Economic Policy Uncertainty

 The Finance Minister announced the government’s commitment to implement the General
Anti-Avoidance Rules (GAAR) from April 1, 2017
 Finance Act 2015 proposed to amend the test of residency for foreign companies on the
basis of PoEM (Place of Effective Management) – this has been proposed to be deferred by
one year
 Retrospective Taxation – Assurance that retrospective taxation which was introduced by
the Finance Act, 2012 will not be resorted to in future. A High Level Committee to be
chaired by Revenue Secretary will oversee implementation of the assurances
 Retrospective Taxation – Proposition of a one-time scheme of Dispute Resolution subject
to withdrawal of cases in courts/tribunals and arbitration/mediation proceedings under
BIPA. Only tax arrears will be payable, interest and penalty shall be waived

 Transfer Pricing – As of May 2015, 500 transfer pricing disputes were pending
between the revenue authorities and various multi-nationals. Government aimed to
sign 120 Advance Pricing Agreements (APAs) by March 31, 2016. CBDT has so far
signed 41 APAs – 38 unilateral and 3 bilateral
 Transfer Pricing – W.e.f June 1, 2016, if the period of limitation available to a TPO to
pass an order is less than 60 days, the remaining period will be extended upto 60
days in certain cases
 Acceptance of BEPS Action Plan 1 recommendation – Finance Minister has proposed
Equalisation Levy (EL) through Finance Bill, 2016 at 6% for payment made to non-
residents exceeding INR 1 lakh a year in case of B2B transactions. Proposition to
introduce section 10(50) in the IT Act, 1961 to exempt amounts subject to EL from
Income Tax

Infrastructure
 India is ranked 87th out of 148 countries for its infrastructure in the World Economic
Forum’s Global Competitiveness Report 2014-15.
 The total investment in infrastructure, which was 5.02 percent and 7.21 percent of
the GDP during the 10th and the 11th Five Year Plans respectively, is projected to go
up to 8.18 percent in the 12th Plan (2012-17) at US$ 1 trillion.
 An increase in infrastructure investment equivalent to one percent of GDP would
translate into an additional 3.4 million direct and indirect jobs in India (McKinsey,
2013).
 India has set an ambitious target to increase production of renewable energy fivefold
by 2019 and halve energy imports by 2030, despite population and demand growth
 Infrastructure push is evident as Government has rolled out stuck projects worth Rs 4
lakh crore (US$ 60 billion) in the past six months (ending November 2015)
 Government has set up Rs 40,000 crore National Investment and Infrastructure
fund of which Rs. 20,000 crore from government and the remaining from other
investors
Sources: RBI, McKinsey, Budget 2016-17 and International Energy Agency (IEA)

Disinvestment
 Finance ministry has cut its disinvestment target by 57% to Rs.
30,000 Cr from its initial Rs. 69, 500 Cr target (Financial Express,
December 22, 2015)
 LIC has played a crucial role in the government’s disinvestment
process. LIC bought 37 % of Rs. 97620 crore raised through
disinvestment in state-owned firms by the Centre since 2011-12
(Business Line, December 1, 2015).

Summary
Trade Vulnerabilities
Global Weakness in Commodity Prices
Rurban
Smart Cities
Digital India
Capacity to Implement

Rural distress
 The average annual income of the median farmer net of production
costs from cultivation is less than Rs. 20,000 in 17 states
(Economic Survey 2015-16).
 Sharp decline in farm profitability: profitability has declined to less
than 5 per cent in major crops, and is negative for others (Gulati
2016)
 Successive droughts
 Decline in commodity prices
 In a drought year, high tax on petrol and diesel increased the cost on irrigation
and transportation
 Sluggish wage growth in rural areas
 Several measures in the budget to address the rural distress,
however, they do not seem adequate

Banking Sector
 Stressed assets a major concern for Indian banks, particularly the
public sector banks
 Dilution of Equity below 51 per cent not an option
 Political hurdles
 With stressed balance sheets, investors may not be enthused
 Selling shares to LIC not good for the stability of the financial system
 Budgetary allocation of Rs. 25000 crore for recapitalizing the
banks not adequate to address the problem
 Reform in appointment of board of directors. Autonomous Bank
Board Bureau to improve the governance of PSU banks a right step
 Banks should have autonomy to refuse developmental and social
activities, which do not make economic sense

Financial Regulation
 Proposal to bring comprehensive central legislation to tackle illicit deposit taking schemes
 The Bank Board Bureau will become operational in 2016-17
 Proposed amendments in the SARFAESI Act 2002 to enable the sponsor of an ARC to hold up to
100% stake in the ARC
 To provide statutory basis for a Monetary Policy Framework and a Monetary Policy Committee RBI
Act 1934 is being amended though Finance Bill 2016
Source: PRS
Slow progress in implementing the Financial Sector Legislative Reforms Commission
recommendations

Improvement in quality of government expenditure
 In 2015-16, the expected growth in capital expenditure was 25.5 per cent and growth
in revenue expenditure was 3.2 per cent over RE 2014- 15
 Government’s focus on the infrastructure will improve the productive capacity of the
economy
Revenue and capital expenditure (as % of GDP)

Budget 2016-17: Implications for Trade and Investment

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