Elysium Capital India Note 090710

India Note July 10, 2009

Budget 2009 – Repair and Reform at a Steady Pace Overview th

India’s new budget, released July 6 , has invoked mixed reactions from both the Indian and international communities. Some see the budget as neutral to positive – with more infrastructure spending, tax reliefs and funds for rural development - while some are dissatisfied at the government’s failure to communicate what it intends to accomplish, in wider detail, in its 5 year term. The government, disappointingly, did not address in the budget wider measures such as structural reforms and mechanisms to increase FDI. Either way, the equity market, up an exuberant 50% in the three months to June, fell 6% after Finance Minister Pranab Mukherjee’s budget speech. Investors were alarmed at the announcement of a budget deficit of 6.8% of gross domestic product and Mukerjee’s nods to statist policies with regards to privatisation. However, we feel that while the budget does little to inspire, along with the announcement of a higher deficit, investors should not have been shocked as the government has been in the red at 6.2% of GDP in 2008-09 due to a fiscal stimulus it is currently continuing. The government does indeed need to contain the deficit (and stabilise and reduce eventually) but rightly placed the emphasis on growth. The deficit does not have to be painful if India continues to grow at a higher rate. The government has spaced out this increased borrowing program so as to be rate neutral (without hardening interest rates) and both S&P and Moody reiterating their confidence in the government’s ability to manage the deficit.

Key Elements The government has taken steps towards rationalising taxes by planning to implement the Goods and Service Tax (GST) by April 2010, which will replace multistage taxes such as the CANVAT, Service Tax, VAT etc., thereby simplifying tax collection and easing compliance by tax-payers. There may not be major tax relief for most sectors but almost every sector will benefit from some sort of relief. For example, IT exporters have received an extension of tax breaks; removal of the Fringe Benefit Tax (a tax on benefits for employees); real estate developers involved in low cost (defined as housing for the Low Income Group end-user segment) housing will receive tax exemptions; and removal of the education cess (a tax on tax).

The Budget at a Glance Fiscal deficit: Forecast to rise to 6.8% this year from 6.2% the year before Growth: Forecast to return to near 9% in the next fiscal year Total spending: To rise to INR10,200 bln, up 36 % from 2008-09, with the emphasis on defending high growth rates Structural reform: No big measures, such as disinvestment in state- owned companies or mechanisms to attract foreign direct investment. Asset sales to raise INR11.2 bln Infrastructure: Sharp increase to 9% of GDP in spending on highways, railways and urban and rural infrastructure Rural development: Spending for rural employment to be increased 144% to INR391 bln. Targeted agricultural credit of INR325 bln, up 13%. Subsidised crop loans to farmers at 7% interest rates Real Estate: No big measures announced but tax relief for individuals welcomed. Exemptions for prefab goods made at construction sites are a positive for low-income and affordable housing Tax: Removal of surcharge of 10% on personal income tax and Fringe Benefit Tax. Timeline for introduction of goods and services tax, optimistic but appreciated. Rise in minimum alternate tax to 15% from 10%. No change in corporate tax

The budget has planned for the deregulation of the sugar and fertiliser industry, resulting in increased competition and lower prices from producers. Additionally, provisions to subsidise fertiliser prices for the agriculture sector, as opposed to subsidising inputs for producers, will benefit the sector and consumers. The government also has planned disinvestments in Rail India, Cochin Shipyard amongst others but has fallen short of expectations of more structural reforms and the privatisation of airlines and financial services. Disinvestment of loss making Public Sector Units (PSUs) would also have provided more support to the economy as private players would increase efficiency and help in reducing the fiscal deficit. Another major element involved the long term issue of deregulating fuel prices. This is expected to drastically change the transportation cost of goods, affecting prices of goods invariably. This will have widespread effect throughout all consumer levels but will notably affect materials pricing for the infrastructure sector as the government has aggressively increased funding.

Infrastructure & Real Estate The Indian Infrastructure Finance Company (IIFCL) has been authorised to raise INR100,000 crore (US$20 bln) to facilitate incremental lending to the infrastructure sector through refinancing via commercial banks. Additionally, an allocation increase of 87% for the Jawaharlal Nehru National Urban Renewal Mission (JNNURM) is a definitive positive in the development of suburban infrastructure of Tier I cities to meet the increase in demand for homes further out of city centres with road and transportation connectivity and addition of services, amongst other benefits. The government also increased plan allocation for the National Highways Development Authority (NHAI) by 23% to INR8,578 crore (US$1.7 bln) for the national highway development programme.

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INR100 crore (US$20 mln) has been allocated for the Pradhan Manatri Adarsh Gram Yojana (PMAGY), a pilot government initiative to aid development in rural villages with allocations over and above the Rural Development and Poverty Alleviation Schemes. This aims to improve social and physical infrastructure at the rural level. If the economy is to grow at the 9% rate as the government intends, attention has to be focused on nationwide infrastructure building and rural development. With the majority of India’s population living in the hinterland, this budget addresses increased development at the grassroots level and tries to bridge the gap to urban development. Allocations for rural development will indirectly boost the economies in Tier II and III cities as the more economically empowered rural population spends their income there. Rajiv Awas Yojana, a program to promote a slum free India in five years, was introduced to provide basic amenities and services for slum areas and low income settlements as well as provide subsidised credit. However, no provisions were made for middle income home buyers. On the somewhat negative note, the Software Technology Parks of India (STPI) scheme will now carry a higher burden of Minimum Alternate Tax (MAT) thereby making it less attractive than Special Economic Zones (SEZ). The SEZs receives tax benefits on state taxes and stamp duty with more exemptions offered depending on industry type. We expect to see STPI benefits phased out slowly even though, from a development perspective, it is more attractive with higher Floor Space Index (FSI) allowances relative to SEZs. The budget also did not stipulate any relaxation of rules for FDI investments in real estate and did not mention legislation or promotion of REITs and REMFs (Real Estate Mutual Funds). No mention was made on removing service tax on rentals which was introduced in the last budget, negatively affecting commercial and retail leasing. Unfortunately, the budget does not do much to encourage ordinary Indians to become homeowners. The budget though, does increase Income Tax exemption limits for individuals (removal of a 10% surcharge), which will increase purchasing power, but not by much. This will act as more of a consumer confidence boost. There was also a lack of positive action on increasing tax exemptions on housing loans, interest and principal repayments. This of course would have done much more towards encouraging homeownership. The budget does provides tax relief for manufacturers of pre-fabricated concrete slabs (prepared onsite) thus benefitting lower income and lower middle-income groups which, until now, were largely ignored by developers. This relief could motivate more developers to move into the low-income and affordable housing sectors. Companies like Tata have already entered the market with projects like their Nano housing, building apartments costing from INR4-7 lakhs per unit.

Oliver Ontiveros Chief Investment Officer Elysium Capital Ltd +91 9500 103555 [email protected] MSR Krishnan Director Elysium Property Advisers P Ltd +91 9952 415262 [email protected]

The views expressed above are based on information which we believe to be reliable but are not guaranteed as to accuracy or completeness by Elysium Capital. This document is not, nor should it be construed as, an offer or the solicitation of any offer, or as general or definitive advice to buy or sell any investments and expressions of opinion are subject to change without notice. Sources of data are available from Elysium on request.

Elysium Capital Ltd

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