Intelligentguess

The Indian Finance Minister presented the annual budget in Parliament today.

Key decisions concerning direct taxes are elucidated below (alongwith some brief comments)

Threshold limit of exemption in the case of all assessees to be increased by Rs.10,000.

• In the case of a woman assessee, threshold limit to be increased from Rs.135,000 to Rs.145,000
• In case of a senior citizen from Rs.185,000 to Rs.195,000

This gives a relief of Rs. 1000 (Rs. 2000 in case of senior citizens) in tax payments. Too miniscule to be of much import.

Surcharge on income tax on all firms and companies with a taxable income of Rs.1 crore or less to be removed.

The surcharge is at a rate of 10%. This would thus benefit companies which qualify as per the eligibility norm.

A five year income tax holiday for two, three or four star hotels and for convention centres with a seating capacity of not less than 3,000; they should be completed and begin operations in National Capital Territory of Delhi or in the adjacent districts of Faridabad, Gurgaon, Ghaziabad or Gautam Budh Nagar during April 1, 2007 to March 31, 2010.

This move is intended to incentivise creation of hotel rooms in Delhi and surroundings. Clearly targeted at the Commonwealth games due to be held in Delhi in 2010.

Tax holiday to undertakings in Jammu & Kashmir to be extended for another five years up to March 31, 2012.

The minister could have as well said “indefinitely” instead of specifying the terminal date.

Minimum Alternate Tax (MAT) to be extended to income in respect of which deduction is claimed under sections 10A and 10B.

Secs 10A and 10B deal with profits earned from units located in Special Economic Zones. Perceived to be a negative for small and medium IT companies.

Deduction under section 36(1)(viii) to be restricted to 20% of profits each year.

Section 36 allows deduction for transfer of profits to special reserve upto 40% for banks/ FIs engaged in long term finance. The proposal to reduce it to 20% increases the effective tax rate by approximately 5%. Negative for entities like IDFC, HDFC etc.

Pass-through status to be granted to venture capital funds only in respect of investments in venture capital undertakings in biotechnology; information technology relating to hardware and software development;nanotechnology; seed research and development; research and development of new chemical entities in the pharmaceutical sector; dairy industry; poultry industry; and production of bio-fuels, and hotel-cum-convention centres of a certain description and size.

An unnecessary attempt at micro management by the Finance Minister

Rate of dividend distribution tax to be raised from 12.5% to 15% on dividends distributed by companies; and to 25% on dividends paid by money market mutual funds and liquid mutual funds to all investors.

Negative for investors in company shares. Effective tax on dividend distribution by “liquid” mutual funds to individuals more than doubles to 28.3% from the current 14.02%. Increase in effective tax rates for corporates investing in “liquid” mutual funds increases by approximately 5.5%.

ESOPs to be brought under Fringe Benefit Tax regime.

A big negative for all those who dream of riches from ESOPs. The government now eyes a share of the pie

Cash withdrawals by Central and State Governments to be excluded from the scope of Banking Cash Transactions Tax (BCTT); exemption limit for individuals and HUFs to be raised from Rs.25,000 to Rs.50,000

Better late than never. BCTT is anyway a controversial measure. Raised a lot of hackles when introduced. Personally, would prefer that this tax be withdrawn.

An additional cess of 1% on all taxes to be levied to fund secondary education and higher education and the expansion of capacity by 54% for reservation for socially and educationally backward classes.

Education cess has been hiked from 2% to 3%. This move is distinctly unpopular. It leads to a cascade increase in all taxes.

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Indian Finance Minister, P Chidambaram presents the annual budget in Parliament at 0530 hrs GMT (1100 hrs IST) on Wednesday, Feb 28.

The event, significant to Indian markets in itself, comes in the backdrop of a global stock market meltdown on Tuesday.

It all started with the Chinese stock market benchmark, the Shanghai composite index posting its biggest single day loss of almost 9% since February 1997. On that occasion the index had dropped 9.14% on the death of the Chinese reformist leader Deng Xiaoping.

Incidentally, the Chinese index has gained more than 130% in 2006 and also touched its all time high on Monday. The triggerfor the sharp fall this time around, however, is more rooted in reality than sentiment. Tuesday’s decline on the Chinese market was triggered by fears that the government would intervene to slow down the market.

Amongst other markets, the US Dow Industrials is down by about 190 points (1.5% approx), the NASDAQ composite is down more than 2.4% and the S&P 500 is down more than 1.75% (as I write this).

Brazil’s benchmark is down by about 4%, and the major European European indices have closed as below

London FTSE : 6286.10; -148.60; -2.31%

Paris CAC 40 : 5588.39 ; -174.15 ; -3.01%

German DAX : 6819.65 ; -207.94; -2.96%

Bond yields in major markets continue to rule low as investors take flight to safety. All major currencies have rallied against the US dollar with the Japanese Yen rising the most (an almost 1.60% gain over the previous day, as i write). It now trades at approximately 118.60 to the US dollar.

The attempted terrorist attacks, against US Vice President Dick Cheney in Kabul and the US and Italian Ambassadors in Sri Lanka, have also worsened sentiment.

While other Asian markets will open before the Indian markets and provide cues on the global market mood, investors should brace themselves for a rough ride when markets open on budget day.

As it is, the ruling party has suffered losses in two of the states that it ruled. With the key state of Uttar Pradesh due for elections in April-May, brace yourself for a populist budget. Not so good news for the stock markets though.

Update : The Dow has fallen by more than 2% while the NASDAQ fall breached 3%. The sharp fall in the New York Stock Exchanges Composite Index has also trigerred the circuit breaker (collar) mechanism of the exchange after a long time - first time since June 2006. Things are looking really gloomy.

Update 2 : It’s actually worse than expected. The Dow lost more than 400 points at close, after having suffered a close to 550 point loss (attributed to a technical glitch) mid session.  Asian markets have also opened weak. The Japanese and Hong Kong benchmarks are down more than 3% mid morning. Worse, emerging markets actually lost ground even more sharply. Brazil, Mexico, Argentina all closed down by more than 6%. Phillipines is trading down more than 6% mid morning. Expecct a sharp 2-3% loss in the Bombay Sensex within the first hour of trade. 

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Kohlberg Kravis Roberts and Co (KKR) and Texas Pacific Group (TPG) have announced a leveraged buyout transaction (LBO) to take over Texas based power utility TXU Corporation (a press report here) for a record breaking USD 45 billion.

This marks the first time that the size of a buyout deal has crossed USD 40 bn leaving behind the Blackstone group’s recent purchase of Equity Office Properties. What’s more, even this USD 45 bn record may be broken, as the merger agreement provides for a so called go-shop period during which TXU may consider offers from other interested buyers.

The price of credit default swaps (which is a close proxy to the risk of owning corporate bonds) moved up sharply in the wake of TXU’s announcement. CDS spreads on TXU’s debt almost doubled to 157 basis points (Bloomberg report) a rise of approximately 73 basis points over one day. CDS spreads of other similar companies too moved sharply higher.

Worlwide, the size of the CDS market is estimated at approximately USD 25 trillion. Such sharp moves in spreads (prices) clearly bring about a lot of pain (and gain). There must have been many a glum (and cheerful) face on trading desks yesterday, but then who said trading is child’s play.

No wonder, the saying goes, traders age many many years in a day.

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Press reports seem to suggest that, the Indian Finance Minister, P Chidambaram intends to increase the tax rate on dividends distributed by fixed income oriented mutual funds, in his budget proposals to be unveiled on February 28.

Such a move, if it fructifies, would come after intense lobbying by the banking industry, demanding parity with mutual funds on tax treatment.

It is significant to note that aggregate deposits of the banking system is well in excess of Rs. 25 trillion (USD 600 bn approx.) while the size of the fixed income oriented mutual funds is approximately Rs. 2 trillion (USD 45 bn). It is also notable that the banking industry has added in excess of Rs. 3 trillion in deposits in the last 11 months, 50% more than the entire size of the fixed income fund industry.

What makes bankers feel threatened by the growth of mutual funds is beyond comprehension.

Currently, a significant portion of the mutual fund portfolios actually comprise instruments issued by banks. This has been an efficient source of funds for banks, on the lookout for wholesale funds to boost balance sheet size.

Mutual funds have been acting as efficient intermediaries for banks in this respect. Any removal (or dilution) of the slim tax advantage that funds enjoy would only lead to inefficiencies in resource mobilisation for banks themselves.

Mr. Chidambaram should also recall that his dream budget of 1997, which exempted dividends from tax, actually gave a big fillip to the mutual fund industry, paving the way for a vibrant and active market in debt instruments.

Further, the tax advantage enjoyed by mutual funds over bank deposits is only marginal and is likely to be of import only to large and fickle investors. In a way banks are saying, these large sums of money is what we need to lay a hand on to show growth. What they probably do not forsee, is that they probably already have a recourse to these funds, via mutual funds.

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The Reserve Bank of India has just released a press note stating that

1. The statutory minimum and maximum cash reserve ratio (3% and 20% respectively) stipulations still exist, since the Government is yet to notify the relevant amendment to the RBI Act;
2. Graded interest payments will be made to banks on CRR balances above the statutory minimum of 3%.
3. The interest payments would be at
   • 3.5% p.a. for the period June 24, 2006 to December 8, 2006;
   • 2.0% p.a. for the period December 9, 2006 to February 16, 2007;
   • 1.0% p.a. for February 17, 2007 and beyond.

This comes as a bit of a surprise as the market had all along been given to believe that the statutory limits on the compulsory impounding of cash pre-emption of funds through CRR had been removed.

The interest being paid by RBI to banks on eligible CRR balances is negligible, to be of much importance.

Update : I have been asked by a few to clarify what exactly is the surprise. It was announced in June 2006 that the minimum (3%) and maximum (20%) limits placed on CRR had been withdrawn. Consequent to the above decision RBI had stopped paying interest on CRR balances. The markets had all along been led to beleive that the limits no longer exist. The press release by RBI explicitly refutes this and clarifies that the statutory minimum and maximum limits continue to exist since their removal has not been notified by the Government.  Consequently, interest payments (though at modest rates) on CRR balances are also being reinstated. Strange are the ways of our system.

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India released its weekly inflation numbers today.

Provisional headline inflation based on a year on year change in the Wholesale Price Index (WPI) came in at 6.63% for the week ended February 10.

The WPI itself remained unchanged at 209.2.

Retail fuel prices (which are controlled by the government) were cut last week. The impact of this cut should be reflected in the index numbers for the next week. Further, with elections in a key state due in April, the Government is expected to go all out and manage price levels. This should help to keep any growth in the “provisional” WPI at modest levels, thereby preventing a sharp run up in revealed inflation numbers.

More worryingly, the final inflation number for the week ended December 16 has been revised upwards to 5.73% (from the provisional figure of 5.43%). It does not bode well if the trend of the final numbers being revised sharply upwards, continues. It has been so for some time now.

Update : The sub index for Primary Articles (comprising Food and other essential Non food items) has  dropped marginally week on week to 215.8 from 216.1. Have food prices really come down? Hard to say, but expect more of such moderation in the provisional numbers. After all, crucial elections are due, and the provisional numbers are probably driven more by politics, rather than ground level economics. The reality can, for the time being be postponed to the final numbers. By that time, elections would have come and gone.

Note : Provisional WPI (and therefore inflation) numbers are released with a delay of two weeks. This is updated with the final number after three months. While, the provisional numbers is highlighted well by mainstream media, rarely has focus been cast on the final updated number.

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Situation 

On an annual basis -  Orders grew by by 3.99 % p.a in December 2006 compared to December 2005.
The index grew by 6.09 % p.a in November and 10.24%  p.a  in October.

On a monthly basis - Orders index grew by by 2.8%  in December 2006 compared to November 2006. ( 1.1%  in November but fell by 0.3%  in October)

As compared to the same period last year - the rate of growth has been steadily dropping since August 2006 ( 14.24 % p.a ) and the current growth is the lowest since July 2005 ( where it was in a rising trend).

Conclusion 

This has an impact in two areas :

- The Production Indices ( IIP )  cannot be expected to rise in the coming 2-3 months ( read also: Euro area Industrial Production )

-  ECB will need to consider the negative impact of raising Interest rates further -  on falling New Orders / IIP .  

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The Consumer Price Index  (CPI) for January 2007 was up by  2.08% as compared to  January  2006.

Core CPI ( excluding food and energy) grew by 2.7 % for the same period. Energy costs, which increased 4.2 % in  December 2006 as compared to the previous month , declined 1.5 percent in January 2007 ( as compared to December 2006)

 As can be seen in the attached chart ( Double/single click for the big picture )
both CPI as well as PPI are at the lower end of their range - and is likely to remain in the lower end of their range.

Under the current conditions it does seem like inflation is well under control - and is likely to remain low for the coming 3-4 months

Conclusion 

The Fed will not be inclined to increase interest rates - in the immediate 2-4 months.

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The US Bureau of Labour Statistics released the latest CPI data for January today.

The overall CPI came in slightly higher than expected. However, most the increased contribution came from abnormally large increases in the indexes for medical care and food. With analysts reckoning these to be of lesser importance (for the Fed), markets seemed to shrug off the higher headline number.

An interesting observation comes in a footnote in the BLS press release

“Effective with this release, index levels are now published to three decimal places. Percent changes based on these three-decimal place indexes will continue to be published to one decimal place.”

So, the Americans are going to make their data more precise!

While this removes the problem of rounding off errors, how accurate will the data become - only time will tell.

There is no doubt that economic data coming out of the US is of a far higher quality - the move to make it more precise will only improve it further - than, say, India, China or Russia. Coming to think of it, these are the very countries many expect to stand tall in the coming global economic order.

It’s, probably, high time that these (and other) countries start paying attention to the quality and reliability of their economic data. Hopefully, the American move to set their own bar higher would act as a catalyst (or should I say wake up call) for others.

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At the Monetary Policy Meeting held today, the Bank of Japan decided, by a 8-1 majority vote, to raise the uncollateralized overnight call rate from 0.25% to 0.5 %

The Bank states

” With regard to the future course of monetary policy, the Bank will adjust the level of interest rates gradually in the light of developments in economic activity and prices, while maintaining the accommodative financial conditions ensuing from very low interest rates for some time.”

Translation

Interest rate hikes - depends on growth expectations

Conclusion

The gap in the inflation indices and the lending rate in Japan was commented upon recently. Japan does not have much of a choice - but to raise interest rates to bridge this gap. But it does tread with caution. ( reasons are explained in the link within the paragraph )

Japan has been reluctant to act and was looking for some consumption growth before trying to bridge this gap.

Last week Japan had reported an annualised 4.8% growth for Q4 2006 - as compared to a 0.3% annualised growth in Q3 2006.

This triggered the change in stance.

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