Economy Matters, June-July 2014

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In the June / July 2014 issue of Economy Matters, we track the economic developments in the major advanced economies in Global Trends. In the section on Domestic Trends, we discuss the trends emanating out of the recent releases on IIP, Inflation and Monsoon. Additionally, the recent Economic Survey and Railway Budget are also covered. The Sectoral spotlight for this issue is on the Warehousing Industry. In Focus of the Month, the spotlight is on Union Budget 2014-15. Special Feature discusses the importance of Chemical Industry for economic growth.


  • JUNE -JULY 20141 FOREWORD Global activity has broadly strengthened and is expected to improve further in 2014-15, with much of the impetus coming from the developed economies. However, the policymakers in these economies need to avoid a premature withdrawal of monetary accommodation. US economy is recovering, albeit a slow pace, consequently the Federal Reserve has vowed to keep interest rates low in order to aid the growth recovery process. European Central Bank (ECB) injected monetary stimulus in June 2014 in order to prevent the economy from fall- ing into deflation trap as sustained low inflation is not conducive for recovery of economic growth. Japans economy is doing well, with the first quarter GDP rising sharply aided by robust growth in domestic demand. Abenomics seems to be doing the trick for the Japanese economy. On the domestic front, deficient monsoons are fast emerging as significant macroeconomic risk. As per the latest data, cumulative rainfall deficiency (till 20th July, 2014) stands at 31 per cent below the LPA. Unless, there is significant recovery in monsoons in the coming weeks, we are at a risk of staring at yet another drought, the fourth in the past decade. In some posi- tive news for the economy, industrial output rose for the second month in a row in May 2014. We expect further rebound in industrial production as the reforms oriented and forward looking budget is expected to boost business confidence, going forward. On the back of the recent measures announced by the government to increase supply of fruits & vegetables in the market, both CPI and WPI inflation moderated in June 2014. However, with the danger of El Nino looming large over the economy this year, a rise in food inflation in the latter part of the year cannot be ruled out. Coming to the most important development of the month of July 2014, in the Union Budget 2014-15, the new government activated a number of directional changes that would stabilize the economy, boost investments, and encourage savings with a view to reviving GDP growth to 7-8 per cent in the near term. Specifically, the budget stood out for its pragmatic and bold approach for initiating measures aimed at reinvigorating the economy. The vision articulated in the budget showed that the government meant business. In this issue of Focus of the Month, sectoral experts discuss the implications of the Union Budget 2014-15 on their respec- tive sectors. Chandrajit Banerjee Director General, CII
  • 3 JUNE -JULY 2014
  • EXECUTIVE SUMMARY ECONOMY MATTERS 4 Global Trends Global economies experienced subdued growth for yet another year in 2013, unable to meet even the modest pro- jections made by many institutional forecasters. Underper- formance in the world economy was observed across almost all regions and major economic groups. Most developed economies continued struggling in an uphill battle against the lingering effects of the financial crisis, grappling in par- ticular with the challenges of taking appropriate fiscal and monetary policy actions. Some signs of improvements have shown up more recently: the Euro Zone has finally come out of a protracted recession. As per IMFs recent Global Eco- nomic Outlook, growth outlook across advanced economies has improved significantly to 2.2 per cent in 2014 as com- pared to 1.3 per cent growth in 2013. This is confirmed by the latest GDP releases across the major economies. Real GDP in US increased to 1.5 per cent on a y-o-y basis in the first quar- ter of 2014 as compared to 1.3 per cent in the corresponding quarter of previous fiscal. In the Euro Area, the GDP growth rate expanded to 0.9 per cent on a y-o-y basis in the first quarter of the current year as compared to contraction to the tune of 1.1 per cent in seen in the first quarter of 2012. Domestic Trends Though the occurrence of normal monsoon is pivotal in supporting the growth rate of the farm sector every year, but this fiscal it assumes greater importance in the context of the macroeconomic challenges facing the economy. As per the latest data, rainfall deficiency for the period from 1 June to 20 July 2014 stood at 31 per cent below LPA as compared to 16 per cent above LPA during the same period last year, even after the gap shrank in the week of 10-17th July, 2014 due to improve- ment in rainfall in some areas of central and northwest India. Unless there is a significant recovery in monsoons in the next few weeks, we would be staring at yet an- other drought, the fourth in the past decade. In some positive news for the economy, continuing its good per- formance of April 2014, industrial production growth rose sharply to 4.7 per cent in May 2014, indicating sig- nals of turnaround of the beleaguered sector. Both CPI and WPI based inflation cooled off in June 2014 on the back of deceleration in food prices and lower base ef- fect of last year. Sector in Focus: Warehousing Industry Warehousing forms a crucial link in the overall logistics value chain. It accounts for close to 5 per cent of the Indian logistics market (excluding inventory carrying costs, which amount to another ~30 per cent). Ware- housing in India has been evolving rapidly from being traditional godowns a mere four-wall-and-shed with sub optimal size, inadequate ventilation and light- ing, lack of racking systems, poor hygiene conditions and lack of inventory management or evolved solutions such as warehouse management systems into modern setups with storage and handling points where raw ma- terial, intermediate and manufactured goods are col- lected, assorted, stored and distributed to the point of consumption/sale. The size of the Indian warehousing industry (across commodities and modes) is pegged at about Rs 560 billion (excluding inventory carrying costs, which amount to another Rs 4,340 billion). The industry is growing at over 10 per cent annually. In this months Sector in Focus, we review this important sector. Focus of the Month: Union Budget 2014-15 The Union Budget 2014-15, the maiden budget of the newly elected government, was announced at a time when the macro-economic milieu continues to be domestically and globally challenging. As a result, the year 2013-14, was pri- marily marked by slowdown in GDP growth and persistent inflationary pressures. The Union Budget 2014-15 stood out for the pragmatic and bold approach adopted by the Finance Minister to lift growth, reignite investment, boost savings and provide a fillip to employment generation. A bold and re- formist budget, it rightly focused on the priority areas which would boost business confidence by providing an impetus to growth. The vision articulated in the Budget showed that the government meant business. In the current issues Focus of the Month, sectoral experts discuss the implica- tions of the Union Budget 2014-15 on their respective sec- tors.
  • 5 JUNE -JULY 2014 Budget at a Glance 2014-15
  • ECONOMY MATTERS 6 GLOBAL TRENDS Gauging the Economic Performance of Major Developed Economies Global economies experienced subdued growth for yet another year in 2013, unable to meet even the modest projections made by many institutional fore- casters. Underperformance in the world economy was observed across almost all regions and major economic groups. Most developed economies continued strug- gling in an uphill battle against the lingering effects of the financial crisis, grappling in particular with the chal- lenges of taking appropriate fiscal and monetary policy actions. Some signs of improvements have shown up more recently: the Euro Zone has finally come out of a protracted recession, with gross domestic product (GDP) for the region as a whole returning to growth in 2013; a few large emerging economies, including China, seem to have backstopped a further slowdown and are poised to strengthen, going forward. As per IMFs recent Global Economic Outlook, growth outlook across advanced economies has improved sig- nificantly to 2.2 per cent in 2014 as compared to 1.3 per cent growth in 2013. It is further expected to improve to 2.3 per cent in 2015. The uptick in 2014 is primarily due to Euro Area which is expected to return to posi- tive growth rate of 1.2 per cent in 2014 from last two years of contraction in growth. US is the second larg- est contributor (after China) to the somewhat stronger outlook for 2014, where growth is expected to increase sharply from 1.9 per cent in 2013 to 2.8 per cent in 2014. We discuss the economic performance of the major de- veloped economies in the subsequent paragraphs. We are also including China in this discussion, though it is not a developed economy yet, as the economic pros- pects of China are closely intertwined with the perfor- mance of the developed economies. a. United States (US) Real GDP in US moderated to 1.5 per cent on a y-o-y basis in the first quarter of 2014 as compared to 2.6 per cent in the previous quarter. On seasonally-adjusted q-o-q basis, GDP contracted by 2.9 per cent in the first quarter as compared to growth of 1.1 per cent recorded in the same quarter last year. As far as different components of growth are concerned, on a y-o-y basis, positive con- tributions to growth were made by personal consump- tion expenditure, whose growth improved marginally to 2 per cent against a 1.9 per cent in the first quarter of 2013. A severe fall was seen in the growth of residential fixed investment to 2.7 per cent in the first quarter of
  • 7 GLOBAL TRENDS JUNE -JULY 2014 2014 against 12.9 per cent in the comparing period last year. However, an upturn was seen in growth of non- Coming to inflation, in May 2014, CPI based inflation in US rose marginally to 2.1 per cent as compared to 2.0 per cent in the previous month. However, core inflation (excluding energy and food prices) increased to 2.0 per cent in May 2014, the highest figure since February 2013. Food inflation too accelerated to 2.5 per cent in the re- porting month, its largest 12-month increase since June 2012. The recent upward pressure visible on CPI infla- tion has led to the market talks of possibility of a less dovish Federal Reserve. However, Federal Reserve (Fed) is expected to con- tinue its accommodative stance for 2014-2015. In ac- cordance with the forward monetary policy guidance of the Fed, it is assumed that in the forecasting period of 2014-2015, the federal funds interest rate will remain within the range of 0.0 to 0.25 per cent until mid-2015, followed by a gradual increase starting in the third quar- ter of 2015. The adjustment of long-term assets on the Fed balance sheet has already started last year in De- cember 2013. In its meeting held on June 19th 2014, Fed reduced its asset purchase program from US$45 billion/ residential fixed investment to 3.5 per cent, against 2.4 per cent recorded last year. month to US$35 billion/month. Component wise, Fed would trim its purchases of long-term Treasury bonds to US$20 billion/month (from US$25 billion previously) and mortgage-backed securities (MBS) to US$15 billion/ month (from US$20 billion). QE3 is expected to be ter- minated in fourth quarter of 2014. b. Euro Area In the Euro Area, the GDP growth rate expanded to 0.9 per cent on a y-o-y basis in the first quarter of the cur- rent year as compared to 0.5 per cent in the previous quarter and contraction to the tune of 1.1 per cent in seen in the same quarter of 2012. Amongst the various sectors of GDP, the growth of household final consump- tion expenditure and government final consumption expenditure increased to 0.4 per cent and 0.2 per cent respectively in the reporting quarter, as compared to contraction to the tune of 1.2 per cent and 0.6 per cent respectively recorded in the same quarter last year. Growth in gross fixed capital formation improved to 1.9 per cent in the reporting quarter, as against a decline of 5.5 per cent in the same period last year.
  • ECONOMY MATTERS 8 GLOBAL TRENDS The growth trends among individual countries in the Euro Area were varied (see below table). Among mem- ber states for which data are available for the first quarter of 2014, Hungary (3.2 per cent), Poland (3.5 per In Euro Area, CPI inflation moderated to 0.5 per cent in May 2014 from 0.7 per cent in April. The largest upward impact to inflation came from tobacco, restaurants & cafs, and electricity, while vegetables, telecommunica- tions and fruit had the biggest downward impact. The European Central Bank (ECB) is assumed not to cut its policy interest rates further, but to keep policy rates at the current levels through the end of 2015, followed cent), Romania (3.8 per cent) and the United Kingdom (3.1 per cent) recorded the highest growth on a year- on-year basis. Estonia (-1.5 per cent), Cyprus (-4.1 per cent) and Finland (-0.8 per cent) registered the largest decreases. by a gradual path of increases. The outright monetary transaction programme will remain in place and refi- nancing operations will continue to meet the needs of the banking sector. Additionally, ECB unveiled a number of monetary easing measures ranging from lower policy rates to targeted Long Term Refinance Operations (TL- TROs) to extension of fixed-rate full-allotment tender procedures without any time limit in its meeting held in first week of June 2014.
  • 9 GLOBAL TRENDS JUNE -JULY 2014 c. Japan In the Asian continent, Japan saw its GDP growth accel- erated to 3 per cent on a y-o-y basis in the first quarter of 2014 as per Cabinet Office, Japan, as compared with growth of 2.5 per cent in the previous quarter and 0.1 per cent in the same period last year. The upswing in GDP was aided by robust growth in domestic demand The CPI based annual inflation accelerated to 3.7 per cent in May 2014 from 3.4 per cent in April, as the ef- fects of a sales tax increase continued to push consum- er prices up. Further upward push to CPI inflation was provided by increase in prices of fuel, light and water charges and furniture and household utensils. The Bank of Japan (BoJ) is assumed to continue its Quantitative and Qualitative Monetary Easing Pro- gramme as it was originally designed until the end of 2014. To be sure, BoJ has set a goal of an annual increase in the monetary base of between 60 trillion yen and 70 trillion yen ($690 billion) in order to ensure that inflation picks up to its 2 per cent target. The policy rate for BoJ is also assumed to stay within the range of 0.0 to 0.1 per cent through the end of 2015, to accommodate the sec- drivers. Growth of public investment strengthened to 11.4 per cent as compared to contraction to the tune of 0.7 per cent during the same quarter of last year. Growth in private consumption increased to 3.7 per cent as compared to 1.5 per cent last year as households tried to beat the increase in the sales tax in April 2014 and brought purchases forward. In contrast, govern- ment consumption saw a decline to the tune of 0.9 per cent as compared with 1.4 per cent last year. ond hike of the consumption tax rate that is assumed to be implemented in October 2015. d. China Chinas economic growth improved to 7.5 per cent in the second quarter of 2014, from 7.4 per cent recorded in the previous quarter. The improvement in growth comes as the government undertook a series of meas- ures to support growth, which were collectively dubbed as mini-stimulus. The government in April 2014 had pledged to increase spending on railways, affordable housing and extend tax sops to small firms. Data sug- gest that the improvement in economic activity was widespread, with growth improving in both secondary and in the tertiary sector (which includes infrastruc- ture).
  • ECONOMY MATTERS 10 GLOBAL TRENDS Other Global Developments During the Month US non-farm payrolls (NFP) increased by 288K in June, better than market consensus of ~215K increase. The readings for both April and May jobs growth were revised upward by total 29K. Thus, NFP increased by an aver- age of 272K in Q22014, faster than Q1 average of 190K. As per the household survey, the unemployment rate fell to 6.1 per cent in June, defying market expectation of a flat reading at Mays level of 6.3 per cent. However, the recent decline in the unemployment rate is partially attributable to the persistent fall in the labour force participation rate (LFPR). The LFPR remained flat at a 35- year low of 62.8 per cent in June. In line with market expectation, the Fed reduced its asset purchase program from US$45 billion/month to US$35 billion/month in its meeting held last month. Component wise, Fed would trim its purchases of long- term Treasury bonds to US$20 billion/month (from US$25 billion previously) and mortgage-backed securities (MBS) to US$15 billion/month (from US$20 billion). QE3 is expected to be terminated in Q4 of 2014. Federal Reserve members have also revised down their projections for 2014 GDP growth given contraction in the first quarter. The Fed expects the economy to grow at a lower pace of 2.1 per cent to 2.3 per cent in 2014 (previous expectation: 2.8 per cent to 3.0 per cent). However, it expects unemployment rate to reduce to 6.0- 6.1 per cent range in 2014 as against its previous projections of 6.1-6.3 per cent range. Bank of England (BoE) maintained status quo with official policy rate at 0.5 per cent and Asset Purchase Facility (APF) at GBP 375 billion in its meeting held on July 10, 2014. BoE implemented some macro-prudential measures to address housing market risks last month, which are unlikely to have a substantial impact in the near term. IMF Chief Lagarde has hinted that the Funds 2014 global growth forecast of 3.6 per cent might be revised down slightly lower. She said that global economic activity should strengthen in second half of 2014 and ac- celerate in 2015, although momentum could be weaker than expected. Consumer price index (CPI) in the UK grew at higher-than-expected rate of 1.9 per cent on y-o-y basis in June 2014 vis--vis 64-month lowest level of 1.5 per cent in the previous month. Interestingly, barring miscellaneous goods & services, all components of CPI moved up in June 2014. The major drivers of higher-than-expected inflation were clothing & footwear, which accounted for almost half of the increase in Junes inflation (added 18 basis points (bps)), food & non-alcoholic beveragesand transport (added 7 bps each). Coming to inflation, CPI based inflation rate rose to 2.5 per cent in May 2014, up from Aprils 1.8 per cent increase. This was the highest figure in the last four months. The politically sensitive food inflation acceler- ated sharply to 4.1 per cent in May 2014 from the previ- ous months 2.3 per cent rise. In May 2014, the biggest increases were reported for prices of services (2.7 per cent), clothing (2.5 per cent), housing (2.3 per cent) and recreation, education & culture (2.1 per cent). For 2014, the government has set inflation target of around 3.5 per cent. Monetary policy has eased somewhat after remaining prudent for most of 2013 and the first quarter of 2014. Latest data showed that money supply (M2) growth increased in the April-June period (in year-over-year growth terms) along with a rise in bank lending. Never- theless, monetary policy is not expected to be substan- tially eased any further as the PBoC continues to remain concerned over risks emanating from shadow banking. In fact, regulators announced slightly tighter norms for interbank lending in the middle of the second quarter. Conclusion Global activity has broadly strengthened and is expect- ed to improve further in 201415, according to the April 2014 WEO, with much of the impetus for growth com- ing from advanced economies. Although downside risks have diminished overall, lower-than-expected infla- tion poses risks for advanced economies. Additionally, there is increased financial volatility in emerging market economies, and increases in the cost of capital will likely dampen investment and weigh on growth. Advanced economy policymakers need to avoid a premature withdrawal of monetary accommodation. Emerging market economy policymakers must adopt measures to changing fundamentals, facilitate external adjustment, further monetary policy tightening, and carry out struc- tural reforms.
  • 11 DOMESTIC TRENDS Deficient Monsoons: Another Macroeconomic Risk? JUNE -JULY 2014 Though the occurrence of normal monsoon is pivot- al in supporting the growth rate of the farm sector every year, but this fiscal it assumes greater importance in the context of the macroeconomic challenges facing the economy. The economy, at present, is grappling with high inflation rates emanating from the surging food prices and normal monsoons would provide the much needed relief by easing the domestic supply-side pressures. As rainfall is the main source of irrigation for 55 per cent of arable land, sub-normal rainfall (to the tune of 31 per cent below LPA from 01 June-20 July 2014) received so far has increased the risk of fuelling food inflation further except in wheat and rice where we already have buffer stocks. As is evident from the below chart, years in which there was a higher deviation of monsoons from long period average (LPA), higher food inflation was recorded. However, food inflation was low during the drought in 2002-03 as there were huge buffer stocks of food grains, much above the rec- ommended levels. In contrast, food inflation was high last year despite normal monsoons due to structural factors plaguing the sector.
  • ECONOMY MATTERS 12 DOMESTIC TRENDS The forecast for the South-West (SW) monsoon, which occurs between the months of June and September, was revised from 95 per cent of LPA announced ear- lier in April 2014 to 93 per cent by the Meteorological Department in June 2014 mainly on account of the El Nino factor. El Nino is an abnormal warming of the wa- ter in the Equatorial Pacific Ocean that can weaken the South-western monsoon winds and, thus, significantly reduce rainfall in the North-west and Central regions. This means that the rainfall this year will be below nor- mal this year. The IMD classifies rainfall between 90-96 per cent of the LPA as below normal and between 96- 104 per cent as normal. Rainfall anywhere below 90 per cent of the LPA is considered deficient. The slow pro- gress of the SW monsoon so far has jeopardized the prospects of a normal Kharif crop this season. As per the latest data, rainfall deficiency for the period from 1 June to 20 July 2014 stood at 31 per cent below LPA as compared to 16 per cent above LPA during the same period last year, even after the gap shrank in the week of 10-17 July 2014 due to improvement in rainfall in some areas of central and northwest India. Still, central India has the maximum deficiency gap of all the major regions of the country. Out of the 36 meteorological sub-divisions, rainfall was deficient/scanty in 25, and normal in 11 sub-divisions. The map shown below shows the spatial distribution of rainfall across the country.
  • 13 DOMESTIC TRENDS JUNE -JULY 2014 Source: IMD Unless there is a significant recovery in monsoons in the next few weeks, we would be staring at yet another drought, the fourth in the past decade. A poor monsoon season, besides stoking inflation, would also have adverse impacts on exports and overall demand in the economy. Spatial Distribution of Rainfall
  • ECONOMY MATTERS 14 DOMESTIC TRENDS Continuing its good performance of April 2014, indus- trial production growth rose sharply to 4.7 per cent in May 2014, indicating signals of turnaround of the belea- guered industrial sector. The performance of consumer goods sector stood out as it moved into the positive ter- ritory after seven consecutive months of contraction. To be sure, a weak base of last year also lent a helping hand to the industrial output growth in May 2014. This becomes amply clear from the fact that the sequential momentum as indicated by the movement in the sea- sonally-adjusted month-on-month series showed that industrial output growth declined in May 2014 (from 1.9 per cent in April 2014 to -0.7 per cent in May 2014). However, the April-May IIP growth average of 4 per cent is encouraging and the momentum is likely to con- On the sectoral front, output of the manufacturing sec- tor, which constitutes over 75 per cent of the index, in- creased sharply to 4.8 per cent in May 2014 as compared to 2.5 per cent in the previous month, partly due to a weak base of last year. In terms of industries, sixteen (16) out of the twenty two (22) industry groups (as per 2-digit NIC-2004) in the manufacturing sector showed positive growth during the month of May 2014 as com- pared to the corresponding month of the previous year. The industry group Furniture; manufacturing n.e.c. showed the highest positive growth of 60.0 per cent, tinue for the rest of the year and may even accelerate towards the end of the fiscal on the back of significant decisions announced in the budget to boost manufac- turing sector. Core sector output, which has a weight of 37.90 per cent in the Index of Industrial Production (IIP), grew at a diminished pace of 2.3 per cent in May 2014 as com- pared to a healthy 4.2 per cent increase in April 2014. Coal production increased 5.5 per cent, while the elec- tricity generation increased 6.3 per cent in May 2014 over May 2013. The production of fertilizer increased 17.6 per cent, while that of steel declined to 2.0 per cent in May 2014. The output of crude oil, natural gas and pe- troleum refinery also declined in the reporting month. followed by 37.1 per cent in Tobacco products and 33.7 per cent in Electrical machinery & apparatus n.e.c.. On the other hand, the industry group Radio, TV and communication equipment & apparatus showed the highest negative growth of (-) 40.3 per cent, followed by (-) 28.6 per cent in Office, accounting & computing machinery and (-) 7.4 per cent in Motor vehicles, trail- ers & semi-trailers. Mining sector, which had turned the corner in the last couple of months, grew by 2.7 per cent in May 2014 as compared to 2.6 per cent growth in the previous month. Electricity sector output growth mod- Pace of Industrial Output Accelerates for the Second Consecutive Month
  • 15 DOMESTIC TRENDS JUNE -JULY 2014 WPI based inflation cooled off to four month low of 5.4 per cent in June 2014 as compared to 6.0 per cent in the previous month on the back of deceleration in food prices. Total food inflation (primary and manufacturing) moderated to 6.2 per cent in the June 2014 as compared to 7.0 per cent in the previous month. Retail inflation (CPI) also dropped sharply in June 2014, falling to a re- cord low of 7.3 per cent from 8.3 per cent in the previ- ous month. Lower food inflation was the main driving force behind reduction in CPI inflation. CPI food infla- erated to 6.3 per cent in the reporting month as com- pared to a healthy 11.9 per cent in the previous month. The use-based sectors displayed broad based recovery with all sub-sectors posting positive growth since Octo- ber 2012. Volatile capital goods segment output moder- ated to 4.5 per cent in May 2014 as compared to robust double-digit rate of 14.3 per cent in April 2014. Interme- diate goods, which registered steady growth for most part of last fiscal, continued its good performance in May 2014 too, growing by 2.7 per cent, albeit a modera- tion from the previous month. Basic goods growth too moderated to 6.3 per cent in May 2014 from 7.3 per cent in the previous month. In contrast, consumer goods growth moved into the positive territory after languish- ing in the negative territory for the last seven months. Consumer goods output grew by 3.7 per cent in the re- porting month as compared to an average contraction to the tune of 4.4 per cent in the last seven months. The improvement in the sector was underpinned by the positive growth recorded in consumer durables sector after a gap of seventeen months. This improvement is reflected in the uptick in passenger vehicles sales as well. Consumer non-durables growth too moved into the positive territory in May 2014, although its future trajectory would also be determined by how rural in- come is affected by the uncertainty in monsoons. Inflation Moderates in June 2014 Outlook The rise in IIP for the second month in a row in May 2014 provides a glimmer of hope that the economic recovery could be on the anvil. CII anticipates a further rebound in industrial production as the reforms oriented and forward looking budget would boost business confidence. CII hopes that the government would implement and follow-up on the policy announcements made in the Union Budget 2014-15.
  • ECONOMY MATTERS 16 DOMESTIC TRENDS tion fell to 28-month low of 7.9 per cent in June 2014, mainly on account of lower base effect of last year. Core CPI also continued to moderate. To be sure, the sharp- er-than-anticipated moderation in CPI inflation is much below the RBIs glide path. However, RBI is expected to remain vigilant regarding the impact of weak monsoons Primary inflation decelerated to 6.8 per cent in June 2014 from 8.6 per cent in the previous month. This was mainly attributable to moderation of inflationary pres- sures in both its food and non-food components. Prima- ry food inflation decelerated to 8.1 per cent in June 2014 from 9.5 per cent in the previous month. However, how far this moderation in food prices is able to sustain is a matter of debate as the prospects of El Nino weather event derailing the monsoons this year has grown high- er. Primary non-food inflation too decreased to 3.5 per cent in June 2014 as against 4.9 per cent in the previous month. Interestingly, inflation in minerals which had jumped to twenty-month high of 8.8 per cent in May 2014 came down sharply to 4.4 per cent in June 2014. Fuel inflation decelerated to 9.0 per cent in June 2014 as compared to 10.5 per cent in the previous month. Infla- tion in high-speed diesel moved down to 13.6 per cent in June 2014 from 14.2 per cent in the previous month. Inflation in petrol also moderated to 9.0 per cent in the reporting month from record-high of 12.3 per cent in the previous month. Going forward, there is an impending threat of further increase in fuel prices, if the govern- ment accepts recommendations of the Saumitra Chaud- huri Committee on Auto Fuel Vision & Policy 2025, which on inflation as it has not started to show in the official data. Much of the moderation in both WPI and CPI infla- tion was attributable to lower food prices which in turn were a result of the slew of measures such as imposing a minimum export price on certain essential vegetables etc., announced to tame inflation. has recommended that the petrol and diesel prices be hiked by 75 paise a litre each to upgrade fuel standards in the economy. Additionally, the recent upward fuel price revisions along with the budgeting of a decline in oil subsides in the current fiscal (which tantamount to frequent increase in fuel prices as the government would bring the domestic oil prices in line with the mar- ket ones) also pose upside risk to fuel inflation, going forward. Manufacturing inflation increased marginally to 3.6 per cent in June 2014 as compared to 3.5 per cent in the previous month. Worryingly, non-food manufacturing or core inflation, which is widely regarded as the proxy for demand-side pressures in the economy, inched up to 3.9 per cent during the month as compared to 3.8 per cent in May 2014 on the back of continued price hikes by manufacturers particularly in metals, chemicals and tex- tiles sectors, on the back of rising input costs coupled with pressured profit margins. In the coming months, we expect core WPI to hover around 3.0-3.5 per cent, RBIs comfort level for this inflation measure. Manufac- turing food inflation showed a marginal uptick during the month.
  • 17 DOMESTIC TRENDS JUNE -JULY 2014 As per the latest LAF data, the average liquidity defi- ciency stood at 105 billion in June 2014 as compared to Rs 69 billion in May 2014. Continuation of inflows from the overseas market, pick-up in the government spend- ing and low credit demand has aided the easing of the systemic liquidity during May-June 2014. The countrys forex reserves increased to US$315.8 billion by 27 June 2014 from US$309.9 billion as on 25 April 2014. To be sure, non-food credit grew at a sluggish pace of 13.5 per cent in June 2014 as compared to over 14.4 per cent in March 2014. The easing of the liquidity condition is reflected in a fall in banks reliance on the Reserve Bank various re- finance facilities. Banks aggregate daily borrowings under the liquidity adjustment facility (including term repos), marginal standing facility and standing liquidity facility averaged Rs 1169.5 billion during the June 2014 quarter as compared to Rs 2011.6 billion in March 2014. Interest rates in the inter-bank call money market sof- tened to 7.86 per cent during the June quarter from around 8.5 per cent in the latter half of March 2014. Liquidity Conditions Ease in May-June 2014 Outlook The moderation in both WPI and CPI inflation in June 2014 on the back of lower food prices is a great relief for the policymakers. Core CPI inflation has also continued to decelerate. However, with the danger of El Nino looming large over the economy this year, a rise in food inflation in the latter part of the year cannot be ruled out. With the RBI recently re-emphasising its intent to lower CPI inflation to 8 per cent by January 2015 and to 6 per cent by Janu- ary 2016, RBI is expected to remain in a wait-and-watch mode for few more quarters.
  • ECONOMY MATTERS 18 DOMESTIC TRENDS In view of the comfortable liquidity condition, the RBI conducted 4-days term reverse repos on 2 June 2014 and 3 July 2014 respectively. It intended to suck out li- quidity worth Rs.150 billion and Rs.200 billion, respec- tively, from the system via the term reverse repos. These, however, did not entice strong response from banks as they parked Rs 20.3 billion with the RBI in the term reverse repo auction conducted in June. They parked even lesser Rs 2 billion in the auction conducted on 3 July. With the Union Budget 2014-15 pegging the net market borrowings only marginally higher by 1.6 per cent in 2014-15 over 2013-14, the pressure on liquidity is not ex- pected to be any higher than evidenced in the last fiscal. The Economic Survey 2013-14 was tabled in the parlia- ment by Finance Minister Shri Arun Jaitley on July 9th, 2014. The survey delineates the economic vision of the government and provides macro economic backdrop for the long-term policy agenda. The key highlights of the survey are as follows: Growth Economy is likely to grow in the range of 5.4 5.9 per cent in 2014-15 Reforms are needed for long term-growth pros- pects in three key areas: low and stable inflation regime, tax and expenditure reform and regulatory framework. Inflation The strategy to control inflation has to take into ac- count the following factors: Deregulation of diesel prices, powersector re- forms, and generally the move from administered to market-determined prices will release sup- pressed inflation in the short run. MGNREGS needs revamp to link to productive asset creation as it has led to labour shortage in agri sec- tor and has also resulted in a wage price spiral. MSP should be linked to cost of production. FCI should procure stocks more efficiently from the market and manage risks through the futures mar- ket. The State Agricultural Produce Marketing Commit- tees (APMC) Acts have created monopolies and dis- tributional inefficiencies. Reforms are required to create alternative trading platforms in the private sector where it is possible to reduce intermediation. Meanwhile, fruits and vegetables should be taken out of the purview of the APMC Acts immediately. Inflation Outlook: Going forward, inflation is expected to inch downwards, paving the way for monetary eas- ing. However, risks to the outlook are from a possible sub-normal monsoon, possible rise in international crude oil prices and exchange rate volatility. Fiscal Issues The fiscal policy for 2013-14 was calibrated with two-fold objectives; first, to aid growth revival; and second, to Economic Survey 2014-15
  • 19 DOMESTIC TRENDS JUNE -JULY 2014 reach the fiscal deficit level targeted for 2013-14. The survey emphasizes the need for a new FRBM Act with teeth; fiscal consolidation remains im- perative for the economy. Fiscal consolidation can be achieved through ra- tionalization of subsidies and raising tax-GDP ratio, among other measures. On the subsidy front, there is need to review nutrient based fertilizer subsidy. The introduction of the goods and services tax (GST) will have a significant impact on the resource raising potential of state governments and will im- prove tax buoyancy. Direct Taxes Code (DTC) required to replace exist- ing income tax laws; will reduce compliance costs and boost tax collections. Fiscal consolidation achieved by cutting expendi- ture (majorly plan/capital expenditure) is unsustain- able. Financial Intermediation RBI has indentified five sectors -- infrastructure, iron and steel, textiles, aviation and mining as the stressed sectors. The New Pension System (NPS), now National Pen- sion System, introduced for the new recruits who join government service on or after January 2004, represents a major reform of Indian pension ar- rangements and the passage of the PFRDA Act and the Financial Sector Legislative Reforms Com- mission (FSLRC) report were major milestones in FY2014. Infrastructure financing would require a mature and capable bond market. Balance of Payments & International Trade Current account deficit is expected to be 2.1 per cent of GDP (US$ 45 billion) in FY15 as compared to 1.7 per cent FY14. Key challenges for export potential: While there has been market diversification and compositional changes in Indias export basket, not much of demand-based product diversification has taken place. In the top 100 imports of the world at four-digit HS level in 2013, India has only five items with a share of 5 per cent and above. Export infrastructure, particularly ports-related in- frastructure, which affects trade, needs immediate attention. Some FTAs/RTAs of India have led to an inverted duty structure like situation which discourages do- mestic value addition. A clear signal needs to be given for Indian SEZs as fresh investments are slowing down in recent years and the greenfield SEZs have not really been suc- cessful. Agriculture and Food Management State APMC laws are a major hurdle to moderniza- tion of the food economy. They have artificially cre- ated cartels of buyers who possess market power. APMCs remain a non-level playing field. In addition, some state governments have introduced barriers to trade within the country through taxation and technical requirements. Alongside the removal of conventional interven- tions in the food economy, there is a need to place a priority upon the three national-level public goods in the field of food: production of knowledge, finan- cial regulation of futures trading, and information interventions that address the market failure in warehousing. Creation of a national agri market: For establishing such a market, some reforms are needed: -Examine the APMC Act, EC Act, Land Tenancy Act, and any such legally created restrictive structures -Rigorously pursue alternate marketing initia- tives -Examine inclusion of agri related taxes under the GST -Establish stable trade policy based on tariff in- terventions instead of non-tariff barriers Industrial Performance In order to boost manufacturing sector, the gov- ernment has already announced setting up of six- teen national investment and manufacturing zones (NIMZs). Of these, eight are along the Delhi Mum- bai
  • ECONOMY MATTERS 20 DOMESTIC TRENDS Industrial Corridor (DMIC).In view of the ongoing industrial slowdown, the policy focus now needs to target key growth drivers in the short-term. Industrial policy needs to focus on labour-intensive and resource-based manufacturing in informal sec- tor to rejuvenate small businesses. In the medium-term, challenge for the Indian manu- facturing is to move from lower tech to higher tech sectors, from lower value-added to higher value added sectors and from lower productivity to high- er productivity sectors. Measures to boost business environment Create electronic repository for rules and regula- tions applicable to businesses. Existing regulatory landscape needs to be reviewed. The existing separation of land into commercial and residential plots is detrimental to setting up MSMEs and needs to be reviewed. A lot of land is held by developmental authorities, PSUs, and large firms which are unutilized. The gov- ernment could institute a policy to free up this land, which can be used for industrial estates, common facilities, incubators, etc. Indian legislation governing business needs to be thoroughly revamped. Laws should be streamlined, especially in the areas of taxation, labour, environ- ment, and safety. Services Sector Performance India ranked 12th in terms of services GDP in 2012 among the worlds top 15 countries in terms of GDP (at current prices). World class tourism infrastructure needs to be cre- ated. MGNREGA can be used for creating perma- nent assets like tourism infrastructure. Indian ports do not have the necessary draft. As a result, third-generation ships are not able to enter the harbour and goods have to be offloaded out- side in smaller ships, adding to costs. Immediate focus should be on building world class ports and lowering port charges. FDI and privatization in the railways likely to be the next round of necessary reforms. There is an exist- ing proposal, which envisages allowing FDI in all areas of the rail sector except railway operations. Even in railway operations, FDI is proposed in PPP projects, for suburban corridors, high speed train systems, and dedicated freight lines. Social Sector Performance According to HDR 2013, India has slipped down in HDI with its overall global ranking at 136 (out of the 186 countries) as against 134 (out of 187 countries) as per HDR 2012. It is still in the medium human de- velopment category. The poverty ratio (based on the MPCE of Rs 816 for rural areas and Rs 1000 for urban areas in 2011-12 at all India level), has declined from 37.2 per cent in 2004-05 to 21.9 per cent in 2011-12. In absolute terms, the number of poor declined from 407.1 million in 2004-05 to 269.3 million in 2011- 12 with an average annual decline of 2.2 percentage points during 2004-05 to 2011-12. Infrastructure Development The performance of the coal sector in the first two years of the Twelfth Plan has been subdued with domestic production at 556 MT in 2012-13 and 566 MT in 2013-14. Plan to add 88,537 MW power capacity over next 5 yrs. A total length of 21,787 km of national highways has been completed till March 2014 under various phas- es of the NHDP. In spite of several constraints due to the economic downturn, the NHAI constructed 2844 km length in 2012-13, its highest ever annual achievement. During 2013-14 a total of 1901 km of road construction was completed. Summing Up The Economic Survey 2013-14 laid stress on areas such as low inflation, quality of fiscal consolidation, capex recovery and revamping regulatory framework. In or- der to address each of these areas, the Union Budget 2014-15 laid out elaborate measures which have been discussed later in Focus of the Month.
  • 21 DOMESTIC TRENDS JUNE -JULY 2014 The Railway Budget was announced on July 8th , 2014 by the honorable Railway Minister Shri D.V. Sadananda Gowda on the floor of the Parliament. The key high- lights of the Railway Budget are as follows: Budgetary Estimates & their Funding - Given the Railways Minister has already hiked the passenger fares and freight rates by 14.2 per cent and 6.8 per cent respectively in June 2014, there were no hikes in passenger and freight rates. - The annual plan outlay has been budgeted at a re- cord high of Rs 654.5 billion for FY2015, an increase of 10.3 per cent on y-o-y basis over the previous year and 1.8 per cent over the interim budget presented in February-2014. - Financing of the record plan outlay is expected to be achieved through increased reliance on internal resources. In the Budget speech, the Railway Min- ister also stated the need for alternative sources of funding given the rising expenditure requirements. - To solve the problem of funding, honourable min- ister indicated that several Public Private Partner- ships (PPP) projects are in the pipeline, in addition to FDI being planned in railway projects, except in operations. - Further, Railway PSU resources to be leveraged by bringing in the investible surplus funds in infrastruc- ture projects of Railways. - The gross traffic receipts is budgeted to grow by 14 per cent on y-o-y basis to Rs 1602 billion, broadly in line with 13 per cent growth registered during FY2014. New Initiatives - Introduction of a Diamond Quadrilateral network of high speed trains connecting major metros (160- 200 km/hr). The 1st Bullet train would be introduced in Mumbai-Ahmedabad sector. - To facilitate connectivity to upcoming ports (like Sagar Mala project). There are plans to sanction Rs 400 billion worth of rail projects to connect ports. Further, connectivity to new ports to be increased via private participation. - Construction of critical coal connectivity lines to be facilitated (in areas like Jharsuguda). Improved coal connectivity to add 100 mn tons in annual freight. - Dedicated Freight Corridor (DFC) project imple- mentation: Eastern and Western DFCs to be closely monitored. - Plan to hike speed of trains to 160-200 km/hr in 9 sectors. - Revamping Railway Reservation System into Next Generation e-Ticketing System. - Online booking to support 7,200 tickets per minute; to allow 1.2 lakh users log in simultaneously. - Setting up of Project Management Groups consist- ing of professionals and State Government Officials at Railway Board and Zonal level for coordinating and expediting project management with respec- tive State Governments. - Paperless offices in Indian Railways in 5 years. - Provision of foot-over bridges, escalators, lifts, etc. at all major stations including through PPP route. Summing Up The first railway budget of the new government clearly showed its intent for structural reforms. The budget provided measures to improve efficiency in the near term, while at the same time laying out the long-term vision for development. Railway Budget 2014-15: A New Beginning
  • ECONOMY MATTERS 22 DOMESTIC TRENDS Indicating a sharp improvement in investors senti- ments amidst heightened expectations that the new government means business along with some improve- ment in basic macro indicators, the CII Business Confi- dence Index (CII-BCI) for April-June 2014 quarter moved up to 53.7 from 49.9 in the previous quarter. A score above 50 indicates positive confidence while a score above 75 would indicate strong positive confidence. On the contrary, a score of less than 50 indicates a weak confidence index. Domestic economic uncertainty, low GDP growth and high inflation were cited to be the top most concerns of the respondents, highlighting the need for stepping Most (46 per cent) of the respondents expect GDP growth to settle in the range of 5.0-5.5 per cent in 2013- 14, while only 16 per cent expect it to lie between 5.5-6.0 per cent. To be sure, economic growth slowed down to 4.7 per cent in 2013-14, the second consecutive year of sub-5 per cent annual GDP growth. Expectation of high- er economic growth in the current year is rooted in opti- mism about the overall demand situation. As high as 56 per cent of the respondents expect their sales and new order to increase in the first quarter of 2014-15, which is much higher than the previous quarter wherein only around 35 per cent respondents expected a rise in sales. Similarly, majority of the respondents expect their in- vestment, domestic as well as international, to go up up efforts in the direction of improving business senti- ments and removing supply bottlenecks. The 87th Business Outlook Survey is based on the re- sponses from over 150 industry members. Majority of the respondents (50 per cent) belong to large-scale sec- tor, while medium scale companies comprise another 13 per cent. Around 31 per cent and 7 per cent respec- tively are from small-scale and micro firms. Further, 54 per cent of the respondents were from the manu- facturing sector while 45 per cent were from services. The respondents in the survey were asked to provide a view on the performance of their firm, sector and the economy based on their perceptions for the previous and current quarter. during the current quarter. As regards to inflation, majority of the respondent firms (53 per cent) expect WPI based inflation to lie in the range of 5.5-6.5 per cent for the current fiscal. This would be in continuation of the moderation seen in in- flation from 7.4 per cent in 2012-13 to 6.0 per cent in 2013- 14. However, we need to maintain a cautious approach with regard to inflationary expectations given the up- ward risks to inflation from enhanced possibility of an El Nio, disrupting the monsoon in 2014. Though on the flip side, inflation may be capped as the lagged impact of previous rate hikes seeps through and a strong base effect from last year lowers headline inflation. CII Business Confidence Index Moves Up
  • 23 DOMESTIC TRENDS JUNE -JULY 2014 As far the twin deficits of fiscal and current account are concerned, the largest 44 per cent of the respondents expect fiscal deficit to lie in the range 4.5-5.0 per cent of GDP in 2014-15, which is higher than the budgeted 4.1 per cent for the year. Given that the fiscal deficit for pre- vious year stood at 4.6 per cent of GDP, this indicates limited expectation of rationalization in the deficit in the current year. Similarly, 32 per cent of the respond- The pick-up in BCI for the current quarter comes as a silver lining for the economy. However, it should also be approached with a bit of cautious optimism as the downside risks to growth have still not abated from the ents expect current account deficit in the range of 2.5- 3.0 per cent of GDP in 2014-15. It is pertinent to note that Indias current account deficit (CAD) narrowed sharply to 1.7 per cent of GDP in 2013-14 from 4.7 per cent of GDP in 2012-13. The CAD in the current year may move up in the backdrop of faster increase in imports as the economic activities pick up. horizon. Moreover, it will remain to be seen; how far the new government is able to deliver on its promises, especially the ones outlined in the recent Union Budget 2014-15.
  • ECONOMY MATTERS 24 SECTOR IN FOCUS Warehousing Industry Warehousing forms a crucial link in the overall lo- gistics value chain. It accounts for close to 5 per cent of the Indian logistics market (excluding inventory carrying costs, which amount to another ~30 per cent). Warehousing in India has been evolving rapidly from be- ing traditional godowns a mere four-wall-and-shed with sub optimal size, inadequate ventilation and light- ing, lack of racking systems, poor hygiene conditions and lack of inventory management or evolved solutions such as warehouse management systems into modern setups with storage and handling points where raw ma- terial, intermediate and manufactured goods are col- lected, assorted, stored and distributed to the point of consumption/sale. The size of the Indian warehousing industry (across commodities and modes) is pegged at about Rs 560 bil- lion (excluding inventory carrying costs, which amount to another Rs 4,340 billion). The industry is growing at over 10 per cent annually. Multiple business models ex- ist within the warehousing industry. Additionally, given the importance of the sector to the economy, Union Budget 2014-15 announced the follow- ing steps to improve its outcomes: - Allocation of Rs 5,000 crore provided for the Ware- house Infrastructure Fund. - Transformation plan to invigorate the warehousing sector and significantly improve post-harvest lend- ing to farmer. - Service tax exempted on loading, unloading, stor- age, warehousing and transportation of cotton, whether ginned or baled. The key segments of warehousing industry can be rep- resented as: Industrial/Retail warehousing: accounts for 55 per cent of the total market Agri warehousing: 15 per cent share Cold stores: 16 per cent share Inland Container Depots (ICDs)/Container Freight Stations (CFSs): 14 per cent share
  • 25 SECTOR IN FOCUS JUNE -JULY 2014 The following section reviews the warehousing sector based largely on the Report Indian Warehousing In- dustry: An Overview prepared by the Confederation of Indian Industry (CII) and Ernst & Young. The report ex- plores and assesses the growth drivers, challenges and outlook for these key segments. (A). Industrial/Retail Warehousing Industrial/Retail warehousing has a market size of Rs 310 billion in FY13, and it has been growing at a CAGR of 1012 per cent over the last few years. Demand for in- Growth Drivers Although currently at a nascent stage, modern ware- housing in India is growing at a rapid pace. In addition, it is estimated to grow at a CAGR of 2530 per cent for the next 5 years, driven by: 1). Growing GDP: Growth in GDP and changing demo- graphics are creating higher primary and secondary demand. Indian GDP has grown significantly over the last decade. Despite the downturn, it continues to grow at a significant rate. Growing GDP, increas- ing population and improved purchasing power parity are creating new demand for warehouse space. 2). Growing external trade: Rising exports (13 per cent CAGR between FY08 and FY13) and imports (14 per cent CAGR between FY08 and FY13) are supporting warehousing growth. 3). Rising share of organized retail: This form of retail dustrial warehousing space is estimated to have grown from around 420 million sq. ft. in FY11 to 475 million sq. ft. in FY13, at a CAGR of 6 per cent. Retail, food, engi- neering goods, chemicals, electronic and telecom, phar- maceutical and automobiles are the major industrial consumers of warehousing in India. Among these, engi- neering goods, and the IT, electronics and telecommu- nication sectors (which have been growing at a CAGR of 89 per cent during 201013) are expected to lead warehousing demand. The other sectors are growing at 57 per cent. constitutes 8 per cent of the total retail market, and it is growing at a CAGR of 2530 per cent annually. As a result, it is expected to gain a higher share in the growing pie of the retail market in India. In- creasing organized retail activity is pushing demand for modern warehousing. 4). GST implementation: The Government plans to phase out Central Sales Tax (CST) and introduce GST. The move would help the logistics industry in re-arrangement of its operations and would enable manufacturers to store and distribute goods across the country without any state boundaries. This will enable higher growth and consolidation in the warehousing industry. Challenges Despite its strategic importance in the Indian economy, scale of opportunities offered and its immense poten-
  • ECONOMY MATTERS 26 SECTOR IN FOCUS tial for growth, the Indian warehousing sector is faced with several challenges including the lack of sufficient physical infrastructure. The time lag between devising and implementing strategies, due to the lack of inter- national warehousing standards, is another concern. High fragmentation and the dominance of unorganized players due to various applicable taxes at the state and central level are other issues plaguing the warehousing space. Indian players face challenges and bottlenecks at various stages of their operation life cycle. Some of these challenges are strategic, while others are opera- tional and need to be managed on an ongoing basis. In such a scenario, the sustainable growth of the ware- housing sector depends on how effectively industry players and the government can work together to ad- dress challenges in the long-term. Outlook The global warehousing and storage industry has wit- nessed significant growth during the last five years. It is expected to offer good growth opportunities to in- dustry players over the next five years also. The Indian warehousing industry is set to grow at a CAGR of 810 per cent and modern warehousing at 2530 per cent Growth Drivers Growing annual agriculture production is creating on- going demand for more storage space to reduce wast- age. Agri exports from India are increasing by 2025 per cent annually and have emerged as the one of the largest exporters of fruit and vegetables, propelling growth in high-quality demand for warehousing. Re- cently, private sector participation in agri warehousing has increased, making this segment more competitive. Private players are focusing on improving the quality of agri warehouses with the use of technologies and are challenging public sector players. Besides, the Govern- ment is determined to improve agri warehousing infra- structure to reduce agricultural wastage. It has already issues various policies to drive growth in agri warehous- ing; some of these are: over the next 5 years due to various factors including the anticipated increase in global demand, growth in organ- ized retail and increasing manufacturing activities, pres- ence of extremely affordable and desirable e-commerce options and growth in international trade. (B). Agri Warehousing Agriculture supply chain in India suffers from inefficien- cies in the supply chain, leading to heavy losses of com- modities throughout the country due to lack of proper storage and transportation facilities. Poor front-end in- frastructure, such as storage facilities, improper ware- housing facilities, redundant food processing technol- ogy and farmers inaccessibility to value-added services, results in wastage of 40 per cent of the fruits and veg- etables. Agri warehousing accounts for 15 per cent of the ware- housing market in India in FY13. It has been growing at a 1012 per cent rate over the last 3 years. Agri warehous- ing capacity in India is 110120 million metric ton (MT), and it has been growing at a CAGR of 810 per cent over the last 5 years. In addition, the Government has announced 35 million MT additional capacity under the Twelfth Five-year Plan.
  • 27 SECTOR IN FOCUS JUNE -JULY 2014 1). The Warehousing (Development & Regulation) Act, which aims to standardize warehousing operations, makes warehouse receipts (WRs) negotiable and establish accreditation agencies for warehouse reg- istration. 2). Agri-warehousing activity covered under Priority Sector Lending by RBI. 3). Tax incentives offered such as tax relief under 80(I) (B) and investment linked deduction under section 35AD. Challenges Even with the significant development of storage ca- pacity sanctioned under NABARD and NCDC schemes, 2030 per cent of the total food grain harvest is esti- mated to go waste due to inadequate storage capac- ity, regional imbalance in warehouses, lack of adequate scientific storage and inefficient logistic management in the country. Each grain bag is handled at least six times before it is finally opened for processing, which leads to higher storage and transportation charges, as well as increases the wastage of food grain during transit and handling. Furthermore, the storage capacity available with state agencies is primarily used for keeping central stock of food grains for buffer stock, public distribution systems and other Government schemes. This consequently leaves marginal capacity for other players to store their produce. Food grain (mainly wheat and rice) is the main commodity stored, while the other major crops storable in godowns include oilseed, spices and cot- ton. Although the government has started focusing on building storage capacity through various schemes, the emphasis is still largely on the storage of wheat and rice, which are considered as staple food in the country. Outlook Overall agri warehousing capacity is increasing by 810 per cent annually; however, 2030 per cent of the total food grain harvest is wasted due to the lack of availability of storage capacity, regional imbalance in warehouses, lack of adequate scientific storage and inefficient logistic management in the country. Building additional storage capacity and upgrade of the existing state-owned warehouses would be crucial for Indian agri warehousing growth. Also, the major storage ca- pacity of government agencies is occupied by wheat and rice, which leads to acute shortage of storage ca- pacity for other food grains and agri commodities. The Government needs to step up focus on the storage of commodities other than rice and wheat. The entry of private players has changed the face of agri warehous- ing in India. These players are providing value-added services, along with the traditional warehousing space (C). Cold Stores Cold stores are essential used for the storage and dis- tribution of perishable goods such as fruits and vegeta- bles, chocolates, dairy products; frozen foods such as meat and ice cream, and temperature-sensitive pharma- ceutical products. Cold stores account for 16 per cent of the total warehousing industry and it estimated to worth a Rs 90 billion industry. The cold storage industry is expected to grow at 15 per cent per annum on a sus- tained basis over the next 5 years, with the organized market growing at a faster pace of 20 per cent. In addition to cold storage, trucking and value-added services are being provided by cold store players. All these service offerings are cumulatively known as cold chain. The Indian cold chain market is highly fragment- ed among more than 3,500 companies in the whole val- ue system. Organized players contribute only 810 per cent of the cold chain industry market. Growth Drivers Organized cold store is growing at a very high rate due to various factors. Growth in organized retail is one of the key factors driving the growth of the organized cold chain segment. The share of the organized market in re- tail, which is at 10 per cent in FY13, is expected to grow to 30 per cent, with food being the least penetrated seg- ments and poised for high growth. Similarly, the Indian food processing Industry, which is at a nascent stage, is expected to grow at more than 17 per cent. With most of the processed categories requiring cold chain ser- vices, demand is expected to increase at a higher rate. Besides, the Quick Service Restaurants (QSR) segment
  • ECONOMY MATTERS 28 SECTOR IN FOCUS is expected to witness 30 per cent growth over the next 3 years on account of changing consumption habits and increasing presence of QSRs and restaurants in India. This will create huge demand for storing perishable food items. Challenges Healthy capacity utilization, ability to provide integrat- ed solutions to end users, deep understanding of per- ishable commodities and prudent capex phasing will be the key features of successful cold chain players. Cold stores are high fixed cost businesses by nature entailing heavy initial investments in refrigerator units and land. Ensuring healthy capacity utilization through customer linkages in the form of long-term contracts or anchor customers will help secure a healthy return on invest- ment. Cold-stored commodities require control of tem- perature and humidity throughout the value chain. The lapse of service, either by the storage provider or the transporter, adversely impacts the quality of perishable commodity, as well as reduces its value. Hence, inte- grated players providing end-toend service will be bet- ter placed to gain customers and market share. Outlook Globally, the focus has now shifted from increasing pro- duction to better cold storages and transportation of food produce. Cold chains have now become an inte- gral part of supply chain management for the storage and transportation of temperature sensitive goods. The utilization of cold chain logistics includes both cold storages and refrigerated transportation and is used to increase the shelf life of food produce. Growth in the or- ganized retail and the food processing sector drives the cold chain market in India. Rising demand for cold stor- ages in the pharmaceutical sector is also driving growth in the cold chain market. (D). Container Handling and Storage The Container traffic at major ports has almost doubled in the past 5-6 years. According to estimates, the world container throughput will reach 1 billion TEUs by 2020, which is almost double of the current container traffic. The emerging Asian & African Countries are expected to be the prime movers in achieving this growth. Most of the shipyards are filled with orders for container ships of over 10,000 TEUs capacity. These container ships will form the major part of the world maritime fleet in the coming years. India is going to be the preferred desti- nation for a global manufacturing hub. This fact pre- sents many opportunities for the ports to change their current operation style and be ready for the foreseen surge in demand of handling and faster evacuation of containers. Container Freight Stations (CFS) and Inland Container Depots (ICDs) form a key part of the logis- tics industry infrastructure. A CFS/ICD can be defined as Common user facility with public authority status equipped with fixed installations and offering services for handling and temporary storage of import/export laden and empty containers carried under customs con- trol. Trans-shipment of cargo can also take place from such stations. CFS/ICD accounts for 14 per cent of total warehousing market in India and is estimated at around Rs 75-80 bil- lion in FY13 in India and has grown with a CAGR of 10-15 per cent over last 3 years. ICD/CFS facilities have been rising due to increase in port traffic and containerization level in India. It is expected that CFS/ ICD market will continue to grow at CAGR of 10-15 per cent over next few years and estimated to reach Rs 125 billion by FY15. Growth Drivers The CFS & ICDs are amongst the most rapidly growing segments of logistics industry in India. The increasing container traffic at ports needs the support infrastruc- ture which can accommodate the traffic volumes of the containers. Growth in containerized cargo and opening up of container rail transport boosted CFSs and ICDs. Containerized cargo traffic is growing at 12-15 per cent CAGR in India and it has grown dynamically in recent years across all ports with JNPT topping the list. CFS/ ICD are also working at a one stop point for the shippers for custom clearance, stuffing/ de-stuffing, packaging, inspection, consolidation of cargo, etc. Challenges Despite the apparent benefits of CFS/ICDs, several bot- tlenecks persist. Road is still a preferred mode of trans- port even over long distances, and the trend has been on an upswing. The share of rail transport has regressed from close to 28 per cent of cargo movement to merely
  • 29 SECTOR IN FOCUS JUNE -JULY 2014 22 per cent, creating a challenge for ICD operators in offering frequent rail services and timely transports, as opposed to export cargo moving directly to a CFS near the port facility. Although there are myriad factors at play and they vary in form and magnitude for each ICD location, the two key factors encouraging direct road movement through ports are transit time and costs. Transit time refers to the frequency of rail services, which, in turn, is related to traffic/demand. Therefore, cost benefit and ease of doing business over direct road transport is paramount. Outlook CFSs and ICDs are some of the fastest-growing seg- ments of the Indian logistics industry. Their growth will gain pace in line with the increasing need to tackle the growing complexities of maritime intensive sup- ply chain. Growing competition from private participa- tion will also force players to provide new services and customized logistic solutions. Recent investments in developing Free Trade Warehousing Zones (FTWZs) by private players are illustrative of the growth potential and patent need of supporting infrastructure. However, to sustain high growth in container storage, few chal- lenges need to be tackled. The modal shift from road to rail will play a key role in facilitating a smooth flow of cargo from distant hinterlands to the port, decongest- ing ports and National highway in a safe and environ- mentally sensitive manner. Outlook Driven by growth in production and organized retail, warehousing is the major segment contributing to the growth of the Indian logistics industry. As customers become increasingly demanding, warehousing companies have been left with no choice but to evolve into efficient and effective supply chain partners for their customers, as against being passive entities leasing out space. Changing business dynamics and the entry of global 3PLs have led to the re-modeling of logistics and warehousing services in India. From a mere combination of transportation and storage services, logistics is fast emerging as a strategic function that involves end-to-end solutions that improve efficien- cies. The growth of organized industry sectors such as retail, automotive, manufacturing, pharma and agriculture in India is expected to give rise to more integrated supply chains, requiring better services, processes and storage facilities. Furthermore, the roll out of GST by the Indian Government will play a major role in the growth of the logistics industry and its warehousing business. Dynamic market requirements have made it imperative for Indian warehousing players to overcome challenges, as well as maintain, improve and sustain competitiveness. Various measures such as skill development, policy initia- tives and government measures, IT adoption and increased investments in the sector can be effective in increasing the competitiveness of Indian warehousing players. The challenges and concerns should be addressed with collab- orative efforts among all stakeholders, including the government and its agencies, policy makers, entrepreneurs, investors, logistics service providers, manufacturers, farmers and sellers.
  • ECONOMY MATTERS 30 FOCUS OF THE MONTH Union Budget 2014-15 The Union Budget 2014-15, the maiden budget of the newly elected government, was announced at a time when the macro-economic milieu continues to be domestically and globally challenging. As a result, the year 2013-14, was primarily marked by slowdown in GDP growth and persistent inflationary pressures. At the same time, declining industrial and manufacturing production, subdued consumption, stalled investments and high fiscal deficit indicates that recovery is still some distance away. The budget stands out for the pragmatic and bold ap- proach adopted by the Finance Minister to lift growth, reignite investment, boost savings and provide a fillip to employment generation. A bold and reformist budget, it has rightly focused on the priority areas which would boost business confidence by providing an impetus to growth. The vision articulated in the budget shows that the government means business. Some of the key highlights of Union Budget 2014-15 are as follows: - First budget of the new government lays down broad policy directions for achieving a sustained growth of 7-8 per cent or above within the next 3-4 years along with macro-economic stabilization - The government is committed to achieve fiscal def- icit targets of 4.1 per cent in FY15, 3.6 per cent in FY16 and 3 per cent in FY17 - Plans to make food and petroleum subsidies more targeted - The composite cap of foreign investment to be raised to 49 per cent with full Indian management and control through the FIPB route - The composite cap in the insurance sector to be in- creased up to 49 per cent from 26 per cent with full Indian management and control through the FIPB route - Requirement of the built up area and capital condi- tions for FDI to be reduced from 50,000 square me- Arun Jaitley, Minister of Finance, Corporate Affairs and Defence interacting with the Members of the CII National Council on Union Budget 214-15 in New Delhi on 15th July, 2014. Others in the Picture are (L-R): Sumit Mazumder, President Designate, CII; Shaktikanta Das, Revenue Secretary, Ministry of Finance; Ajay S. Shriram, President CII; and Chandrajit Banerjee, Director General, CII.
  • 31 FOCUS OF THE MONTH JUNE -JULY 2014 tres to 20,000 square metres and from US$10 mil- lion to US$5 million respectively for development of smart cities - Rural infrastructure to be promoted via PPP through Shyamaprasad Mukherjee Rurban Mission for which a grant of Rs 500 Crores has been set aside. The scheme would serve to strengthen rural infrastructure and prevent rapid pace of urban mi- gration - An institution to provide support to mainstreaming PPPs called 3P India will be set up with a corpus of Rs 500 crores - Banks will be permitted to raise long term funds for lending to infrastructure sector with minimum regulatory pre-emption such as CRR, SLR and Prior- ity Sector Lending (PSL) - Infrastructure Investment Trusts (INVITS) to be set up with tax incentives. This would provide long term affordable finance to the Sector and hopefully these steps would provide incentive to banks for lending - Incentives for Real Estate Investment Trusts (RE- ITS). Complete pass through for the purpose of taxation - Definition of MSME to be reviewed to provide for a higher capital ceiling - Find a solution in the course of this year and ap- prove the legislative scheme, which enables the in- troduction of GST - Setting up of Expenditure Management Commis- sion to look into expenditure reforms - A decrease in the threshold limit of investment al- lowance on plant and machinery from Rs 100 crore to Rs 25 crore will promote investment in plant and machinery - Personal Income-tax exemption limit raised by Rs 50,000/- that is, from Rs 2 lakh to Rs 2.5 lakh in the case of individual taxpayers, below the age of 60 years. Exemption limit raised from Rs 2.5 lakh to Rs 3 lakh in the case of senior citizens - Investment limit under section 80C of the Income- tax Act raised from Rs 1 lakh to Rs 1.5 lakh - Deduction limit on account of interest on loan in re- spect of self occupied house property raised from Rs 1.5 lakh to Rs 2 lakh - In PPF scheme, annual ceiling will be enhanced to Rs 1.5 lakh p.a. from Rs 1 lakh at present - Income arising to foreign portfolio investors from transaction in securities to be treated as capital gains - Investment allowance at the rate of 15 per cent to a manufacturing company that invests more than Rs 25 crore in any year in new plant and machinery. The benefit to be available for three years i.e. for investments upto 31.03.2017 - Introduction of a Roll Back provision in the Ad- vanced Pricing Agreement (APA)scheme so that an APA entered into for future transactions is also ap- plicable to international transactions undertaken in previous four years in specified circumstances - Introduction of range concept for determination of arms length price in transfer pricing regulations - To allow use of multiple year data for comparability analysis under transfer pricing regulations - To boost domestic manufacture and to address the issue of inverted duties, basic customs duty (BCD) reduced on certain items - To broaden the tax base in Service Tax, sale of space or time for advertisements in broadcast media, ex- tended to cover such sales on other segments like online and mobile advertising Analysis of Fiscal Trends Finance Minster, Mr Arun Jaitley laid stress on fiscal pru- dence in his maiden budget speech, retaining the fiscal deficit target of 4.1 per cent of GDP for 2014-5, while aiming to progressively reduce it to 3.6 per cent in 2015- 16 and 3.0 per cent in 2016-17. To be sure, the revised fiscal deficit for 2013-14 stood at 4.6 per cent of GDP as compared to 4.8 per cent in 2012-13. To lower the fiscal deficit to 4.1 per cent of GDP in 2014-15, the government is betting on revenue and expenditure growth both to
  • ECONOMY MATTERS 32 FOCUS OF THE MONTH the tune of 12.9 per cent as compared to the revised es- timates for 2013-14. Faced with an economy struggling with low growth rates over the last two years and given the fact that the governments revenue collection has been falling below the budgeted revenue in five of the past six years including the last fiscal year, the revenue targets for 2014-15 look ambitious. Revenue deficit is budgeted to decline to 2.9 per cent of GDP in the current fiscal as compared to 3.3 per cent in the previous year. In the Union Budget 2012-13, gov- ernment had introduced a new fiscal indicator-effective revenue deficit- which is calculated after excluding the expenditure on grants for creation of capital assets. The effective revenue deficit will decline to 1.6 per cent in 2014-15, from 2.0 per cent in the previous year. As per the medium-term policy statement, revenue deficit will As far as the revenue receipts are concerned, given only a marginal improvement of economic growth in the current fiscal, total receipts are budgeted to increase by an insignificant 12.9 per cent in 2014-15 as compared to 12.8 per cent growth in 2013-14, underpinned by 17.7 per cent expansion in tax receipts. Positively, disinvest- ment receipts are budgeted to grow sharply this year, turning around the dismal state of affairs prevalent in moderate to 2.0 per cent in 2015-16 and 1.5 per cent in 2016-17, while effective revenue deficit is budgeted to be eliminated from 2015-16. Though the fiscal deficit has been targeted at 4.1 per cent of GDP in the current fiscal, lower than 4.6 per cent achieved in the last year, net market borrowings have been pegged marginally higher by 1.6 per cent in 2014-15 over 2013-14. This is expected to put slight upward pres- sure on yield for the 10-year benchmark government se- curity. Additionally, and perhaps more importantly, the FM has reduced his dependence on market loans for financing the deficit in 2014-15. As a result, the propor- tion of funding provided through market borrowings is expected to be 86.8 per cent in 2014-15 against a sub- stantially higher share of 95.3 per cent in 2012-13. the last couple of years. Encouragingly, gross tax re- ceipts are budgeted to grow by 17.7 per cent in 2014-15 as compared to 11.8 per cent in the previous year. Con- sequently, gross tax revenue to GDP ratio is expected to rise to 10.6 per cent for 2014-15 from 10.2 per cent in the previous year. In contrast, non-tax revenue receipts are expected to diminish by 10.0 per cent in 2014-15 as compared to a high growth of 40.7 per cent in 2013-14.
  • 33 FOCUS OF THE MONTH JUNE -JULY 2014 Summing up, to lower the fiscal deficit to 4.1 per cent of GDP in 2014-15, the government is betting on both revenue and expenditure growth of 12.9 per cent as compared to the revised estimates for 2013-14. In order to achieve the revenue growth target, tax revenues, Coming to the expenditure side, according to the budg- et estimates of 2014-15, total expenditure is budgeted to grow marginally by 12.9 per cent in 2014-15 as compared to 12.8 per cent growth in 2013-14. Encouragingly, non- plan expenditure is budgeted to moderate to 9.4 per cent in the current year as against 11.9 per cent in the previous year. Plan expenditure is estimated to increase by 20.9 per cent as compared to 15.0 per cent over the which form around 80 per cent of total revenues, need to prop up. Moreover the nature of expenditure com- pression needs to be kept in mind as trimming of capital expenditure will further slow down the economic re- covery process. comparable period. Subsidies are one of the most im- portant components of non-plan revenue expenditure. In growth terms, subsidies are budgeted to increase by 2.0 per cent in the current year as compared to decline in the previous year. Interestingly, petroleum subsidy is expected to decline by 25.8 per cent in 2014-15, while food subsidy is expected to grow at the highest rate.
  • ECONOMY MATTERS 34 FOCUS OF THE MONTH Given the GDP growth slowdown to below 5 per cent for two consecutive years, industry was ex- pecting a Union budget targeted at reviving growth and setting in place the framework for generating jobs on a large scale. These expectations have largely been met by the government, which has unveiled a prudent and progressive budget. Taken together, the overall vision in the document signifies much more than the sum of the parts. Slated to set a strong base for future growth, the budg- et addresses multiple growth drivers of the economy, including consumer demand and savings, private, do- mestic and foreign investments, and infrastructure. The adherence to the fiscal deficit roadmap of the interim budget maintains continuity and demonstrates the significance attached to macroeconomic strength. We hope that the actual revenue and expenditure will be closely monitored over the year as the fiscal deficit tar- get of 4.1 per cent is challenging. The announcements of an Expenditure Management Commission and revis- iting subsidies indicate that the government would seri- ously address fiscal consolidation. Most important, Union finance minister Arun Jaitley offered reassuring statements regarding stability and predictability of taxation while noting the issues of ret- rospective taxation and transfer pricing. These have greatly revived investor sentiments and set the stage for attracting funds into productive sectors. Directional change in the economy is envisaged through the high priority accorded to converging manufacturing and infrastructure as key growth drivers. Entrepreneur- ship, small enterprises, higher education and skill devel- opment have received attention, enabling all to contrib- ute to development. Manufacturing is widely expected to offer jobs to the youth as needed. Hence, a welcome move is to strength- en the sector through industrial corridors, clusters, and specific steps for different sectors. Special emphasis has been placed on sectors of strategic significance such as capital goods, electronics, steel and chemicals through changes to indirect taxes. MSMEs would be greatly encouraged by measures such as lowering of the investment allowance floor to Rs 25 crore, change in definition and easier access to finance through a fund of Rs 10,000 crore for start-ups, among others. Under infrastructure, a comprehensive agenda address- ing financial access, mainstreaming public private part- nerships and individual sectors would boost new pro- jects. A key accent in the budget is on promoting urbanisa- tion. Low-cost housing will be encouraged through in- crease in interest exemption limit. FDI has also been in- centivised by liberalising its participation in real estate. Also, urban amenities such as water and sewage have Much More than the Sum of the Parts
  • 35 FOCUS OF THE MONTH JUNE -JULY 2014 been addressed. These would work towards establish- ment of smart cities to absorb the expected urban pop- ulation of 600 million by 2031. Recognising that half of the workforce is dependent on agriculture, the budget aims to productively deploy MGNREGA funds and undertake strong measures for ir- rigation and water management along with agricultural R&D. Farmer markets are being encouraged out of the APMC Act ambit, while agri-credit has received high at- tention. Such steps can increase agricultural productiv- ity, but more should have been done for allied activities. With strong emphasis on services such as media, en- tertainment and tourism, as well as financial services, a comprehensive growth agenda has been initiated. We look forward to more policy announcements to carry forward the good work of budget 2014-15. This article first appeared in Hindustan Times dated 16th July 2014.
  • ECONOMY MATTERS 36 FOCUS OF THE MONTH Budget 2014-15 has come at a time when the Indian economy faces multiple challenges relating to growth deceleration, subdued investments, slow job creation and difficult global conditions. A fine balancing act was needed to revive investor sen- timents and set the macroeconomic framework for re- storing growth impulses. Under these circumstances, it has succeeded in adhering to fiscal prudence while ad- dressing multiple economic growth drivers. In its pre-Budget memorandum to the finance ministry, the CII had recommended areas for critical intervention such as fiscal consolidation, promotion of savings, re- vival of investments and tackling agriculture to mitigate inflationary pressures. Manufacturing was placed as high priority in order to generate jobs. The macroeconomic agenda demands strong fiscal dis- cipline, and the Finance Minister has adhered to the tar- get of 4.1 per cent for the fiscal year. This was critical to avoid further deterioration in savings and investment rates. Reviving Spirits The announcement of an expenditure reforms commis- sion and overhaul of subsidies implies that rationalising both sides of the Budget accounts is on the anvil. In ad- dition, as the private investment rate touched a decadal low of 23.9 per cent in FY13, it was important to rebuild the investment pipeline while also encouraging savings. The Budget unveiled a slew of measures across differ- ent areas to meet these economic imperatives, thus strongly reviving investor sentiments and imparting a fresh fillip to consumer confidence. On the savings side, the Budget provides for small savings schemes and of- fers some relief to the tax-payer by raising the threshold of personal income tax exemption and savings under sec 80c. For promoting investments, the Budget has taken up issues in tax administration, FDI, PPP, long-term financ- ing, and sectoral initiatives. The intention to avoid retro- spective taxation and the commitment to a clear, stable and predictable tax regime would greatly reassure in- vestors. Opening up the defence and insurance sectors as well as e-commerce for FDI was also a much-awaited step. The establishment of a 3P institution to support public private partnerships could assist new projects. Long-term financing by encouraging bank loans, strengthening the bond market and liberalising ADR/ GDR would go a long way to bringing new investments into infrastructure. The crux for reviving investments would be to keep the project pipeline flowing smoothly and continuous monitoring of ongoing projects. Hope for Farmers Agriculture has been accorded high priority. A note- worthy aspect is that supply chain linkages have been stressed, connecting farm produce to markets. Re-ori- enting the state APMC Acts to establish private mar- kets, development of farmers markets in towns, and encouraging farmer producer organisations would of- Budget Boosts Growth Drivers
  • 37 FOCUS OF THE MONTH JUNE -JULY 2014 fer more selling avenues to farmers. The price stabilisation fund of Rs 500 crore contributes to moderating inflationary pressures. While rejuvena- tion of warehousing would help post-harvest lending, storage and cold chain infrastructure could have also received some benefits. A welcome initiative is on ad- dressing power supply in rural areas through the Deen Dayal Upadhyaya Gram Jyoti Yojana. For industrial growth, the route of corridors, transport connectivity and smart cities has been finalized, thus bringing together the objectives of promoting manu- facturing and urbanisation. As India increasingly shifts out of rural areas, the man- ufacturing sector must be geared towards providing more job opportunities. By integrating this with the ur- banisation process, productivity of workforce could be enhanced, thus raising incomes. The proposed National Industrial Corridor authority should look at long-term perspective planning, including land use. It is very welcome that entrepreneurship and the MSME sector should be high on the Budget priority list. CII had long recommended that redefinition of MSME was in order as the previous capital investment limits had been set in 2006. We look forward to working with the Gov- ernment on setting realistic thresholds to define micro, small and medium enterprises. We had also suggested that the investment allowance floor at 100 crore should be brought down and this has now been set at 25 crore, which would greatly incen- tivise more investments from smaller companies. Multitasking A fund of Rs 10,000 crore is proposed to finance start- ups, and another fund of Rs 200 crore for innovation and agri industry was also a much needed initiative. Now, MSMEs would also find it easier to exit once the legal bankruptcy framework is instituted. Budget 2014-15 addresses multiple issues in the power sector relating to extension of tax holiday for 10 years for generation, distribution and transmission, and coal linkages. However, it stops short of revamping coal min- ing. The renewable energy sector receives many benefits including ultra mega solar power projects and customs duty reductions on some intermediates. The Budget has also announced strong interventions for skill develop- ment, particularly in reforming the Apprentice Act. We hope that these policies would be rolled out without delay. As the maiden financial statement of a new Govern- ment, Budget 2014-15 meets the expectations of indus- try. This article first appeared in Hindu Business Line dated 10th July 2014.
  • ECONOMY MATTERS 38 FOCUS OF THE MONTH The new government had been in office all of 45 days, but the Finance Minister was carrying lofty expecta- tions to revive growth and introduce fiscal prudence in his maiden budget. He has set a generally managed to spread cheer. There are several notable proposals, which will need greater attention and time in the imme- diate future. TheFinanceMinisterscommitmenttomaintainingfiscal deficit at 4.1 per cent of GDP is ambitious. The Govern- ments approach appears to be to increasing economic activity which will translate into better tax collections and help address the deficit. The minister proposes to constitute an Expenditure Management Commission, which will look into various aspects of expenditure re- forms. Government expenditure reform involves three elements: shifting subsidy programmes away from price distortions, a change in the focus of government spend- ing towards provision of public goods and a system of accountability through a focus on outcomes. With a the Expenditure Management Commission expected to give its interim report by this financial year, reform in this area is likely to take 2-3 years to implement. Investment clearly is the underlying theme in this budg- et. Realising that growth rate of the economy is cor- related with the investment rate, the budget contains proposals for development of industrial and economic corridors, with smart cities linked to transport connec- tivity. The Finance Minister also announced the Govern- ments commitment to revive Special Economic Zones as also initiatives for development of small and medi- um enterprises. The proposal to establish a INR 10,000 crore venture capital fund may be the first step to devel- oping Indias Sovereign Wealth Fund for promotion of entrepreneurship. It is commendable that given the short period of time in office, the Honble Finance Minister, Shri Arun Jaitey still managed to table a significant proposal in the budget insofar as the real estate and infrastructure sector is concerned in the form of a specific tax regime for Real Estate Investment Trusts (REITs) and Infrastructure In- vestment Trusts (InvITs). Introduction of REITs & InvITs in India is expected to bring in a fresh source of funding to the cash strapped sectors, ease pressure on the In- dian banking system and provide a new financial instru- ment to the common man. In order to ensure that REITs / InvITs kick off in the intended manner a favourable tax regime was the need of the hour. This was a long-await- ed demand of the industry and is a positive step. The income-investment model of such REITs and In- vITs has distinctive elements such as the trust would raise capital by way of issue of units to be listed on a recognized stock exchange as well as by raise debt di- rectly from resident and non-resident investors; income bearing assets would be held by the trust by acquiring controlling in an Indian company from the sponsor; the income generated would be distributed to the unit holders. It was announced that REITs & InvITs will be granted a pass through status. The budget proposes to amend Implementing the Budgets Investor-Friendly Proposals
  • 39 FOCUS OF THE MONTH JUNE -JULY 2014 the tax law to put in place a specific taxation regime for providing the way the income in the hands of such trusts is to be taxed and the taxability of the income dis- tributed by such trusts in the hands of the unit holders. The regulations provide that income tax and dividend distribution tax would be levied at the company level. Dividend income of the REIT / InvIT would be exempt and onward distributions by the REIT/ InvIT would not be subject to dividend distribution taxes or taxes in the hands of investors. Interest income of the REIT/ InvIT would be exempt and allowed as deduction to the com- pany. Onward distribution of interest income by the REIT/ InvIT would be taxable in the hands of unit-hold- ers and subject to tax withholding by the REIT/ InvIT. Long-term capital gains on sale of shares of company would be subject to taxes at applicable rates. Any other income received by the REIT/ InvIT would be taxable at maximum marginal rate. To incentivize creation of these vehicles, a deferral has been provided by exempt- ing the transaction of transfer of shares of the company (holding assets) to the REITs/ InvITs by sponsors in ex- change for units of the REIT/ InvIT. The sponsor would be subject to tax on future sale of such units. These steps will give a boost to those sectors, opening up newer avenues for funding, though the proposed tax rules may need some review as hasty drafting has left enough room for doubt and misapplication. While the memorandum provides for the taxation of the units of the trusts to be taxed as equity shares, the fine-print of the bill states the period for such units to be regard- ed as long-term capital assets only on the completion of 3 years. A tax deferral has been provided when the sponsor transfers shares of a company to the trust in exchange for units but minimum alternate tax may con- tinue to apply thereby nullifying the benefit intended; also the tax deferral has not been provided where the asset is directly (instead of shares of company) contrib- uted to the REIT/InvIT in exchange for units or interest in a partnership firm (holding the asset) is transferred to the trust in exchange of units. Additional clarity is also required on the mechanism for allocation of trust expenses to unit holders when the corresponding income passes through; and the cost of acquisition of shares of company/ assets and the date of acquisition of such shares of company/ assets in the hands of the trusts, where the assets are transferred by the sponsors to the trusts. Significantly, foreign direct investment and foreign portfolio investment should be allowed in REITs and In- vITs upto 100 per cent under the automatic route.This will facilitate global institutional capital to flow into In- dia. The current tax environment owing to the narrow and inconsistent approach of the tax authorities has creat- ed a lot of uncertainty in the mind of the investors and to some extent have a negative impact on the inflow of money in the economy. In order to provide an impetus to launching REITs & InvITs in India, it is essential that a clear, certain and robust tax regime is in place to ensure we do not end up with tax controversies and litigation. Interventions during the post-budget consultations should help iron out these issues, paving the way for the intended outcome. Indias complex tax system suffers from problems in both structures and administration. Expert Committees in the past have identified problems with the taxation system, including retrospective amendment of laws, frequent amendments, especially after the tax admin- istration is unable to establish a tax claim in courts and issues with arbitrary tax claims. The commitment to provide a stable and predictable tax regime is welcome. After causing consternation in the international busi- ness community in the 2012-13 budget by way of a ret- rospective amendment to tax indirect transfers, the government has now proposed that all fresh cases of indirect transfer taxation arising will be scrutinized by a high level committee. Unfortunately, contrary to ex- pectations, the budget does not contain any proposal that would provide relief to taxpayers who are already in litigation on this matter. Taxpayers who are currently embroiled in litigation would need to continue defend- ing their positions in litigation which can be expected to be time consuming and uncertain. One would hope that the proposal to enlarge the scope of income-tax settle- ments would provide an alternative non-adversarial fo- rum for resolving their disputes.
  • ECONOMY MATTERS 40 FOCUS OF THE MONTH The Finance Minister has recognized that one immedi- ate imperative on the agenda of the new government is the need to find a faster and better way to resolve tax disputes. The proposals to extend the scope of ad- vance rulings to cover residents, enlarging the scope of Income-tax Settlement Commission and enabling roll back of Advance Pricing Agreements (APAs) would seek to minimize the scope for disputes and improve the taxpayers experience in dealing with the tax ad- ministration. Indias APA programme has seen a lot of interest since its launch in 2012. The absence of roll back provisions in the Indian APA rules has often been stated as a concern by many taxpayers. Permitting roll back of APAs would go a long way in further enhancing the ben- efits of the Indian APA. The Minister re-affirmed the commitment to introduce a GST, even though a time line or a road map to im- plement the same was not spelt out. Just as the GST is a transformation of indirect taxes, a comprehensive reform of the direct taxes is required for a clean and modern administration. The Direct Taxes Code (DTC) proposed by the earlier regime was meant to achieve this objective. The Finance Minister announced that the government would review the DTC in its present form and take a view on the matter. The proposal to deny corporate tax deduction for expenditure incurred by companies on Corporate Social Responsibility as man- dated by the Companies Act, 2013 may be a disappoint- ment for corporate India as would be the effective in- crease in the rate of dividend distribution tax. The Minister also emphasised on the need for conver- gence of Indian accounting standards (AS) with the In- ternational Financial Reporting Standards. Accordingly, companies other than banking and insurance com- panies would need to prepare for implementation of Indian AS by 2016-17. The government also intends to separately notify tax AS which would apply for compu- tation of taxable income. The budget proposals presented by the Finance Minis- ter would go a long way in addressing concerns which triggers risk-aversion and had injected considerable un- certainty in investment activity. The steps announced are only the beginning of a journey towards a sustained growth of 7-8 per cent along with macro-economic sta- bilization. (Views are Personal)
  • 41 FOCUS OF THE MONTH JUNE -JULY 2014 The government had no financial leeway to deliver a growth-pushing Budget. Nor did it have enough time to design a well-thought-out, big-bang, reform- ist Budget. But expectations were running ahead of reality on the back of a decisive election mandate. On the whole, the Budget does not break any significant ground and spreads its resources thinly across too many government schemes and programmes. But there are some good micro-level initiatives, which, if built upon, will lead to a sustainable and job-inducing lift in growth over the medium run. For 2014-15, the Budget is non-inflationary and will pro- vide mild support to growth and employment genera- tion. Putting more money in peoples hands by raising the exemption limit and concessions on housing loans and small savings will support consumption growth. The budgeted increase of 24 per cent in infrastructure spending too will help cushion growth. We expect the economy to log 5.5 per cent GDP growth and CPI (consumer price index) inflation to be con- tained within the RBIs target of 8 per cent this fiscal. Even if the monsoon is sub-normal, CPI-based inflation can be reined in within the target if the government proactively takes pre-emptive supply-side measures such as release of foodgrain stocks when needed and timely imports, coupled with a crackdown on hoarders. The risk to our 5.5 per cent growth forecast is from a severe failure of monsoons and/or a spike in oil prices. A small yet important initiative in the Budget is its focus on supporting job-creating areas within manufacturing and services. Textiles and food processing are among the most labour-intensive manufacturing activities. The Budget has allotted Rs 3.3 billion for textiles, which is the largest employer and has the highest labour inten- sity (number of people employed to generate Rs 1 mil- lion of GDP growth) within the manufacturing sector. The labour intensity is 13 in textiles compared with an average of 4.8 in overall non-agriculture. The lowering of excise duty to 6 per cent from 10 per cent for speci- fied food processing and packaging machinery will help this sector grow. Construction generated more employment than manu- facturing during 2004-05 to 2011-12 and has a high la- bour intensity of 12.2. The increased allocation to rural roads and highways will generate employment, buffer rural income in a weak monsoon year and also help im- prove connectivity and efficiency over the medium run. Tourism, also a labour-intensive service sector activity, will benefit from the e-visa facility. The fiscal deficit target of 4.1 per cent of GDP for this fiscal as well the medium-term objective of trimming it down to 3 per cent by 2016-17 is laudable but challeng- ing. We expect fiscal deficit at, higher than the budget estimate, at 4.5 per cent of GDP this fiscal. The govern- ment is betting on a sharp growth in revenues (17 per cent over last year) in a slow growth year, and has made no reductions in subsidy. Over the last two fiscals, the government had to cut productive spending/capital expenditure to bring down the fiscal deficit to the tar- geted levels envisaged in the Budget as the optimistic revenue projections were missed. If revenue targets are not met, the government may have to do the same this year in its zeal to cap the fiscal deficit at 4.1 per cent. Positive, But Thinly Spread
  • ECONOMY MATTERS 42 FOCUS OF THE MONTH The medium-term fiscal deficit target will critically hinge on what happens to growth. Typically, tax buoyancy measured as the percentage increase in revenue for every percentage point increase in GDP goes up dur- ing high-growth phases and vice versa. Tax buoyancy, which was close to 1.5 in the high growth phase of 2004-2008, has fallen below 1 now. A lift in GDP growth, therefore, can yield disproportionately higher gains in government revenues. I believe that implementation of Goods and Services Tax (GST) is a must for attaining the fiscal consolida- tion envisaged in the Budget. Implementation of GST can push up both growth and government revenues. By eliminating the cascading effect of multiple central and state taxes, GST will reduce the cost of doing business and increase profitability, which, in turn, will attract in- vestments and ultimately help GDP growth. And by sim- plifying the tax regime, GST can significantly improve tax compliance and increase tax revenues. I expected the Budget to do more for Indian capital mar- kets. Some benefits to retail investors and uniform KYC norms are a positive. But some steps to develop capital markets to alleviate the domestic funding constraints would have been welcome in at a time when the bank- ing sectors has limited ability to support growth due to stress from bloated non-performing assets. (Views are Personal)
  • 43 FOCUS OF THE MONTH JUNE -JULY 2014 The newly elected Government has presented a for- ward looking and progressive Union Budget 2014 15. It managed to touch upon all topical issues of reviv- ing economic growth, attracting investments, churning industrial production, promoting urban development, and creating infrastructure creation. The budget struck a fine balance between fiscal prudence and populism, and managed to provide the governments thought process on contentious issues such as retrospective taxation and fuel/food subsidies. The biggest announcement for the real estate sector was the Securities and Exchange Board of India (SEBI) being directed to introduce Real Estate Investment Trusts (REITs) and Infrastructure Investment Trusts in India. We expect the entry of this much-awaited invest- ment instrument to provide alternative funding chan- nels to the realty sector. Going forward, it will also act as a key enabler for capital markets in the country, and provide investors with exit options. I perceive this an- nouncement as the single most consequential reform witnessed in the sector in recent times and will have significant positive impact on the real estate market in times to come. However, the tax treatment of this REIT structure needs to be examined in detail. A relaxation of Foreign Direct Investment (FDI) norms in the Housing sector was announced, with major policy revisions including reducing the minimum capitaliza- tion for wholly-owned subsidiaries; and trimming the minimum area of construction projects to a carpet area of 20,000 sq. m. The real estate sector has already at- tracted FDI worth approximately US$ 13 billion during 200514. However, this was just about 4 per cent of the overall FDI received by the country during the period. In the previous fiscal alone the total investment received by the sector was worth approximately US$ 1.23 billion, which was only about 3 per cent of the overall FDI re- ceived. Hence, relaxation in entry norms may provide a fillip to the quantum of investments going into the sec- tor, particularly in tier-II and III cities. Although low cost affordable housing projects for the urban poor are to be exempt from the FDI restrictions; the government has announced its commitment to ease FDI flow into the segment. Allocating Rs. 4,000 crore through the National Housing Board (NHB) for providing cheaper loans for low cost housing to sup- port the housing for all by 2022 scheme is a positive move. Additionally, Rs. 8,000 crore has been allocated for the rural housing scheme under NHB. As announced earlier, a 100 SMART Cities are to be set up as satellite towns to existing cities, at a budget allo- cation of Rs. 7,060 crore. These are to be linked through industrial corridorsfor a budget allocation of Rs. 100 croreconnecting 20 new industrial clusters to be set up along the Golden Quadrilateral. In addition, the allo- cation of Rs. 5,000 crore for warehousing in rural areas; the development of more airports at tier-I and II cities; and including slum development as part of Corporate Social Responsibility (CSR) initiatives are all encourag- ing steps. Banks have also been encouraged to provide long-term loans to the infrastructure sector, with mini- mal lending regulations in place. Revised ceiling for foreign investment in the insurance Impact of Union Budget on Real Estate Sector
  • ECONOMY MATTERS 44 FOCUS OF THE MONTH sector from 26 per cent to 49 per cent shall bring in funds in the long-term to the sector. Industry estimates point to approximately US$ 20 billion worth of invest- ments waiting for the insurance sector through the FDI route over the next few years. After reaching maturity, one can assume that a portion of these funds may get diverted into the real estate sector as well. This could provide an alternate avenue for investment to the sec- tor in the long run. Although the statement on the revival of SEZs was en- couraging, the demand for removal of MAT and DDT was not mentioned. On the personal tax front, the de- duction of interest on the housing loan to Rs. 2 lakh is disappointing as this will have no impact in encouraging housing purchases. The exemption should have gone up to Rs. 5 lakh instead. Overall, this was a good budget and will stimulate growth in the real estate and infrastructure sector in the long term. However, the real impact on the econ- omy and the sector will be felt upon investing all the funds allocated in the Budget through project imple- mentation, with a sense of urgency. (Views are Personal)
  • 45 SPECIAL FEATURE Chemical Industry: Building Block for Economic Growth JUNE -JULY 2014 Soon after taking charge couple of months ago, the recently appointed Minister for Chemicals and Fertilizers Mr. Ananth Kumar announced that the new government intends to place the farmer at the center of the agriculture sector, the village and the countrys economy. This was also articulated in the recently pro- posed budget by the Finance Minister, a clear indicator of the governments realistic roadmap for the future. The governments strategic thrust on infrastructure and agriculture will support the growth of the manu- facturing sector, a move that will propel the chemical industryas a key driver of most manufacturinginto the next growth trajectory. The chemical industry is the energizer of economic de- velopment. It is at the heart of all modern industries, including electronics, information technology, biotech- nology and nano-technology. While Mr Ananth Kumar focused largely on fertilizers and on making India self-reliant in fertilizer supply, the reality of the chemicals industry is that; it enriches the farmers life in much more far-reaching ways. It not only serves as the basis for pesticides and herbicides that en- sure a healthy crop, but also helps to provide him with clothing and footwear, paint for his doors and window- frames and medicines. It even powers his battery-op- erated radio and lights his way through the fields. Not just the farmer, but the chemical industry touches and impacts everyones daily lives, in myriad ways. Thus, the need for holistic focus on the sector stems from the fact that it is one of the major industries and probably the only industry that can help India face the growing challenge of meeting the demands of a rapidly increasing population with finite resources, without causing further harm to the ecological system. The chemicals industry has gone through radical chang- es over the last few years. With increasing challenges and issues of sustainability and resource management across sectors - food, agriculture, textiles, automobile, aerospace, cosmetics, manufacturing etc. The game-
  • ECONOMY MATTERS 46 SPECIAL FEATURE play of the chemical industry is no longer just about supplying bulk chemicals. On the back of investments of time, energy and resources over the past three dec- ades, the chemical companies have metamorphosed into leading solutions providers partnering with organi- zations across sectors and providing sustainable solu- tions for business and social development. The dynamic ground reality is that the chemicals indus- try directly contributes 7 per cent to Indias GDP. How- ever, indirectly, it contributes much more than that esti- mate. If we account the contribution of the industry to other manufacturing sectors, the contribution is close to 60 per cent of the GDP - the textiles industry (which contributes four per cent to Indias GDP), engineering and machinery manufacture (which contributes eight per cent to Indias GDP), the transportation industry (8.5 per cent), the information technology (IT) industry (nine per cent), construction (13.5 per cent) and agricul- ture (15.7 per cent). Additionally, given the Finance Ministers emphasis on employment generation and on bolstering entrepre- neurship, it is also important to note that the chemical industry, directly and indirectly, through its key role across manufacturing, construction and other sectors is a major employer with the potential to generate more employment and a host of downstream small and me- dium businesses. To take a closer look, categorized on the basis of end-use, the modern chemicals business serves the following broad classes of economic activity: manufacture using basic chemicals; manufacture of life sciences products; use of specialty chemicals; and con- sumer products manufacture. Basic or commodity chemicals are used in an ever- expanding range of engineering and manufacturing processes. Organic chemicals such as propene and ben- zene are used to make plastics and pharmaceuticals, while inorganic chemical compounds such as chlorine and sodium carbonate are used in plastics, fertilizers, soaps and surfactants, and building materials. Polymers are the largest end-use for chemicalsmade from bulk petrochemicals and basic chemicals, polymers serve all categories of plastics and man-made fibers used in packaging, home construction (pipes, waterproofing, electrical fittings, etc.), containers, appliances, comput- ers, shoes, transportation and toys. Pharmaceuticals use about 15 per cent of all chemicals produced in India, the paints and dyes sector about 5 per cent, polymers about 6 per cent, man-made fibers 16 per cent, soaps and toiletries about 11 per cent, ferti- lizers as much as 18 per cent and pesticides 3 per cent. The recent announcements by Mr. Ananth Kumar on plans to boost the chemical industry and to make India one of the top five global chemical producers is timely. His vision of developing new industry hubs and PCPIRs (Petroleum, Chemicals and Petrochemicals Investment Regions) in India and investing in reverse economic zones in countries supplying feedstock could shake In- dia out of its long-static three per cent contribution to the world chemicals economy. The Finance Ministers decision to reduce import duties on key manufacturing components like ethane, propane and butane, along with rationalization of import duty on all forms of coal, are also welcome changes. These would be the much needed steps towards fulfill- ing the promise of a minimum 11 per cent growth per annum envisaged as a base case scenario in the cur- rent Twelfth Five-Year Plan (2012-17). According to es- timates, 11 per cent CAGR would double the size of In- dias chemical industry and its contribution to the global chemical sector. To conclude, the setting up of chemical parks, imple- mentation of zero duty on the import of chemicals to facilitate easy availability and higher import of cheap- er feedstock, tax holidays similar to that extended to boost the power sector and a waiver of Special Addi- tional Duty (SAD) would further grow the chemicals in- dustry and give it a much needed boost, to take it closer to its growth potential. This article first appeared in Hindu Business Line dated 17th July 2014. (Views are Personal)
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