The Union Budget Context and Impact Presentation at Delhi School of Economics July 30, 2004

2 Structure of Presentation  The Macroeconomic Context of the Budget  Impact on Key Macro Indicators

3 Overall GDP Growth

4 Sector-wise GDP Growth

5 Drivers of Industrial Recovery  Critical background developments  Structural changes in interest rates  Revival of public capital spending  Retail Finance  Construction  Investment Upturn

6 PPF and G-sec Rates

7 PLR and Housing Finance Rates

8 Revival in Public Capex

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10 Growth drivers: From Auto and Construction to Capital Goods Manufacturing Sector Growth Q1FY02Q2FY02Q3FY02Q4FY02Q1FY03Q2FY03Q3FY03Q4FY03Q1FY04Q2FY04Q3FY04Q4FY04 % Basic Chemicals & Chemical ProductsNon-metallic Mineral Products Basic MetalsMachinery and Equipment Transport EquipmentOthers Manufacturing Sector

11 Budget :Main Impressions  Clear signals of persistence with reforms  Major rural focus, with objective of de-risking agriculture  Revenue increases appear highly optimistic  Intent to address investment, competitiveness and subsidy issues in February 2005

12 Rise in Plan Spending

13 Growth in Plan Infra Spending BE (Budget Support + IEBR)

14 Foreign Direct Investments—current status

15 FDI – Expanding Space  Announcement to raise FDI limits in telecom, insurance unanticipated and a positive surprise.  Expected to enhance FDI inflows not just to these sectors but other sectors as well.  However, unless other bottlenecks for investment such as power costs, administrative delays resolved, sharp jump in FDI inflows unlikely.

16 What does all this mean for growth?  In the short run, no significant triggers for acceleration, but no impediments either  Direct tax changes – higher threshold, but education cess – may neutralize each other as far as consumption spending goes  Increased spending will not have much impact in the remaining months of  Current momentum in industry and services sustainable  GDP growth for %; Non-agri GDP 8% +

17 What does all this mean for growth? In the long run:  Expanding plan expenditure on infrastructure will clearly contribute (even in medium term, as spending begins)  Roads programme continues, with sightly expanded allocation for the year  De-risking agriculture critical to stabilizing the contribution of this sector to growth  Hope from concerted thrust on investment climate and manufacturing competitiveness

18 Revenue Arithmetic % ShareGrowth BE Gross Tax revenue Union Excise Corporation Tax Customs Income Tax Service Tax Other Tax :

19 Room for Slippage ITEMSLIPPAGE (Rs crore)COMMENT Tax Revenue20,000 (After factoring in 100 in new taxes) Unrealistic Tax Arithmetic. Premised on recovery of arrears ExpenditureNilNon-Plan Expenditure reduction Target Ambitious Fiscal Deficit0.6 of GDP

20 The Industry – Revenue Nexus

21 What does this mean for the Fiscal Deficit?  Budgeted Fiscal Deficit of 4.4% of GDP as per the requirements of the Fiscal Responsibility and Budget Management Act  Our analysis shows that this is premised on highly optimistic revenue projections  Possibility of slippage of 0.6 per cent of GDP

22 Inflation: Inching Up

23 Inflation: Sectoral Trends

24 Inflation Prospects  Inflation firming up in fuel and manufacturing; direct impact of budget marginal  Result of both demand and supply factors  Fuel and metal prices the cost push factors  Recovery in manufacturing is the demand pull factor  Prospects of inflation staying in the band of per cent.  International crude prices - a risk factor, but current outlook moderate

25 Domestic interest rates—pulls and pressures  ‘Push’ factors  Harder US rates  Sustained demand for domestic credit  Slowdown in forex inflows affecting domestic liquidity.  Anticipation of overrun in fiscal deficit  ‘Pull’ factors  RBI’s policy bias towards keeping rates low  Current high levels of liquidity –estimated at Rs cr and Rs cr  Moderate core inflation

26 The interest rate momentum

27 The interest rate view  Potential fiscal deficit overshoot of Rs crores and slowdown in forex inflows to drive interest rates up.  100 bps increase in 10 year yields, bps at the short end projected by year-end  Turnover tax on debt transactions to push up short-run volatility, reduce volumes

28 The Rupee  US interest rate hike to drive re-alignment of global capital flows  Export growth prospects good, but domestic recovery also causing acceleration of imports  Rate of net forex inflows will slow  Rupee to remain stable in 45-46/US$ range for rest of the year

29 Conclusions  Relief: Reforms are still on track, for now  Concerns: Unrealistic revenue expectations Criticality of delivery mechanisms  Hopes: Concrete solutions for investment, competitiveness and subsidy issues De-risking agriculture