1. The Union Budget 2004-05 Context and Impact Presentation at Delhi School of Economics July 30, 2004

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

3. 3 Overall GDP Growth

4. 4 Sector-wise GDP Growth

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

6. 6 PPF and G-sec Rates

7. 7 PLR and Housing Finance Rates

8. 8 Revival in Public Capex

9. 9

10. 10 Growth drivers: From Auto and Construction to Capital Goods Manufacturing Sector Growth 2.61 2.5 2.9 3.35 4.07 6.91 6.08 6.90 5.95 7.57 7.95 7.52 0.00 1.00 2.00 3.00 4.00 5.00 6.00 7.00 8.00 Q1FY02Q2FY02Q3FY02Q4FY02Q1FY03Q2FY03Q3FY03Q4FY03Q1FY04Q2FY04Q3FY04Q4FY04 % Basic Chemicals & Chemical ProductsNon-metallic Mineral Products Basic MetalsMachinery and Equipment Transport EquipmentOthers Manufacturing Sector

11. 11 Budget 2004-05: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. 12 Rise in Plan Spending

13. 13 Growth in Plan Infra Spending 2004-05 BE (Budget Support + IEBR)

14. 14 Foreign Direct Investments—current status

15. 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. 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 2004-05  Current momentum in industry and services sustainable  GDP growth for 2004-05 6-6.5%; Non-agri GDP 8% +

17. 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. 18 Revenue Arithmetic % ShareGrowth 2003-042004-04BE Gross Tax revenue100.017.924.6 Union Excise36.212.218.2 Corporation Tax24.736.440.4 Customs19.410.09.9 Income Tax15.89.326.5 Service Tax3.3101.470.5 Other Tax0.623.3-61.9 :

19. 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. 20 The Industry – Revenue Nexus

21. 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. 22 Inflation: Inching Up

23. 23 Inflation: Sectoral Trends

24. 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 5- 5.5 per cent.  International crude prices - a risk factor, but current outlook moderate

25. 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 75000 cr and Rs 90000 cr  Moderate core inflation

26. 26 The interest rate momentum

27. 27 The interest rate view  Potential fiscal deficit overshoot of Rs 20000 crores and slowdown in forex inflows to drive interest rates up.  100 bps increase in 10 year yields, 20-30 bps at the short end projected by year-end  Turnover tax on debt transactions to push up short-run volatility, reduce volumes

28. 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. 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