Would industry still hail a budget without tax sops if cost of money rises?

Higher interest rates will clip investment plans of companies and could bad news for FM Nirmala Sitharaman who feels she has kept her part of the deal in Budget FY22 by not raising taxes

The Reserve Bank of India (RBI) has a big problem on its hand. Debt market experts reckon it will need to buy more than Rs 3 trillion of older government papers from the bond market March onwards. Buying those bonds will release cash to dealers and make them interested when newer papers arrive in the market. It is a costly exercise for everyone concerned, since older papers are often more valuable than the new ones for the dealers. 

To make the trade-off happen, the dealers want the government to offer more attractive prices for the new papers, which translates as higher interest rates. As the manager of the government bond programme, the RBI wants the opposite. Higher interest rates mean the government has a larger interest bill to pay out for its Rs 12.06 trillion of gross borrowing.  

Higher interest rates will also clip the investment plans of companies. This could bad news for finance minister Nirmala Sitharaman who feels she has kept her part of the deal in Budget FY22 by not asking for more tax. She now expects companies to use the financial room to spend more on expanding capacity. Industry captains broadly agree. “We see that both the Government and the Central Bank are moving in tandem - which is the need of the hour,”, read a note from industry chamber Ficci, post Budget. 

Encouragingly, while tempers are frayed in the bond market, they have still not spilled over to manufacturers or services sector companies. These sectors have, instead, surprisingly cheered a Budget that gave them hardly any new tax set offs. After decades of knee jerk reaction to ask for such set offs before every Budget, industry captains are possibly realising that tax certainty is a better thing to ask for. It keeps cost of operations low and allows for expansion of business. 

Trade off: 

India has always found it difficult to manage between the golden mean of expanding government spending and yet keeping money cheap to make private sector also spend. This time in a bold departure from the past, Sitharaman has focussed most of her spending on the capital sector and has offered no tax cuts. It is a delicate balancing act since investments shall not immediately add to the spending power of people in the economy. Mohammed Rahees, who drives an Uber cab in Delhi, had returned to his village for the fortnight before the Budget. He says daily rides are still at the half way mark before Covid. Private sector company staff who were his most regular customers are still working from home, he points out. The Budget numbers do not translate to more rides, immediately. 

Yet, the Budget is still an attractive deal, agrees Shailesh Pathak, CEO of L&T Infrastructure Development Projects Ltd. This does not mean that private sector infra companies will rush in to build roads or ports. They will buy up such properties big time once the government builds them. The easy liquidity promised in Budget FY22 will encourage them to buy the assets, he said.

The finance minister thinks so too. The Budget will support a national monetisation pipeline, through which operational infrastructure projects will be bid out to institutional investors like pension, insurance and sovereign wealth funds, she said. 

Kumar V Pratap, former joint secretary, infrastructure in the finance ministry notes these asset monetisation models, like the Infrastructure Investment Trust or InvIT model in road, power transmission, telecom towers and others have already generated Rs 80,000 crore in the past two years. So there is enough scope to push them further. A key element of that push is, however, keeping the cost of such buyouts cheap, something which RBI is struggling to do right now. 

Changed expectations:

The pre-budget memorandums of all industry groups focussed on demands for tax set offs. The renewable energy manufacturers for instance wanted lower basic customs duty on imports of glass. A key industry survey carried out by Ficci with consultancy firm Dhurva Advisors found 28 per cent of the respondents in the survey flagged tax incentives as their main ask. It was not fulfilled. 

A key measure introduced by the government as a reform at the height of the Covid crisis was the Production Linked Incentive scheme or PLI. It is meant to spur more capacity and therefore more production in thirteen sectors with a government subsidy close to Rs 2 trillion. No chamber made it a strong budget pitch. “No one is going to manufacture for a prize, unless there is a commercial sense to expand”, said a top level source in a consultancy firm, on condition of anonymity. The scheme for the first time provides incentives as explicit subsidies instead of hard to measure tax set offs.

Yet post budget industry seems more pleased, even though they shall have to earn it by expanding production like PLI rather than manage through  often illusory investment numbers. 

The reason for comfort is possibly because the other key demand of industry that of tax certainty has been recognised. In the joint Ficci-Dhruva Advisors survey to the question “What should be the key focus area of the Government to create a manufacturing ecosystem including under the Make-in-India initiative?”, the overwhelming answer by company bosses was the Ease of Doing Business. Sixty-one per cent of the respondents opted for it and they meant stability in tax rates. Rival industry chamber, CII too had sought tax certainty meaning “greater clarity in law, simplification of procedures and reduction of litigation”. Chartered accountant Girish Ahuja who has been part of several tax committees of the ministry of finance describes it as coming of age of segments of the industry.

On the same note Bornali Bhandari, senior fellow, NCAER underscored the need for investors to have long term macro stability including of fiscal deficit and inflation. A one year policy is unlikely to be statistically significant without such stability, she said. 

There are naysayers, of course. The steel industry is one of those. The RBI is absolutely correct in reading broad-based cost push pressure in industrial raw material, argued Engineering Exports Promotion Council Chairman, Mahesh Desai. But then it has not cut rates and that will hurt manufacturing exporters, he said. 

Still, when the government builds assets, private industry is happy to buy, argues Pathak. If FY22 keeps the cost of money cheap, it is a deal. If the cost of money rises, there shall be big risks, as in the case of solar power. The absurdly low rates of Rs 1.99 per unit is simply built on low interest rates. Global prices of solar equipments have not crashed and neither are states offering land at cheap rates. Any upturn in the cost of money could severely hurt the sector. It is up to the RBI once again to keep the deal with industry alive.