A Mixed Bag

COVER STORY: BUDGET 2007-08

P Chidambaram

Budget 2007-08 has been a mixed bag. The small scale sector has received some attention

It was presented against a backdrop of high expectations with the economy having moved into the high growth trajectory of 8.5 per cent, supported by a strong growth in services and industry sector. Yet many observers believe that big-ticket reform in Budget 2007-08 have not been taken on the way they should have and tax changes have left most quarters wanting, as substantial giveaways had been anticipated.

The overall numbers are mostly modest. For instance, growth in gross tax revenue next year is expected to be 17 per cent, the slowest in five years, and the growth in total expenditure an even more modest 10 per cent. The numbers reveal that GDP will grow slower next year""by 13 per cent in nominal terms, i.e. including inflation (this year's figure being close to 15 per cent).

Keeping spends on a tight leash (albeit a fairly robust increase in budgetary support for the annual plan) has helped target the fiscal deficit at 3.3 per cent of GDP, down from 3.7 per cent this year. T he tax buoyancy during the current year (28 per cent growth in revenue) would have helped achieve a smaller fiscal deficit if it were not for an over-run on interest payments (on account of higher interest rates) and the fertiliser subsidy, apart from some other budgetary heads.

The government appears well on course to hit the 3 per cent fiscal deficit mark by 2008-09, as mandated by law, though the revenue deficit ( i.e. without counting capital expenditure or receipts) for next year is high at 1.5 per cent and is unlikely therefore to drop to zero a year later, as required. The entire deficit next year is on account of interest payments for past debt.

Among the tax changes are a slight raising of the exemption limit for income tax, reduction in customs duties (including in the peak rate from 12.5 per cent to 10 per cent), an additional education cess that will fetch Rs 5,000 crore, and an increase in the dividend distribution tax from 12.5 per cent to 15 per cent that will fetch Rs 1,750 crore. After adjusting for giveaways, the net additional taxation is Rs 3,000 crore.

The fringe benefit tax has been extended to employee stock option plans, and the service tax has been extended to several new areas including rent on commercial real estate and all works contracts. The planned phase-out of the central sales tax has been started, with a drop in the rate from 4 per cent to 3 per cent.

In a push for what he called "horizontal equity," Chidambaram withdrew tax concessions for debt mutual funds""thus leveling the field for bank deposits that compete with these funds, and which already attract tax.

In a Budget speech that sought to strike the right notes with regard to inflation control and concern for the aam aadmi (common man), Chidambaram reported that the Forward Markets Commission had banned futures trading in wheat and rice, and introduced a dual taxation scheme for cement (pegged to a retail price of Rs 190 per bag of 50 kg).

He dwelt at length on programmes for agriculture and announced hefty spending increases for education and health care as also for the infrastructure-oriented Bharat Nirman.

But while extending the national rural employment guarantee scheme to 130 new districts (adding to the 200 covered this year), the financial allocation has not been increased much from this year's budgeted number.

There is a package of incentives for small and medium industry, including a raising of the exemption limit from Rs 1 crore to Rs 1.5 crore.

As for reform measures, the first step has been announced to take government treasury operations away from the Reserve Bank of India, and to vest it in a new debt management office.

The finance minister also announced a scheme to tap the RBI's foreign exchange reserves to finance the foreign exchange component of capital expenditure for infrastructure""a variation of an idea that was first aired three years ago and then shelved.

News for SMEs

Budget has, however, announced a host of sops for the small scale industries sector. The sops proposed include raising exemption limit for excise duties from Rs 1 crore to Rs 1.5 crore for small scale units. The exemption on service tax for small service providers has been increased from Rs 4 lakh to Rs 8 lakh. SSIs will benefit from the removal of surcharge on income tax on all firms and companies with a taxable income of Rs 1 crore or less. An industry unit is designated as a SSI unit, if the maximum investment in the plant is Rs 5 crore.

Finance Minister P. Chidambaram also increased the central plan out lay for the Ministry of Small Scale Industries. While the revised estimates of central plan outlay for 2006-07 stood at Rs 532 crore, the budgets estimates for the year 2007-08 has been proposed at Rs 532 crore, which is an increase of 8.64 per cent. In addition, an allocation of Rs 186.80 crore has been made for credit support programme to provide collateral-free loan to the SSI sector. This head includes outlays for promotion of village and rural industries.

"These benefits would help the SSI sector both in the short and long time basis," said Sarita Nagpal, head of manufacturing services division, CII. She added that the reduction of customs duties on raw material required for textile and the gems and jewelry sector will make SSI units competitive in the domestic and the international market.

These announcements come a day after Ministry of Commerce and Industries decided to de-deserve 125 items from the list of items reserved for the small scale industries. This decision was taken in a advisory committee meeting, which was held last week and a notification in this regard will be issued soon

In fact, the ministry had notified de-reservation of 87 items through a notification in January this year. With this, big companies would be able to manufacture 212 items, which were earlier reserved for the SSI sector, while the small scale industries would have 114 items reserved for them.

The country has 24 lakh registered SSI units, while in the unorganised sector, the numbers could be five times higher. The organised SSI sector employs more than 29 million people in the country.

Closer to Asean levels

Finally, taking a step forward towards aligning customs duties to Asean levels, Finance Minister P Chidambaram reduced peak customs duties to 10 per cent from the existing level of 12.5 per cent. The new peak rates in customs are in tune with the expectation of the industry. The move is also seen as a measure to deal with rising inflation and comes after a cut in duties earlier this year.

The cut comes at a time when custom collections had risen by 33.8 per cent in April-September 2006 period, against a forecast of 18.1 per cent in 2006-07. The increased collection has been attributed to higher imports. The revised estimates for customs collection for 2006-07 stood at Rs 81,800 crore, up by 6.14 per cent from the Budget estimate of Rs 77,066 crore. The customs collection target for 2007-08 has been set at Rs 98,770 crore, over 20 per cent more than the current year's revised estimate.

Experts feel that the duty reduction will make Indian industry more competitive in the global arena. "It will benefit exports as products in sectors such as gems and jewellery, which are heavily dependent on imports, will become more globally competitive," said Ajai Sahai, Director General, FIEO.

Meanwhile, the import duty on dredgers has been slashed completely and duty on all coking coal irrespective of the ash content has been completely waived. Giving a fillip to the textile sector in the country, duty on polyester fibers and yarns, DMT, PTA and MEG has been reduced from 10 per cent to 7.5 per cent. Moreover, the gems and jewellery sector also got a boost as duty on cut and polished diamonds will be reduced from 5 per cent to 3 per cent, rough synthetic stones from 12.5 per cent to 5 per cent and unworked corals from 30 per cent to 10 per cent.

Duties on chemicals and plastics have been reduced from 12.5 per cent to 7.5 per cent and seconds and defectives of steel from 20 per cent to 10 per cent. To check the increasing prices of edible oil, Chidambaram proposed to reduce

the duty on both crude and refined sunflower oil, by 15 percentage points. In addition, the additional Countervailing Duty of 4 per cent on crude and refined edible oil has also been waived off completely.

Taking cognizance of the Hoda Committee report on mineral policy, Chidambaram also proposed to impose an export duty of Rs 300 per metric tonne on export of iron ores and concentrates and Rs 2,000 per metric tonne on export of chrome ores and concentrates.

SMEs need to go global

Though the overall reactions on Budget 2007-08 are not entirely favourable, yet it has some promise for SMEs feels Ravi Poddar, chairman, Ravi Auto Group, who is also chairman, CII National SME Forum. He is the also honorary consul, Republic of Portugal in Kolkata.

Your reaction on the Budget 2007-08, will it benefit SMEs?

Overall, the reaction on this Budget is not favourable. However, SMEs will get an advantage because bank credits will now be more easily available and those SMEs rated will stand to gain in terms of faster process, lower interest rates. Also, after the SME Bill was passed a few months back, the over all concentration on SME sector has increased. It is reassuring that the powers that be recognise SME contribution to the growth of the economy. CII itself has been working hard on the segment and takes up their cause all the time.

On a more general note, today It is vital that the outlook has to be more global and less domestic if the competitive forces, have to be addressed in a planned, phased and a time bound manner. Hence specific policy areas such as the labour laws, legislative framework, reservation policy, credit and equity participation, technology, export thrust need to be looked at.

Can SMEs cope with the de-reservation policy adopted by government?

CII has suggested for a phased and gradual dereservation of the products that are exclusively reserved for the SSI sector. The market, on its own, will very efficiently and impartially allocate which items are to be manufactured by the SSI sector and those that need to be manufactured by medium-scale and large-scale sectors. Hence, each sector will produce only those items that it can manufacture more efficiently than the other sectors. Finally, country as a whole will benefit with efficient resource allocation.

In this context how vital is it for SMEs to have an international network?

The international network of SMEs is vital where "capacity building" holds the key to globalisation. The removal of trade barriers to facilitate cross-border commerce and the increase in cross-border financial flows, have largely been undertaken by MNCs, financial institutions and government. SMEs will need to be creative in finding ways through technology to be part of the global value chain that is mostly enjoyed by large corporations. As we are all aware, Asia has mainly been used for production efficiencies "" involving cheap labour, cooperative governments keen on attracting FDI have made the regulatory environment and industrial-relations easier.

"" Shabana Hussain

What's ahead for SMEs?

There are economic realities to contend with, though the Budget 2007-08 has sought to address some areas. What are the challenges and opportunities for SME? Dr. Subir Gokarn, executive director & chief economist, CRISIL, looks at the scenario:

We now know that GDP will grow at over 9 per cent in 2006-07. The services sector will touch 11 per cent growth for the year, while industry will achieve 10 per cent. In other words, if we leave agriculture out of the calculation, the rest of the economy, accounting for over 80 per cent of activity, will grow at over 10.5 per cent!

This is an enormously positive environment for businesses. It is a sharply rising tide, which will pull any venture, which produces an acceptable product with reasonable efficiency, to growing revenues and increasing profitability. But, like any strong tide, it also has its dangerous side. It will sweep away companies whose business models are weak. Those who cannot adapt to rapidly changing market requirements or keep improving their value proposition will find the going very difficult.

Most forecasts for 2007-08 expect some moderation in the growth momentum, arising from a variety of factors. The Reserve Bank of India has been raising its benchmark interest rates for over two years now and, sooner or later, this must translate into slower growth. The global economy is also expected to be less buoyant in the coming year, for essentially the same reason; central banks have been universally trying to fight inflation by slowing growth.

Of course, all this does not translate into anything drastic, either for the world economy or for India. We will probably see forecasts for the year ahead converging in the 8-8.5 per cent range. This is still a huge positive force for businesses, provided that they display the characteristics mentioned above.

In such an environment, in which both opportunities and threats are equally magnified, there is a natural tendency for businesses to consolidate in order to take whatever advantage they can of scale economies "" in procurement, production or marketing and distribution.

In fact, if one looks at the growth in revenues of large corporates, by any indicator, they far exceed the overall growth of the economy, suggesting that size is a decided advantage in today's circumstances. Large companies are growing both organically and inorganically. This intensifies the challenges that SMEs have to deal with, but also holds out the promise of large potential rewards for the more successful amongst them.

Under these circumstances, SMEs have to work with strategies that play to their timeless strengths which have kept them viable in the global economy amidst technological discontinuity and the trends towards consolidation. Simply stated, these are innovativeness, flexibility and the ability to cater to market niches, which larger companies, driven by standardization, do not find attractive.

It is the first two attributes that are traditionally associated with that resource called "entrepreneurship", which is so difficult to define, but is so easy to spot in successful businesses. In short, the more driven by entrepreneurship SMEs are, the better will be their ability to deal with the challenges and opportunities thrown up by the environment. Simply trying to downsize a business model more suited to large scales because of resource constraints or, worse, policy incentives, is a recipe for disaster.

From a policy perspective, even as the importance of genuine entrepreneurship in driving the SME sector is acknowledged, it must be recognized that high rates of failure are endemic to the sector. A few will morph into tomorrow's successful giants, but many will fall by the wayside.

Nobody, least of all government, can know or predict which ones will rise and which ones will fall. A truly facilitating environment will accommodate the fact that enterprises will die, but entrepreneurs, workers and other resources don't have to. The ability to deal with failure is perhaps the most important attribute of the true entrepreneur.

(The author's views expressed here are personal.)

How limited liability partnerships work

The Limited Liability Partnership Bill has huge implications for the SMEs. S Seetharaman, advocate, Lakshmi Kumaran and Sridharan, explains its implications. His firm deals with indirect taxes and corporate law.

What is the Limited Liability Partnership (LLP) Bill?

There are four types of business models. A business can either be a sole proprietorship, where the business is owned by one individual; a public limited company or a private limited company. The fourth model, LLP, is a hybrid between a limited liability company and a partnership firm.

Under this model, the liability of partners of an LLP will be limited to the extent of investment made by them in the LLP. A partner will not be personally liable for the wrongful acts or omission of any other partner in the company. The Bill was presented to the Rajya Sabha on December 15, 2006. It has now been referred to a special parliamentary committee.

Are there any flaws in the Bill?

LLP is likely to benefit SMEs as lot of venture capitalists and individuals will encourage to invest in them. But there some flaws, the biggest is that the proposed LLP Bill is, in some ways, similar to the Companies Act.

The Bill is as complicated as the Companies Act which takes away the benefits of having a new and simpler business model. Under the LLP Bill, registration of companies is a very lengthy and tedious process. Also, inspection and investigation of companies is a concept that has been borrowed from the Companies Act. The LLP Bill has introduced a whistleblowers concept, under which, if a partner blows the whistle on the fraud, then the authorities will subject him to a lesser penalty.

This might lead to false litigations and complaints by unhappy partners. The proposed Bill also requires LLP companies to file statement of solvency ever year in addition to statement of accounts. This is an additional burden which has been imposed on LLP companies. At present, even public and private companies are not required to file statement of solvency.

"" Shabana Hussain