Moving to the ‘A' of the POTA Cycle
January 11, 2010
By Chetan Ahya | Singapore & Tanvee Gupta | India
Five Key Reforms to Watch in 2010
The verdict of the May 2009 general elections had raised hope of acceleration in the pace of reforms, considering that the share of the single-largest party in the Lower House of the Parliament had increased to the highest levels since the 1991 elections. However, every major policy decision in India goes through a one- to three-year cycle of POTA (Proposition, Opposition, Treaty-Consensus and Action). The good news is that many of the key reforms are now moving towards the action phase. The most prominent measures likely to see action in F2011 (the 12 months ending March 2011) are:
a) The Goods and Services Tax system;
b) Consolidation of the public sector deficit;
c) Meaningful steps towards divestment of the government stake in state-owned enterprises;
d) Acceleration in infrastructure spending, particularly in roads; and
e) Direct tax reforms.
Streamlining of Indirect Taxes - GST
The government has already announced its intention to transition to a consolidated nationwide goods and services tax (GST) system from the current system of different types of indirect taxes and multiple rates of indirect taxes. The new law will cover a wider base including all goods and services. The current system taxes production whereas the GST will aim to tax consumption. Indeed, the current law levies taxes on movement of goods from one state to other - effectively creating borders within borders. It distorts the allocation of resources and inhibits productivity growth. Transition to GST will be an important milestone from a macro perspective. While the government had earlier announced its intention to implement it from April 1, 2010, it appears that it will most likely be implemented from October 1, 2010.
Consolidation of Public Sector Deficit
The strong growth trend in F2006-08 was also accompanied by an increase in the fiscal deficit to double-digits as a percentage of GDP and a rise in the ratio of public debt to GDP to 76.1% as of March 2009. In F2010, we expect the combined central plus state government deficit (including off-budget items) to remain high at 10.7% of GDP, with public debt to GDP increasing to 78.6% in March 2010. The current high level of unproductive government expenditure and public debt is weighing on the long-term growth potential.
We expect the government to take the first step towards reducing the deficit to more sustainable levels in the February 2010 budget. The recent report of the 13th Finance Commission will be a good guide for the government to move on this correction path. We see the government cutting expenditure to GDP by 1pp in F2011. A simultaneous increase in tax to GDP should help cut the combined deficit to 9.2% of GDP in F2011 from 10.7% of GDP in F2010. We expect a further reduction in the deficit to 7.7% of GDP in F2012.
Divestment of State-Owned Enterprises
The current high level of fiscal deficit will likely make it difficult for the government to increase its spending to support economic growth. We believe that, in such an environment, the government will need to augment its financial resources though divestment of stakes in state-owned companies. Since the formation in May 2004 of the coalition government led by the United Progressive Alliance, the pace of the divestment in state-owned enterprises has been extremely slow. The total proceeds from divestments during the five years ending March 2009 were just US$3.1 billion.
We estimate the value of government stakes in the listed state-owned enterprises at about US$320 billion. If we include the unlisted companies, the total value would be approximately US460 billion. We believe that the divestment program can play a key role in augmenting government resources for investment in productive areas, such as rural infrastructure, without causing deterioration in government finances.
The government has already announced a plan to raise about US$5.6 billion from divestment by March 2010. The government intends to bring down its stakes in all listed entities to 75%. We expect a significant pick-up in the government's divestment from March-April 2010. In 2011, we believe that the government could collect US$5-10 billion from divestments.
Acceleration in Infrastructure Spending
After steadily rising to 5.7% of GDP in F2008 from the trough of 3.7% in F2005, infrastructure spending has been stagnant over the last two years. We expect infrastructure spending to start rising from F2011 again.
One of the key areas where we expect a meaningful increase in spending is the transportation sector (national highways). The Ministry of Transportation intends to award US$20 billion worth of road contracts on an annual basis over the next three-and-a-half years. Our infrastructure analyst, Akshay Soni, believes that the government will be able to issue contracts worth about US$12-13 billion over the next 12 months (the first year) compared with US$6-8 billion worth of contracts issued over the last 12 months.
Similarly, the momentum in implementation of electricity projects is also likely to pick up further.
Also, with credit markets improving and capital markets normalizing, private infrastructure spending in general should reaccelerate. We expect infrastructure spending to rise to 7.7% in F2013 from an estimated 6.1% of GDP in F2010.
Direct Tax Reforms
The Ministry of Finance has already put out a draft of new code for direct taxation. The thrust of the new code, as its foreword code says, "is to improve efficiency and equity in direct tax system by eliminating distortions in tax structure, introducing moderate levels of taxation and expanding the tax base".
For broadening the tax base, the code will minimize exemptions. The removal of these exemptions will improve tax to GDP and improve efficiency in allocation of resources. The new code will also simplify the language and law to reduce litigation and check tax evasion. Moreover, the new code also aims to encourage long-term savings. The tax incentives for savings will be rationalized. The code aims to follow the Exempt Exempt Tax (EET) rule, under which the initial savings contribution and accrual of interest are exempt but, on withdrawal, they would be subject to normal taxes.
The Ministry of Finance is likely to start implementing the new code from the February 2010 budget.
Bottom Line
After a long lull, we expect the government to be able to implement a number of the critical policy changes in 2010. We believe that some of these changes are critical to lift India's sustainable annual growth to 9%.
Important Disclosure Information at the end of this Forum
FM Kan Clarifies FX, Monetary and Fiscal Stance
January 11, 2010
By Robert Alan Feldman | Tokyo
Summary
New FM Naoto Kan clarified his stance on the exchange rate, monetary policy and fiscal policy yesterday (January 7). My take-away is quite positive. He has defined a yen policy clearly, and has made it clear that he expects the BoJ to cooperate. On fiscal policy, he emphasizes the demand side, but does so by emphasizing demand-inducing regulatory reforms. This approach is quite similar to what I discussed in my ‘Rocky Road' piece from August last year (see Rocky Road to Fiscal Sustainability, August 5, 2009). Should Kan's view prevail in upcoming policy debates inside the DPJ, the impact on both growth and fiscal sustainability would be positive.
Details
On the yen, in the press conference on Thursday night, Kan said not only that a yen/dollar rate in the middle of the ¥90s/$ is correct, but also that "we must work together with the BoJ to ensure the appropriate level". So he is still very much pushing the BoJ for extra measures, and will likely continue to do so. All the more reason that our call on the BoJ, i.e., a lot more easing, should come true.
Some clients have asked about extra fiscal steps. At this point, it is very hard for Kan to say anything, because the regular budget for FY10 has not passed the Diet yet. The Diet reconvenes in late January, and then it will take about two months before the budget is finally passed. Given potential for LDP criticism, DPJ leaders may feel compelled not to divulge new fiscal measures. Last year, the LDP took the same strategy, and it worked. The LDP then started talks on a new supplementary budget almost immediately. So, it will be March before any extra fiscal package involving the budget is discussed.
On the issue of regulatory form, Kan made a very interesting observation in his blog from December 13. He said, "There is no wisdom in doing traditional fiscal spending, because it would take so much money to close the output gap with low-multiplier impact public works. We need the wisdom to find demand impact of many times or many tens of times that of fiscal spending. In addition, rather than fiscal spending, there have to be policies that create a great deal of demand through changing social rules, such as regulations."
This statement could be significant for the DPJ, because it takes them a major step towards the types of deregulation policies adopted in the 1990s, under PMs Hosokawa, Murayama and Hashimoto. These policies led to the boom in IT spending, corporate reorganization (e.g., change of the anti-monopoly law, to allow holding companies), and even labor market deregulation. As an example of such social ‘rules', Kan mentioned the use of small fiscal subsidies to spread energy-saving technology in the consumer side of the economy. He also doffed his hat to the producer sector, saying that they have already achieved a huge amount of energy efficiency. With this statement, Kan was most likely trying to appear business-friendly.
Note also: Kan is NOT talking supply-side economics. The latter is a completely different area, which concerns the enhancement of productive resources for the economy. Should Kan start talking about augmenting productive resources too (and there are a few references to such things in the December 25 national strategy outline), then investors should take note. One such policy would be a more forward-looking stance on corporate income tax cuts - which are an effective tool for keeping employment in Japan. Note also that rule changes often have impact on both demand and supply sides of the economy. What FM Kan may propose as demand-enhancing policy could well turn out to have a larger impact on productivity gains and the supply side.
Important Disclosure Information at the end of this Forum
Disclosure Statement
The information and opinions in Morgan Stanley Research were prepared by Morgan Stanley & Co. Incorporated, and/or Morgan Stanley C.T.V.M. S.A. and their affiliates (collectively, "Morgan Stanley").
Global Research Conflict Management Policy
Morgan Stanley Research observes our conflict management policy, available at www.morganstanley.com/institutional/research/conflictpolicies.
Important Disclosure for Morgan Stanley Smith Barney LLC Customers
The subject matter in this Morgan Stanley report may also be covered in a similar report from Citigroup Global Markets Inc. Ask your Financial Advisor or use Research Center to view any reports in addition to this report.
Important Disclosures
Morgan Stanley Research does not provide individually tailored investment advice. It has been prepared without regard to the circumstances and objectives of those who receive it. Morgan Stanley recommends that investors independently evaluate particular investments and strategies, and encourages them to seek a financial adviser's advice. The appropriateness of an investment or strategy will depend on an investor's circumstances and objectives. Morgan Stanley Research is not an offer to buy or sell any security or to participate in any trading strategy. The value of and income from your investments may vary because of changes in interest rates or foreign exchange rates, securities prices or market indexes, operational or financial conditions of companies or other factors. Past performance is not necessarily a guide to future performance. Estimates of future performance are based on assumptions that may not be realized.
With the exception of information regarding Morgan Stanley, research prepared by Morgan Stanley Research personnel is based on public information. Morgan Stanley makes every effort to use reliable, comprehensive information, but we do not represent that it is accurate or complete. We have no obligation to tell you when opinions or information in Morgan Stanley Research change apart from when we intend to discontinue research coverage of a company. Facts and views in Morgan Stanley Research have not been reviewed by, and may not reflect information known to, professionals in other Morgan Stanley business areas, including investment banking personnel.
To our readers in Taiwan: Morgan Stanley Research is distributed by Morgan Stanley Taiwan Limited; it may not be distributed to or quoted or used by the public media without the express written consent of Morgan Stanley. To our readers in Hong Kong: Information is distributed in Hong Kong by and on behalf of, and is attributable to, Morgan Stanley Asia Limited as part of its regulated activities in Hong Kong; if you have any queries concerning it, contact our Hong Kong sales representatives.
Morgan Stanley Research is disseminated in Japan by Morgan Stanley Japan Securities Co., Ltd.; in Canada by Morgan Stanley Canada Limited, which has approved of and takes responsibility for its contents in Canada; in Germany by Morgan Stanley Bank AG, Frankfurt am Main, regulated by Bundesanstalt fuer Finanzdienstleistungsaufsicht (BaFin);in Spain by Morgan Stanley, S.V., S.A., a Morgan Stanley group company, supervised by the Spanish Securities Markets Commission(CNMV), which states that it is written and distributed in accordance with rules of conduct for financial research under Spanish regulations; in the US by Morgan Stanley & Co. Incorporated, which accepts responsibility for its contents. Morgan Stanley & Co. International plc, authorized and regulated by Financial Services Authority, disseminates in the UK research it has prepared, and approves solely for purposes of section 21 of the Financial Services and Markets Act 2000, research prepared by any affiliates. Private UK investors should obtain the advice of their Morgan Stanley & Co. International plc representative about the investments concerned. RMB Morgan Stanley (Proprietary) Limited is a member of the JSE Limited and regulated by the Financial Services Board in South Africa. RMB Morgan Stanley (Proprietary) Limited is a joint venture owned equally by Morgan Stanley International Holdings Inc. and RMB Investment Advisory (Proprietary) Limited, which is wholly owned by FirstRand Limited.
Trademarks and service marks in Morgan Stanley Research are their owners' property. Third-party data providers make no warranties or representations of the accuracy, completeness, or timeliness of their data and shall not have liability for any damages relating to such data. The Global Industry Classification Standard (GICS) was developed by and is the exclusive property of MSCI and S&P. Morgan Stanley bases projections, opinions, forecasts and trading strategies regarding the MSCI Country Index Series solely on public information. MSCI has not reviewed, approved or endorsed these projections, opinions, forecasts and trading strategies. Morgan Stanley has no influence on or control over MSCI's index compilation decisions. Morgan Stanley Research or portions of it may not be reprinted, sold or redistributed without the written consent of Morgan Stanley. Morgan Stanley research is disseminated and available primarily electronically, and, in some cases, in printed form. Additional information on recommended securities/instruments is available on request.
The information in Morgan Stanley Research is being communicated by Morgan Stanley & Co. International plc (DIFC Branch), regulated by the Dubai Financial Services Authority (the DFSA), and is directed at wholesale customers only, as defined by the DFSA. This research will only be made available to a wholesale customer who we are satisfied meets the regulatory criteria to be a client.
The information in Morgan Stanley Research is being communicated by Morgan Stanley & Co. International plc (QFC Branch), regulated by the Qatar Financial Centre Regulatory Authority (the QFCRA), and is directed at business customers and market counterparties only and is not intended for Retail Customers as defined by the QFCRA.
As required by the Capital Markets Board of Turkey, investment information, comments and recommendations stated here, are not within the scope of investment advisory activity. Investment advisory service is provided in accordance with a contract of engagement on investment advisory concluded between brokerage houses, portfolio management companies, non-deposit banks and clients. Comments and recommendations stated here rely on the individual opinions of the ones providing these comments and recommendations. These opinions may not fit to your financial status, risk and return preferences. For this reason, to make an investment decision by relying solely to this information stated here may not bring about outcomes that fit your expectations.
|
![](/img/clear.gif"){kind=spacer}