The government recently presented the Union Budget 2016-17, its second full-year budget, in which it reiterated its focus on infrastructure development as it moved into its third year in power. In the budget there are a series of proposals across infrastructure segments, which aim to ease policies to facilitate greater investment activity. However, some expectations remain unmet.
Amidst a difficult global environment, India’s economic growth in 2015-16 has been estimated at 7.6 per cent. In the near future, the government expects the global economic scenario to remain difficult. It plans to respond to this by trying to boost domestic demand and continue with the ongoing reform process to facilitate infrastructure development. The creation of infrastructure has been heavily stressed upon, and has been referred to as the ”fifth pillar” of the “Transform India” theme in the budget .
A plan outlay of Rs 2.21 trillion has been announced for the infrastructure sector with the objective of reviving the investment cycle. Proposals pertaining to the revitalising of public-private partnerships (PPP), improving credit rating of infrastructure projects, deepening of bond markets, and improving asset quality are among the other highlights.
A sector-wise analysis of the announcements…
The government announced a number of measures to augment fund flow. Guidelines for the renegotiation of PPP concession agreements will be issued. Besides this, the Public Utility (Resolution of Disputes) Bill will be introduced during 2016-17 to reduce litigation. A new credit rating system for infrastructure projects will be inducted. This will aid in the appropriate pricing/costing of projects and will benefit all stakeholders. Once these announcements translate into action, sectors such as power and ports will benefit greatly.
The bond market continues to remain underutilised by infrastructure players. However, it received some long-awaited attention in the budget.
- It was announced that a dedicated fund will be set up by the Life Insurance Corporation of India to provide credit enhancement to infrastructure projects. This will help in improving the credit rating of bonds floated by infrastructure companies.
- To shift some of the financing load from banks to bond markets, the Reserve Bank of India (RBI) will issue guidelines to encourage large borrowers to access a certain portion of their financing needs through market mechanisms. According to CARE Ratings, assuming that large exposures are defined as those over Rs 1 billion, if 10 per cent of such offerings raise funds from the market, the incremental funds raised would be to the tune of Rs 4 trillion in the medium term.
- It was also proposed that the investment basket of foreign portfolio investors will be expanded to include unlisted debt securities and pass-through securities issued by the securitisation of special purpose vehicles (SPVs). An electronic auction platform will be introduced by the Securities and Exchange Board of India (SEBI) for primary debt offers. This will create an enabling environment for private placements.
Public sector units such as the National Highways Authority of India (NHAI), the Power Finance Corporation, the Rural Electrification Corporation, the Indian Renewable Energy Development Agency, the National Bank for Agriculture and Rural Development and the Inland Water Authority have been permitted to raise around Rs 313 billion through bond issues.
To address poor asset quality, asset reconstruction companies (ARCs) have received a boost. The maximum sponsor stake permitted in these entities has been raised from 50 per cent to 100 per cent; and the foreign direct investment (FDI) limit has been raised from 74 per cent to 100 per cent under the automatic route. Further, non-institutional investors have been permitted to invest in security receipts (SRs). Foreign portfolio investors too can invest up to 100 per cent in each tranche of SRs issued by ARCs (subject to sectoral caps).
In addition, a complete pass-through of income for securitisation trusts set up by ARCs has been proposed (income of investors to be taxed directly). It has also been announced that debt recovery tribunals will be strengthened. These announcements are big positives; ARCs may significantly augment their capital base and this would aid in cleaning up banks’ books. Foreign investors can also foray into India’s stressed asset markets, with greater clarity on taxation and judicial treatment.
Asset quality is also a concern for non-banking financial companies. The budget proposes that these entities will be eligible for deduction to the extent of 5 per cent of income, as a provision for bad and doubtful debt. Meanwhile, reforms in the FDI policy in the insurance and pension segments and stock exchanges have also been proposed. In addition, it has been announced that dividend distribution from the income of special purpose vehicles (SPVs) to real estate investment trusts and infrastructure investment trusts (InvITs) with a specified shareholding will not be subject to dividend distribution tax, with respect to dividend distributed after a specified date.
Oil and gas
A big positive for the oil and gas sector was an announcement pertaining to the proposal (currently under consideration) for new discoveries and areas which are yet to commence production. One idea was to provide calibrated marketing freedom and the other was to do so at a predetermined ceiling price to be discovered on the principle of the landed price of alternative fuels. Another welcome step is the switch from a fixed cess of Rs 4,500 per tonne to a 20 per cent ad valorem cess on domestically produced crude oil. The government has also allocated Rs 20 billion for new liquefied petroleum gas connections to poor families. Besides this, the provision of subsidies for sensitive petroleum products of Rs 269 billion in 2016-17 (budget estimate) has also been proposed.
Other key announcements were customs duties exemptions on specified goods imported for petroleum exploration, incentivising gas production from deep-water/ultra deep-water areas, and withdrawal of deductions, under Section 80-IB of the Income Tax Act (IT Act), on the production of mineral oil and natural gas.
The overall impact of the budget has been quite positive, even though some key issues have only been touched upon, and have not been addressed to the extent the industry had hoped for. For example, the ad valorem cess on domestically produced crude oil was expected to be reduced to 10 per cent (it has been pegged at 20 per cent). Moreover, there have been omissions such as silence on the next round of oil and gas block auctions and no clarity on the tax incidence on petrol and diesel.
Power: Conventional and renewable
In a bid to diversify the energy mix, it was proposed that Rs 30 billion per year be allocated towards the development of nuclear-based capacity for power generation.
Meanwhile, a target of 100 per cent rural electrification, to be achieved by May 2018, was announced. Funds to the tune of Rs 85 billion have also been allocated for part-funding of distribution capital expenditure-oriented schemes like the Deen Dayal Upadhyaya Gram Jyoti Yojana (DDUGJY) and the Integrated Power Development Scheme (IPDS).
On the renewables front, the clean energy cess (renamed clean environment cess) on coal, lignite and peat has been increased from Rs 200 per tonne to Rs 400 per tonne. The resulting increase in costs to thermal power generation companies, with ”fuel cost pass-through” clauses, will be recovered from consumers; however, this will not be the case for companies that have fixed price power purchase agreements.
With the increased cost of thermal power, the differential between the cost of generation through thermal and renewable sources will be reduced. This will make the latter more competitive. It has also been proposed that accelerated depreciation provided under the IT Act will be limited to a maximum of 40 per cent, from April 1, 2017, as against the present rate of 80 per cent (applicable to renewable power projects) which is valid till March 31, 2017. This is likely to affect financial and corporate investors’ appetite for investment in the non-independent power producer segment.
The road sector received significant funding in the budget. The government has proposed an allocation of Rs 550 billion for the development of roads and highways. This includes an allocation of Rs 50 billion for the Special Accelerated Road Development Programme (including the allocation of the Kaladan multimodal transport project). An additional Rs 150 billion will be raised by NHAI through bonds. The total investment in the sector, including the allocation for the Pradhan Mantri Gram Sadak Yojana, will be around Rs 970 billion. The government has increased its financial support (total plan outlay) to NHAI to Rs 789.32 billion for 2016-17, as against Rs 574.2 billion for 2015-16 (revised estimate).
Further, it was stated that the central government has inherited over 70 stalled projects worth Rs 1 trillion, covering 8,300 km. Notably, 85 per cent of these are now back on track. The government reported the award of the highest ever length of national highways in 2015. During 2016-17, it aims to approve projects for the development of 10,000 km of national highways. In addition, 50,000 km of state highways will be upgraded to national highways. The pace of completion of road projects will also increase to about 10,000 km in 2016-17.
The announcements for the proposed increase in budgetary allocation that pertain to improving the credit rating of infrastructure projects and resolving issues related to execution in the public-private partnership mode are expected to provide a significant stimulus to the road sector.
The central government has made specific allocations for three ambitious programmes – the Swachh Bharat Mission, the Atal Mission for Rejuvenation and Urban Transformation (AMRUT) and the Smart Cities Mission (SCM). For the Swachh Bharat Mission, Rs 90 billion has been allocated. The Centre has also approved a policy for the conversion of city waste into compost under this programme. Besides, Rs 72.96 billion has been set aside for AMRUT and the SCM. Moreover, a major programme for the sustainable management of groundwater resources has been initiated with an estimated investment of Rs 60 billion. These announcements are positive and should lead to acceleration of construction activity in the sector.
Ports and shipping
With regard to port development, a corpus of Rs 8 billion for the development of new greenfield ports and inland waterways has been proposed. It was announced that new facilities are planned on the eastern and western coasts. In addition, the implementation of the Indian Customs Single Window Project (proposed in the previous budget) will take place in 2016-17. Work on national waterways is also being expedited.
Following these announcements, project implementation in expected to gain pace. While the total funding requirement is expected to be significantly higher than the corpus announced, it should facilitate progress and is a positive for incumbents in the port sector as well as those involved in external trade. Overall, the budget has been neutral but PPP-related initiatives are likely to bring some relief in terms of project execution.
On the shipping front, the budget stated that services provided by Indian shipping lines by way of transportation of goods by vessels outside India will not be charged and that input tax credit will be allowed on these movements, with effect from March 1, 2016; 14 per cent service tax will be charged on transportation of goods by vessels from outside India up to the customs station in India, with effect from June 1, 2016. Further, a provision of Rs 500 million has been made as subsidy to non-central PSU shipyards and private sector shipyards for 2016-17.
With regard to the airline industry, announcements have been made with respect to reducing the cost of maintenance, repair and overhaul (MRO) services, specifically for airlines that carry out these activities themselves. Exemption from basic customs duty, countervailing duty, and special additional duty for tools and tool kits imported by MRO companies has been proposed. Other key announcements in the segment include:
- Exemption from excise duty on tools and tool kits procured by MRO companies
- Restriction of one year for utilisation of duty- free parts for MRO of aircraft to be removed
- Simplification of procedures for availing of customs duty and excise duty exemptions for MRO companies
- Extension on stay of foreign aircraft for MRO to six months from the existing 60 days
- Excise duty on aviation turbine fuel (ATF) (other than for supply to scheduled commuter airlines from the regional connectivity scheme [RCS] airports) is proposed to be increased from the existing 8 per cent to 14 per cent. ATF for supply to aircraft under the RCS will continue to attract 8 per cent excise duty.
As far as airport development is concerned, the government plans to partner with state governments to develop 160 airports that are currently non-functional to enhance regional connectivity. These airports will be revived at an indicative cost of Rs 500 million to
Rs 1,000 million each. Similarly, 10 of the 25 non-functional airstrips under the Airports Authority of India will also be developed. As in the ports sector, the Indian Customs Single Window Project will come into effect in the airport sector from 2016-17.
While the increase in excise duty on ATF is likely to hurt airlines, the effect will not be too significant in the near-term owing to low fuel prices. In the MRO space, some major facilitating measures have been announced, in line with the vision of establishing India as an MRO hub. Growth in this segment will augment airport operators’ revenues as well as aid in the reduction of airlines’ costs.
The budget has provided much-awaited clarity on the transfer of the right to use of spectrum. The government clarified that the assignment of right to use radio frequency spectrum will not be taken as a sale of intangible goods and, therefore, will be liable to service tax levy. Earlier, there was ambiguity with respect to the treatment of spectrum trading deals: whether they should be under the ambit of service tax or value added tax. Since service tax is applicable, a company paying the tax will get the benefit in tax liability, which will ultimately be credited back to it. The move is expected to induce more spectrum transactions.
The 10 per cent exemption on tax on specified telecom equipment has been withdrawn. The withdrawal of customs duty exemptions will drive the domestic manufacturing of such products. However, in the interim, it will raise the cost of these products for companies.
The budget has made some strong proposals which will positively impact the infrastructure sector. It is especially useful in terms of resolution of issues with the PPP model and makes an effort to tackle bad assets and weed them out. While the announcements augur well for the sector (as they will ratchet up private player interest), action on the ground must follow.
Previous budget proposals such as the establishment of “3P India” are yet to materialise. It is understood that policy-to-action translation is time-consuming. However, the government must endeavour to speed this up. Meanwhile, higher budget outlays for most sectors are certainly encouraging, and an improved framework for conducting business should draw private investments.