Sinha fails to walk the talk

ommencing his speech, Finance Minister Yashwant Sinha painted a rather sombre backdrop against which the Budget was presented. "It (the year) started with the Gujarat earthquake on January 26, and ended with the terrorist attack on our Parliament on December 13, punctuated by the September 11 incident in the United States and the October 1 outrage in Srinagar. On the economic front too, it has been a difficult year. World economic growth is estimated to have slowed down to 2.4 per cent in 2001 after seven consecutive years of higher growth. International terror and the global economic slowdown have been the saddest features of the past year." India IT Inc experiencing the brunt of the global slowdown sympathised and nodded in perfect agreement. The recession in the US economy, the subsequent Nasdaq meltdown had tanked profits of an industry accustomed to 100 per cent growth. Sixty minutes later the industry expectant of a support package was reeling with an additional tax burden. Tech stocks pointed southward as Finance Minister Yashwant Sinha failed to walk the talk.

Sinha knocked out hopes of further incentives for the software industry by rolling back the ten-year tax holiday under Section 10A/10 B of the Income Tax Act for units registered with STPI/SEZ/EOUs. For an industry that had lobbied hard for an insertion under Section 10A that profits derived from "onsite development" of computer software outside India would be deemed to be profits and gains from exports of software outside India, the premature withdrawal was a major setback. The 36.75 per cent tax on 10 per cent of export earnings will now lead to a further 3.675 per cent erosion in profits. Industry observers fear that frequent policy changes are bound to hamper India's competitiveness in global markets. Nasscom Chairman Phiroz Vandrevala, said: "Such inconsistencies in the tax regime will affect the confidence of overseas investors in the Indian software industry; especially since other countries such as China, Ireland, Philippines are pulling all stops in providing incentives to attract FDI in this sector. Domestic companies will find it difficult to plan their future strategies and investments in light of the uncertainties created by inconsistent policies. Hence, we are confident that the government will withdraw this provision and abide by its commitments made to the fast growing, globally competitive software industry."

The price of the dampened industry sentiment is a trifling Rs 200 crore more in the government's kitty. Nasscom has pegged export earnings in the next fiscal at Rs 47,450 crore; estimated profit is Rs 5,665 crore. At the rate of 36.75 per cent on 10 per cent of profits, the government will mop a mere Rs 200 crore. The amount will make a marginal difference to the cash strapped government but for Indian SMEs trapped in an analogous situation, the ill-conceived ill-timed and inconsistent measure literally and metaphorically spells taxing times ahead. "In the current challenging global environment," Nasscom President Kiran Karnik said, "Indian companies, especially SMEs and ITES companies are making significant investments in setting up sales and marketing infrastructure in the overseas markets. This withdrawal of tax exemption would reduce their investible surplus and affect marketing efforts during the year 2002-03."

The government also disappointed the industry with continuation of sub-section (9) under Section 10(A) and Section 10(B). As per this clause, if during the year, more than 51 per cent of shareholding (beneficial interest) changes in a 100 per cent EOU, STP, EPZ then the company will cease to get Income Tax exemption from that year. This provision not only impacts the ability of companies to raise funds either from capital markets or venture capitalists but acts as a deterrent to mergers and acquisitions, which is today seen as an important step for future growth.

The government attempted to soften the blow by enhancing the investment limit and allowing companies to invest in joint ventures up to 50 per cent of their net worth. Although this will help in charting out an aggressive inorganic growth strategy, it clearly failed to reassure a jittery industry.

Hardware scored over software in wrangling benefits for the government. The Finance Minister rectified the inverted tariff structure imposed on domestic hardware manufacturing by slashing customs duty on number of hardware components to 5 per cent and retaining import tariffs on finished PCs at 15 per cent. Earlier the import duty on capital goods and certain input components was higher than the peak rate of 15 per cent import duty on finished goods, The move will benefit domestic PC players. Some of the inputs that will be available at lower costs are parts of printers for computers, cable assemblies for computers and periphreals, ink cartridges and ribbon gear etc. In addition 25 capital goods items will now attract customs tariff of 15 per cent as against 25 per cent.

Another item on the hardware sector's wishlist that the Budget fulfilled was the extension of the zero duty regime to 2005 which as per the WTO agreement was to come into effect in 2003. This provides a necessary breather to domestic players to consolidate their growth and investment plans and hopefully scale to global level to meet challenges of international competition.

The measures however failed to provide an overall fillip to the hardware sector. Finance Minister Yashwant Sinha did not concede to a long standing demand to reduce excise duty on all IT products to a uniform 8 per cent. The reduction was essential to combat the grey market which presently takes up 35 per cent of the market share. The new tax regime were heavily criticised. MAIT President, Vinay Deshpande, reacting on the outcome of the Budget said, "The hardware industry believes that while infrastructure issues will take time to get addressed, the industry is looking at other higher value added options like exports of designs, firmware and even technology, but unfortunately issues like withholding tax and taxation on royalty from exports of technology that are proving to be deterrents and have gone unaddressed."

According to a recent joint study released by Mait and Ernst and Young, India's domestic market will touch $37b, exports will cross $25 b, contract manufacturing will be a $11 b opportunity and design exports another $ 7b and domestic PC sales touching $22 m in 2010 with PC penetration of over 69 per 1,000 people in 2010. The study reveals that the Indian hardware industry can attain a turnover of $ 62 billion by 2010, twelve times its existing size. The Budget failed to fuel to this optimistic potential.

In contrast to the software and the hardware sector, e-telecom had much to crow about. The waiver of 16 per cent countervailing duty on mobile phones will help mobile manufactures hurting from the high price differential between the legal and the grey market. Manufacturers like Siemens, Motorola and Nokia responded immediately by slashing prices.

Recognising the telecom service sector as an "industrial undertaking" under Section 72A, will facilitate efficient mergers and acquisitions. The basic telecom operators, who have been complaining of partiality towards cellular operators, also have reason to cheer. For the last five years, the rate of customs duty on imported cellular equipment was much lower than that for basic services. In this Budget, the Finance Minister has rationalised this duty and brought `basic' and `cellular' on an equal platform. This will boost the basic telephony industry, which has not happened in the past four years."

In his concluding remarks the Finance Minister said: “This is a Budget for consolidating, widening and deepening the reform process.” From the perspective of India’s blue chip sector, the words sounded hollow. In a vicious macroeconomic climate the process of consolidation and widening gains has by and large been left to the industry. A tough pill for India’s showcase sector to swallow

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