December, 2004

In a bid to double India's share in global trade in the next five years, the Government has recently unveiled a comprehensive Foreign Trade Policy which replaces the 5 year Exim policy 2002-07 and focuses on stepping up employment-generating agriculture and services exports. The key aspects of the Policy are:

1. Strategy

(a) It is for the first time that a comprehensive Foreign Trade Policy is being notified. The Policy takes an integrated view of the overall development of India’s foreign trade.

(b) The objective of the Policy is two-fold:

(i) to double India’s share of global merchandise trade by 2009; and

(ii) to act as an effective instrument of economic growth by giving a thrust to employment generation, especially in semi-urban and rural areas.

(c) The key strategies in the Policy are:

(i) Unshackling of controls;

(ii) Creating an atmosphere of trust and transparency;

(iii) Simplifying procedures and bringing down transaction costs;

(iv) Identifying and nurturing special focus areas to facilitate development of India as a global hub for manufacturing, trading and services.

2. Special Focus Initiatives

(a) Sectors with significant export prospects coupled with potential for employment generation in semi-urban and rural areas have been identified as thrust sectors, and specific sectoral strategies have been prepared.

(b) Further sectoral initiatives in other sectors will be announced from time to time. For the present, Special Focus Initiatives have been prepared for Agriculture, Handicrafts, Handlooms, Gems & Jewellery and Leather & Footwear sectors.

3. Some key announcements

Exporters who have achieved a quantum growth in exports would be entitled to duty free credit based on incremental exports substantially higher than the general actual export target fixed.

Export-oriented units (EOUs) exempt from service tax and all exporters with a minimum turnover of Rs. five crore from bank guarantee requirement.

EOUs shall be permitted to retain 100% of export earnings in foreign currency accounts.

Import of capital goods shall be on self-certification basis for EOUs.

A new scheme to establish Free Trade and Warehousing Zone has been introduced to create trade-related infrastructure to facilitate the import and export of goods and services with freedom to carry out trade transactions in free currency. This is aimed at making India into a global trading-hub. Foreign investment would be permitted up to 100% in the development and establishment of the zones and their infrastructural facilities. Units in these zones would qualify for all other benefits as applicable for Special Economic Zone units.

A new mechanism for grievance redressal has been formulated and put into place to facilitate speedy redressal of grievances of trade and industry.

Biotechnology Parks to be set up which would be granted all facilities of 100% EOUs.

Government to promote establishment of Common Facility Centres for use by home-based service providers, particularly in areas like engineering and architectural design, multi-media operations, software developers etc., in State and District-level towns.

July, 2004

The annual Budget is the single most significant fiscal policy statement of the Government. It is a much awaited event each year by all constituents of the economy - business leaders, salaried classes and self-employed. The early part of the year 2004 saw an “interim budget” delivered by the BJP led Government. Post-elections the political scene changed with the formation of Congress led coalition government. The architect of the ‘Dream Budget’ of 1997, Mr. P. Chidambaram presented this year's Budget on July 8 against the backdrop of political compulsions facing his coalition government.

While the prime focus of the Budget is on agriculture and rural development, it contains clear signals that economic reforms continue on the agenda. The much debated hike in FDI limits in telecom, insurance and aviation sectors reiterates the continuation of the reform process and puts to rest fears among businesses and global investors about the policy direction of the new government.

Following are the highlights under headings: ‘Infrastructure’; ‘Foreign Direct Investment’; ‘Industry’; ‘Capital Markets’; ‘Taxes’ and ‘Miscellaneous’:

July, 2004

1. Several incentives announced for the regeneration of the agriculture sector. These include enhanced and cheaper credit (there is a proposal to double agriculture credit over the next three years), enhanced farm and cattle insurance and tax concessions for activities like horticulture and dairying. Indeed, ‘return to agriculture’ could be said to be the main theme of this year’s Budget.

2. The Government to set up a Board for Reconstruction of Public Sector Enterprises to advise it on the measures to be taken to restructure public enterprises, including cases where disinvestment or closure or sale is justified.

3. Full exemption from excise on computers granted. This is expected to result in accelerating overall PC penetration in the country, stimulate domestic industry and increase the opportunity to deliver a higher level of citizen-centric IT services by the government and private players.

4. Hospitals with hundred beds or more set up in rural areas entitled to 100% deduction of profits for a period of five years.

5. Procedure for registration and operations to be made simpler and quicker for foreign institutional investors.

6. Investment ceiling for foreign institutional investors in debt funds to be raised from US$1 billion to US$1.75 billion.

7. Relevant provisions of the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act to be amended to address the Supreme Court's concerns regarding a fair deal to borrowers while ensuring that the recovery process is not delayed (please see the section on Corporate Laws).

July, 2004

1. Education cess of 2% on income tax; corporate tax; excise duties; customs duties and service tax to be levied. Even though individual and corporate tax rates and slabs remain unchanged, additional education cess of 2% takes the effective tax rate at the highest slab for individuals from 33% to 33.66%. Similarly, there is a marginal increase in the corporate tax rate from 35.88% to 36.59% and in the dividend distribution tax rate from 12.5% to 13.07%.

2. No income tax for individuals with annual income upto Rs. 100,000. This exemption is expected to bring 14 million out of 27 million taxpayers out of the tax net. The increase in disposable income in the hands of these mostly urban middleclass households augurs well for consumer durables.

3. Service tax extended to 13 more services with an enhanced rate of 10% - up from 8%.

4. Peak customs duty pegged at 20% - in keeping with the announcement made early this year by the then Finance Minister, Jaswant Singh, counter vailing duty exemption knocked off on imported products where there is no corresponding exemption from excise duty on the domestic product. This is expected to provide a level playing field for domestic manufacturers.

July, 2004

1. Long-term capital gains on securities sold in a stock exchange abolished and transaction tax at 0.15% of value of purchase (payable by purchaser) introduced. Short-term capital gain on securities to be subject to tax at 10% plus cess. This is expected to bring about liquidity and efficiency in the capital market. It is however not clear yet if the transaction tax will be applicable to debt securities as well.

The introduction of transaction tax of 0.15% may have the effect of rendering foreign investors ineligible for a tax credit for the transaction tax in their home country. This is since tax treaties generally apply only to taxes in the nature of income tax. Even so, Mauritius will continue to be useful for short-term foreign investors since by routing investment through Mauritius, tax on short-term capital gains can be avoided in toto.

2. Equity oriented mutual funds to continue to be exempt from tax on dividends. Rate of tax on corporate unit holders of debt oriented mutual funds to be raised from 12.5% to 20%.

3. Proposal to strengthen the existing curbs on dividend stripping by extending the holding period from 3 months post-record to 9 months. Provisions for curbing bonus stripping also introduced.

July, 2004

1. Proposal to set up National Manufacturing Competitiveness Council to work as a forum for policy dialogue to energise and sustain the growth of manufacturing industries. The Council will perform functions such as suggesting measures for enhancing competitiveness in the manufacturing sector.

2. Tonnage tax introduced for the shipping industry. With this, the existing benefits available to the shipping industry under the Income Tax Act i.e. full tax exemption of profits set aside for future fleet expansion stands withdrawn. The new regime is optional. Tax is on the basis of notional income determined on the basis of cargo carrying capacity of the ship. The introduction of tonnage tax is expected to bring Indian shipping on par with international counterparts as domestic companies will have more flexibility insofar as they can forecast tax liabilities.

3. In order to boost exports and to make India a major hub for manufacturing and exports, there is a proposal to enact a Special Economic Zones (SEZs) Act and a new trade policy. SEZs currently operate under government policy and notifications issued from time to time.

4. The pension sector to be opened up with the Government signalling a full-fledged regulator and putting in place tax breaks exclusively for contributions to pension plans. This is expected to give a fillip to the equities markets as the pension plans also envisage investment in equities.

5. New tax regime for textiles to benefit the $36-bn textile-to-clothing industry. There will be no mandatory excise duty on pure cotton, wool and silk across the value chain — from fibre, yarn, fabric to garment. These products will be subject to an optional excise duty of 4%, as against the current mandatory duty of 8-10%. Blended textiles and pure non cotton to have a different tax regime – these will be subject to an optional excise duty of 8%.

6. Automobile industry to be notified as an industry entitled to 150% deduction of expenditure on in-house R&D facilities.

7. 85 items have been de-reserved from the small-scale sector list. Investment in these items will now be open to large enterprises as well.

July, 2004

1. The sectoral cap for foreign direct investment in telecom sector proposed to be increased from 49% to 74%. This is expected to address the urgent need for infusing fresh capital in the rapidly growing telecom sector. Earlier surveys had shown that an investment of about Rs 5000 billion is required in the sector in the next three years to keep pace with the growing demand and since such funds are not available in the domestic market, the relaxation in FDI investment will help boost growth and increase telecom penetration in the country.

2. The sectoral cap for FDI in civil aviation proposed to be hiked from 40 per cent to 49 per cent and in insurance from 26 per cent to 49 per cent. However, it is not yet clear if foreign airlines would be eligible for investment in civil aviation (currently they are prohibited).

3. Proposal to establish an Investment Commission to work towards providing attractive environment for investors in the country. The Commission would be chaired by an eminent person and vested with a broad authority of the Government to engage, discuss with and invite domestic and foreign businesses to invest in India.

With this, it is expected that the FIPB would be phased out in due course.

July, 2004

1. Recognising that the inadequacy of water could be one of the most devastating crisis for the country, the Budget proposes pilot initiatives on both the restoration of water bodies and on water harvesting. First large desalination plant to be installed near Chennai and many more plants to be installed along the Coromandel Coast through public-private partnership.

2. Encouraged by the past success of the Inter-Institutional Group (IIG) in bringing several power projects to financial closure, the Budget proposes to extend this measure to other infrastructure sectors. The IIG which comprises institutional development agencies and public sector banks will pool its resources to an extent of Rs 400 bn. and work for speedy conclusion of loan agreements and implementation of infrastructure projects - initially in airports, seaports and tourism related projects.

3. The Government to facilitate the construction of an International Container Transhipment Terminal at Vallarpadam in Kochi port on Build, Operate and Transfer basis. This is expected to enhance the draft and cargo handling infrastructure at Kochi port which has substantial locational advantages compared to other major Indian ports.

4. The Ministry of Shipping to establish a special purpose vehicle to raise funds for Sethusamudram Ship Canal Project in which the Government will participate through a mix of equity support and debt-guarantee. The Sethusamudram Project involves deepening of the channel between India and Sri Lanka to facilitate movement of cargo vessels.

5. A 10-year tax break proposed for all investments in modernisation of existing transmission and distribution businesses. This measure will correct the skew in the existing fiscal structure which allows tax breaks only for investments in fresh or new projects.