(BAD)GET for 2007-08

While I have not still looked into the fine prints of the budget, this budget seems to be more politically driven than anything else. Possibly the loss of elections in two northeastern states would have weighed heavily on the congress while announcing the budget. Anyway, getting on to the budget - if you recollect reading my earlier blog my view the government needs to closely monitor the commodity markets to keep a watch on unncessary speculation seems to have been bang on.

Before we go into the direct taxes lets have a look on the feel good factors for the economy as a whole:
Growth rate acheived - 9.6% (well on course for the targeted 10%)
Manufacturing sector grows by 11.3%
Service sector gorws by 11.2%
Per capita income increase by by 7.4%
Savings rate estimated at 32.4%
Investment rate estimated at 33.4%
Total Forex reserve stands at USD 180 bn
Avg inflation 5.4%
Merchandise exports exceed USD 100bn
Service exports exceed USD 125 bn
Government to aquire RBI's stake in SBI (has set aside 40000 cr for this purpose)
CST rates reduced from 4 to 3%
Lot of thrust given on Primary and secondary Education (a seperate cess called Higher Education Cess introduced)

Now lets look at some of the Direct Tax proposals:
Weighted deduction for approved inhouse research extended for another 5 years
Section 40A - earlier if any payment in excess of Rs.20000 was made by cash only 20% of the expenditure was disallowed. From now on the entire expenditure will be disallowed.

ESOPS will now be taxable as a fringe benefit. As a result of this the value of ESOP which will be taxed as Fringe benefit will be considered as cost of aquisition in computing capital gains arising on sale of such shares.

The term capital asset for the purpose of capital gains now includes jewellery and work of art (earlier these were excluded from the definition of capital assets)

Cap on investment under section 54EC - a maximum cap of Rs.50 lacs has been put on investment in specified bonds (NHAI and Rural electrification bonds)

Section 80CCD to apply to non government employee also

Section 80E - now available for higher education of the assessee's relative also (earlier it was only for self higher education) - relative means only spouse and children.

Section 80D- limit has been raised from Rs.10000 and Rs.15000 (senior citizens) to Rs.15000 and Rs 20000 respectively.

Section 80IA now available for companies engaged in laying and operating a cross country natural gas distribution network.

Section 10 incomes to be included while computing Minimum alternate Tax.

Section 115 O - Dividend distribution tax increased from 12.5% to 15%

Section 115R - Dividend Distribution tax for Money market Mutual funds 25%

I have not dealt with the changes in procedures and TDS in this blog.

Hope you find this helpful

REDDY GOES BOOM:2 : --- (CRR)azy kiya re........

Refer my earlierblog titled : Reddy to go northwards " where I had said that we can look forward to some more turbulent times as far as interest rate scenarios is concerned. It has been proved right by the recent move yesterday by the RBI governor to hike the CRR rates to 6% (from the earlier 5.5%).
The hike will be implemented in two phases of 0.25% each on Feb 17th and March 3rd. The move will suck out a total of Rs.13,500 crores from the system and has been spurred by the RBI's concern over the current trends in inflation which in the recent past has touched 6.8%. What needs to be seen is how far will this move be successful in achieving the goal of inflation supression. Rising commodity prices has been troubling the government for some time now - however what is to be analysed is that how much of the commodity inflation is on account of consumption demand and how much can be attributed to the operations of an erstwhile bull who is now rumored to be playing a big role in the commodities market. If the demand in the other sectors like realty etc does not subside (this may happen if the realty sector continues to rise on account of demand and is not deterred by the high cost of funds) then the prices will go up anyway inspite of the CRR hike. Infact in such a case the CRR hike may spur a disproportionate inflation because the builders will pass on the higher interest burden to the buyers.

The 2nd phase of the hike on March 3 will have a higher impact on short term money rates as the timing of the hike will coincide with year end payments like taxes etc. (though one might argue that there will still be 27 days for the year end and by then the money will be back in the system).

Impact on deposit rates:
The move will benefit the fixed deposit investors as banks are likely to raise the interest rates on term money. We seem to be heading towards days where a double digit interest rate will be a reality after a long time. But the flip side is that consumer loans and housing loans will now become costlier.

Impact on Yields and government securities.
If I were a bond dealer, right now I would be wishing to just run away from this market and rather be sitting on a beach side in Hawai with a lei around my waist. A bond market is the last place I would be wanting to be in today. The yields will take a beating and will move northwards and the longer term securities segment could witness a gory blood bath.

The securities market has been ailing for some time now and this move is likely to pull out the oxygen from the market and leave it gasping for breath. The fall in the prices will affect the mark to market valuations of the banks and the impact will be seen in the banks balance sheet for the ye 31.03.2007.

Impact on corporates:
Corporates now face the prospect of a higher financing costs which is likely to hit the bottom lines and the impact of the same will be mostly felt in the next FY 08-09. Corporates who have borrowed at floating rate will be left holding the short end of the stick.

Stock markets
Banking stocks took a beating yesterday in the light of the interest rate movement northwards. The PSU banks are likely to be the most hit as their ability to pass on the interest rate hike to the consumer will not be absolute keeping in mind their social responsibilities. Moreover as mentioned earlier in this post, the balance sheet of most banks will take a serious knocking on the mark to market process - especially in the longer duration securities. In fact at the time of my writing this blog SBI is trading at 1102 - 6% lower than previous day closing

The road ahead
If the inflation figure stays above 6% then we cant rule out the possibility of further hikes. Rupee will also face some pressure as the rate hike in the long run as continuous rise in the interest rates are perceived as weakening of economy. However in the short run we can see some dollar inflows to take advantages of interest rates arbitrages.

Other steps being taken
The government has decided to ban the exports of wheat to curb the price rise in wheat. But in my opinion the government needs to have a closer look at the factors in play in the Indian commodities markets and curb excessive speculation. It is time that we realise that unregulated speculation in the commodities markets doesnt benefit the farmer in the immediate run and only results in affecting the common man as a consumer who will have to bear the brunt of increased price.

Special Purpose Vehicles (SPVs) are in the news these days what with the banks and FIs and the corporates using this powerful tools for various purposes.

Banks and FIs and financial companies use this for undertaking off balance sheet financing or for hiving off their slow moving assets, while corporates are using this tool for funding their acquisitions e.g. TATA - Corus deal.

The use of SPVs originated in the US of A in the 1980s as a method of undertaking tax efficient transactions by establishing companies in tax havens like Cayman islands or Isle of Mann / Gibraltar etc.

However with the passage of time the usage of this product has spread across the globe and for varied uses other than tax efficient transactions.

So what is an SPV?
An SPV is a firm or legal entity established to perform some narrowly-defined or temporary purpose. The sponsoring firm accomplishes that purpose without having to carry any of the associated assets or liabilities on its own balance sheet. The purpose is achieved "off-balance sheet."

Usage of SPV
From the initial use of the SPV to enhance tax efficiency, SPVs are now used for a wide variety of transactions as the financial markets have become more and more sophisticated:
               Securitising loan portfolios of a bank
               Securitising financial assets such as:
               Auto loans
               Credit card and hire purchase receivables
               Finance leases
               Aircraft operating leases
               Real estate mortgages
              Aircraft and ship financing
              Catastrophe bond issues (CAT Bonds - I will be writing on this shortly)
              Specialised financing deals, such as Ijara financing (Ijara financing will be covered in another discussion in this blog)

How is the tool of SPV used?
The originating company transfers its assets into a specially formed company called the SPV. The SPV then issues bonds or notes which are backed by the receivables generated by the assets transferred to it. The investor investing in such bonds / notes does so by evaluating the SPV as a standalone entity and not as an arm of the originating company. Hence an SPV does not impose any strain on the credit limits of the originating company.

How is the ownership of an SPV structured?
The SPV may be a subsidiary of the originating company or may be a "orphan entity"

By its very nature, an SPV must be distanced from the sponsor both in terms of management and ownership, because if the SPV were to be owned or controlled by the sponsor, there is no difference between a subsidiary and an SPV.

In most of the cases an SPV is used either for enhancing tax effeciency or for off balance sheet financing. In the case of an SPV being used for tax purposes the originating company does not directly participate in the ownership of the company. The ownership of SPV in such a case is vested with a trust which is formed for this purpose.

In the event of an SPV being used for off balance sheet financing the originating company only has a partial ownership in the SPV. This is because if the entire ownership of the SPV was vested with the originating company then the financial statement of the originating company will have to incorporate the balance sheet of the SPV as well which in turn defeats the very purpose of the SPV.

Advantages of off balance sheet financing
Off-balance sheet financing is attractive from a risk management standpoint. When assets and liabilities are moved from one balance sheet to another, the risks associated with those assets and liabilities go with them. For example, if a firm transfers credit risky assets to an SPV, the credit risk goes with those assets.

What is a pass through certificate (PTC)?
A pass-through is a security issued by a special purpose vehicle. The SPV holds assets and pays the pass-through's investors whatever net cash flows those assets generate. In this way, the SPV's assets and liabilities are automatically cash matched, so there is no asset-liability risk.

Risks associated with an SPV?
Like any finance structuring tool SPVs come with their own inherent risk of misuse. A classic case of misuse was demonstrated by ENRON which created a number of SPVs (almost 3000) to hide its risk debts.

Why do investors prefer subscribing to SPV notes rather than lend to originating company

Although the subscribers are supposed to be taking the risk on the SPV itself, in most of the case the originating company takes a moral responsibility to repay in case of a default. Hence in practice an SPV can never go bankrupt. Therefore the pricing of the notes should not include any risk premium on account of bankruptcy.However this logic does not apply to the originating company as it is susceptible to bankruptcy risk. Hence the investors might prefer investing in an SPV note at a slightly lesser rate than what they would demand for the originating company note.

But this does not mean that there are no strings attached to the SPV route. Setting up of an SPV would involve a fixed cost and the originating company might not be able to claim the tax break on the interest paid by the SPV

How is a SPV bankruptcy remote?
An SPV is bankruptcy remote i.e even if the sponsoring company goes bankrupt the creditors cannot seize the assets of the SPV. Typically it is structured in such a way that it is ineligible to be a debtor under the US bankruptcy rules - how to structure this kind of an entity is a seperate topic matter for discussion.

TATAS SING IN C(H)ORUS

Every Indian has been celeberating the aquisition of corus by Tatas and is probably justified in doing so.

But as finance professionals one needs to look in the financial viabiity or other wise of the whole thing.

The TATAs have aquired Corus at 9 times EBIDTA which is almost double than what Mittal paid for Arcelor.

Moreover, Standard & Poor’s, the international rating agency has put Tata Steel on the watch list with negative implication. However, the agency has maintained its ‘BBB’ long term corporate rating after the Corus acquisition.

Further if one considers the fact that the steel cycle is almost nearing its peak any fall in the demand for steel is likely to impact the top line.

The borrowings required for funding this aquisition will be huge and irrespective of the debt equity mix adopted for funding this - there is likely to be considerable strain on the TISCO bottomline.

It would be interesting to observe the funding pattern to be adopted by the TATAs as this is the largest aquisition by an Indian corporate. The mode of funding adopted might be a guide post for other corporates planning on aquisition in the future.