India economic update
Milind S. KothariManaging Partner
M & A tracker
Rajesh ThakkarPartner /Transaction Tax
Tax & Regulatory Services
Pranay BhatiaPartner / Tax and Regulatory Services
In the backdrop of a thumping election victory in May 2019, the second term of the Prime Minister Mr. Narendra Modi began with much hope and enthusiasm.
The expectations from Ms. Nirmala Sitharaman, who assumed the mantle as Finance Minister and presented the first annual Budget earlier in July had heightened, since as a pre-cursor to the Budget, the Prime Minister set a medium-term target of making India a USD 05 tn economy in the next 5 years. Unfortunately, while the Budget set tone for a 10-point agenda for a socio-economic revival, the near-term expectation of economic revival seems more distanced than before.
Evidence, both statistical and anecdotal suggest that the economy is slowing down with the levers of growth unable to give the impetus that the economy needs. Net exports are slowing and both global & domestic conditions aren’t conducive for revival. With economic revival looking weak, the GDP growth is likely to be lower at 6.5% in FY 2020. A high double-digit target for revenue collection to fulfill a 7% GDP growth seems unlikely, given the single digit trot of 2018-19. A general pessimism seems to have settled and it is common expectation now that the much-delayed private sector capex growth could take anywhere between 12-18 months before the sector starts adding capacity. The slow down isn’t going away in a hurry, with both the engines, private household consumption led by an acceleration in savings, and government spending with the reality of large deficits, sputtering. Unfortunately, the Budget provided no stimulus and the total capex budgeted for 2019-20 is lower than it was last year.
The big themes that emerged from the Economic Survey preceding the Budget, explicitly battled for restructuring investment-led growth. Experiences across economies including India's, revealed that strong growth can only be sustained when underpinned by private investments. Bursts of consumption driven growth are unsustainable because they inevitably spawn imbalances. An investment led strategy therefore has to be the key for sustained 8% growth that would seem to be a minimum to service the size and state of the Indian economy.
The tax proposal of a super surcharge on the rich and FPI was a disappointment for those looking for tax cuts especially in corporate taxes, where India's effects in tax rates are nearly double those of competition, like China. The continuation of dividend distribution tax seems questionable given that it funnels less efficient allocation of capital, especially at a time when India is looking to attract FDI, whereas the tax environment looks self-defeating and becoming less attractive to FIIs. On non-tax revenues particularly on monetization of asset through privatization, it was stressed that given that a large part of the value will come from land holding of public sector enterprise, unless the land inventory process is completed, the sale of such assets may not happen.
Like a patient in intensive care, the diagnosis for revival of lagging exports also seem to be signaling red with the real effective exchange rate still almost 15% stronger than it was 5 years ago. Therefore, India should not resist Rupee depreciation, particularly if the Chinese Yuan is also depreciating because India's greatest competitive concerns are vis-à-vis China.
The way forward is fraught with challenges and the need for the government is to focus on smoothening the process for private investments into infrastructure and other areas where it is unable to make investments. Also, creating an enabling environment by setting in motion structural reforms, clarity & predictability in policy & processes, efficiency in allocation of risk & resources and ensuring an adequate return on capital, would seem to be of paramount importance. The ask from the private sector for stepping in seems to be on a framework that provides ease of business and predictability. Given that the government itself is not in a fiscal position to make investments that the economy requires, it may be time to redirect its energies on providing the environment to encourage private sector investments.
In the background of the current economy reality, the dream of a USD 05 tn Indian economy may seem highly ambitious, given that India’s nominal GDP must grow at least at 12.7% compounded annually with an underlined assumption of rupee-dollar rate remaining stable; both of which parameters seem difficult to achieve. Therefore the build-up of hope needs a lot more reinforcing through smart policy initiatives to fix the present and leave the ambition & worry of the medium term, for later.
M&A in India
Between May 2019 to July 2019, around 110 M&A deals were announced / completed aggregating to approx. USD 3,992.77 mn; dominated by domestic deals (70) followed by cross border deals (40)
In terms of sectors, the Industrial sector saw maximum deal value, with deals worth USD 1,011.53 mn followed by Information Technology sector with deals worth USD 718.80 mn and Consumer Staples sector with deals worth USD 631.75 mn
(Deals mentioned in the M&A Tracker do not include those with undisclosed deal values as well as those which have been announced but not closed)
Target Company: Mobiquity Inc.
Acquiring Company: Hexaware Technologies Limited
Deal Value (in mn USD): 182
- In June 2019, Hexaware Technologies Limited indirectly acquired Mobiquity Inc. for USD 182 mn (INR 12.61 bn).
- As a part of the transaction, two acquisitions have taken place:
- Hexaware Technologies Inc., a wholly owned subsidiary of Hexaware Technologies Limited has acquired 100% shares of Mobiquity Inc
- Hexaware Technologies Limited has acquired 100% shares of Mobiquity Softech Private Limited, wholly owned subsidiary of Mobiquity Inc
- The total consideration includes an upfront pay out up to USD 131 mn & deferred consideration up to USD 51 mn, part of which is contingent on earnouts.
- Mobiquity is at the point of transforming customer experiences which aligns very well with Hexaware's strategy. Mobiquity’s strategy, design and mobile capabilities will strengthen customer experiences proposition and help pursue large scale digital deals.
Target Company: Promius Pharma LLC
Acquiring Company: Upsher-Smith Laboratories LLC
Deal Value (in mn USD): 110.50
- Upsher-Smith Laboratories LLC had entered into a definitive asset purchase agreement with Dr Reddy's Laboratories Limited and acquired neurology branded products, namely, Zembrace, Symtouch and Tosymra for USD 110.5 mn (INR 7.66 bn) through Promius Pharma LLC.
- As a part of the transaction, Upsher-Smith acquired the US and select territory rights for Zembrace, Symtouch and Tosymra.
- As per the agreement, Dr Reddy's Laboratories Limited received USD 70 mn as upfront consideration, USD 40.5 mn in near term milestones and additional financial considerations including, existing contractual obligation and inventory.
- Subsequently, Dr Reddy's Laboratories Limited will receive sales-based royalties on a quarterly basis.
Target Company: Flipkart Pte Limited
Acquiring Company: Walmart Inc.
Deal Value (in mn USD): 76.40
- In June 2019, Walmart Inc. acquired an additional 0.33% stake in Flipkart Pte Limited for USD 76.4 mn (INR 5.30 bn) from Binny Bansal, Co-founder of Flipkart Pte Limited.
- As a part of the transaction, Binny sold 539,912 shares at a price of approx. USD 141.50 (INR 9825.51) per share which reduced his holding from 3.85% to 3.52% in the company.
Target Company: TVS Automobile Solutions Private Limited
Acquiring Company: Mitsubishi Corporation
Deal Value (in mn USD): 42.00
- In June 2019, Mitsubishi Corporation acquired an additional 22% stake in TVS Automobile Solutions Private Limited (TVS) for USD 42 mn (INR 2.91 bn).
- The transaction is a combination of primary investment and secondary purchase.
- As a part of the transaction, Kitara Capital Private Limited has partly exited TVS while other promoters of TVS have also sold sell some of their stakes to Mitsubishi Corporation.
- The acquisition would help TVS to source parts from Japanese auto parts suppliers directly for India’s automotive aftermarket, while Mitsubishi Corporation, along with TVS, would replicate the latter’s business model. Further, the investment would provide TVS with access to competitively priced automobile parts, and Mitsubishi Corporation would leverage its own overseas network to develop TVS’s business model overseas.
- Post the transaction, Mitsubishi Corporation increased its stake from 3% to 25% in TVS.
Budget 2019 – Striking the right chord to boost foreign investment
With an intent to reach a USD 05 tn economy in the next few years, the FM proposed structural reforms by investing heavily in infrastructure, digital economy and job creation. This budget also flagged off ten points of the government's vision that revolve around sectors of agriculture, education, employment generation, healthcare, start-ups etc. To achieve its objective, the government has proposed several key amendments, to attract both domestic and offshore investments.
In its first term, the government announced reduction in corporate tax rates to 25%. Continuing high rate of tax, remains a concern for foreign investors and the opportunity to rationalize the corporate rate to 25% has not been fully exhausted. Indian companies with turnover in excess of USD 57.9 mn continue to pay the headline tax rate of 30%.
Though there are no changes to the tax rates for other taxpayers, "Super-rich" tax has been extended, by adding surcharge at higher income levels, taking the highest tax rate to a staggering 42.7% for individual and non-corporate assesses. This has also raised concerns for offshore taxpayers organized as non-corporate entities, such as Trusts, who are required to pay substantially high surcharge.
With a view to boost start-ups and encourage investors to invest in start-ups, focused amendments have been proposed. Some, like relaxation in conditions for set off and carry forward of loss, exemption on capital gain if invested in start-up could be hugely beneficial. Amendments are also proposed to permit investors to invest merely based on certain declarations and disclosures at commercially agreed values. The terrors of 'angel tax' have been substantially diluted by proposing important amendments. Special administration arrangements are also proposed for resolving pending tax assessments and redressal of grievances. The government has not only stopped proposing tax changes but has also announced starting of broadcast programmes to assist budding entrepreneurs. These features promote start-ups and discuss issues relevant to their growth. It is also proposed that venture capitalists would provide comments and guidance through such features
Certain regulatory announcements have also been proposed with a view to further open up investments in specific sectors. FDI has been opened up in – Aviation, media, insurance sector and further permission to invest 100% in insurance intermediaries. Rules in relation to local sourcing for single brand retail have also been proposed to be relaxed. 24% ceiling of FPI shall be done away with and FPI investment will be increased to sectoral limits. NRI portfolio investment route is proposed to be merged with FPI route.
A deeming fiction has been introduced to tax a non-resident in relation to any monies received outside India, from an Indian tax resident. This seems to be an attempt to extend the territorial jurisdiction of the Indian tax law.
In addition to the above, certain additional tax benefits for International Financial Centre have been proposed.
The amendments proposed in Union Budget 2019 are welcome as, inter-alia, it has doled out incentives to non-residents and opened new sectors for investments.
With the drafting of a new tax code in the offing, this budget seems to have undertaken limited proposals before the Parliament. In that sense, it seems to be a missed opportunity. Considering the hard stand on some of the budget proposals, it is possible that the new tax law will also have targeted legislation with an intent to collect larger taxes. It would also have to be seen how various compliances required under the present law are streamlined and simplified in the new code.
Faultless execution of Budget 2019 could be India's path to a USD 05 tn economy
This Budget has taken the path of strategic divestment of Public Sector Undertakings (PSUs), that ideally should look like those of Hindustan Zinc & Maruti Suzuki and certainly not like Air India, last year. Today, PSUs take anywhere between USD 14.4 bn to USD 28.9 bn directly or indirectly from the budget; however if strategic divestments are executed correctly, these institutions would be able to contribute similar amounts to the budget.
Opening up of Gilt market for FPIs including sovereign bond issuance will augment domestic savings for faster growth, resulting in more resources for private sector and thus lower interest rates. It is also imperative to bring in Bond Index to attract long term flows.
This budget focussed on getting higher FDI and FPI flows, recognising the limitations of domestic savings, which has fallen by more than 8% of GDP, over the last decade. Augmenting local savings with global savings is necessary to achieve the USD 05 tn economy vision. Increased interactions during international investor summits could act as a catalyst for exploring more FPI and FDI flows. Simpler Know Your Customer (KYC) norms for FPIs are a welcome step to increase ease of doing investment. We should also plan to hold an annual investor summit for domestic investors to understand their viewpoint; and simplify KYC for domestic investors so that buying Mutual Funds becomes as simple as buying gold
Increasing minimum public holding in listed companies to 35% and increasing FII limit in government companies which are part of equity Index to sectorial limit, is a step to increase our weight in MSCI EM index and will create fresh demand from FPIs. Increased supply of about USD 5.4K has unnerved the market. It now important to focus on creating demand by increasing allocation from Provident Funds and tax incentives for mutual funds to mobilize retail savings. The market looks forward to an announcement from SEBI for a longer timeline of approximately 05 years to absorb this supply.
Monetisation of surplus land by government and PSUs for affordable housing, is a step in the right direction. We should demonstrate the same by quick execution in few places where real estate demand exceeds supply.
Setting up of payment platform for government entities for MSME should be extended to all suppliers, as delayed and disputed payment from the government is one big reason for the slowdown in India Inc.
Incentives for Electronic Vehicles(EV) as well as affordable housing will boost growth in these sectors. The tax benefits given to EVs should also be extended to hybrid models. A boost is needed to support demand for over all auto and real estate market.
Controlling fiscal deficit at 3.3% is remarkable intent. However in order to achieve the required revenue collection, economic growth will have to pick up substantially from current levels. Appropriate liquidity, reduced cost of capital, smoother transmission of credit along with increased ease of doing business will be needed to achieve revenue target.
With the fiscal situation under control, care should be taken to limit off- budget borrowing so that private sector investment is not crowded out.
Providing first loss guarantee on securitisation of good NBFCs is an innovative move. Such benefit should be available to all investor's and not just PSU banks so that larger participation is achieved.
While the objective for increasing import duty on gold to deter gold consumption is laudable care should be taken to ensure that gold smuggling doesn't revive.
The budget has levied tax on the super-rich to the level last seen in 1992. However, this burden is coming-on only to the salaried class. Considerations could be made to tax rich agriculturist and businessmen. Some soft incentives like invitations to government socials , priority at airports etc. should be available to people paying tax in the highest category, to encourage more participation.
This budget provides a blueprint for India to become a USD 05 tn economy and if executed efficiently, will go a long way in achieving this vision.