Hike in FDI limit eludes banking sector

Fall in interest rates and tax on dividend form debt mutual fund will be beneficial

Budget provisions
Presently, banks are allowed to deduct upto 5% of their total income against provisions made by them for bad and doubtful debts. In order to strengthen the financial position of banks I propose to increase this allowance to 7.5% of the total income. Further, in budget for the year 1999-2000, an option to banks was granted o deduct upto 5% of their NPAs falling in the category of loss or doubtful assets as on the last day of the accounting year. Now it is propose to enhance this optional deduction to 10%, and also allow a similar option of deduction upto 10% of loss or doubtful assets to public financial institutions.

Administered interest rates will now be benchmarked to the average annual yields of government securities of equivalent maturities in the secondary market. Accordingly, most administered interest rates are being reduced by 50 basis points from March 1, 2002. Such adjustments will henceforth be made annually on a non-discretionary automatic basis. The benefit of reduction in interest rates on small savings deposits will be fully passed on to the States.

The implementation of this long sought reform in the treatment of small savings and administered interest rates is another step forward in the deregulation of interest rates in the economy that has been carried out in phases over the last 10 years. This should help in reducing the interest burden on the government and private sector alike in future.

A corresponding reduction of 50 basis points will be made in the interest rate applicable to Government of India Relief Bonds. Further, a ceiling of Rs 2 lakh per year is being put on investment in these bonds.

A new Bill on Banking Sector Reforms is proposed to be introduced in Parliament to strengthen creditor rights through foreclosure and enforcement of securities by banks and financial institutions. This Bill will also enable securitisation for money locked up in long term loans.

A pilot Asset Reconstruction Company (ARC) will be set up by June 30, 2002 with the participation of public and private sector banks, financial institutions and multilateral agencies. This company will initiate measures for taking over non performing assets in the banking sector and also develop a market for securitised loans.

The Deposit Insurance Credit and Guarantee Corporation (DICGC) will be converted into the Bank Deposits Insurance Corporation (BDIC) to make it an effective instrument for dealing with depositors' risks and for dealing with distressed banks. Appropriate legislative changes will be proposed for this purpose.

Reforms in the financial sector have posed new challenges for the development finance institutions (DFIs) like IDBI. It is proposed to make legislative changes to corporatise IDBI within the coming year to provide it appropriate flexibility.

In the banking sector foreign banks are permitted to operate in India as fully owned branches with specific permission of the Reserve Bank of India (RBI). As recommended by the Committee on Banking Sector Reforms, it has now been decided to give an option to foreign banks to either operate as branches of their parent banks or to set up subsidiaries. A foreign bank will have to choose only one of the two options. Such subsidiaries will have to adhere to all banking regulations, including priority sector lending norms, applicable to other domestic banks. Necessary amendments will be proposed in the Banking Regulation Act 1949 to relax the maximum ceiling of voting rights of 10% for such subsidiaries.

Housing Finance
Continuing the thrust given to the housing sector over the last four years, it has been proposed to allow the deduction for interest payable on housing loans for self-occupied houses even where such houses are acquired or constructed after 31st March 2003, as long as the acquisition or construction is completed within three years from the end of the financial year in which the loan was taken. For giving a further impetus to investment in the housing sector, it is proposed to extend the capital gains exemption provided in section 54EC of the Income-tax Act to bonds issued by the National Housing Bank.

The initiatives taken in the housing finance area in the last four years have shown positive results. Total disbursement from housing finance institutions in 2000-01 was Rs 26,300 crore, a growth of about 28% in the year. This amount financed the construction of about 28 lakh houses, much higher than the annual target of 20 lakh houses. In the current year the growth rate is expected to be around 35%. To further strengthen housing finance the following measures are being taken:

Consequent to the amendment to the National Housing Bank Act, NHB has commenced securitisation of housing loans and is operationalising foreclosure of mortgages.

The NHB will launch a Mortgage Credit Guarantee Scheme, which would be provided to all housing loans thereby fully protecting lenders against default. This will make housing credit more affordable thereby also increasing access to housing credit in rural areas.

The target under the Golden Jubilee Rural Housing Finance Scheme is proposed to be increased to 2.25 lakh for 2002-03, up from 1.7 lakh in the current year. About 1 lakh units have already been financed up to December 2001.

The allocation of the Indira Awas Yojana is being increased by 13 per cent to Rs 1725 crore for 2002-03.

Reactions
Most of the Analysts are unanimously disappointed over the budget. They say the market was eagerly awaiting a decision to hike foreign direct investment (FDI) limit in public sector banks, which didn't materialise. Meanwhile, the launching of the Asset Reconstruction Company has also been delayed. Finance minister Yashwant Sinha announced during the budget that the Asset Reconstruction Company is expected to concretise by 30 June 2002. It will take over the non-performing assets (NPAs) of the banking sector.

Analysts say the only positive from the current budget is the cut in small saving rates by 0.5%. Overall, analysts opine that there is nothing much about the budget that banks can rave over.

As regards to housing finance most of the analysts feel that the concessions given to this sector in previous budgets have already started paying rich dividends. Also the industry is growing at a CAGR of 30%. So by continuing with the said concessions will maintain the pace of growth in this sector. Further with the launch of a Mortgage Credit Guarantee Scheme by NHB, which will provide fully protection to the lenders against default will see more players coming into this sector.

Arun Kaul, Managing Director, PNB Gilts
"The Union Budget 2002-03 while proposing to strengthen the process of second generation economic reforms further aims to consolidate and implement these policies at all levels."

"In the Govt securities market, the proposal to announce an issuance calendar for dated securities is a move in the right direction as it would help the investor plan the investments in advance and thus would ensure stability in the markets. Proposal to introduce a new Govt securities bill replacing the old Public Debt Act of 1949 is another welcome step in this direction."

Sanjay Sachdev, CEO & Managing Director, IDBI-PRINCIPAL AMC
The Finance Minister has attempted the usual balancing act that confronts all Indian FM's. However this year the act needed was particularly crucial since recessionary times require bold measures necessary to stimulate growth. To that extent the Budget disappoints.

On a positive front, the announcement of a deadline to introduce a defined contribution pension plan by IRDA by June 30,2002 is big step. Today, retirement savings invariably go into government paper, and in the process substantially increases long term liabilities. The majority of workers, around 90% of the working population are today engaged in the unorganised sector. The unorganised sector (which accounts for more than 50% of the total labor force), includes professionals such as doctors, lawyers and small businesses all over the country, account for over 75% of the population, and have no access to any formal pension saving system of old age economic security. Thus, truly, the time was now ripe for the Government to urgently move ahead, and open up the Indian Pension Sector to private players.

Industry Impact
The rate cut of 50 basis points has been as against the expectation of 100 basis points. The Economic Survey 2001-2002 had stated that the cut in interest rates on small savings had become essential to align them with the overall interest rates in the economy. Rate cut in small savings is positive for the banks' as they normally maintain a high rate of interest on deposits in order to match the returns offered by the government to the small savers. Also, Banks are also facing stiff competition from mutual funds in re-pricing the deposit rates. A rate cut is small saving rate is positive for banks as now they will be bale to reduce their deposit rates which could lead to a marginal improvement in their interest spread. In the last budget finance minister Yashwant Sinha had cut the interest rates on administered savings by 150 basis points.

As regards to NPAs setting up of Asset Reconstruction Company is expected to be positive for most of the banks. It will take over the NPAs of the bank and clean their balance sheets.

The tax on distribution of dividend has been removed. This will have positive impact on profits of banks paying high dividend

Banking sector will also be benefited from removal of tax free status of dividend income of Debt Mutual Funds. Earlier while dividend income from debt mutual fund was tax free, interest from bank deposit was taxable at normal rates. Now both interest & dividend will be tax at same rates. So investor will not be shifting funds from Bank deposits to debt mutual funds just to save tax.

Housing Finance
Expectations of hike in interest and principal repayment deductible for tax purposes have been belied. To that extent budget disappointed market players.

With the launch of a Mortgage Credit Guarantee Scheme by NHB, which will provide fully protection to the lenders against default. This will make housing credit more affordable and increase access to housing credit in rural areas.

The tax on distribution of dividend has been removed. This is likely to add gains to the bottomline of HFCs paying high rate of dividend.

Companies to watch
State Bank of India, HDFC, ICICI