For a software industry haunted by slowdown blues, and a hardware industry witnessing negative growth rates in some sectors, Budget 2002 meant great expectations. However, what finally came up has disappointed the Indian IT industry, even though it’s not all bad, say Ivor Soans and Srikanth R P

Zensar’s deputy chairman and managing director, Ganesh Natarajan perfectly summed up the mood of the software industry: “We expected nothing from the Budget, but what we got was somewhat negative.” Natarajan was reacting to changes in Section 10 A & B of the Income Tax Act which reduces the deduction in export profits from 100 percent to 90 percent. While the software industry isn’t exactly howling over the change, which will only have a marginal impact on their bottomlines, Union finance minister Yashwant Sinha’s move has yet jolted them because in April 2000 he himself had announced a 10-year tax holiday for software exporters.

On the flip side, the positives were the move to permit Indian firms to invest up to $100 million overseas, and also overseas investments in joint ventures abroad by market purchases without prior approval up to 50 percent of their net worth.

The hardware sector definitely seems to have got a better deal with Sinha pushing back the zero duty commitment deadline under the Information Technology Agreement with the WTO to 2005, from the earlier announced 2003. Also, import duties on capital goods are down from 25 percent to 15 percent, and on some components from 25 percent/35 percent to 5 percent. However, the hardware industry isn’t exactly dancing in the streets the zero-duty deadline pushback was expected, and the duty cuts are only a rectification of an inverted tariff structure.

Neither here nor there. Neither khushi nor gham. That pretty much says what the Indian IT industry thought of Sinha’s Budget 2002. While Indian IT CEOs didn’t curse Sinha, they didn’t sing hosannas to him either. Here’s why:

Hard on software

Pravin Gandhi, Infinity

From the perspective of VCs, the Budget was not an inspiration.

One of the reasons the Indian software industry grew spectacularly was because when it was tiny and insignificant, the government almost ignored it. By the time our lumbering administration woke up, India Software Inc had already reached an enviable size, and is likely to emerge as the largest exporter during 2002-03 with near-zero government support, and zero intervention. Whenever a software firm CEO in India says his prayers, he prays the government would continue with its zero-intervention policy. Until February 28.

While the removal of the 100 percent exemption on export profits may work out to a tax incidence of just around 3.675 percent of export profits for software companies availing exemption under Section 10 A & B, it’s the going back on the earlier promise of a 10-year tax holiday that rankles. While industry association Nasscom cautiously welcomed the Budget as one that “consolidates the ongoing reform process, focuses hard on key infrastructure issues and recognises the need to strengthen agriculture and rural development,” it termed the Section 10 A & B changes as a retrograde step. The only reason Nasscom isn’t crying murder is because it knows that even with this new step, the Indian software industry is still far more favoured by the government as compared to other sectors. Rather than attack the government directly, Nasscom has chosen to raise the bogey of India’s competitiveness in global markets. Nasscom also said that it understands from the Notes to the Finance Bill that the provision applies only for the assessment year 2003-04.

Kiran Karnik, Nasscom

Withdrawal of tax exemptions and non-clarifications on certain provisions will hit SMEs and start-ups in software and ITES.

Said Phiroze Vandrevala, Nasscom chairman, “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 are pulling out all stops in providing incentives to attract FDI in this sector.” Nasscom president Kiran Karnik felt that the withdrawal of tax exemption would reduce the investible surplus and thus affect the marketing efforts of small- and medium-sized software firms and IT-enabled services firms.

Nasscom is now hoping that the government will withdraw this move, but the message seems clear in tough times, even pampered, blue-eyed boys like the Indian software industry can’t take things for granted.

What’s worse is that the demand to make some procedures simpler, and clarifications on some earlier provisions contained in Section 10 A & B and Section 80 HHE haven’t come through. Software firms wanted an insertion in Section 10 A that profits derived from onsite development of computer software outside India should be deemed to be profits from exports of software. Sadly, Sinha ignored this demand and instead sprang a disappointing surprise.

In the long term, the change may have a greater undesirable impact. Explains Srinivasan, CEO & MD, ICICI Infotech: “In developed countries there is a general expectation of a stable tax regime to enable corporates to make long term plans. Frequent modifications of various elements of tax and duties do not help as they make it difficult for companies to plan ahead predictably.”

S Gopalakrishnan, Infosys

The restriction on tax deduction raises concern about the long-term tax policy of the government.

Nasscom was also expecting the removal of sub-section (9) under Section 10 A & B. As per this clause, if during the year, more than 51 percent of shareholding changes in a 100 percent export-oriented unit, STP or EPZ, then the company will cease to get income tax exemption from that year. This clause especially hits SMEs and start-ups in software and the ITES space where the shareholding pattern may change with the exit of VCs. This provision also acts as a deterrent to mergers and acquisitions, which many in India’s software industry see as vital for growth today. The VC industry is also furious over the government glossing over this issue in Budget 2002. Said Electra Asia Partners country head Prakash Karnik: “This sort of Budget affects sentiment and does nothing for attracting foreign direct investment, and investors of any kind are also not likely to be attracted.”

Raj Saraf, Zenith

Budget unlikely to boost the much needed growth rates in the IT sector.

The software industry has however welcomed the new provisions on overseas investments, which will make overseas acquisitions a little easier. Nasscom says that these new provisions are likely to enable software companies to strengthen their global competitiveness through acquisitions and alliances. Says Deepak Ghaisas, CEO, India operations, i-flex solutions, “This will now allow software companies in India to aggressively pursue a global vision, in turn encouraging software companies to extend their business and increase employment opportunities with foreign exposure.”

Soft on hardware?

Balu Doraisamy, Compaq

A set of policies for hardware and communication, similar to beneficial policies that allowed the software industry to grow exponentially, is still missing.

At first glance, it did seem as if the hardware sector had lots to cheer about in Budget 2002. But a closer look proves that other than the introduction of some changes which were long due, Sinha has done precious little to make India score over China or other South East Asian economies as an attractive location for manufacturing.

Why the hardware sector isn’t overly enthused about the reduction in duties on capital goods from 25 percent to 15 percent, and also on certain electronics components to 5 percent is because this was a legitimate grouse and justice has finally been done. Earlier, the import duty on capital goods and certain input items was higher than the peak import duty rate on finished goods at 15 percent!

Similarly, the zero-duty deadline pushback was also a legitimate demand, and not some manna from high, the industry feels. While they welcome the move as pro-domestic manufacturing, the flip side is that some MNCs like Cisco aren’t very happy about the extension and say that this will prove a deterrent to the affordability of imported hardware.

Ajai Chowdhry, HCL Insys

PC prices will remain unaffected by the Budget.

And in what is perhaps the best barometer of how the Budget affects everyone, prices are not expected to come down as most components of IT products (especially PCs and peripherals) are already in the duty range of 5 percent. With no reduction in excise duty as requested by the industry, prices will stay constant or even rise. Says Balu Doraisamy, managing director of Compaq India: “With none of the expected benefits of this Budget coming through, an increase in memory prices in the last three months and falling rupee prices vis-à-vis the dollar, we expect the prices of IT products to ncrease in the coming days.”

Vinnie Mehta, MAIT

The confidence of the domestic hardware manufacturing industry will increase.

Vinnie Mehta, director of MAIT had the last word: “The hardware manufacturing industry has been under considerable pressure for quite a while now. The confidence of the domestic hardware manufacturing industry will now increase, and we also need to urgently focus on reforms of procedures both on domestic levies as well as on customs. We have unduly high transaction/turnaround times, and procedural reforms are critical to improve the manufacturing climate.”