Rural demand is supposed to be the next saviour of the economy. Agriculture growth in 1998-99 has been revised sharply upwards to 6.8 per cent, and this is expected to spark a revival in rural demand. However, it needs to be remembered that agriculture grew by 9.40 per cent in 1996-97, with no appreciable effect on the rest of the economy.

Take a look at the proxies for rural demand. The upturn in consumer non-durables in November and December, when the sector grew at 8.3 per cent and 6.2 per cent according to the IIP data, has been reversed in January. The IIP for consumer non-durables fell by 1.0 per cent during the month, compared on a YoY basis, while for consumer durables, the percentage change in January 1999 over the previous year was a negative 1.3 per cent.

Tractor sales have been sluggish. Tractor production was up only 2.3 per cent in volume terms in January, compared to the corresponding month in 1998. For the three months November, December and January combined, tractorproduction was lower than for the corresponding period of 1997-98. The IIP data for bicycles showed a growth of a mere 1.3 per cent in January 1999 over the production in January 1998.

While there is no doubt that higher rural incomes will boost consumption, the data so far available do not confirm this trend.

Employee stock options

If the government is serious about promoting employee stock options so as to enable companies to retain crucial personnel, it needs to clarify the tax position on these instruments.

The Finance Bill, 1999, has partly clarified the tax treatment of Employee Stock Options (ESO-not to be confused with Employee Share Ownership Plans or ESOP) but still at least four issues remain unanswered. No attempt was made to undo the draconian decision of Authority for Advanced Ruling (AAR) in the case of Microsoft's 100 percent subsidiary (detailed in 102 Taxman). In this case, stock option offered by the US holding company to the employees of 100 percent subsidiary, an Indiancompany, was treated as a perquisite. Though there is no employer-employee relationship, the judgement specifically referred to the 100 percent ownership. Although the ruling of AAR cannot be used as a precedent, the basis of judgement can certainly be used in other cases. The question that arises is, will the ESO given by a foreign company to the employees of Indian subsidiary be treated as perquisite only if the subsidiary is 100 per cent owned, or will the treatment be the same even if the holding is 51 per cent (on account of it being the controlling interest)? In other words, will the offer by the parent deemed to have been made on behalf of the Indian subsidiary? The answer seems to be in the negative because except for 100 per cent ownership, two entities cannot be treated as one and the same. But then, the logic of the ruling is hard to understand, and the area continues to be very grey.

Another question is about the timing of the taxability of the ESO. Will it be taxable at the time of grant ofoption or at the time of vesting or when the option is exercised? This is important because the rate of exchange fluctuates. An employee may be able to vest the option only if he stays in the service for, say, three years. The depreciation of the Indian currency during the intervening period can make a large difference to the tax liability. Another issue is that, when the shares are sold, will it attract capital gains tax or will it be taxed under Income from other sources? If it is capital gains, will it be short-term or long-term because the shares are sold immediately? Again, what will be the period for classifying capital gains into short-term or long term? Shares held for a period exceeding one year qualify for long-term capital gains, while for other assets, the period is three years. In this case, since shares will be sold immediately on conversion, what will be the period of holding? Is it a share or is it an "other asset"?

J&K Bank

Jammu & Kashmir Bank's 69 per cent growth in net profitsduring 1998-99 is impressive, and is in large measure a result of lower provisions. This has been possible as a result of the central government reimbursing the bank loans written off as a result of a policy decision by the government. At the gross level, profits have increased by 10.3 per cent, from Rs 161.17 crore to Rs 177.70 crore.

Higher volumes have offset declining spreads for the bank. While interest expended as a percentage of average deposits and borrowings declined from 7.7 per cent to 7.3 per cent, interest earned as a percentage of advances plus investments went down from 14.1 per cent to 13.6 per cent. This is in tune with industry-wide trends. While the profitability of the bank's bread and butter business fell, the decline was accentuated by substantially lower fee-based income. Add to that 30 per cent higher operating expenses, and much of the shine has been taken off the 37 per cent advances growth.

Nevertheless, the bank management has said that this year, the state government willreimburse several guaranteed loans, and that will further reduce the need for provisions. J&K Bank seems to be a rare case where association with a state government is beneficial.

Markets and the budget

The markets had risen post-budget due to the expectation that money would flow into mutual funds as a result of the sops given in the budget. The promise of more money flowing into the markets was what drove the Sensex up. The UTI bailout had contributed to the improved sentiment. If the budget is passed soon, will the situation then revert to status quo ante in the markets?

That may not be likely, although the argument for putting money into mutual funds will hold. Domestic fund buying will then put a floor to the market. This is particularly likely as funds declare their dividends in June, and investors would like to avail of the benefits. On the other hand, the imminence of elections could result in the postponement of FII investment, and that would remove the reason for a rally.

(Withcontributions from Urmik Chhaya)