FM Nirmala's giveaways bound to jeopardise fiscal math

Finance Minister Nirmala Sitharaman, who had resolved to honour the fiscal glide path and stick to the fiscal deficit target of 3.3% until recently, is having a re-think. Her latest efforts to fire up the economy through Rs 1.45 lakh crore in corporate tax cuts and an estimated shortfall in the tax collections, is going to leave a gaping hole in the Centre’s revenues to the tune of Rs 2.35 lakh crore.

Various estimates suggest the net impact on the fiscal deficit could be anywhere between 70 to 90 basis points and the Centre’s borrowings could go up by Rs 1.5 lakh crore from the budgeted Rs 7.04 lakh crore in the current fiscal ending March 31.

But be warned, this math will hold good only as long as all government expenditures remain same till the time the finance minister goes to present her next Budget, revenue buoyancy improves, oil prices remain range-bound and monsoon does not play truant. Looks less likely.

The cut in corporate tax will amount to Rs 1.45 lakh crore lower collection from corporations in FY20. This comes on the back of a meagre 5.5% growth in the direct tax collections as against the budget target of 18% for the fiscal and only 6% uptick in GST collections.

After touching Rs 1.13 lakh crore in April, GST collections have fallen off to Rs 98,000 crore in August 2019. If this trend continues, collection shortfall could be close to Rs 40,000 crore for the fiscal.

Soon after the tax cut announcement, the 10-year bond yields had risen by 20 basis points to 6.802%.

It happened because investors sold government bonds leading to a drop in prices and a rise in yields. If the yield on a bond is much higher than what it was when issued, it indicates that the government which issued it is financially stressed. The same thing happened on Friday. Bonds were sold in response to expectations of higher borrowing by the government this fiscal. The bond market is a strong indicator of investor confidence in the government.

These are headwinds of Sitharaman launching her government’s biggest fiscal stimulus within hours of the incumbent and a former Reserve Bank of India governors asking her not to do so.

But first up, what can cushion the impact of a rise in expenditure is the RBI’s economic surplus of Rs 58,000 crore. Secondly, the revenue surplus from PM-Kissan Yojana to the tune of Rs 28,000 crore (this could occur due to slow data validation process of the scheme’s beneficiaries). Experts estimate savings of around Rs 40,000 crore may occur from expenditure rationalisation and subsidy postponement. The government has on an average rolled over 30% of its food subsidy bill to the Food Corporation of India over the last three fiscal years.

But even after balancing against the windfall, the fiscal deficit could be as large as 4% of the GDP.

According to Moody’s Investor Service, while the reduction brings India’s corporate tax rate closer to peers throughout Asia and will support the business environment, rural financial stress, weak corporate sentiment, and a slow flow of credit in the financial sector remain obstacles to near-term growth.

It did not expect the tax cut to revive growth such that stronger tax buoyancy compensates for the loss in revenues.

The lowest corporate tax rate

On the positive side, however, the reduction in corporate tax rate from 30% to 22% has placed India among the countries having the lowest level of corporate tax.

Among emerging economies, Brazil, South Africa and China now have a higher corporate tax rate than India. Low tax rates can be an incentive for foreign companies to set up base in India.

It can also help attract investment from companies in China, which are looking for new destinations for expansion or starting a new venture with an eye on the US market. The US has a similar rate of about 21%, while China has 25%.

India indeed looks more exciting but experts suggest that such measures should have come through the Budget and not as an afterthought. If the minister brought them through the Budget, she would also have had made provision for required revenues.

The tax collection, borrowings and disinvestment targets could have set accordingly. However, the modifications in the Budget come only after Prime Minister Narendra Modi gave a call
that wealth creators should be given due respect as they were doing a national service by producing riches, which can then be distributed further. “Those who create wealth are India’s wealth,” Modi had said from the ramparts of the Red Fort, and that changed the Union Budget’s tax proposal narrative.

It heralded a 180-degree shift in the finance minister’s stance. In a tough Budget that she chose to give, she had not only raised taxes on super-rich but brought into the higher net start ups, angel investors, FPIs, capital gains, and a share buyback of companies among others.

Within two-and-a-half months, each one of them has been done away with. The exercise has led to a number of changes in the Finance Act, the Income Tax Act and staring at the prospects of revising the Fiscal Responsibility and Budget Management (FRBM) Act.

This is probably the only Budget in the history of independent India, which has undergone such a massive change. It is almost being re-written every week.