Finance minister hopes tax buoyancy will do the trick

India’s fiscal deficit could go up 70 basis points to 4% of the gross domestic product (GDP) in the ongoing fiscal year after the government decided to cut the corporate tax rates, which may result in rising interest rates as it will need to borrow more to meet the shortfall.

Bond yields rose 0.15 percentage points following the decision, which the government said would cost Rs 1.45 lakh crore in foregone revenue.

The government has budgeted for a fiscal deficit of 3.3% of the GDP in the current financial year.

Finance minister Nirmala Sitharaman said the government was conscious of the impact the tax cut would have on fiscal deficit, but added there could be tax buoyancy.

“The idea is that economic buoyancy will itself generate enough reasons for better income, revenue generation. The moment the taxes are brought down you are also expected to widen the basket. So, that is another reason why we will be having a positive impact on the revenue collection,” she said in response to a question.

Independent economists expect fiscal slippage of 30-70 basis points for the financial year. One basis point is 0.01 percentage point.

“There is pressure from lower goods and services tax (GST), and now these announcements will further add to the slippage. We expect fiscal deficit at 4-4.1% of the GDP,” said Sakshi Gupta, senior economist, HDFC Bank.

India’s fiscal deficit touched Rs 5.47 lakh crore in the June quarter, which is 77.8% of the budget estimate for 2019-20, as revenues remained muted. Advance tax collection in the July-September quarter was up only 4%, while GST collections have been below target.

A higher transfer from the Reserve Bank of India’s surplus will provide some respite, but the government is still likely to face a big shortfall.

The RBI will transfer Rs 1.76 lakh crore to the government following a recommendation by the Bimal Jalan-led committee. Of this, Rs 28,000 crore was given as interim dividend last year.

The government had budgeted Rs 90,000 crore as dividend from RBI this fiscal year, which means it will get about Rs 58,000 crore over and above the budget estimate.

The government has also set an ambitious Rs 1 lakh crore selloff target.

It met the fiscal deficit target of 3.4% of GDP for the previous financial year, after sharply cutting spending towards the end of FY19 as revenue fell short of estimates.

“In the current scenario when tax buoyancy is already low, the revenue shortfall is expected to result in significant fiscal slippage. Netting out the positive inflow from the RBI dividend, we see a net tax shortfall of Rs 1 lakh crore, which amounts to approximately 0.5% of GDP,” said Upasna Bhardwaj, economist at Kotak Mahindra Bank.

If the government decides to cut spending to meet the target, capital spending would take a hit and economic growth would suffer.

Lower central tax collections will impact the fiscal situation of state governments as well through likely cuts in devolution of central taxes, and borrowing constraints may force state governments to curb or defer expenditure.

With roughly 42% of the central tax shortfall to be shared by states through lower devolution, expenditure cuts are likely to avoid substantial fiscal slippage.

“All these measures are supply side interventions and the economy is facing demand-related challenges. They might have a medium- to long-term impact, but it is too early to comment,” said Devendra Kumar Pant, chief economist at India Ratings.