All the actions by the government in the past month suggest that the government is trying to please all segments of the economy to boost GDP.
As expected the GST council made sweeping changes to the tax structure and compliance rules to give relief to small businesses and consumers a month ahead of the Gujarat elections.
As per the council, this decision will result in a revenue loss of Rs 200 billion (US$3bn or 0.1 per cent of GDP) to the exchequer. This combined with loss on the non-tax revenue front will make it very hard for the government to achieve the fiscal deficit target of 3.2 per cent of GDP for FY18 unless it decides to radically curtail expenditure.
From the perspective of FY19, we believe that the fiscal prudence will be sidestepped as the government would want to please all sections of the society. This combined with the bank recapitalisation plan should boost FY19 GDP to 7 per cent YoY (as against our estimate of 5.8 per cent YoY in FY18).
The event
In our note dated November 6, 2017 we said that,
“Our discussions last week with policy experts in Delhi yielded the following takeaways: (1) Expect several items to be removed from the current 28 per cent bracket at the upcoming GST council meet; (2) Discussions are underway to see whether the RBI’s reserves can be used to recapitalise banks; (3) A clear focus on ‘housing’ and boosting ‘agricultural production’ is likely to define the next Union budget; and (4) The government is aiming to show a fiscal deficit of 3.2 per cent of GDP in FY18 but in FY19 we should expect a deviation from the path of fiscal consolidation as the NDA, like its predecessors, boosts expenditure in the run-up to the general election of 2019.”
In line with our expectations, the GST council on November 10 decided to lower tax on over 200 items (most of which previously attracted a 28 per cent tax rate), reduce the levy on restaurants to 5 per cent (without input tax credit) and increase the turnover limit for the composition scheme for SMEs to Rs 20 million (wherein a unified tax rate of 1 per cent will be levied for businesses with turnover of Rs 20 million or less and such businesses can file monthly returns instead of quarterly).
Government gives relief to consumers and businesses ahead of elections
As highlighted in our notes dated October 26, November 06 and November 09, the GST council reduced tax rates on over 200 items (tax rate on 178 items were reduced from the peak 28 per cent slab to 18 per cent). The table blow highlights the major changes announced by the council on November 10 (see exhibit below).
Exhibit 1: The Government gave relief to both consumers and businesses
| Tax rate reduction | The GST Council pruned the list of items in the top 28 per cent GST slab to just 50 from current 228. The council also decided to bring down tax rate 13 items form 18 per cent to 12 per cent. Tax rate on six items has been lowered to 0 per cent from current 5 per cent. |
| Restaurants | All restaurants will be levied the GST at 5 per cent , without input tax credit (ITC) benefits |
| Composition scheme | Increased the composition scheme to Rs 20 million (from current Rs 15 million); a unified tax rate of 1 per cent will be levied for businesses with turnover of Rs 20 million or less and such businesses can file monthly returns instead of quarterly. |
Source: Media reports, Ambit Capital research.
What should we expect hereon?
Our discussions with policy experts suggest that the party is acutely aware that a rising proportion of the electorate is unhappy owing to: (1) the way and manner in which GST was implemented; and (2) the demonetisation decision that was undertaken a year ago.
In our note dated November 09 we had highlighted that our survey suggests that small and medium businesses (SMEs) are reeling under distress due to disruptions such as demonetisation and GST.
In fact, a pre-poll survey conducted by Lokniti-CSDS in Gujarat suggested that even as the BJP is set to retain control of the state,
- 40 per cent of voters were of the view that GST was a bad move (see exhibit above),
- The Congress now leads BJP amongst the farmers of Gujarat; and
- 49 per cent of voters were of the view that Prime Minister Modi has failed to bring about the ‘achhe din’ (i.e. ‘good times’) that he had promised (see our note dated
Nov 10, 2017 for details).
Consequently, we expect this government to resort to a range of policy measures to please the business community (particularly small-scale businesses), consumers and farmers over the next 18 months that form the run-up to the 2019 general elections.
Government will have to cut expenditure to meet fiscal target in FY18
The council has highlighted that the reduction in tax rates will cost the exchequer around Rs 200 billion (US$3 billion or 0.1 per cent of GDP). This combined with loss on the non-tax revenue front (Rs 300 billion or US$5 billion shortfall on RBI dividends and a possible shortfall of Rs 200 billion or US$2 billion on disinvestments) will make it very hard for the government to achieve the fiscal deficit target of 3.2 per cent of GDP for FY18 unless they decide to curtail expenditure (which is already visible).
Fiscal prudence to be put on the back-burner in FY19
As per the medium-term fiscal policy statement tabled in Parliament on 1 February 2017, the government said that it will aim to hit a fiscal deficit of 3 per cent of GDP in FY19 (down from 3.2 per cent of GDP in FY18).
A government which is extremely focused on winning elections (and also coping with having taken some difficult policy decisions) is hence unlikely to resurrect the FRBM Act; this will free the government from the obligation to consolidate fiscal deficit in FY19.
Our checks suggest the government may well end up with a fiscal deficit of 3.5 per cent of GDP in FY19 as against the 3 per cent outlined in the FRBM.
Government fiscal boost and bank recap to push GDP growth to 7 per cent in FY19E
All the actions by the government in the past month suggest that the government is trying to please all segments of the economy, sidestepping fiscal prudence and working to boost GDP growth in the short term.
As highlighted in our note dated October 26, the bank recap plan along with the fiscal boost should help achieve 7 per cent YoY growth in FY19 (as against our estimate of 5.8 per cent YoY GDP growth for FY18).
Saurabh Mukherjea is the CEO of Ambit Capital Pvt. Ltd. This analysis was originally circulated as a note on the economy by Ambit.