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Budget 2023: Why a decision on cutting taxes won't be easy for Nirmala Sitharaman

Nov 21, 2022

Synopsis
The most important question on everybody's mind is whether the government will roll out any income tax cuts or not in the upcoming Budget. It won't be an easy decision to make. Industry body CII has batted for income tax cuts to boost disposable incomes at a time when recession in advanced economies will chip away some of the domestic growth momentum particularly due to slowing exports.

In a few months from now, the Modi government will announce its last full Budget before the 2024 general elections. All eyes will be on finance minister Nirmala Sitharaman as she unveils the fiscal plan for a year that is going to be tumultuous for the global economy.

The most important question on everybody's mind is whether the government will roll out any income tax cuts or not. It won't be an easy decision to make. Industry body CII has batted for income tax cuts to boost disposable incomes at a time when recession in advanced economies will chip away some of the domestic growth momentum particularly due to slowing exports.

In a note recently, HSBC economists said that they expect the balance of concerns to tip towards growth as it softens over the next few quarters. They have projected a 50 basis points hike in repo rate in December followed by a prolonged pause.

Goldman Sachs forecasts India's economic growth at 5.9 per cent in the next calendar year owing to consumer demand taking a hit due to higher borrowing costs. The momentum will return in the second half with global growth recovering.

While slashing income tax will put more money in the hands of people to spend and aid economic growth, the flip side that will be playing on the FM's mind is the stubborn inflation that is finally showing signs of easing. Increased spending risks fuelling inflation.

The RBI has raised interest rates by 190 basis points since May and is expected to go for another hike in its December policy. Retail inflation for the month of October eased below the 7 per cent mark. A recession in advanced economies will cool the commodity prices which is one of the main drivers of inflation. But heightened uncertainty still looms over the future of global economy as the Russia-Ukraine war is far from over and supply chains are in a flux. Any shift away from the path of inflation control will be a risky bet.

Also, India's relatively better performance compared to its peers in terms of growth and inflation will also have resonance in the decision making for any tax tweaks. Despite bleak estimates for the global economy, India is seen as a bright spot.

Recently, IMF chief Kristalina Georgieva hailed India as a bright spot in the global economy underlining how structural reforms have driven India's growth momentum.

Ritika Chhabra, Economist and Quant Analyst at Prabhudas Lilladher, feels that the second half of the current fiscal will be critical in terms of uncertain global environment and its spillover impact on India and if the govt goes for a tax cut, it would affect its ability to spend on capex.

"It is highly unlikely that any cut in personal income tax rates will be announced in the coming budget. While the direct and indirect tax revenues have been buoyant so far this year, the second half will be critical amidst uncertain global economic environment and its spillover effects on the Indian economy," Chhabra said.

What will bolster India's prospects is an improving rural scenario. Rural demand has taken a hit due to higher inflation. The consumer non-durable sector has been consistently in the red signalling rural distress. However, healthy Rabi crop sowing augurs well for rural demand as it is expected to boost incomes. Cereal inflation is likely to come down once the harvest reaches the market next year.

FMCG companies are also hopeful of a demand recovery in rural areas on the back of good harvest and inflation easing due to cooling of global commodity prices.

The upcoming Budget will also take into account the rural distress and announce measures to boost spending. Extension of welfare schemes cannot be ruled out.

"The central government’s priority remains fostering of the nascent investment cycle through continued increase in public capital outlay. Also, while there are various indicators that suggest that urban India is doing reasonably well, the same cannot be said about rural India. Therefore, there may be need for additional spending on rural economy including extension of welfare schemes. These call for maintaining revenue momentum," Sujan Hajra, Chief Economist and Executive Director, Anand Rathi Shares and Stock Brokers, said.

He feels that the upcoming Budget won't offer much relief to personal income taxpayers. "The buoyancy in such tax collection also gives the impression that the relatively better of portion of the population is doing well and direct tax sops may not be needs immediately," he added.

The FM will also keep in mind the importance of keeping the economy on the path of fiscal consolidation. India is expected to meet the budgeted fiscal deficit target of 6.4 per cent for FY23 on the back of robust tax revenues. A higher-than-budgeted nominal GDP growth will keep the fiscal gap at 6.4% of GDP, according to a BofA Securities report.

Any reduction on the income tax front will complicate the fiscal math at a time when India's strong economic fundamentals are likely to act as a magnate for global capital flows.

"Resisting a temptation to announce a populist measure like tax cuts would lend greater credibility to the government’s fiscal consolidation initiatives," Chhabra added.

While the government will want to spur demand by putting more money in the hands of the consumer, cutting taxes won't be an easy decision in the wake of global uncertainties.

[The Economic Times]