The core of the government’s fiscal policy in the Union Budget will depend on how it treats its fiscal deficit. For the coming year, the Union Budget may keep the fiscal deficit target in the range of 3-3.5%. One of the problems of the FRBM is that it tends to be cyclical rather than counter-cyclical. Ideally, Fiscal Deficit should come down in times of high growth and be allowed to go up in terms of low growth. However, the FRBM insists that the discipline of fiscal deficit control be maintained irrespective of the pump-priming that the economy will require. While we believe that the government in this budget will focus largely on pump-priming the economy to a higher growth trajectory, it will also take care to ensure that the fiscal deficit does not spiral out of control. Indian Rupee tends to be vulnerable to higher levels of Fiscal Deficit and CAD and the government will be keen not to repeat the experience of 2013. Broadly, we expect the following line of thinking in terms of government revenues in the Union Budget…
Approach to revenues: Direct Taxes:
The Union Budget is likely to have a two-pronged focus in this budget. Direct tax rates may be cut, slabs may be rationalized and exemptions and rebates may be increased. All these could have an overall impact of Rs.45,000 crore on the budget. However, the entire amount will not become a burden on the government budget. Part of this will be recovered by a broader tax base by using technology and demonetization to bring more individuals and businesses under the taxpaying net. Also one can expect another modified amnesty scheme after the phenomenal success of the IDS last year. These amnesty schemes and some form of progressive taxation on the HNIs and the super rich will largely finance the higher exemptions offered to the people under direct taxes.
Approach to revenues: Indirect Taxes:
This will be the last budget where specific excise duty rates will be relevant. This budget will pave the way for GST rates to be set for specific goods and services. We expect this budget to contain the first step towards aligning the rates of excise duties and service tax with the future GST rates so that the transition can be done seamlessly. The service tax rate at 15% is still way below the likely rate of tax of 18% GST. We may immediately see the rates of service tax go up in this budget impacting a host of services in the form of higher costs. Here again the government will look to combine technology and demonetization to get a better audit trail and higher indirect tax revenues through wider and better compliance.
Approach to revenues: Dividends and investment income..
We expect this head of revenues to play a key role in this Union Budget. We expect a budgetary announcement making existing profit making PSUs to pay out more to the government in the form of dividends. The government may also ask profitable PSUs with limited future investment requirements to compensate shareholders with stock buybacks as a more efficient way of rewarding shareholders. These are likely to be limited to PSUs that are predominantly government owned. Government may look to use these additional revenues to finance investment in PSUs as well as the recapitalization of banks.
Approach to capital receipts: Disinvestments…
This could be the big theme for the Union Budget. For the fiscal year 2015-16, the government badly lagged behind in terms of budgetary targets. Year 2016-17 is expected to be likely better. We expect the government to be more aggressive with respect to disinvestment in the coming budget. It may look to divest up to 49% in case of PSU banks and also gradually move PSUs towards private ownership and private management. The government is also expected to give a big push to strategic sale of loss making units with a clear cut package for parcelling the sum-of-parts and hiving them off as investment options. However, we believe that the government may choose to keep the divestment targets conservative compared to fiscal year 2015-16 where it failed to achieve even 50% of its targets.
Approach to capital flows: FDI and FII flow…
We expect the budget to announce aggressive FDI targets at a time when India is already the largest recipient of FDI; even greater than China. We expect a further liberalization of the FDI limits across more industries in this budget. We also expect special incentives for “Make in India” programs and give clarity that these businesses will remain outside the purview of the withdrawal of exemptions for Indian corporates. The government is also likely to count heavily on Foreign Portfolio flows during the year. The yield gap with the US and the stable rupee will ensure that a lot of the FPI debt outflows in the Oct-Dec quarter could be reversed. The government may also dilute the implementation of GAAR and DTAA to ensure that FPI flows continue. Despite the strong increase in domestic flows, FPI flows continue to remain critical as they impact domestic markets as well as the Indian currency.
This year’s budget may see a distinct shift in the revenue focus of the government. The focus will be on both revenue and capital receipts in the Union Budget. How the government balances its various constituencies in this budget will be interesting to see!
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