The Indian government has clarified that it will neither revise its fiscal deficit target immediately, nor is it planning any spending cuts at this stage.
After Finance Minister Nirmala Sitharaman slashed corporate tax rates by almost 10 percentage points on Friday to boost private investment, there was speculation that the government may have to carry out spending cuts, as it had claimed that lowering of taxes would lead to a revenue shortfall of 1.45 trillion rupees (US$20.37 billion).
Sitharaman clarified that the government would only review the fiscal deficit target closer to the 2020-21 budget. She also ruled out any cuts in spending.
Though the tax cuts were hailed by corporate India and equity markets on Friday staged their biggest rally in 10 years, bond yields spiked to a nearly three-month high on speculation the government may have to borrow more to meet its spending needs.
Commenting on the tax cuts, Reserve Bank of India governor Shaktikanta Das termed them as a bold and welcome measure. “It will augur extremely well and will be highly positive for the economy,” Das said at the time.
However, the governor did not speak about the fiscal impact of the massive tax giveaways. A day before Sitharaman made the announcement, he said, “Fiscal deficit is at 3.3%. There are lots of discussions about the borrowings by public-sector industrial units. Both put together there is already very little space for fiscal expansion.”
Well-known columnist T N Ninan commented in his weekly column in Business Standard that with this move the government had dumped fiscal restraint. He also pointed out that tax revenue was well short of targets and expected the deficit this year could “well be the highest in a decade.”
The move did not find much favor from rating agencies. S&P Global said India’s move to cut corporate tax rates was a “credit-negative development” despite potentially boosting the economy as it would widen the fiscal deficit.
Moody’s said this move would narrow the government’s fiscal room for maneuver. However, it described the rate reduction as credit-positive for companies because it would enable them to generate higher after-tax incomes.
After growth in gross domestic product for the April-June quarter slipped to a six-year low, the government was under pressure to stimulate private investment. The slowdown in investment and consumer demand had derailed manufacturing, which grew just 0.6%. The farm sector also posted a meager 2% rise, and this added to the demand slowdown.
In addition, the government also had to contend with rising unemployment, which according to official figures stood at a 45-year high of 6.1% for the 2018 fiscal year.
The government hopes its slashing of corporate tax rates will help India position itself as an attractive investment destination and gain from the ongoing US-China trade standoff.
It also hopes that reducing tax rates to 15% from 25% for new manufacturing companies that start production before March 2023 and are incorporated on or after October 1, 2019, will help its “Make in India” program boost the manufacturing sector.