Tax cuts will not lower inflation significantly
It was perhaps only a matter of time before the Union government acted to address public pressure on inflation, particularly emanating from rising fuel prices. The inflation based on the consumer price index surged to 7.8 per cent in April, while the wholesale price index rate spiked to 15.1 per cent. Thus, to ease some pressure, the government on Saturday lowered excise duty on petrol and diesel by Rs 8 and Rs 6, respectively. It also announced a subsidy of Rs 200 per gas cylinder for the beneficiaries of the Pradhan Mantri Ujjwala Yojana. Besides petroleum products, in order to contain prices, it reduced import duty and increased export duty on certain kinds of steel products and raw materials used in the sector.
The government’s decision to reduce duty on fuel will help ease some political pressure, but is unlikely to have a significant impact on the overall inflation outcomes because the pressure is fairly broad-based. According to estimates, cuts in fuel taxes will reduce the retail inflation rate by 20 basis points from June. This is unlikely to change overall inflation outcomes significantly and will not ease the pressure on the Reserve Bank of India (RBI). A research note by Nomura, for instance, said that it was leaving the consumer price inflation projection for the current fiscal year unchanged at 7.2 per cent because of a number of other upside risks. This underscores the level of inflationary pressure in the economy. The Monetary Policy Committee in an off-cycle meeting increased the policy repo rate by 40 basis points earlier this month. It is now widely expected to increase the rate by another 50 basis points in the June meeting. Financial markets are now awaiting the RBI’s revised inflation projections to get a better sense of future monetary action.
Even though tax cuts may not have a significant impact on inflation, they will have a bearing on fiscal calculations. The revenue forgone on account of fuel tax reduction will be Rs 1 trillion per year. The actual impact would be a little lower, accounting for the fact that roughly seven weeks in the fiscal year have already passed. Additionally, the gas subsidy will have an impact of Rs 6,100 crore. However, the bigger impact on the Budget will come from the additional fertiliser subsidy. The government is allocating additional Rs 1.1 trillion, taking the subsidy to Rs 2.15 trillion.
The additional subsidy burden, along with the revenue foregone on account of tax cuts and lower than expected dividends from the RBI, will inevitably put pressure on the Budget. Political pressure on the government to provide relief is likely to continue as global commodity prices are unlikely to come down sharply in the near term. It is worth noting here that the increase in global crude oil prices has not yet been fully passed on and oil-marketing companies are absorbing part of the increase, which will also have Budget implications. However, on the other side, tax collection is likely to be strong and a higher rate of expansion in nominal gross domestic product (GDP) will also help. While some analysts are projecting slippage from the targeted fiscal deficit of 6.4 per cent of GDP, more clarity will emerge in the coming months. Given the level of uncertainty, it will be important for the government to not cut the allocation for capital expenditure.