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• The FY17 Union budget reflects a tough juggling act: managing the need to stay prudent fiscally while accommodating funds for an expanding wage bill, banking sector recapitalization, rural sector, and growth critical infrastructure spending. We think today's budget, touching on some revenue measures (we particularly like the increase in excise duty on tobacco products and additional tax on luxury cars), administrative efficiency (new dispute resolution mechanism for settling tax obligations, phasing out of some corporate tax exemptions), and better targeting of spending (to the rural poor affected by drought) did a satisfactory job given the challenging macro structural environment. We particularly find the budget's aim to boost spending on health and education encouraging.

• The government targets 3.5% of GDP deficit under its definition, in line with its medium term adjustment path articulated last year. By our estimate the target is an improvement in fiscal effort by 0.2% of GDP (defined as change in primary balance ex-disinvestment proceeds and banking sector recap cost).Considering that growth momentum, as measured by high frequency indicators of production, sales, trade, capacity utilization, and credit growth, has been slowing since last October and global macro risks are rising, attaining this goal will be quite challenging.

• First, the budget's goal to boost non-tax revenue by 0.4% of GDP could prove to be optimistic as the market environment may not be supportive of spectrum auctions or disinvestment activities. Second, expecting nominal GDP to grow by 1 1% could be a stretch, given the prevailing global disinflationary headwinds. Third, full implementation of the seventh wage commission recommendations could lead to higher pick up in current spending than currently envisaged. We think that with these factors, the government may end up with an unchanged fiscal stance by the end of the fiscal year, i.e. our measure of fiscal effort will be 0.2% of GDP lower than budgeted. But even ifthe government struggles to achieve its goals at the central level, maintaining the deficit reduction target will act as a disciplining influence on the consolidated fiscal balance-sheet, in our view.

• The budget assumes that gross tax revenue would be maintained at 10.8% ofGDP in FY17 (11.7%yoy), same as the FY16 likely outturn, led by improvement in direct and buoyant indirect taxes collection. Centre’s net tax revenue is also expected to be maintained at 7.0% of GDP, after transferring 3.8% of GDPworth revenue to the states, broadly same as this year.Within taxes, direct tax projection is a tad optimistic on the personal income taxes front, which is estimated to mobilize 2.3% of GDP worth revenues inFY17. We think there could be a shortfall of 0.1% of GDP, just like in FY16.Corporate tax mobilization target of 3.3% seems realistic and is in line with past years’ trend. Interestingly, the government did not cut the corporate tax rate below 30%, as was envisaged in last year’s budget, except for some small companies, for which the tax rate was cut marginally to 29% (plus additional cess).

• Overall, the growth in direct taxes of 12.8%yoy is slightly higher than the 11% nominal GDP growth estimated for FY17; we estimate direct taxes growth to be about 11.3%yoy, with some down side risk likely to the 11% nominalGDP growth projection.We are surprised by the fact that the government did not increase the services tax rate to 16%, in an effort toward aligning the rate to a unified GST rate which is likely to be fixed at 18%. This along with the fact that the budget did not give any material details about the GST roadmap indicates that the implementation of the GST from April 2017 could be at risk.

• The main support to indirect taxes is likely to continue from union excise duties, which is expected to contribute 2.1% of GDP revenues. The government has raised excise duties on energy products multiple times in the last 18 months and this has been a big support to revenues so far. Overall, indirect tax collection growth of 10.7%yoy looks realistic, in our view.

INR: A REPRIEVE FROM THE BUDGET

• The Indian government has retained the budget deficit target for FY16/17 at 3.5% of GDP, against market fears of fiscal slippage. Our economists now see an improved chance of a 25bps cut by the RBI at the next meeting in April.

• Market reaction has been mixed – more positive for the bond market than the stock market. At any rate, this will provide a reprieve to the INR.

• That said, the long-term up-channel in USD/INRwill likely remain intact, with support coming in at around 67.0-67.5.

• The Indian government delivered a better-than expected Budget FY16/17. It kept its deficit target at3.5% of GDP as promised earlier, down from an estimated deficit of 3.9% of GDP for FY15/16. With fiscal consolidation on track, this will provide room for monetary easing as alluded to by the RBI in itsFebruary meeting. Author see an improved chance of a 25bps cut by the RBI in the next
meeting on 5 April (and possibility of a June cut if Feb inflation does not provide comfort to the RBI).

• The rupee has fared poorly to-date this year, down3.3% against the USD and the second worst performer in Asia after the KRW. One key reason behind its underperformance was sustained portfolio outflows, which have amounted to USD5.6bn since lastNovember, to nearly unwind all the inflows seen in early 2015.

• Impetus to portfolio inflows, has been on hold since last September. The Budget has now opened the door for one last rate cut in this easing cycle.Already, the bond market has responded positively to the Budget. With positioning much lighter now, we expect some sustained inflows of foreign funds into the bond market. Sentiment is however not as upbeat in the stock market, partly due to the lack of major reforms in the budget and a projected slowdown in government investment which will add to the capex down-cycle in the private sector .In other words, not all is good yet. We expect a reprieve for the INR but the up-channel in USD/INRwill likely remain intact. Support for the spot may come in at 67.0-67.5 (which is 50-day moving average) vs 68.4 currently.

Advice for both Exporters and Importers: Well as we understand that there are lots many challenges before the Government to implement current Budget and at the same time Global Economy is facing all time big recessions along with war like situations between various countries which would surely impact the markets. Exporters and Importers are advised to hedge their Foreign Currency Receivables and Payables using mix of Forwards, Options and Options Payoffs also known as Cost Reduction Structures.


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