India Budget FY17 - Expectedly Steady and Staid
Published on 02 Mar, 2016
Budget 2016-17Taking the rural road to growth, while staying within the lane of fiscal limit.
India’s finance minister, Mr. Arun Jaitley, chose fiscal prudence and rural revival as key themes for Budget 2016-17.
He managed to achieve the fiscal deficit target of 3.9% of the GDP for 2015-16 and maintained the previous target of 3.5% of the GDP for 2016-17 in an increasingly slowing global growth environment. Instead of accelerating growth by incentivizing corporate India, he chose to focus on areas such as rural economy, social sector, and continued infrastructure spending.
To account for the large increase in salary and pension expenses on account of the Seventh Pay Commission, the finance minister chose to curtail plan expenditure on capital account, thereby risking slow gross capital formation for FY17.
Furthermore, increase in several indirect taxes, introduction of new cess, withdrawal of exemptions for income tax, and aggressive assumptions for increase in direct tax collections for FY17 reveal the stress of wanting to meet an ambitious fiscal deficit target for FY17, which may appease global investment community and credit rating agencies, but not find any favors with the Indian corporate sector. All eyes may now turn to the Reserve Bank of India Governor Raghuram Rajan to see if monetary action turns accommodative to reciprocate the discipline shown in fiscal policy.
Several of Our Expectations Came True in Budget 2016-17
In our pre-Budget report, we had outlined several key expectations which were announced in Budget 2016-17.
Fiscal deficit target for FY16 was met apart from increased outlay for infrastructure segments such as roads and railways. Support for export sector was announced. While service tax rate remained the same, several new cess were announced (infrastructure and rural cess) as forecasted apart from increase in few existing cess (Clean Energy cess). As expected headline tax rates were unchanged and several concessions in taxes were withdrawn.
While import duty on gold was kept unchanged, 1% excise duty on gold and diamond jewelrywas introduced to achieve the same effect of curtailing gold demand.
Rural, Social, InfrastructureThrust on key focus areas to boost economic growth
Budget 2016-17 was as much about reviving economic growth in weak areas as about maintaining fiscal deficit.
With successive years of poor monsoon affecting rural economy, the finance minister chose to announce several initiatives to renew focus on the agriculture and allied sectors. Without an outright announcement of a large stimulus package, the minister provided for several programs in the areas of crop insurance, rural credit, connectivity and irrigation that can bring about fundamental improvements in the conditions of agriculture, thereby reducing dependence on nature. In addition, direct support in the form of higher allocation to the ongoing rural employment guarantee scheme (MGNREGS) and inclusion of projects benefiting agriculture as part of MGNREGS, if implemented diligently and efficiently, should help improve the rural economy.
With regard to infrastructure, the budget attempts to provide for the large-scale need for quality infrastructure across the country. Extensive allocation for the overall sector, especially roads, is to be supplemented by fundraising from agencies such as National Highways Authority of India (NHAI).
With regard to the social sector, the budget focuses on the lower income strata with support in the form of Liquefied Petroleum Gas (LPG) connections to Below Poverty Line (BPL) families, lower income tax for low income groups, a new health protection insurance scheme, and additional interest deduction for small houses.
From the Micro Small and Medium Enterprises (MSME) viewpoint, increase in the turnover limit under the presumptive taxation scheme (section 44AD of the Income Tax Act) to INR 20million will positively affect a large number of MSMEs.
Key Focus Areas of Budget 2016-17
Pushing the Government’s Growth AgendaIncentives for Startups and Digital India
While focusing on the fundamental growth drivers of infrastructure and the rural and social sectors, the finance minister also attempted to create an enabling environment for the startup ecosystem taking roots in India. From tax holiday to incentivizing entrepreneurship skill training, the budget boasts supportfor startups in the form of:
- Tax holiday for startups for three of the first five years of setting up acompany.
- Lowercorporate IT rate for companies witha turnover of less than or equal to INR 5 crore, to 25% plus surcharge.
- Amendmentsto the Companies Act that ensure speedy registration for startups.
- 100% deduction in profits for startups for three of the first five years; MAT to apply.
- Tax exemption for capital gains on investments in regulated fund of funds for startups.
- Long-term capital gains for unlisted firms lowered from three to two years.
- Hub to support SC/ST entrepreneurs.
- INR 500 crore earmarked for SC/ST and women entrepreneurs under the Startup India scheme.
- Entrepreneurship to be taught through MOOCS. This will open up access to educational resources across the country.
Similarly, the budget attempts to support the initiative of Digital India by providing several avenues to expand the reach of IT infrastructure across India through initiatives such as:
- A bill on targeted delivery of financial services, using Aadhar, to be introduced.
- Digital repository for all school leaving certificates and diplomas.
- Unified e-platform for farmers to be inaugurated.
The Finance Minister Respects "red lines" of Fiscal Deficit Targets
While allocating resources for various initiatives, the finance minister has been mindful of the fiscal consolidation framework.
The expectation to meet the fiscal deficit target of 3.9% of the GDP for 2015–16 was fulfilled by the finance minister. Surprisingly, the finance minister retained the target of 3.5% of the GDP for 2016–17,despite large expenses on account of the Seventh Pay Commission recommendations on hike in salary and pension. While conforming to fiscal consolidation - despite slowing global growth and moderate domestic growth — is commendable, we took a close look at the fiscal math for any unrealistic assumptions for FY17 andfound a few.
Nevertheless, the numbers and commentary will satisfy global credit rating agenciesand relieve investors (especially in the fixed income market) who suspected breach in the fiscal deficit targets.
Indirect Taxes Aid Fiscal Deficit in 2015-16Direct Taxes to Assume Burden in 2016-17
As outlined in our previous article on budget expectations, indirect taxes such as service tax and excise helped offset the lower-than-estimated collection of direct taxes in FY16.
However, for FY17, the finance minister expects an 18% increase in income tax collection and 9% increase in corporate tax collection, without any outright increase in tax rates. On the other hand, service tax is expected to increase by a modest 10%. With regard to expenditure, while plan expenditure on revenue account expectedly increased on account of provision for the Seventh Pay Commission, the plan expenditure on capital account is accounted to increase by a marginal 3.3% compared with 39% in FY16.This raises doubts about the government’s intent on capital investments.
Budget FY16-17 - Key Segments
|All Amount (INR billion)||2014–15||2015–16 (BE)||2015–16 (BRE)||2016–17 (BE)||Growth (%)||Comments for 2016–17 BE|
|Tax Revenue (net)||9,036||9,198||9,475||10,541||11.2||Assumed 18% and 9% increase in tax collection under income tax and corporate tax, respectively|
|Non-tax Revenue||1,979||2,217||2,586||3,229||24.9||INR 989.95 billion from spectrum auction assumed|
|Non-debt Capital Receipts||515||803||442||671||51.8||Divestment target of INR 565 billion very high|
|Plan Expenditure||4,626||4,653||4,772||5,500||15.3||S29% increase in pensions|
|On Revenue Account||3,576||3,300||3,350||4,036||20.5||Large increase for FY17 due to Seventh Pay Commission payout|
|On Capital Account||1,050||1,353||1,422||1,464||2.9||Marginal 3.3% increase in Central Capital Plan Expenditure compared with 39% in FY16|
|Fiscal Deficit (%GDP)||4.1||3.9||3.9||3.5|
Revenue Growth Commendable in FY16Do FY17 estimates indicate lurking tax rise?
Overall gross revenue receipts for FY16 increased 17.2% YoY, better than the expectation of 16.4% in budget estimates (BE).
This was led by indirect tax collections, with excise duty collections increasing a staggering 50% on account of successive excise hikes on petroleum fuels during the year. Service tax collections increased 25%, in line with the estimate. Both corporate tax and income tax collections fell short of expectations, highlighting the struggling growth in domestic economy.
On the backdrop of muted growth in corporate and income tax collections, the high growth assumptions for both these taxes for FY17 is both surprising and concerning. Although several deductions under Income Tax have been phased out, the underlying economic growth may not be strong enough to offset the deductions and boost income tax collections. Considering the stable economic growth expectations (between 7 and 7.75% for FY17), the finance ministry could introduce an increase in tax rates during the year to meet its ambitious tax collection targets.
In FY16, after the slow tax collections in the first half of the fiscal year, the ministry introduced a new cess in November 2015 (Swachh Bharat Cess), in addition to successive excise duty hikes for petrol and diesel, which helped shore up indirect tax collections.
Incidentally, for FY17, the finance ministry expects muted growth in tax collections for customs, service, and excise taxes at 9.8%, 10%, and 12.2%, respectively, despite introducing various new cess such as KrishiKalyan Cess, Infrastructure Cess, and increase in Clean Energy Cess at the start of the year. The low growth in customs is understandable from the viewpoint of slow global trade. However, the 10% growth assumption in service tax for FY17 due to 25% growth in FY16 indicates a high base effect considered while estimating revenues from service tax.
In terms of non-tax revenues, budget 2016–17 assumes INR 989.95 billion from spectrum auction. Considering the government received revenues in excess of INR 1 trillion in the previous auction, the assumption for FY17 appears reasonable. On the other hand, the expected revenues from divestment of INR 565 billion appear to be a tall order, if we take into account the volatile equity market environment and past record of lower-than-estimated funds raised from divestment.
Proposed Changes in Taxes for 2016-17
|Tax||2015–16 (BE)||2015–16 (BRE)||2016–17 (BE)||Growth (%)||Changes for 2016–17 BE|
New Taxes and Cess Introduced
- KrishiKalyan Cess, @ 0.5% on all taxable services, w.e.f. June 01, 2016. Proceeds would be exclusively used to finance initiatives for improvement of agriculture and welfare of farmers. Input tax credit of this cess will be available.
- Infrastructure cess, of 1% on small petrol, LPG, CNG cars, 2.5% on diesel cars of certain capacity and 4% on other higher engine capacity vehicles and SUVs. No credit of this cess will be available nor credit of any other tax or duty be utilized for paying this cess.
- "Clean Energy Cess" levied on coal, lignite, and peat renamed to "Clean Environment Cess" and rate increased from INR 200 per ton to INR 400 per ton.
- Tax to be deducted at source at the rate of 1% on purchase of luxury cars exceeding value of INR 10 lakh and purchase of goods and services in cash exceeding INR 2 lakh.
- Securities Transaction Tax (STT) in case of “Options” proposed to be increased from 0.017% to 0.05%.
Expenditure to Increase in FY17Due in no small part to Seventh Pay Commission payouts, expenditure to increase by about 11%
Budget 2016–17 accounts for the recommendations of the Seventh Pay Commission, leading to a sharp increase in plan expenditure on revenue account.
The provisions for pensions alone are estimated to increase by 29% in FY17, leading to a 21% hike in plan expenditure on revenue account compared with a decline of 6.3% in FY16. To offset and control the increase in overall expenditure, the finance minister has curtailed growth in plan expenditure on capital account to a marginal 3% compared with 35% in FY16.
We expect to see the effects of slow capital expenditure in the gross capital formation component of the GDP in FY17.
Will a Fiscally Prudent Budget be Followed by Monetary Policy Action?Now that budget 2016–17 is considered to respect the boundaries of fiscal consolidation, the investor community will look forward to the monetary policy to support the fiscal policy in shoring up growth.
Although the stated stance of Reserve Bank of India Governor Raghuram Rajan is to target inflation, he expects to maintain fiscal discipline in the fight against inflation. Now that this expectation has been met for the time being and the focus on growth revival through targeted spending has been outlined by the budget, it is to be seen whether the RBI governor will support the growth agenda by lowering interest rates in the near term. A stable currency, relative calm on the global macroeconomic front, and the US Federal Reserve not being in a hurry to undertake another rate hike may create a window of opportunity for the RBI to cut rates at least once by 25 basis points. If the RBI governor would like to err on the side of caution, he may wait till the next set of monthly inflation figures are released to be sure about his action.