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India's generous giveaways threaten fiscal health before election

Government unlikely to meet deficit target of 3.3% as revenues slide

Indian Finance Minister Arun Jaitley. Analysts fear reduced GST rates will weigh on revenue, making it difficult for the government to meet its deficit target.   © Reuters

NEW DELHI -- With nationwide polls just months away, Prime Minister Narendra Modi's government is expected to dole out more goodies to woo voters away from an increasingly attractive opposition. But the plan could backfire if it widens the budget deficit, which the government wants to cap at 3.3% of gross domestic product.

In late December, New Dehli announced it would slash the sales tax on nearly two dozen goods and services, including movie tickets, televisions and air travel for religious pilgrimages, a move seen by analysts as appeasing voters, but one that is expected to lead to an annual revenue loss of 55 billion rupees ($785 million).

Days before the decision, Modi said luxury goods such as big cars and cigarettes would remain subject to the highest tax rate of 28%. "Now, we are heading toward a direction where 99% of items will be taxed at or below 18%," he said.

Dubbed as India's biggest tax reform since its independence from Britain in 1947, the Goods and Services Tax introduced in July 2017 replaced 17 indirect levies. Almost all goods and services are now subject to one of four rates: 5%, 12%, 18% and 28%. But reduced GST rates, analysts fear, will weigh on revenues, making it harder for the government to meet its deficit target of 3.3%.

According to a late November report by India Ratings and Research, the fiscal deficit is likely to be 3.5% of GDP for the third consecutive year, or about 6.67 trillion rupees. "The central government is once again staring at fiscal deficit overshooting the budgeted estimate for FY19."

In addition, research company Capital Economics said on Dec. 21 that it looks "virtually impossible" for the government to meet its central fiscal deficit target of 3.3%, and predicted tough times for markets in 2019.

"India's financial market performance this year has been the proverbial mixed bag, with bond yields roughly flat, equities rising, and the rupee slumping against the U.S. dollar," the company said. "In 2019, we expect falls in both equities and the currency, due to a combination of local political factors as well as our view that investors will retreat from risky assets more generally as the U.S. economy slows."

Indian National Congress President Rahul Gandhi, left, poses a threat to Prime Minister Narendra Modi's rule.    © Reuters

Against this background is the bitter defeat of Modi's Bharatiya Janata Party in the November and December elections, when the main opposition Indian National Congress was able to leverage the anger of farmers in the states of Rajasthan, Madhya Pradesh and Chhattisgarh to pull out big wins.

Now, pressure is building on the BJP to quickly address the plight of farmers, who are demanding loan waivers and better prices for their crops.

Soon after forming governments in the three states, the INC announced it would keep its campaign promise to waive farm debt. Not to be outdone, the BJP declared welfare schemes for farmers in some of the states it governed, including Assam and Gujarat, though it has yet to come up with a nationwide plan for farmers.

Addressing a rally in northern Himachal Pradesh state on Dec. 27, Modi called out the INC for misleading farmers. "Their fake promises and tokenism will not cut ice with the hardworking farmers of India," he said.

His remarks were strongly rebuked by the INC, with its senior leader and former finance minister P Chidambaram tweeting, "PM says that Congress governments' loan waivers are only to win elections. So, shall we assume that PM's 'Farmers' Relief Plan' is intended to lose elections?"

As the latest data on government expenditures and revenue paints a less than rosy picture, he asked, "Where is the money for the new plan?"

According to a Dec. 27 statement by the Finance Ministry, the fiscal deficit from April through November was almost 115% of the full-year target of 6.24 trillion rupees ($89 billion), mainly due to lower tax receipts.

Total expenditure up to November was 16.13 trillion rupees, or 66% of the budget estimate, while receipts stood at 8.96 trillion rupees, or 49.3% of the estimate, compared with 54.2% over the same period last year.

Nevertheless, the government remains confident of achieving its deficit target, pinning hopes on better tax compliance in the remaining months of the fiscal year. It also seems to be looking at other ways to cover the extra spending.

The government had reportedly been eyeing 3.6 trillion rupees in excess capital held by Reserve Bank of India, the country's central bank, to help fund its deficit and boost an ailing banking sector. This, along with other causes, turned into a protracted confrontation that eventually led to the resignation of RBI Gov. Urjit Patel on Dec. 10.

Finance Minister Arun Jaitley clarified the government's stance in a Dec. 18 interview with local media, stating that he did not want a "single rupee" from RBI's surplus to meet his deficit target, though he insisted experts should discuss how much reserves RBI should hold.

The government has been looking at other remedies as well. On Dec. 6, Modi's cabinet approved selling 53% of the government's 58% stake in state-run Rural Electrification Corp. to Power Finance Corp. -- another state-run company. The deal will bring in about 150 billion rupees.

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