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Budget 2012: Focus on fiscal consolidation - Outside View by PersonalFN

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Budget 2012: Focus on fiscal consolidation
Feb 27, 2012

The year 2011 was rather turbulent for the Indian economy as it was steered by series of downbeat economic and geopolitical events, both in India as well as across the globe. As the Reserve Bank Of India (RBI) adopted an anti-inflationary monetary policy stance, to tame the inflation bug, it took a toll on the economic growth rate clocked by our country as it dwindled due to high interest rate regime and slowdown in consumption.

(Source: CSO, PersonalFN Research)

Thus as an impact of the economic slowdown, advance tax payment made by India Inc. for Q3FY12 too reported a growth of mere 10% as against 18% growth in the second quarter and 14% growth witnessed in the first quarter of 2011-12.

At present although the Government has fixed an optimistic target for the fiscal deficit at 4.6% of the GDP, its disinvestment plan has taken a beating due to unfavourable economic and political conditions which have occurred in the past. Thus against a disinvestment target pegged at Rs 40,000 crore for the fiscal year 2011-12, they have mopped only Rs 1,144.5 crore (as per the latest data published by Ministry of Disinvestment). Moreover, with the Government revising its borrowing target to Rs 4.7 trillion by March 2012 (from the budgeted Rs 4.17 trillion), it is rather worrisome as it implies that fiscal deficit target of 4.6% for fiscal year 2011-12 may not be met, and there could be a deviation of +1.0%. It is noteworthy that for the period April to December 2011, the fiscal deficit has already spiralled to 92% of the budgeted sum, against 64% for the same period a year before.

Hence, we think that with the Government battling to meet the fiscal target, the focus in Budget 2012 would be on fiscal consolidation. Thus we can expect that in 2012 the Government may emphasise on fiscal measures, before they turn a little populist in the year 2013 which will be last full budget before the elections schedule in May 2014.

It is noteworthy that unless focus is not shifted to fiscal consolidation there could be the following risk which we may face:

  • WPI Inflation: If the Government expenditure is focused on consumption spending, it can result in inflationary pressures creeping in.

  • High interest rate regime: Thus in order to tame inflationary pressures, the central bank too may step in and increase policy rates, which would translate in high borrowing cost and input cost as well, which may have a dampening effect on earnings and thus the taxes paid by companies. This again may depress revenues and compel the Government to borrow more. But excessive borrowing may again push interest rates upwards as investors may not be interested in oversupply of Government securities unless high interest rates are offered.
Thus, unless steps towards fiscal consolidation aren't taken we could be caught in a vicious circle of low economic growth, high inflation and a high interest rate regime.

We also are of the view that, apart from focusing on the goal of fiscal consolidation, the Government is also likely to give a push to key reforms (such as FDI in retail and aviation sector), which are indeed required to propel economic growth by attracting foreign investments. Like the last budget, enough emphasis on rural development is also likely to follow in Budget 2012 to provide fillip to rural infrastructure and demand.

Hence expecting that fiscal consolidation may be the focus of Union Budget 2012, but due to concerns on present economic dynamics we think that the following measures may be taken.


Although the Government has planned to replace more than five decade-old Income Tax Act, 1961 with the Direct Tax Code (DTC) in April 2012, it now appears that it may be introduced only from April 2013 instead, due to differences on some of the issues. The Parliamentary Standing Committee on Finance (headed by Mr Yashwant Sinha, a senior BJP leader and former Finance Minister) has postponed adoption of its final report on the Direct Tax code, and is expected to give its nod by March 02, 2012 only after three more meetings.

Thus the existing statute for Direct Tax i.e. the Income Tax Act, 1961 would continue to be in effect, where we can expect the following fiscal measures to be adopted.


  • Base exemption

    As far as the base exemption limit under the Income Tax Act, 1961 is concerned, we think the Government is likely to move a step closer to the DTC (Direct Tax Code), but not much populist measures can be expected. The base exemption limit may be extended to Rs 2.00 lakh (from the current Rs 1.80 lakh), but keeping the current tax slabs unchanged.

    Income-tax rates as per Finance Act, 2011 Expected Income-tax rates in Budget 2012
    Taxable Income Tax Rate Taxable Income Tax Rate
    Upto Rs 1,80,000 Nil Upto Rs 2,00,000 Nil
    Rs 1,80,001 to Rs 5,00,000 10% Rs 2,00,001 to Rs 5,00,000 10%
    Rs 5,00,001 to Rs 8,00,000 20% Rs 5,00,001 to Rs 8,00,000 20%
    Rs 8,00,001 & above 30% Rs 8,00,001 & above 30%

    So, let say if you are a male individual having a net taxable income of Rs 10,00,000; and if the base exemption limit is increased to Rs 2.00 lakh, then your income tax liability will be Rs 1,54,000 - thereby resulting in a tax saving of Rs 2,060.

    Taxable Income   10,00,000
    Upto Rs 1,80,000 Nil -
    Rs 1,80,001 to Rs 5,00,000 10% 32,000
    Rs 5,00,001 to Rs 8,00,000 20% 60,000
    Rs 8,00,001 & above 30% 60,000
    Tax payable   1,52,000
    Education Cess 3% 4,560
    Total Tax (Rs)   1,56,560
    Taxable Income   10,00,000
    Upto Rs 2,00,000 Nil -
    Rs 2,00,001 to Rs 5,00,000 10% 30,000
    Rs 5,00,001 to Rs 8,00,000 20% 60,000
    Rs 8,00,001 & above 30% 60,000
    Tax payable   1,50,000
    Education Cess 3% 4,500
    Total Tax (Rs)   1,54,500

    For senior citizens (qualifying from 60 years of age) and women, the basic exemption limit is also likely to increase by Rs 20,000 each to Rs 2.70 lakh and Rs 2.10 lakh respectively. But for very senior citizen category as introduced in the last Union Budget, the base exemption limit is likely to be retained at Rs 5,00,000.

  • Deduction from Income Tax

    Investment limit in section 80C and 80CCF:

    Focusing on fiscal consolidation in the year 2012, the Government is unlikely to expand the Section 80C limit from the present Rs 1.0 lakh, if the increase in base exemption limit is done as cited above. However, in order to provide the much needed fillip to infrastructure growth in the country, the Government is expected to raise the limit for investment in long-term infrastructure bonds from the present Rs 20,000 to Rs 50,000; which provides a tax benefit under section 80CCF of the Income Tax Act, 1961. In fact, the Finance Ministry's department of economic affairs as part of its suggestions for the Union Budget 2012 has already proposed for raising the limit in these bonds to Rs 50,000 (from Rs 20,000), however the revenue department is expected to take a final decision after weighing expected economic gains, against short-term economic losses.

    Interest on housing loan:

    In a measure to provide a relief to the housing sector, which has encountered the brunt of rising interest rate scenario through slumping sales, the Government is expected to increase the maximum limit for deducting interest paid on housing loans (available under section 24(b) of the Income Tax Act, 1961) from the present Rs 1.50 lakh (in case of Self Occupied Property) to Rs 1.80 lakh, thereby attempting to infuse renewed energy in the real estate and housing loan market.

    Barring the aforementioned deductions available under the Income Tax Act, 1961 we believe that in order tighten belt on fiscal consolidation, there are unlikely chances that the Government may get populist (for individual assessees) and extend the limit of other deductions available under the Income Tax Act, 1961.

    The 5-Yr tax saving bank FDs though, may see a revision in lock-in to 3 years (from the present 5 years).


    Speaking about corporates, the measures for fiscal consolidation may be taken in a very selective way, where changes on direct tax front may occur only selectively, thereby attempting to unhurt economic growth directly. Thus following can be expected:

  • Surcharge

    The Government is expected to keep the surcharge on domestic companies unchanged at its last reduced level of 5.0% (effected in the Finance Act, 2011), thereby refraining from taking any hawkish measures which would hurt the sentiments of the industries. The Government for this purpose may also take cue from the current IIP data of 1.8% in December 2011 (released in February 2012), and the economic growth while taking a decision.

  • Minimum Alternate Tax (MAT)

    Similarly, with the Minimum Alternative Tax (MAT) the rates are expected to be kept unchanged of 18.5% of the book profits. However, health care services are likely to be kept out of the ambit of MAT, as against the present inclusion.

  • Withholding tax rate

    Highlighting the need to attract foreign funds, the Government may also keep the withholding tax rate on infrastructure debt funds unchanged, which is indeed needed to revive long-term economic growth of our country and to put in place proper infrastructure as well.

    Hence, overall in our opinion there are unlikely to be any major populist measures in the direct tax segment in Budget 2012, as there are anyways likely chances of the DTC being implemented from next year (with effect from April 1, 2013), and this time the focus would be on fiscal consolidation.

  • Securities Transaction Tax (STT)

    While the stock exchanges press for removal or reduction of STT, in an attempt to add depth to the Indian equity markets, we think that it is likely that the Government would refrain from abolishing, or even reduce it, because at present the Government collects about Rs 7,500 crore per annum from STT, and abolishing or reducing it, would resulting in the exchequer losing on revenue; which we think the Government would not like to if they have a strict focus towards fiscal consolidation. It is noteworthy that STT (which was introduced in the year 2004), for all cash market transactions is levied at 0.125% (on both buying and selling of securities for delivery trades, while 0.025% on non-delivery i.e. intra-day trades), while for derivative trading it is levied at 0.017% (on selling of a derivative contracts; provided that in case of options being exercised by someone, he has to pay 0.125% of the settlement price).

  • Service Tax

    In case of service tax, it is expected that the service tax rate could be kept unchanged in order for it to be a closer fit to the Goods and Services Tax (GST). In the last budget Government had kept the rates unchanged in order to unhurt demand, in a scenario where the Indian economy felt the tremors of the global financial crisis. However, it included 5 new services under the service tax net. This year too aiming for fiscal consolidation, we may see new inclusions in the service tax net. But a worrisome point could be that the impact of inclusion of new services may put an upward pressure on inflation.

  • Central Excise

    With slumping Index of Industrial Production (IIP) numbers and increase in borrowing cost, this is going to be a tight rope for the Government. If, from the present central excise rate of 10% an increase is proposed, it could hurt the sentiments of the manufacturing industry, since growth may be impacted (due to higher burden of tax to be passed on to the consumers).

    It is noteworthy that in addition to the central excise duty, the state Government levies a Value Added Tax (VAT) of 12.5% to 14.5% on factory output, which according to the CII thus takes the effective tax rate to 24.0% to 26.0%, which is rather high.

    Hence taking the aforementioned view into account, we think that there are likely chances that the central excise duty may be unchanged, because an increase may not only infuse in inflationary pressures, but also result in dampening demand which may thus impede economic growth rate; which we think the Government may not prefer at this time ahead of elections scheduled in May 2014. However, like proposed in the last budget the Government may reduce the number of exemptions in the central excise rate structure.

  • Custom Duty

    Through the last budget, the Government has rationalised the custom duty structure by doing away with multiple duties, and instead bringing in a three slab structure. We expect these rationalisations to continue in the current budget as well. However the Government may display its move smartly by opting to go product / sector specific.

    Speaking about gold, recently the Government had increased the import duty and also shifted to a specific duty of 2.0% (which is levied as a percentage of imports). Given the high demand (for hedging against the turbulence of Euro zone crisis), we think that Government may increase it moderately - in a way that would not encourage smuggling activities in gold. Similarly, for importing foreign gems an upward revision in rates may be seen.

    As far as crude oil is concerned, the Government had removed the duty on imported crude in an attempt to soften prices in a scenario where crude oil prices fuelled, which elevated risk of pushing inflation upwards. While they may like to restore this at present since WPI inflation has dropped in the comfort range, the risk is that Brent crude oil is once again on a rise (US $ 120 per barrel) due to worry of supply contraction occurring from Iran and North Sea (marginal sea of Atlantic Ocean).

    Hence overall, while the focus would be on fiscal consolidation it would be a rather tight rope for the Government to handle this, as any stiff measures on the same may be detrimental for the industry and economic growth rate. Creating a conducive environment for investments, and attracting foreign capital through increase in FDI would be a vital focus, for the Government to maintain its pro-reform image before it steps in for the next general elections scheduled in May 2014.

    On the direct tax front as cited above populist measure would not be seen, but increasing the base exemption limit we may move a step closer to the DTC. Speaking about the implementation of GST, while the Government may take more time to achieve accord on this, we think that overall efforts would be made (vide the indirect taxes) for smooth transition in the GST regime.

PersonalFN is a Mumbai based personal finance firm offering Financial Planning and Mutual Fund Research services.

PersonalFN is a Mumbai based personal finance firm offering Financial Planning and Mutual Fund Research services.


The views mentioned above are of the author only. Data and charts, if used, in the article have been sourced from available information and have not been authenticated by any statutory authority. The author and Equitymaster do not claim it to be accurate nor accept any responsibility for the same. The views constitute only the opinions and do not constitute any guidelines or recommendation on any course of action to be followed by the reader. Please read the detailed Terms of Use of the web site.

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