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More tax cuts in new stimulus even as S&P lowers outlook

More tax cuts in new stimulus even as S&P lowers outlook
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First Published: Tue, Feb 24 2009. 11 53 PM IST

Updated: Tue, Feb 24 2009. 11 53 PM IST
New Delhi: In a bid to revive consumer demand to boost a flagging economy ahead of impending elections, the government unveiled its third stimulus package in as many months on Tuesday, extending previous tax cuts due to expire on 1 April, and throwing in a fresh round of tax cuts that will result in a revenue loss of around Rs28,100 crore.
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The move will further widen the fiscal deficit, which is the government’s resource gap measured by the debt needed to bridge the shortfall between revenue and expenditure.
India’s fiscal deficit has ballooned as the government tries to counter the impact of the global economic downturn on the economy, which has already slowed considerably. The economy is expected to expand at 7.1% in the year to 31 March, after growing by at least 9% in each of the previous three years.
Announcing the stimulus package during his reply to the debate on the interim budget in Parliament on Tuesday, interim finance minister Pranab Mukherjee said the new measures were the result of the government’s view that the global economic outlook would worsen and hurt the country’s economy. The package was passed by a voice vote in the Lok Sabha and come into effect immediately.
The package includes a 2 percentage point cut in median excise duty (or the so-called Cenvat rate) to 8%, a reduction in service tax rate (or the rate at which tax is paid by various service providers) by 2 percentage points to 10%, and amendment of Section 10 AA of the Income-Tax Act to provide consistent tax benefits for all entities operating in special economic zones.
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Industry lobbies and trade bodies welcomed the measures and have promised to pass them on as price reductions to stimulate consumer demand.
“The measures will lead to revenue loss of Rs13,000 crore in service tax, Rs8,500 crore in excise duty and Rs6,600 crore in customs duty,” Central Board of Excise and Customs chairman P.C. Jha said.
A cut in excise automatically lowers import cost of goods through a reduction in the so-called countervailing duty, which is linked to the Cenvat rate. As excise duties are levied on ex-factory prices (or the price of goods at the factory), the impact of a reduction is disproportionately large at the retail level.
“It (a Cenvat cut) has a spiral effect. Customs duty will also go down and the overall reduction is more than 2%,” Pratik Jain, executive director, indirect taxes, at audit and consulting firm KPMG, said.
The third cut in Cenvat in the last one year since the 2008-09 budget has led to halving of the Cenvat rate to 8%. With the expected revenue loss of Rs8,500 crore, collections from excise duty in 2008-09 are likely to dip below Rs1 trillion to Rs99,859 crore, close to level of excise collections in 2004-05, the year the United Progressive Alliance (UPA) government came to power.
Looking ahead: Pranab Mukherjee. Ramesh Pathania / Mint
The revised estimates in Mukherjee’s 16 February budget speech projected the fiscal deficit in 2008-09 to be Rs3.26 trillion, or 6% of the gross domestic product (GDP). Tuesday’s measures raise it to 6.51%.
“Even though the signals are encouraging, the full impact of the recession in other parts of the world, specially Europe and Asia, is yet to unfold. Due to strong export linkages with these economies, it is likely that the Indian economy may feel further impact in the coming months,” Mukherjee said, explaining the reason for a cut in taxes a week after presenting the interim budget.
Tuesday’s measures mark the third fiscal package since December. The previous rounds also included a large dose of monetary policy measures which were clubbed with fiscal measures.
“I am quite stunned. It is totally unprecedented and it is great. My guess is 80-90% of goods would be covered (by the Cenvat cut),” Vivek Mishra, partner, indirect tax, at audit and consulting firm Ernst and Young, said. This was the first time the service tax rate has been cut since its introduction in 1994, he added.
Makers of consumer goods were pleased by the indirect tax cuts. “The development should boost consumer sentiment (just) as it did last time in December when a 4% (percentage point) cut in excise duty was announced”, following which several companies announced price cuts, said R. Zutshi, deputy managing director, Samsung India Electronics Ltd. “Now again, some benefit will be passed on to consumers.”
“The further reductions in excise and service tax by 2 percent(age points) and extension of the earlier 4% (percentage point) cut in excise duty beyond 31 March 2009 will go a long way in stimulating consumption demand” said Chandrajit Banerjee, director general of industry lobby Confederation of Indian Industry in a press release.
Makers of industrial equipment said the cuts would help revive investment demand.
“The duty cut will be completely passed on to the clients. Though it will make power projects cheaper, it will also affect our turnover, which will come down. In order to bridge the gap, we will manufacture more,” said K. Ravi Kumar, chairman and managing director of Bharat Heavy Electricals Ltd.
The cuts in tax rates announced in the three fiscal stimulus packages over the last three months are to extend into the next financial year and will remain in force until the next government chooses to change them. As a result, the fiscal deficit for 2009-10, as projected in last week’s budget speech, is almost certainly set to widen from Rs3.32 trillion, or 5.5% of GDP.
Mint’s Vijaya Rathore, Utpal Bhaskar, Liz Mathew and PTI contributed to this story.
Graphics by Sandeep Bhatnagar / Mint
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First Published: Tue, Feb 24 2009. 11 53 PM IST