Weaning industry off the fiscal stimulus package is not going to be an easy task. Any talk of a rollback makes industry nervous, and understandably so. While the monetary stimulus eased liquidity, the fiscal one did much more. Even as the government’s intention was to boost demand growth, it also boosted profitability, as firms retained some of the savings. One of the key measures was a cut of 4 percentage points in Central excise duty from the prevailing rates of 8%, 12% or 14%, working out to a relief of 28-50%.
This was done in December 2008 and its impact is visible in the current fiscal. The excise-to-sales ratios of most firms in fiscal 2010 would have dropped over the previous year.
Take Maruti Suzuki India Ltd’s figures, for example. Its excise-to-gross sales ratio went down to 8.8% in the September quarter, from 13.16% in the year-ago period. These figures are not available for most firms, as they report only the net sales figure after deducting excise in their quarterly results. The savings in excise duties is a straight addition to their operating profit margin.
When the government rolls back excise rates to earlier levels, firms will feel the pinch. Industry is already in a situation where commodity prices have come off their lows. Firms will find it difficult to absorb a higher excise outgo and pass the hike to their customers. The impact will be limited to the extent that credit on excise paid on inputs is available. While basic and intermediate goods will feel the pinch the most, end-use industries will have the benefit of excise credits.
The effect will be least on firms whose production centres are in excise-free zones such as Uttarakhand, Himachal Pradesh, and Jammu and Kashmir. Service industries and exporters, too, will be less affected, as they do not pay excise. Industries such as petroleum and cigarettes will also not be affected as duties on these products were not changed as part of the fiscal stimulus. That the withdrawal of the fiscal stimulus will lead to inflation in manufacturing, is quite clear. But the more important question is whether demand will grow, or even sustain, in the face of higher prices. Firms will have to exercise restraint in passing on cost hikes; a slowing in demand at this stage would harm their financials. They may face the risk of lower margins, but that is preferable to a slowdown in volume growth.
Perhaps, a phased rollback of excise duties will allow the cost hikes to be passed on without risking a demand shock.
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