Government may cut import duties to curb inflation

NEW DELHI: India is likely to slash import duties in its annual budget next week as it seeks to curb rising prices, but is unlikely to alter corporate or income tax rates significantly as it relies on strong growth to boost its coffers.

Analysts said the centre-left government was expected to cut a third of peak import duties from 12.5% to bring them more in line with those in the Association of South East Nations (ASEAN) and help restrain inflation, which is at its highest in more than two years.

The Congress party-led coalition hopes lower duties will lead to more imports, dampening price pressures in an economy where factories are stretched and demand has far outstripped supply.

The government has already eased some duties as growth of an estimated 9.2% this fiscal year has driven annual inflation up to 6.7%. But analysts see scope for more.

“This is a good opportunity for the government to tinker with the tax rates since inflation is pretty high. I expect the customs duty to be cut to ASEAN levels," said Rupa Rege Nitsure, chief economist with Bank of Baroda.

“It will be in their benefit if they cut taxes (duties) as they want to bring down inflation."

The communist-backed coalition, facing important state elections this year, is deeply worried about inflation, and the surge in the economy, now one of the fastest growing in the world, has given it room to use tax cuts to tackle the problem. The government hopes lower duties on items such as capital goods would prompt firms to raise capital spending and add capacity. This in turn would help address supply bottlenecks, which it sees as the main impetus for higher prices.

As for lost collections, the government hopes the surge in economic activity will bring in more taxes.

Finance Minister Palaniappan Chidambaram may have other tricks in the bag on 28 February. Analysts say he could cut excise, or factory-gate tax, from an average 16% in the hope this would be passed to consumers via lower retail prices.

REFORMS YES, RADICAL STEPS NO

The government has made tax reform the centre of its fiscal policy since being elected in May 2004, subscribing to the view that lower taxes lead to greater compliance.

The concept has worked so far, as tax collection to gross domestic product is expected to rise to more than 11% this financial year from 8% in 2002. Yet, that is still just half the level of Brazil, another large developing economy.

Net tax collections for the first nine months of 2006/07 rose 38% from a year earlier to Rs2.32 trillion ($52.5 billion).

Higher revenues remain the government’s only option for funds, as it already struggles with interest payments on debt.

While Chidambaram is not expected to significantly change corporate or income tax rates, the potential to boost receipts is tremendous as the system is littered with exemptions and rules that often aid rather than prevent tax evasion.

The cash-strapped government needs every penny it can get to double spending on health and education to $50 billion, as promised in its policy blueprint unveiled in 2004, and only 3.5% of the billion-plus population pay income tax.

Analysts don’t expect a tax amnesty like one Chidambaram launched a decade back in an earlier stint as finance minister.

“I don’t think there will be any radical moves. It will be very much incremental, at the margin changes and trying for some short-term changes," said A. Prasanna, economist with ICICI Securities.

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