Budget: 7 big challenges facing the finance minister

Finance Minister Nirmala Sitharaman will be presenting Modi 2.0’s second General Budget on February 1, 2020, amid falling growth and consumption, low investments and rising inflation. India’s GDP growth is expected to fall to 5% for FY20, lowest in 11 years, as the country faces a severe economic slowdown. Unemployment levels too are at a 45-year high.

The government’s revenue collections have fallen short of estimates and its disinvestment plans haven’t taken off leading to concerns that the targeted fiscal deficit number could be breached.

The Indian economy, which is predominantly consumption-driven, is witnessing a slowdown. Consumer confidence is low. Investments have not picked up despite the government lowering corporate tax rate by 10%.

Exports have been declining for the fifth straight month, IIP numbers are not encouraging and inflation levels last month have crossed the target set by RBI. Many sectors like automobiles, real estate are facing decline in sales. While various groups have high hopes from budget and many economists feel that stimulus is the only way out, Nirmala Sitharaman will be facing a tough time while preparing the document.

Some of the challenges which Sitharaman will be facing are enumerated below:

1. Economic slowdown – falling growth, consumption and investment

GDP is expected to grow at 5% in FY20. Consumer spending fell for the first time in four decades. Private investments are not picking up despite a corporate tax cut. How could it, if the operating ratio of companies is at 75%-80%? India's Investment accounted for 29.7% of its nominal GDP in Sept 2019, the number used to be above 35% in 2014. Indian economy is facing challenges on many fronts.

2. Decline in consumer confidence

Consumer confidence weakened further in November, 2019 as per a Reserve Bank of India survey with both the current situation index and the future expectations index declining. The sentiment on the general economic situation prevailing in the country and the job scenario weakened.

It has been consistently declining since March 2019 as shown below. Nirmala Sitharaman has an uphill task at hand to take measures to improve the confidence, without which consumer spending is unlikely to gain momentum in FY21.

3. Rising inflation

Retail inflation rises to 65-month high at 7.35% in December 2019, marking its rise for the third consecutive month. This is way above RBI’s comfort zone of 4%. The Modi government has prided itself on keeping price rise under check, so it is not at all good news for them.

It couldn’t come at a wrong time. When the industry is pressing for rate cuts to boost demand and investment, rising inflation could deter the RBI from reducing interest rates.

This will act as a double shock to the economy and also has repercussions on government plans of leaving more money in hands of people, injection of stimulus, et cetera.

4. Shortfall in revenues / tax collections

In 8 months up to November 2019, revenue receipts were only 50% of Budget Estimates for FY20. The tax revenues were even lesser at 45.5%. The slow economic growth and the reduced rates of GST on many articles have adversely affected the collections. Out of the Rs 1.05 lakh crore disinvestment target, only 17% has been achieved, with no substantial progress in Air India and BPCL disinvestment.

Tax collection target is likely to be missed by Rs 2.5 lakh crore, or 1.2% of the GDP, as per former finance secretary Subhash Chandra Garg. Total receipts are 27% lower than they should have been till November 2019.

With tax collections already facing stress, it will be difficult for FM to implement tax cuts for individuals and reduction in GST rates for certain products, which could lead to further revenue loss in FY21.

5. Tight fiscal position, slippages expected

As of November 2019, we had already overshot our fiscal deficit target. Due to lower revenue receipts, fiscal deficit is expected to breach the estimated 3.3% to 3.8% of GDP for FY20 as per a senior government official. HDFC Bank projects it to be at 3.5%-3.6%.

Some of it could be managed by postponing the reimbursement of subsidies to FCI and OMCs. Tight fiscal position implies that the government could be forced to curtail some expenditure. Its ability to provide stimulus to the economy is also constrained due to this factor.

6. Clamour from individuals to reduce tax

There is a growing clamour not only from individuals but also from industry to provide some sort of tax relief to individuals. Leaving more money in the hands of people is likely to address the demand side problem and provide a boost to consumption. However, as it is said, there are no free lunches.

This will lead to loss of revenues for the government, which it will need to compensate in some form or another. Either by bringing in some other tax, or by reducing expenditure. The fiscal deficit situation compounds the matter, unless the government is prepared to relax the targets for a few years. This may not sound music to the rating agencies though.

7. Clamour from the industry to remove DDT

Industry body associations are also demanding removal of the Dividend Distribution Tax. Currently companies are required to pay DDT of 20% on the declaration of dividends. The dividend income in the hands of shareholders is exempt from tax.

Historically, dividends were always taxable in the hands of shareholders. However, in 1997, DDT was moved from shareholders to companies declaring and paying dividends for the sake of convenience in tax administration. If the government is not able to provide relief to individual taxpayers, loading with more tax in form of DDT will not be a wise decision politically.

To sum up, the Indian economy is facing insurmountable challenges and Nirmala Sitharaman will have to toil hard to bring the economy back on track. Let’s wait and see what she has in store for Budget….