RBI on a rate cut hiatus: Patel flags fiscal slippage, excessive taxes

RBI Governor Urjit Patel said, 'Monetary policy has become much more flexible in terms of responding to inflation risks'

Reserve Bank of India (RBI) Governor Urjit Patel on Wednesday flagged the government’s moves related to adherence to its fiscal policy and the inability to foster a conducive investment environment because of complex tax policies.

During the central bank’s sixth bi-monthly monetary policy meeting in Mumbai, he said: “On the fiscal side, we have news of fiscal slippages at three levels in recent times. A fiscal slippage this year, a fiscal slippage next year compared to what the market expected, and what the target was, and then a postponement of the medium-term adjustment even further.”

In the Budget, Finance Minister Arun Jaitley had stated the fiscal deficit would rise to 3.5 per cent of gross domestic product (GDP) for 2017-18, against the target of 3.2 per cent. The government also had to reset its fiscal deficit target for 2018-19 at 3.3 per cent of GDP, against a target of 3 per cent, to accommodate all its spending plans before the general elections next year.

The effect of fiscal slippages on inflation and the broader macro-financial implications, notably on economy-wide costs of borrowing and financing conditions, are some of the upside risks that might affect the confidence of external investors.

Several factors contributed to the higher deficit this year — low indirect tax collections with teething troubles over the goods and services tax, hardening global crude oil prices, implementation of the Seventh Central Pay Commission’s recommendations, higher levels of debt-financing by state governments, and large-scale spending programmes of the Centre.

Rupa Rege Nitsure, group chief economist at L&T Financial Services, said, “It is just a pause in fiscal consolidation as both growth and investments are at multi-year lows. As capacity utilisation rates are low, higher fiscal spending need not stoke inflation. The reaction of bond yields is excessive.”

The government has since revised its commitments, stating it wanted to achieve the fiscal deficit targets of 3.3 per cent in 2018-19, 3.1 per cent the next year and 3 per cent in 2020-21. The government also said it wanted to reduce its debt-GDP ratio from 50.1 per cent in 2017-18 to 48.8 per cent in 2018-19, 46.7 per cent in 2019-20 and 44.6 per cent in 2020-21.

Economists said the delay in fiscal consolidation created challenges in meeting the inflation target of 4 per cent, set for monetary policy working. Despite the delay, the government has been moving on the path of fiscal discipline.

Patel, when asked about the RBI’s ability to address inflation when fiscal deficit targets were being missed consistently, said: “Monetary policy has become much more flexible in terms of responding to inflation risks. So it is not necessary that 4 per cent (inflation target) should be achieved by the time given in the report. However, having a fiscal stance that is conducive to achieving the target is important and significant, and to postpone deviations from them would make matters more challenging.” 

Ease taxation, not further complication

The Budget was especially disappointing to the urban salaried class, given that there were no concessions on the direct taxation front. The finance minister’s aim to slash the corporation tax rate with an equivalent reduction in exemptions for corporations remained unfinished. 

Instead, the government introduced a long-term capital gains tax on equity holdings, which will kick in from April 1. The government had so far only enforced a short-term capital gains tax of 15 per cent on gains made on the sale of shares within a year of purchase. 

“From a back-of-the-envelope calculation, you have a corporate tax rate, you have a dividend distribution tax rate for dividend income above ~1 million, you have the marginal tax, you have a securities transaction tax and you have a capital gains tax. So there are five taxes on capital, and that would obviously have an impact on investment and saving decisions,” the RBI governor said.

Economists noted that due to all these taxes, the capacity to improve tax compliance, let alone encourage investments, would reduce considerably.