Indian Tax Cuts, Spending Leave RBI With Burden to Check Prices

India’s plans to lower income taxes, increase wages and boost spending risk fueling price gains that will force the central bank to raise interest rates further.

Finance Minister Pranab Mukherjee yesterday unveiled plans to increase spending by 13.4 percent to 12.6 trillion rupees ($278.3 billion) for the financial year starting April 1. The government is boosting incomes through wider exemptions from individual tax payments, reduced costs for some housing loans and the allocation of 1.44 trillion rupees in subsidies.

“The budget hasn’t done enough to curb price pressures and the central bank may have to continue to do the heavy lifting to slow inflation,” said Sonal Varma, an economist at Nomura Holdings Inc. in Mumbai. “More rate actions are in the offing starting this month.”

Prime Minister Manmohan Singh’s government faces five state elections this year and said last week that its “foremost” priority is to curb inflation, which reduces purchasing power in a nation where the World Bank estimates more than three-quarters of the people live on less than $2 a day. The central bank has raised its benchmark rate seven times in the past year and signaled more increases at its last meeting in January.
Stocks Gain

The Bombay Stock Exchange’s Sensitive Index, or Sensex, rose 0.7 percent yesterday and bonds gained as the government pledged to trim its budget shortfall. The Sensex has lost 13 percent this year, making it the world’s third-worst performing benchmark index, on concern government measures to quell inflation will hurt economic growth.

India’s $1.3 trillion economy expanded 8.2 percent last quarter, making it the fastest-growing major economy after China, government figures showed yesterday. The benchmark wholesale- price inflation rate averaged 9.4 percent in the nine months through December, the most in the past decade, the finance ministry said in a report on Feb. 25.

Singh’s budget must be approved by India’s parliament, where the ruling coalition has been battling opposition protests over corruption allegations for months. The final parliament session of 2010 was the least productive in 25 years.

Even as he reduced the income-tax burden, Mukherjee moved to boost levies in other areas that might contribute to price pressures. The finance chief included more services under the tax net to lift revenue. Taxes would now be collected from air- conditioned restaurants, hotels, airlines and hospitals.
Drug Prices

He also imposed an excise duty of 10 percent on branded garments and raised the levy on drugs, textiles and medical equipment to 5 percent from 4 percent. Cipla Ltd., an Indian drugmaker, plans to pass on the increase in excise duty on medicines to customers, its Chief Financial Officer S. Radhakrishnan said yesterday.

“I doubt the budget has anything very concrete to dent inflation,” said Samiran Chakraborty, a Mumbai-based chief economist at Standard Chartered Plc. “The burden of controlling inflation will be more on the monetary policy in the near term.”

From the next financial year, incomes below 180,000 rupees won’t be taxed, higher than the previous threshold of 160,000 rupees. Mukherjee also announced a 1 percent interest-rate subsidy for housing loans up to 1.5 million rupees and said the government will give cash to the poor to buy kerosene.
Rail Fares

India’s state-controlled railway operator last week said it will leave passenger and freight charges unchanged to help tackle inflation that accelerated to the fastest in a decade.

“The central bank is getting some help from the budget but not very much,” said Leif Eskesen, an economist at HSBC Holdings Plc in Singapore. “It has to carry the burden on really addressing the near-term inflation pressures.”

The finance ministry estimates GDP may grow as much as 9.25 percent in the year starting April 1. The government estimates growth in revenue will outpace outlays, forecasting the budget deficit will narrow to 4.6 percent of gross domestic product in the financial year starting April 1 from 5.1 percent of GDP in the previous year.

“The budget may be difficult to deliver in practice as growth assumptions are quite optimistic and they are relying on a significant compression of non-planned spending including a decline in the subsidy bill,” HSBC’s Eskensen said. “If delivered as planned, it will be contractionary. There may be more subsidy outlays later in the year.”

Deficit Reduction

Mukherjee cut taxes and stepped up government spending in 2008 and 2009 to provide stimulus worth more than 4 percent of GDP to cushion the Indian economy from the impact of the global financial crisis.

If the 4.6 percent fiscal deficit target “is met, then it will be a massive withdrawal of stimulus,” said Jahangir Aziz, an economist at JPMorgan Chase & Co. in Mumbai. “It will be largest fiscal consolidation, if it is done, in the history of India.”

The government plans debt sales of 4.17 trillion rupees in the next financial year, less than the estimated 4.47 trillion rupees this year. Yields on benchmark 10-year government bonds were at 8.02 percent late yesterday in Mumbai, compared with the two-year high of 8.25 percent reached on Jan. 10, according to data compiled by Bloomberg.

The Reserve Bank is next expected to release its monetary policy decision on March 17. Governor Duvvuri Subbarao on Feb. 26 declined to comment on whether the central bank would take interest-rate action between scheduled monetary policy announcement days.

“Growth will slow down next year as the Reserve Bank of India tightening takes effect,” said Dharmakirti Joshi, a Mumbai-based economist at Crisil Ltd., the local unit of a Standard & Poor’s Ratings Services. “The government is taking steps to ease inflation in the budget and the RBI, on its part, will raise interest rates further.”