Corporate tax cuts may bolster growth eventually; fiscal impact to come sooner: Fitch Ratings

New Delhi: Fitch Ratings on Thursday said the steep cut in tax paid by companies may stimulate investments and economic growth only in the medium term, but it will lead to breach fiscal targets in the current fiscal itself. Finance Minister Nirmala Sitharaman on 20 September announced the lowering of the base corporate tax rate to 22 percent from 30 percent for companies that do not seek exemptions and reduced the rate for some new manufacturing companies to 15 percent from 25 percent. Including surcharges and cesses (levies to raise funds for specific purposes), the effective corporate tax rate will drop by nearly 10 percentage points to 25.2 percent. “India’s corporate tax cuts support efforts to stimulate investment and GDP growth in the medium term, but will cause the fiscal deficit to widen in the near term. “As such, slippage from previous government fiscal targets this year (FY19-20) is now very likely,” Fitch said. Sitharaman had in her maiden budget, presented on 5 July, targeted a fiscal deficit of 3.3 percent of the GDP. [caption id=“attachment_7158481” align=“alignleft” width=“380”] Representational image. Reuters.[/caption] The corporate tax cut follows other measures by the government to prop up slowing GDP growth adopted since the May general elections. These include efforts to reduce red tape and boost FDI, and plans to consolidate the state-owned banks. “We would characterise these and the latest tax cuts as structural reforms to improve competitiveness and efficiency (for example, by reducing the use of tax exemptions) rather than as cyclical stimulus measures. “As such, they may succeed in stimulating investment, although a positive growth impact is only likely over the medium-term, the agency said. Fitch said a positive impact on FDI would be more likely if the tax cuts were accompanied by further measures to improve India’s business environment. “In particular, corporate tax rates are likely to be only one in a list of factors determining investment decisions, along with the legal environment, labour market regulations, infrastructure development and enhancements to the overall business climate,” it said. Faltering domestic demand, a weak global trade environment, asset-quality challenges at banks and funding pressure on non-banking finance companies have contributed to economic slowdown. GDP growth slowed for a fifth consecutive quarter in April-June to 5 percent, the slowest pace in six years. The contribution of private consumption fell to 1.8 percentage points (pp) from an average of 4.6 pp in the preceding four quarters, while manufacturing grew by just 0.6 pp year-on-year. Fitch said it will later this month release its revised growth estimate for 2019-20 fiscal year for India which “will be significantly lower than the 6.6 percent” forecast in June. “The policy measures taken will likely support a gradual recovery in FY20-21 and FY21-22,” it added. In contrast to the growth impact of tax cuts, the fiscal impact will be felt in this fiscal year, it said, adding the corporate tax reduction will cost around 0.7 percent of GDP in lower revenue - about two-thirds to the central government and one-third for state governments. Revenues this year are already behind target although the record annual transfer of $24.8 billion from the Reserve Bank of India, announced in August, should largely fill this gap. “Expenditure postponements are more difficult for the government given weak growth, and we expect the central government to miss its 3.3 percent of GDP deficit target for FY19-20 by about 0.4 pp. We now expect a general government deficit of 7.5 percent of GDP, well above the ‘BBB’ category median of 1.9 percent,” it said. The rating agency said the general government debt ceiling of 60 percent of GDP is unlikely to be met by March 2025, as stipulated by the Fiscal Responsibility and Budget Management Act, as this would require significant deficit reduction. “The interplay of growth and fiscal policy are an important element of our Indian sovereign rating assessment. Higher sustained investment and growth rates without the creation of macroeconomic imbalances could be positive for India’s credit profile while a rise in the government debt burden could be negative,” it added.