In February, presenting his sixth Union Budget, Finance Minister Pranab Mukherjee
, had pegged direct taxes
at Rs 5.32 lakh crore for financial year 2011/12. Mukherjee's estimate was a result of a better-than-projected growth in the gross domestic product, or GDP, during 2010/11, which led him to bet on nine per cent economic growth for 2011/12. There was also an unspoken assumption that international crude prices, which had spiked in the wake of the political turmoil in West Asia since January, would not rise beyond February levels. All these assumptions had led him to peg the fiscal deficit for 2011/12 at 4.6 per cent of GDP. Now, four months later, most of Mukherjee's projections seem to be going awry.
On June 24, the government increased the administered price of diesel, kerosene and cooking gas for the first time in almost a year in a bid to curb rising oil subsidies. The price increase is expected to bring down the daily losses of oil marketing companies on account of selling underpriced products from Rs 456 crore to Rs 289 crore. It also pared indirect taxes on petroleum products to the tune of Rs 49,000 crore to ease the pressure on the bottom line of oil companies, which will curtail the losses of public sector oil marketing companies on account of underpricing, to around Rs 1.2 lakh crore in 2011/12.
Economists promptly reacted to the move by marking up their forecasts of fiscal deficit, or the excess of spending over revenue that is bridged by borrowings, for 2011/12. Goldman Sachs and Deutsche Bank AG forecast a fiscal deficit of 5.5 per cent, while Standard Chartered Bank expected 5.4 per cent.
The increase in the diesel price is also expected to lead to an immediate spike in inflation. "Higher fuel product prices will add 75 basis points to headline inf lation," says Samiran Chakraborty, Regional Head (Research), Standard Chartered Bank, in a research report. Headline inflation, or wholesale price index, was 9.06 per cent in May, and 8.66 per cent in April. Research reports of Goldman Sachs and Deutsche Bank expect headline inflation to peak in September, by which time the combined impact of interest rate increases and the government's moves to control expenditure are expected to weaken aggregate demand in the economy and ease pressure on prices.
But a pullback in inflation may get delayed and fiscal deficit may expand beyond 5.5 per cent of GDP due to the impact of a slower GDP growth this year on direct tax collections. In May, the Reserve Bank of India revised the growth estimates to eight per cent, which would be a dampener for direct taxes. Besides, unusually large tax refunds this fiscal have led to a contraction in net collections by 48 per cent to Rs 12,954 crore in April and May. There is more bad news on the way.
Advance tax paid by the top 1,000 companies, which make up about 90 per cent of total corporate collections, grew 22.14 per cent over last year to Rs 26,383 crore. But disappointing performances by sectors such as cement, steel and automobiles, which are lead indicators of economic performance, suggest the environment may get tougher in forthcoming quarters.
"Now, slowdown fear is real," says Jagannadham Thunuguntla, Strategist and Research Head, SMC Global Securities. "Companies are picking up only mandatory projects and avoiding discretionary projects."