The third stimulus package came quietly. This is unlike the two that preceded it, which were announced with much fanfare. But the government had to act, that too fast, given that the third wave of the global meltdown is expected to hit home shortly. Signs of it are already visible.
Experts say that default issues in East European countries, which borrowed heavily over the years to finance their economic activity, are likely to put further strain on an already weak global banking system. This could trigger a further loss of confidence among banks to lend, leading to a general squeeze in liquidity.
?A consequence of this would be a further cut in industrial activity, loss of jobs, reduced outsourcing, exports etc. This will take about three months to show. If we want to reduce the impact of these developments on the Indian economy, we need to be ahead of the curve,? says NS Venkatesh, managing director & CEO, IDBI Gilts.
For an economy reeling under the impact of the first two waves of the global meltdown, the third stimulus package then appears timely. Getting the economy on the path to growth has been uppermost for policymakers since the beginning of the credit crisis in September last year.
This becomes imperative also because growth registered by the Indian economy in the last few years was over 8%. But the general slowdown this year is taking the sheen off the economy. India is likely to see an under 7% growth in its gross domestic product (GDP) this year.
Next year, say experts, it will be worse, may be below 6%. Increasing demand then becomes important to push up industrial production and thereby overall growth. That is why a straight 2% cut in excise duty and service tax was announced in the third stimulus round recently. ?This is obviously a quicker approach to reviving the economy,? says DK Joshi, director and principal economist, CRISIL.
Reducing taxes has a direct impact on prices. This way the government hopes to prop up demand especially because most items as far as excise duty is concerned fall in the 10% slab?the bracket where the 2% cut has been effected. This ?along with the 4% cut in CENVAT announced in the first stimulus package in the same slab, that is, from 14% then, excise duty came down to 10% and now it is down to 8% ? implies an overall 6% cut in excise duty alone in the last three months. ?This is a massive cut in excise duty,? says Vivek Mishra, tax partner, Ernst & Young. ?Almost 80-90% of Indian goods fall in the 10% excise bracket. Exceptional items fall in the other two slabs ? 8% and 4% respectively. But those have been left untouched by the government in the current round,? he says.
Says Seshagiri Rao, director, finance, JSW Steel, ?It?s been a long-term demand of industry to bring down excise duty. That has been done. Consequently, the benefit will be passed to consumers.
Consumers, however, will see almost a 7% reduction in price because lower excise means lower value-added tax, that is, 6% plus another 1%, says Mishra. ?Holistically, these are significant reductions by the government,? he says.
A service tax reduction, in contrast, implies a step down in the service bill to that extent. Hence eating out, travelling by first class or business class, paying mobile and allied bills and even going to movies will be cheaper by 2%. ?The reduction in service tax is marginal if you ask me,? says an industry observer. ?But at this point any tax reduction is welcome.?
The loss to the exchequer as a result of these measures is enormous. The third round cuts alone will result in a loss in revenue to the extent of about Rs 30,000 crore to the government. If the first round cuts are taken into account, it would be another Rs 28,000-Rs 30,000 crore. It would cause about Rs 60,000 crore of revenue loss to the government due to two fiscal stimuli packages alone.
The government has already said that the fiscal deficit as a percentage of the country?s GDP will be 6% for the current financial year. But experts say it is likely to be more, given the measures the government has been announcing to tackle the slowdown over the last few months. This coupled with what the states do ? the government has permitted them to borrow up to 3.5% of their GDP in the current stimulus package?implies that the total fiscal deficit as a percentage of GDP will be high.
By some accounts it has been pegged at over 11%. If international credit rating agency Standard & Poor?s estimate is to be considered, then the total fiscal deficit as a percentage of GDP will be 11.4% at the end of the current financial year. Next year, it is likely to be lower at 11.1%, but still high by any yardstick.
No wonder S&P has revised its outlook on long-term sovereign credit for India. It has been revised from stable to negative though the outlook and rating on short-term credit has been maintained. Even Moody?s and Fitch? he other two key rating agencies?have expressed their concern over India?s growing fiscal deficit.
The downgrade on long-term credit by S&P, however, doesn?t imply a rating change for India for now, but it still is not a very good sign since companies will find it difficult to borrow in the international market going forward. ?It?s like putting us on some kind of a watch list,? says an industry executive. ?If the fiscal deficit worsens, then things could get bad for companies here.? Says Ashwini Kakkar, executive vice-chairman, Mercury Travels, ?It will get expensive for companies to borrow in the international market.?
Traditionally, it has been a little cheaper for companies in India to borrow abroad as opposed to borrowing in the domestic market. With the climate, however, being uncertain since the credit crisis, borrowing in the international market hasn?t been easy for anybody including Indian companies.
A widening fiscal deficit makes it only tougher for Indian companies to procure funds from overseas markets. ?This is worrisome,? says Kakkar. ?But the accent of the government is on higher growth and better compliance at the moment.? Agrees Venkatesh of IDBI, ?It?s a tradeoff, if you ask me. Releasing all this money into the system would imply that inflation would come to bite us in the future, even if we don?t consider the deficit that the government is going to face as a result of this. But the government has to get the railings of the economy on track.?
But the government has no choice. If the trajectory of growth is not restored, it could lead to greater problems?social unrest, widespread joblessness, poor industrial growth etc. That is a risk that no government would like to take? not one that is sitting on the cusp of an election.