Tax exemption cap at R1.5 lakh to boost domestic savings likely

Written by Sunny Verma | New Delhi | Updated: Feb 15 2012, 08:09am hrs
Finance minister Pranab Mukherjee is likely to increase the income tax exemption limit on individual savings from R1 lakh at present by up to R50,000, in a bid to raise the savings rate which has been falling since 2007-08.

In recent Budget meetings with ministry officials, Mukherjee has indicated his desire to raise the exemption limit, a senior official said on condition of anonymity.

The savings rate is estimated to have fallen sharply by as much as 500 basis points in the current fiscal from its pre-crisis peak of 36.9% of GDP in 2007-08 as per RBI and CSO data.

There have been representations in the past to raise the savings exemption limit. The Budget may announce it this year, the official said. He indicated that the hike in the limit could be R20,000-50,000 per annum. However, the additional window of R20,000 for investments in infrastructure bonds introduced in the 2010-11 Budget might remain unchanged.

Since investment in the country is financed mainly through domestic savings, the government is keen to raise the latter. By international comparison, savings rate in India is still among the highest along with East Asian economies, where both savings and investment rates are above 30%.

But the government is concerned about the steady decline in savings and investment rates in recent years, especially over the past couple of years. Recently, the government raised rates on small savings schemes and introduced other incentives to arrest the outflow from the National Small Savings Fund.

The savings rate fell as persistently high inflation rates for over two years eroded disposable incomes.

The government's contribution to savings also declined as a result of high fiscal deficit.

Any increase in the exemption ceiling is expected to boost savings by the household sector, which accounts for as much as 70% of the total savings in the country. Private corporates and the government account for the remainder.

India's savings rate surpassed 30% level for the first time in 2004-05, as steady growth in GDP pushed up household and corporate savings. Savings rates remained below 15% until the late 1960s. Between late 1970s and 2001, the savings rate remained between 20% and 24%.

This particular incentive will also appeal ice to key Opposition leaders, who are pitching for a hike in tax exemption on savings currently available under Section 80 C of the Income Tax Act.

In its report on the Direct Taxes Code, the Parliamentary Standing Committee on Finance headed by Yashwant Sinha, too is expected to recommend a 50% hike in the savings limit.

Though India depends largely on domestic savings to finance investments, it is not sufficient yet. A significant portion almost 3% of the GDP is still foreign capital in the form of external commercial loans or foreign equity.

Since the foreign capital flows are considered to be of a volatile nature, there is a case to push up the domestic savings rate, said another finance ministry official, who also did not wish to be quoted.