Macro Note:India,Finally Out Of The 伍德s?Not So Soon
India’s 2Q FY18 GDP reversed the previous 5 quarters of slowdown and expanded 6.3%y/y.
Major rationalization in GST with pruning of the goods taxed at 28%bracket and simplifying filing rules: The GST Council on 10 Novemberannounced a major rationalization of goods taxed at the highest tax bracket of28% and also took steps to simplify return filing to reduce the complianceburden. The GST council decided to keep only 50 luxury and sin goods in thehighest tax bracket (vs 228 goods earlier) and also rationalize some goods inother tax brackets, with a total of 210 goods moving to lower tax rates. TheGST council also announced measures with respect to simplifying the filingprocess and increase in threshold for the composition scheme. All thechanged rules, except for the higher composition scheme turnover threshold,will be applicable prospectively from November 15. See appendix for detailson list of changes in tax rates of various goods and changes with respect tofiling procedures.
Support came mainly from the uptick in investments. However, consumption, the largest partof GDP, remains benign. That means that both the demonetization exercise from November2016 and the implementation of GST in July 2017 is slowing down consumer demand.
Risk of fiscal slippage in FY18 rises: The government’s decision to lowerthe tax rate for 178 goods (to 18% from 28% earlier) is estimated to lead to arevenue loss of INR 200bn (~0.1% of GDP) on an annualized basis. Over themedium term, though, the impact of revenue loss should be nullified withhigher tax compliance and widening of tax net. This implies ~0.05% of GDPimpact for the remainder of FY18. Recall, the government also cut fuel taxeson petrol and diesel in Oct ’17, which is expected to lower tax revenue by INR130bn (0.1% of GDP) for FY18. This loss in revenue along with indirect taxrevenue collections which are tracking lower than budgeted growth, lowerthan expected transfer of dividend from RBI and fiscal deficit which is alreadyat 91.3% of full-year target, implies higher risk of fiscal slippage in the currentyear. The pressure on the government to meet the fiscal deficit target isevident with the contraction in spending in Aug and Sep. We believe thegovernment will likely cut back on spending in order to meet the fiscal deficittarget of 3.2% of GDP in FY18.
Using passenger cars sales as a higher frequency proxy to gauge discretionary consumerdemand, we observe a similar slowdown.
On the inflation front, the lower tax rate for these commodities will likelyimply about a 30-40bp reduction in inflation if the entire impact is passedthrough to the consumer. Moreover, majority of the goods which have movedto a lower tax rate lie in the core inflation component, which has been stickyaround 4.5% levels.
Although inflation has picked up in the second half of 2017, it is not exhibiting the classiccase of “demand-pulled” inflation as the average Indian consumer is not spending as much.
On the growth front, the lower tax rates will at the margin support privateconsumption, which has been the main driver of the growth recovery.
Higher prices reflect the GST imposition.
However, any cut-back in fiscal spending which may be necessitated to meetthe fiscal deficit target could be a dampener on overall consumption growth.
As such, it will be really too early for the RBI to embark on any rate hikes. In fact, we areexpecting another 25bps rate cut in the 6 December policy meeting.
For FY18, we retain our growth estimate of 6.7%YoY vs 7.1% in FY17.
What about RBI policy response? The RBI may be more focused on thefiscal impact of the changes in tax rate given the potential risk of fiscalslippage in FY18. Moreover, the recent spike in vegetable prices and oilprices may also keep upside pressure on near-term inflation. We expect CPIinflation for Oct (to be released today) around the 3.3% mark. In this context,we believe the chances of a rate cut in the Dec policy review are now low (wewere expecting a rate cut) as the central bank could remain more focused onupside risks to inflation from the recent spike in vegetable & oil prices and rising risk of fiscal slippage in FY18.