Officials Seek Tax Reform as Cash Ban Slows India Growth

  • Ban may cut 25-50 bps off 7% FY17 GDP forecast before rebound
  • Recommendations could set the tone for budget announcement

India needs bold tax reform to ensure that Prime Minister Narendra Modi’s growth-crimping cash ban isn’t in vain, advisers said.

Suggestions include bringing real estate under a planned national sales tax, lower income tax rates and more tax payers, accelerate corporate tax cuts, and more accountable tax officers. The government must use filing data to ensure scrutiny is backed by evidence rather than harassment, Finance Minister Arun Jaitley’s economic advisers, led by Arvind Subramanian, said in the Economic Survey presented in parliament on Tuesday.

"Demonetization was a potentially powerful stick which now needs carrots as complements," they said.

These recommendations could set the tone for India’s budget presentation on Wednesday, where the government rides a fine line between placating citizens hurt by the cash ban and reassuring rating companies looking for an improvement in Asia’s widest deficit. Social strife triggered by the cash clampdown -- if left unaddressed -- could hurt Modi’s prospects in a series of state elections starting Feb. 4.

"Tax cuts are possible in the budget tomorrow as the finance minister needs to provide some balm after the cash ban," said Indranil Pan, chief economist at IDFC Bank Ltd. in Mumbai. However, any jump in consumption won’t immediately trigger an increase in investment, he said.

The annual report warned that official data may understate the impact of the ban due to a disproportionate hit on the informal economy, which isn’t directly captured by statisticians. Fifteen of 22 companies from the broad Nifty equity gauge that have reported earnings so far have beaten or matched estimates, according to data compiled by Bloomberg.

The benchmark Sensex index fell 0.7 percent in Mumbai on Tuesday, while the rupee strengthened 0.1 percent to 67.8650 per dollar and the yield on the sovereign bond due 2026 was little changed at 6.41 percent. Jaitley’s advisers see growth in gross domestic product dipping as low as 6.5 percent in the current fiscal year -- down from a 7.1 percent forecast -- before rebounding to 6.75 percent to 7.5 percent in the year starting April 1.

Budget Outlook

Most economists in a Bloomberg survey published this month predict Modi’s administration will ease its deficit target for the year starting April 1 to 3.3 percent of GDP from 3 percent. They see GDP growing 6.8 percent in the current year and 7.4 percent next year. That’s a drop from last year’s 7.9 percent -- the fastest pace among the world’s biggest economies.

The report also estimated unaccounted cash at 3 trillion rupees ($44 billion) in the $2 trillion economy. Modi’s unprecedented cash ban was aimed at eliminating this "black money," as well as curbing corruption, counterfeiting and terrorist funding.

Jaitley will present India’s budget for the year starting April 1 at 11 a.m. on Wednesday.

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