Budget 2018: A tightrope walk for Arun Jaitley

Barring black swan events, the Budget 2018 will be the chief topic of concern this week. Expectations include measures designed to accelerate infrastructure creation, and lots of giveaways for farmers and the rural hinterland. There are fears that fiscal prudence will be compromised and some long-term capital gains (LTCG) tax on equity may be introduced. There are hopes that corporate tax rates will be cut, and that personal income tax slabs will be upgraded.

The market will not react negatively to sops for rural citizens. Indeed, there is already an investor focus on companies that may be good plays in terms of affordable housing, tractors, tillers, fertilisers, cement, steel etc. The market will also respond positively to construction and infra developers if there's some attempt to speed up project financing and implementation. Even an expansion of the MNREGA budget could be discounted positively as a rural consumption-booster.

However, if the rural focus comes at the cost of an expanding fiscal deficit (FD), foreign portfolio investors (FPI) in particular, will be unhappy. The FD will be the most-watched macro-number in this election-year Budget because there is the temptation to abandon prudence and just spend. The rupee has strengthened a lot over the past year against the dollar. If the FD does expand, it may trigger an FPI sell off, leading to a rebound for the dollar.

In addition to fears of higher expenditure, there is an apprehension that indirect tax collections might undershoot. The Goods and Services Tax (GST) hasn’t yet settled down and it's unclear what the split of state-Centre allocations will be, as well. Given a trend of falling GST collections in the last three months, and the short-term disruption (we hope) it has caused, indirect tax estimates will be carefully studied.

In 2017-18, investors assumed there would be a large error factor in indirect tax estimates as GST was impending. The error factors are also likely to be pretty large in 2018-19. There’s been a vast amount of chopping and changing, which makes it impossible to guess the collection trends. As the disruptive effect eases off, collections should climb but we don’t know how long it will take.

The other question-mark is about imposts on petrol, diesel, etc. if crude prices continue to climb, high retail prices will become a political hot-potato. This may put pressure on indirect tax collections, and therefore, the Budget might seek other revenue channels.  

That brings us to a possible change in the LTCG tax. There have been rumours that LTCG tax will be imposed in some form or another, on equity. Now, LTCG is a tax-category with complex and variable tenures and rates. Across assets such as real-estate, equity, jewellery and debt, accepted tenures for classification as ‘long-term’ are all different; the tax rates are also different.

LTCG for equity (and equity mutual funds) isn’t subject to any tax if assets are held for over 12 months. That tenure might be bumped up to two years. Or, there could be a tax imposed. In compensation, the double tax on dividend may be cut, or the securities transaction tax might be cut or removed.

Another possibility: short-term equity profits will be added to other income for tax computation instead of being taxed at a flat rate of 15 per cent. This could more than double collections since the average equity investor is in the highest income tax bracket.  Taxing equity wouldn’t bother FPIs, who work out of tax havens. But it may hurt the retail segment.

Political promises mean little, but Mr Jaitley said he would lower corporate tax rates to 25 per cent, all of three years ago. This is his last chance. If he does, that could lend some upwards impetus.  Start-ups are also praying that the tax department will iron out dodgy interpretations of treating equity investments as capital gains. Individuals also hope that the income tax exemption limit and tax brackets would be rationalised upwards to some degree.  

Beyond this, the Budget could give us some clues about the disinvestment process and bank recapitalisation plans.  My take is that the degree of urgency in these areas depends on the degree of the government's confidence about being re-elected in 2019. If the BJP is less than confident about its re-election prospects, it's more likely to push through things in a hurry.

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