FY2018 will see the implementation of a moderate and simple taxation system in India with the government likely to (1) reduce income tax rates and remove several exemptions for companies from April 2017 and (2) implement GST by July 2017. We model FY2018BE GFD/GDP at 3.3% but note high variability in revenues and expenditure due to the difficulty in assessing the government’s exact response to demonetisation through lower tax rates and higher spending.

Direct taxation initiatives will be the key focus of the Union Budget

We expect the FY2018 Union Budget to lay the foundation of India’s taxation structure in line with the government’s vision of a broad-based, moderate, simple and stable taxation system. The government will likely reduce income tax rates for companies and individuals to encourage greater tax compliance and gradually remove exemptions from April 1, 2017.

Indirect taxation structure to be ready during the course of FY2018 (July 2017)

The government is unlikely to make any major changes to indirect taxes in the budget barring aligning the excise duty or service tax rates for certain goods and services to their purported GST rates and removing surcharges on service tax. It has largely finalised the structure of GST and is on course to complete the necessary legislation over the next few months and implement GST by July 1, 2017.

Demonetisation measure to leave its imprint on the budget

The demonetisation measure of the government will have a large bearing on its (1) taxation policies and (2) FY2018BE fiscal estimates. It will likely seek to bring about a behavioural change among taxpayers through a combination of (1) lower corporate and individual income tax rates (‘carrot’) and (2) demonetisation (‘stick’). Also, the extent of taxation cuts and other fiscal stimulus (higher rural spending) will depend on the government’s assessment of the additional tax revenues it can raise indirectly from the demonetisation exercise.

FY2018BE GFD/GDP at 3.3% but several variables at play

We model FY 2018BE GFD/GDP at 3.3% amidst high ambiguity over several inter-linked variables — (1) direct taxation policies and rates, which in turn will depend on the financial and psychological impact of demonetization on taxpayers, (2) fiscal spending to offset the potential slowdown in consumption demand due to demonetization, (3) timing of implementation of GST and final GST rates for goods and services and (4) new Fiscal Responsibility and Budget Management (FRBM) targets, which may be set out by a government-appointed committee over the next few weeks.

This is an excerpt from Kotak Institutional Equities Economy/Strategy note dated January 20, 2017. Copyright 2017 Kotak Institutional Equities (Kotak Securities Limited). All rights reserved