A dilemma for new FM: roll back duty cut for autos, or take fiscal risk?

Prime Minister designate Narendra Modi's chosen finance minister has a possible dilemma on hands with regard to the automobile industry. A tough choice has to be made in reviving growth in the industry while juggling difficult numbers on the fiscal front.

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With the first full budget of the new government barely six weeks away, all eyes will be on how the finance minister balances the budget books without hurting India's vast consuming class and also with limited legroom to splurge on populist welfare measures.

In the Interim Budget, presented in February, the then finance minister P Chidambaram had slashed indirect taxes on a slew of consumer goods and cars, which made them a tad cheaper, while helping manufacturers.

In an attempt to spur a revival in the domestic automotive industry, the government had slashed excise duties on small cars, scooters, motorcycles and commercial vehicles to 8% from 12%, on sports utility vehicles to 24% from 30%, on mid-size cars to 20% from 24% and on large cars to 24% from 27%. However, it did not have the desired impact on demand as the industry slumped to its second consecutive annual sales decline in 2013-14.

These tax cuts, however, were only for a limited period — till June 30, 2014 — presenting the new government with delicate dilemma: to raise the taxes back to their original levels and risk fanning inflation or continue with the lower taxes and risk lower earnings.

A stimulus in the form of tax cut for companies was aimed at boosting some fragile sectors, while also resulting in cheaper goods. This could, however, be a potential financial headache for the new government, which will find much less revenue to begin with.

Moreover, the government managed to keep the fiscal deficit at 4.6%, notches below a red line of 4.8%. With an untamed deficit, India could have faced a damaging "downgrade" by international credit rating agencies, fears of which seem to have been warded off for now.

The finance minister based his calculations on the assumption of a 19% growth in tax collections in 2014-15, which may not be achievable if the government decides to continue to with reduced rates.

The industry is hoping there would be no reversal of the excise cuts as that is likely to exacerbate the slowdown.

"With a new stable government in place, we expect early implementation of second generation economic reforms," said P Balendran, vice-president, General Motors.

"We expect the excise duty cuts to be retained in June's budget and interest rates to fall or remain at current levels for any chances of recovery for the automobile sector during second half of the year."