India has 7.4% growth, but where are the taxes?

By Andy Mukherjee

India is once again the world’s fastest-growing major economy, despite facing punitive US tariffs for buying Russian oil. Yet, capital is fleeing, the currency is sagging, businesses aren’t investing, and tax revenue is faltering.

That last point has the most immediate significance. Tax collection figures are hard numbers, whereas gross domestic product is a statistical artifact. The ministry responsible for the calculations is predicting an acceleration in GDP growth — to 7.4%, from 6.5% previously. Yet in the first eight months of the current fiscal year, New Delhi’s net tax intake didn’t even hit the halfway mark of what it expects to collect by March 31.

A new federal budget is due Feb. 1, and the bond markets are on edge. Consumption taxes were slashed in September, but if the relief fails to lift economic activity on a sustained basis, investors may be asked to pick up the lingering slack in government revenue.

That challenge could get complicated if the actual state of the economy is not as rosy as the numbers suggest. An outdated base year and reliance on a corporate database that doesn’t directly measure informal activity are well-known methodological infirmities of national-income estimation in India. Businesses that have used cheery growth figures as guideposts have often been flummoxed by a more humdrum reality.

There is a third source of confusion. Nominal GDP, measured at current prices, has slowed sharply since the end of the pandemic and exhaustion of pent-up demand. But real, or inflation-adjusted, GDP growth is holding strong, suggesting that the impact of price changes is perhaps not being captured correctly in official data.

All three problems are likely to be addressed when the government announces a new GDP series toward the end of next month. Even if the revamp doesn’t satisfy all critics, it will hopefully present a more accurate picture directionally — whether growth is headed higher or lower — in the world’s most-populous nation.

That will be of enormous help to policymakers who are currently flying blind. For instance, the central bank’s chief has looked at high reported growth and low inflation to conclude that the economy is in the middle of a rare Goldilocks period. But what if, as the economist Dhananjay Sinha and his colleagues at Systematix, a Mumbai-based brokerage, have argued, the real situation is more a gridlock of “weak tax buoyancy and shrinking fiscal space?”

The sub-par tax collection is unlikely to lead to a blowout increase in the full-year deficit, which will somehow be managed around its budgeted level of 4.4% of GDP. But the manner in which Prime Minister Narendra Modi’s government tightens its belt, for instance by hitting the brakes on capital expenditure or pushing the burden to state governments, could have implications for growth in the coming fiscal year.

India’s 28 states have recently been put on the hook for 40% of the cost of a revised rural jobs program. This is when they’re struggling with a resource squeeze from the Modi government’s decision to cut the nationwide goods and services tax. Those GST rate reductions were aimed to spur local consumption in the face of harsh US tariffs, though their net effect has been to temporarily boost festive-season sales of automobiles and white goods. After meeting the extra demand for retail credit, banks are strapped for liquidity. In the absence of cheap deposits, they aren’t keen to absorb an elevated supply of state government debt.

Bond vigilantes have no worries about inflation. Consumer prices are barely moving higher. If anything, the concern is the opposite: Subdued rural prices suggest weak income growth in villages and anemic demand. The 3.4% drop in tax collections up to November isn’t something debt investors would dismiss out of hand. Back in 2013, it was the Federal Reserve’s decision to taper its monetary easing that exposed India’s unsustainable fiscal and monetary policies. A shadow of that fragility is looming again, though the drivers of discomfort are different.

This time around, the worry is less technical, and more political. Recent comments by US Commerce Secretary Howard Lutnick suggest that the Trump administration is in no mood to give India an early reprieve from 50% tariffs. That puts a question mark over New Delhi’s upcoming budget: Should it play to the gallery of domestic equity investors by lunging for growth? Or should it choose fiscal restraint to keep a lid on rising borrowing costs — both for itself and the private sector? There are no easy answers.

(Disclaimer: The views expressed above are the author's own. They do not necessarily reflect the views of DH.)