Narendra Modi government’s decision to cut the excise duties on fuel — ₹8 per litre on petrol and ₹6 per litre on diesel — may arrest further hike in inflation, but is unlikely to bring down the inflation from the level projected for 2022-23, say analysts at investment bank and brokerage firm Nomura. However, the cut in excise duty, which finance minister Nirmala Sitharaman says will result in a loss of ₹1 lakh crore as annual tax revenues, is likely to impact the fiscal deficit, they add.

According to Nomura’s Sonal Varma and Aurodeep Nandi, their CPI (retail price) inflation projection for FY23 remains unchanged at 7.2% y-o-y, due to a spate of other upside risks. They have raised their fiscal deficit projection for the year from 6.4% of GDP to 6.8% for FY23.

Nomura’s Asia Insights report says that the excise duty cut will have an immediate direct impact on inflation — a ~0.2pp direct impact on CPI inflation (full impact to be visible in the June CPI data) and an additional impact of ~0.1-0.2pp from second-round effects — but is not enough to change their CPI inflation projection for FY23.

“Beyond fuel prices, we still see significant upside inflation risks from other drivers. Higher food inflation, a pending rise in electricity tariffs, the continued passage of higher input costs from firms to consumers and other second-round effects (house rents, wages) are likely to drive inflation. Overall, the fuel excise tax cuts largely offset the upside risks (to our forecast) that were materialising,” Nomura analysts say.

The impact of duty reduction on fiscal deficit is more certain, the analysts add. “Overall, the fiscal measures announced by the government are set to cost ₹2 lakh crore (~0.7% of GDP) in lost revenues and excess spending. In addition, the RBI recently declared a FY22 dividend to the government (reflected in the FY23 Budget) of ₹30,300 crore, which we believe falls approximately ₹30,000 crore (0.1% of GDP) short of the expected revenues. With the government postponing the disinvestment of Bharat Petroleum Company Ltd (BPCL) and amid rising market volatility, we believe the disinvestment target could slip by about ₹25,000 crore (0.1% of GDP). The extension of the free food scheme adds ₹80,000 crore (~0.3% of GDP) to the government’s FY23 expenditure, and we expect an additional burden of ₹50,000 crore (0.18% of GDP), assuming an extension of the free food grain scheme to H2 FY23, with some savings due to lower wheat procurement.”

According to them, these fiscal headwinds are likely to be partially offset by FY23 nominal GDP growth that will likely be well above the Budget’s conservative projection of 11.1% y-o-y; they forecast FY23 nominal GDP growth of 17.6%, given the sharp rise in inflation.

“We see two implications from this. Higher nominal GDP growth typically leads to higher tax revenue growth, as we last saw in FY22, when net tax revenues were approximately ₹2.3 lakh crore higher than budgeted. This year too, we are likely to see a similar windfall gain and, while we have yet to see actual data for any of the months in this fiscal year, we project a gain of ₹1.47 lakh crore (~0.5% of GDP). Also, the higher nominal GDP growth means that the fiscal deficit as a ratio of GDP is likely to be lower, which we estimate will lower the headline deficit by another ~0.46% of GDP. In all, this should lead to net fiscal slippage of ~0.4% of GDP. Therefore, we raise our FY23 fiscal deficit projection from the budget target of 6.4% of GDP to 6.8%, broadly similar to the FY22 deficit of 6.9% of GDP (revised estimate),” the Nomura report says.

Nomura has also raised its FY24 fiscal deficit projection to 6.4% of GDP from 5.8%.

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