India has proposed lowering the Goods and Services tax (GST) on small cars to 18% from the current 28% as part of sweeping consumption tax cuts, a government source said on Monday.

The reduction, part of a programme of the deepest tax cuts announced by Prime Minister Narendra Modi since 2017, will boost sales of the country's biggest carmaker Maruti Suzuki among other manufacturers.

The federal government has suggested lowering GST on small petrol and diesel cars to 18% from the current 28%, said the source who is directly involved in the matter.

GST on health and life insurance premiums may also be lowered to 5% or even zero from 18% currently, the same source said.

The tax cuts, if approved, are expected to be announced by Diwali, a major, five-day Hindu festival in October, the source said. Diwali is also the country's biggest shopping season.

India's finance ministry did not reply to an e-mail seeking comment.

Sales of small cars, defined as those having engine capacity below 1200cc for petrol vehicles and 1500cc for diesel and not exceeding 4 metres in length, have slowed over the last few years as buyers switched to bigger, feature-rich SUVs.

Small cars made up a third of the 4.3 million passenger vehicles sold in the world's third-largest automobile market last fiscal year, down from nearly 50% pre-COVID, industry data showed.

The tax cut will be a big win for Maruti, whose market share has plunged to about 40% from over 50% in the last five years as sales of its small cars such as Alto, Dzire and Wagon-R dropped. The segment makes up half of all cars sold by Maruti - majority-owned by Japan's Suzuki Motor.

Carmakers Hyundai Motor India and Tata Motors also stand to gain.

Cars with higher engine capacity that currently attract 28% GST and an additional levy of up to 22% - resulting in total taxes of about 50% - may come under a new special rate of 40%, the source said.

The source added that details are being firmed up to consider if any extra levies should be imposed over the 40% to keep the overall tax incidence for big cars the same at 43%-50%.

The comments led to a sharp rise in automaker and insurance stocks.

Shares of automakers such as Maruti, Mahindra & Mahindra, Hero MotoCorp, Bajaj Auto and Eicher Motors jumped 2%-8% in the morning trade. Shares of insurance companies such as ICICI Prudential, SBI Life, and LIC jumped 2%-4%

The rise in auto, insurance and consumer firms stocks helped the wider market rise over 1%.

India subsumed local state levies into the new, nationwide GST in 2017, but faced criticism for its complex design that taxes products and services under four brackets- 5%, 12%, 18% and 28%.

It is now proposing its biggest revamp with a two-rate structure of 5% and 18%. The final decision on rates will be made by October by the GST Council, which is chaired by the federal finance minister and has representatives from all states, before a countrywide rollout, the source said.