GST- Best cannot be the enemy of Good

The Government Amendment Bill for the Goods and Service Tax was introduced in Lok Sabha on 19 December, 2014. Earlier it had been considered by the Parliamentary Standing Committee which submitted its report in August 2013. This is one of the key reform initiatives which commenced during the earlier NDA Government was pursued during UPA I and UPA II. It continues to be a centre piece of our tax reforms. The Finance Minister after an introductory statement on 24 April, 2015 requested that the bill be taken up for discussion and enactment. Congress members and some regional parties objected that the Amendment introduced subsequently after taking account of earlier recommendations of the Standing Committee needed further discussion. They wanted it to be resend to the Standing Committee. This would have delayed this bill for much longer.

In essence India still remains a fragmented market. The varied rates of taxes imposed by Centre and States create cascading effect, burden the consumers, deprive government of tax revenue, add to the onerous of compliance and reduce the competitiveness of manufacturing.

The Essence of the Amendment Bill lies in subsuming various Central and State indirect taxes including central excise duty, service tax, countervailing duty, state value added tax, octroi, entry tax, luxury tax among others. The Bill aims at creating a single unified national market for goods and services sans of tax distortions. A GST Council will also be constituted. The membership of the council comprises of the Union Finance Minister, the Union Minister of State incharge of Revenue or Finance and the Minister incharge of Finance and Taxation or any other nominations by State Governments.

The functions of the council include making recommendations on taxes, surcharges and cesses to be levied, goods and services to be included or exempted and so on. The council will model laws and principles governing GST and decide upon the turnover below which GST can be exempted. It will also decide floor rates and bands of GST. It will suggest special rates to raise additional revenues during natural calamity. The Council would also design special provisions with respect to 10 states including Jammu and Kashmir, Himachal Pradesh and North Eastern States.

Implementation of GST would have some clear advantages for the economy.

First, a single comprehensive tax benefits all stakeholders.  Consumers will benefit by paying one tax in place of multiple overlapping taxes like VAT, entertainment tax etc., leading to market distortions. Revenue benefits from the broadened tax base. The suppliers benefit from the minimal burden of tax levied only on the value added by them.

Second, it creates a unified common market. The cascading effect of complex indirect taxes is mitigated. The transparency and simplification improves compliance.

Third, a comprehensive tax improves the competitiveness of manufacturing sector. In the long run, by promoting growth it improves the per capita income. The purchasing power of the growing middle income population of India is enhanced.

Fourth, a transparent and rational tax regime improves the Ease of Doing Business. It boosts investor confidence, encourages capital inflows and gives a fillip to the Make in India programme.

Multiple challenges, however, remain unresolved.

One, states are concerned that a substantial proportion of their indirect tax revenues are now subsumed in one tax. They are also worried that now the tax revenue will accrue to the destination states and not the manufacturing states. Central government’s decision to reimburse the loss in revenue will allay this fear. In the long run, higher growth would make central support unnecessary. The transitional fiscal burden on the central government will also be allayed.

Two, the rate of GST also remains undecided. Tax rates cannot be too low as it will impact Government’s revenue. On the other hand, high tax rates will affect compliance. Our tax rates, in the long run, need to be aligned with the rates in other developing economies.

Three, issues such as taxing inter-state transactions at 1 percent has caused concern. It has been decided that such a tax with an upper limit of 1 percent be collected by the Centre and can be assigned to the States for an initial couple of years. The GST Council reserves rights to make recommendations in this context. However, a higher rate of such tax can create production distortions.

Four, the exclusion of tobacco, alcohol and petroleum and the real estate sector robs major areas from a unified tax structure. Overtime and given experience, the GST Council can phase these in.

Analysts believe that GST is central to our growth strategy. While estimates vary, many believe that it can add upto 1.5 percent to India’s GDP. It benefits all stakeholders. The glitches have to be resolved overtime. The Best should not become the enemy of the Good. An early GST is now an economic necessity.

Singapore and the legacy of Lee Kuan Yew

I was in Singapore on the day of Lee Kuan Yew’s cremation. As the Founding Father of Singapore he was the longest serving Prime Minister from 1959 to 1990 in recent history. Till two years ago even at the age of 89 he was active in the policy domain. Narendra Modi has done India enormous service by participating in his funeral. We even had a national mourning on Sunday. These gestures have made an indelible imprint in the minds and hearts of Singaporeans. George Yeo the former Foreign Minister, with whom I spent some time, told me how deeply touched they were and how indebted they will remain for this symbolic act. Modi’s instinctive decision suggests the high leadership qualities. Leaders emerge not merely from experience but from leadership instincts. Choosing the right moments and the right occasion is what decisive leadership is about. Everyone knows that the relationship between Mrs. Indira Gandhi and Lee Kuan Yew was not particularly warm. India remained contemptuous that a leader of a small city state, successful no doubt, should not preach economic liberalization to a complex country like ours. We viewed his advice with scepticism. Lee Kuan Yew himself regarded India to be a disappointment for not grasping the opportunity which could transform India. He somewhat changed his views following our liberalisation in the 1990s.

In the last 20 years, the India – Singapore partnership has deepened significantly. India for them represents a large demography, unsatiated demand and a market for managerial skills and technology within a functioning democratic framework.    

It is no secret that after Singapore’s partition from Malaysia in 1965, Singapore has rapidly transited from a third world country to a developed economy. Its per capita income rose from US $ 540 in 1965 to US $ 54,040 in 2014. It has repeatedly topped the list of the Ease of Doing Business and is an example of successful Public Private Partnership. This is even though many regard Singapore as a family run concern.  Notwithstanding timely elections and a functioning Parliament it has suppressed individual liberties, curbed the media to enforce discipline and secure productivity gains. The younger segment has persistently resented these curbs. In a country with a total geographical area that does not exceed 700 square kilometers and a population of 5 million which is ageing, persistent immigration has caused social unease.

Broadly speaking, the Singapore success story has four lessons for India.

First, that it is possible to improve productivity and growth in a State run enterprise, if given autonomy, domain knowledge and best technology solutions.  Singapore Airlines, the Changi Airport and important infrastructure projects are owned by Temasek- a public sector company. Making public sector run efficiently and principles underlining their efficiency and productivity are worth replicating.

Second, Singapore stands out as the shining example of urban planning and water management systems.  Not a drop of water is wasted. All water which is consumed is recycled from sewage and effective treating of rain water.  Water conservation systems and urban planning are relevant for us as we grapple with problems of persistent water shortages and unplanned urbanisation. Singapore is the best Smart City one can think off. Chandra Babu Naidu has been quick to recognise this and ask Singapore to help in building its new capital at Amravati. We could do so for the cities and give more tangible content to SMART Cities.

Third, China is often quoted as an outstanding example of what may be called Controlled Capitalism. Fostering the private sector culture of innovation, technological upgradation, vastly superior managerial skills and combining them with public resources have created models of Public Private Partnership from which we need to learn. India is seeking to re-jig its Public Private Partnership model in terms of risk assignment, eliminating the odour of crony capitalism in exploiting natural resources and securing appropriate benefits to all stakeholders.

Fourth, the transparent administrative system in Singapore in framing its labour laws has lessons for India where reforms in Labour Laws have now rightly focused the attention of policy makers. Also, while collective bargaining power of Trade Unions in India detracts investments, the Trade Unions in Singapore instead   use the collective bargaining to improve education and other social services for its members.  

Finally, emphasis of Singapore and its overarching theme, investment in Human Resource Development, inculcation of skills, and payment of high wages to public servants to obviate temptations of corruption have significant lessons for us.   

True, Singapore is a city-state. Even more true, it neither has the demography nor the complex conflicts of language, caste and religion as in a polity like ours. Yes, small is not always beautiful but small city-states like Singapore have multiple lessons for us. The legacy of Lee Kuan Yew will be India’s constant reminder of its missed opportunities, more importantly of misplaced arrogance and decisive inability of our political leaders to readapt our economic and social strategies till compelled to do so by our economic crisis has been our decisive disadvantage. It is never too late to learn and we have successfully course corrected. In forging deeper partnership with Singapore we are drawing the right lessons from the legacy of Singapore’s Founding Father. 

End of Neo-Colonialism

The babel around the Budget and the XIV Finance Commission and subsequent comments and analyses have now ebbed. There are some States and stakeholders who are critical based on inadequacies of allocation in the social sector. But there is a consensus that the Budget represents a credible balancing act and gives a decisive momentum to the economic upturn which has already commenced. Thomas Sowell has said “The first lesson of economics is scarcity: There is never enough of anything to satisfy all those who want it. The first lesson of politics is to disregard the first lesson of economics.” So which lesson did the Budget pursue?

In retrospect, there were some overarching policy options to leverage that the Finance Minister had.

One, the classic choice: growth versus inflation. How much of fiscal flexibility was acceptable to enhance public outlays in infrastructure – railways and highways? The budget has adhered to the path of fiscal rectitude by meeting the fiscal deficit target of 4.1% this year.  It has postponed the terminal fiscal deficit target of 3% by an additional year with somewhat higher intermediate targets. The rating agencies prefer a closer adherence to the fiscal roadmap.  Of course the new time path must be adhered. I have for long argued that parliamentary approvals must be ex-ante than ex-post. The recommendation for a Fiscal Council contained in the Finance Commission’s recommendations is sensible.  This along with the new Monetary Policy Framework Agreement between the Finance Ministry and the Reserve Bank of India would act in congruent ways. It will ensure harmony between monetary and fiscal policy and thus Mint Street and North Block.

Two, subsidy rationalisation. There are significant gains in rationalising petroleum and fertilizer subsidies by de-regulating petrol and diesel and moving over to the Aadhar based LPG subsidy.  Further action is needed on fertilizers, particularly Urea. There must be pari-passu progress as JAM (Jan Dhan-Aadhar-Mobile) gathers momentum.

Three, congenial external environment to be harnessed. Oil prices have dramatically declined from $82 to $59 with soft commodity prices. The current account deficit is acceptable even though in the long run sluggish export behavior needs innovative action beyond conducive exchange rates.  We could have used this opportunity to create greater fiscal space for the future. Public debt could have been retired or a Consolidated Sinking Fund for amortisation of debt created. The Finance Commission suggests this can “tide over, roll over risks and the weak cash management practices.”. A middle path has been preferred. Substantial benefit has been passed to the consumers enhancing their purchasing power, allowing oil companies to recoup some losses and raise revenues to meet fiscal targets. Given the opportunity, this must be pursued.

Four, the XIV Finance Commission’s recommendations. There is overwhelming precedence that on devolutions they have been treated as awards than recommendatory. Consequently, total devolution to the States is now 62% of which 42% is from common divisible pool of taxes. The rise in tax devolution to States and the Non Plan grants to local bodies together represent a sharp cut of ’206292 crore from the Centre’s resource block. In the shrunken resources for the Central government the funding pattern of schemes has under gone a structural shift.  The Budget at a Glance again highlights the middle path. It classifies public outlays in three categories – schemes to be supported by the Union,  schemes to be continued with change in sharing pattern and those fully de-linked from Central support. The major flagship programmes of the government remain in the Union list like the Sarva Shikaha Abhiyan, MGNREGA, Pradhan Mantri Gram Sadak Yojna. There are others which would be financed with a changed sharing pattern. Schemes de-linked from Central support, leaving it for the States to decide are rather small. The most contentious being the Backward Region Grant Fund to Bihar, KBK and Bundelkhand.

There has been misplaced criticism that social sector outlays have been drastically pruned.  In making such comparisons a methodological error has crept in.  Analysts have compared the Budget Estimates of 2014-15 with the Budget Estimates for the current year. Those familiar with public finance know that normally the comparison is between the RE (Revised Estimates) with BE (Budget Estimates). Such comparison would suggest that allocations have been kept more or less intact. In the case of Integrated Child Development Scheme (ICDS) the reduction is sharp, but the pattern of funding is yet to be decided.

Thus the Budget and the Finance Commission are two sides of the same coin. It emanates from the design and conception of a new financial architecture of Centre-State relations. It is a giant step in promoting federalism where much larger untied resources become available to the States for selecting, designing and implementing programmes best suited to their needs. The Government had little option given the shrunken envelope after accepting the Finance Commission’s recommendations.  After all you cannot have the cake and also eat it. States cannot have both the cake of large untied resources and eat the Centrally Sponsored Schemes as originally conceived.  One can argue of whether this was the best approach or could the recalibration have been somewhat different? 

Will this new model of Fiscal Federalism work? There are inherent risks but also existing opportunities for Team India. The risks are well known if the State Governments act irresponsibly or promote fiscal profligacy. But in the end, the Government at the Centre and the States are judged by the improvement and development of life quality by the Electorate whose periodic mandate they seek.

The new fiscal architecture eliminates the form of neo-colonialism like what Rudyard Kipling described as the White Man’s Burden  viz. the Centre knows what was good for the States. A new social compact between the Union and the states has been ushered.

Thus, the adoption of the XIV Finance Commission’s recommendations and the Budget reflect that the Government has accepted both, the first lesson of economics and the first lesson of politics. A credible balancing act is what the budget is all about.

India in 2015: Challenges Ahead

This is my first column for 2015. Let me begin by wishing my readers a very happy 2015. Sarah Ban Breathnach has said, “New Year's Day. A fresh start. A new chapter in life waiting to be written. New questions to be asked, embraced, and loved. Only dreams give birth to change.” and yet Winston Churchil has cautioned us that, “It is always wise to look ahead, but difficult to look further than you can see.”.

The year that went by contributed to some important turnarounds.

First, we have a strong, stable and credible government with a decisive leader. The era of fractured coalition politics is hopefully behind us for some time. The parliamentary majority in the Lok Sabha is decisive for the ruling party. In the Rajya Sabha the ruling party does not have a majority and forging bipartisan support will remain a challenge. It will test the skills of the ruling party in the months ahead. Even while the spectacular victories in Maharashtra and Haryana following the general election of 2014 was a reiteration of the pro-Modi sentiment, the recent victory in Jharkhand and decisive improvement in Jammu & Kashmir mark a continuation of the same trend albeit according to some in muted form. The changed composition of the Electoral College will improve BJP’s strength in upper house in 2016 with continuing improvements.

Second, the economic decline looks to have bottomed out. We have hopefully seen an end of the prolonged period of policy paralysis, sub-5 percent growth, unsustainable Current Account Deficit, raging inflation, rising subsidy bills and little or no credible action aimed at macro-economic stability or structural reforms. This fiscal year will end with growth rate somewhere between 5.4-5.9 percent, moderation of inflation, a manageable current account, a modest revival of investor confidence. Interest rates would come down this week or by the first week of February. The recent ingredients of structural reforms includes deregulation of diesel prices, replacing cooking gas subsidy with direct transfers, reforming coal sector and allowing private sector in it, Pradhan Mantri Jan Dhan Yojna, Swachha Bharat Abhiyan and labour reforms.

Third, looking at the external factors, the world in general presents a mixed picture. Japanese economy will struggle to crawl out of recession even under the renewed leadership of Abe. The slowdown in Chinese economy will persist for a while with declining competitiveness in labour intensive manufacturing. The American economy has shown a sharp upward turn with expectations of increase in interest rates which may encourage outward capital flows with pressure on our exchange rate and current account deficit. The European economy would remain in doldrums. The growing geo political tension between Russia and the West could create multiple dynamics of its own.

Fourth, the altered global energy scenario with medium term prognosis of soft oil prices has huge implications for India. The current downward trend in petroleum and oil prices would benefit fiscal management particularly subsidy flow but make renewable energy less cost competitive. A robust recovery of our exports, given global uncertainties, could remain problematic. This could impact the current account deficit. However, on the whole, the external environment in the short term looks advantageous for us. The subdued inflation behavior should be used as an opportunity to rationalize cross subsidies and pursue many pending reforms.

So what are the challenges which we face? And what could be the most beneficial outcome?

First, combining rapid economic growth with social cohesiveness will remain problematic. Societal evolution in accepting the consequences of rapid growth at best presents a mixed picture. Preserving traditional values, cultural identity, during periods of rapid urbanization and migration poses policy choices on which there are no easy answers.

Second, rapid economic growth cannot be taken for granted. Expectations both form the Prime Minister and the Budget in altering the growth trajectory remain high, almost unrealistic. Policies and procedures when altered have a gestation period. The misalignment between expectations and ground level changes in the short run can create uncertainties. The opposition would hope for political backlash. It is important to persevere and stay on the course.

Third, creating gainful employment both in manufacturing and services will need changes in regulatory framework beyond administrative actions. Some recent measures initiated in earnest to fix time limits on grant of approvals, simplifying the number of approvals needed, resolving contractual disputes, simplifying registration procedures can make a difference on the Ease of doing business. Changes in labour laws would need to go beyond encouraging states to adopt the best practices of some states like Rajasthan and Madhya Pradesh. Legislative action sooner or later will be inevitable. Reports that large foreign investments from relocation of Japanese investment away from China are still in a wait and watch mode for India suggest need for more decisive action.

 Fourth, improving health and education outcomes has received priority focus. Nonetheless, harmonising skill inculcation programmes with emerging demands needs coordinated action between centre and states, the corporate sector and more robust forms of public private partnership.

Fifth, managing parliament, particularly the Rajya Sabha could remain problematic. Government has options by the way of ordinance, its promulgations and Joint Sessions. These are no substitutes for persevering with forging bipartisan support to enact key legislations. Given recent setback in State Elections the opposition may be subdued facilitating greater cooperation during the year.

Sixth, internal security presents a complex challenge. The recent ethnic killings in Assam, challenge of terrorism aided and abated from across the border and the specter of Maoist insurgency in several states requires a robust response. The conduct of peaceful elections in Jammu and Kashmir has many positives.

Finally, harnessing the improved external environment to India’s advantage. The investor appetite in United States Japan and Australia has been rekindled. Translating expectations and commitments into tangible actions may require re-doubling our efforts. Moving foreign policy to foreign economic policy must go beyond rhetoric. Harnessing the enthusiasm of Indian diaspora can be a decisive advantage.

The New Year comes with the renewed hopes and expectations. The prime minister was right when he recently said that the “World is ready for India but is India ready for the world?”. We must prove that we are and that there is credible action to address the key challenges.

It is well said by Joyce Meyer that “We don’t grow when things are easy; we grow when we face challenges.”

नई आर्थिक चुनौतियों की दस्तक

The Power of Zero

In normal parlance achieving zero is not a happy state. Getting zero in examination assessment reports or levels of economic activity or assessing prospects of growth is held as sign of underperformance and weakness. Yet there is some cheer in the economic world for reaching the state of zero inflation. India’s wholesale inflation fell to zero in November- from 7.52 percent a year ago - lowest since July 2009.  There are multiple ways in which price indices are computed in India. The Wholesale Price Index (WPI) measures the price of a representative basket of wholesale goods. In India, this basket is composed of three groups, namely, Primary Articles, Fuel and Power and Manufactured Products. Historically, the wholesale price index (WPI) has been the main measure of inflation in India. The WPI is used by the Government to measure inflation. However, in 2013, the Reserve Bank of India adopted the Consumer Price Index (CPI) as the key measure of inflation following the recommendation of the Urjit Patel Committee. The consumer price index (CPI) undoubtedly works better than wholesale price index (WPI) in capturing market dynamics and arriving at a more realistic inflation forecast. This preferred measure of price index has also come down to 4.38 percent in November from 11.6 percent a year ago. Part of the sharp fall in both retail and wholesale inflation is due to the significant moderation in prices of food and fuel witnessed in recent weeks in addition to the favourable base effect.  There are several questions which this raises.

 

First, the cost and condition of accessing formal credit is influenced by inflationary trends. Contrary to expectations, the RBI in its last policy review announced two weeks ago decided to keep the interest rates unchanged at 8.0 percent which is considered as too high for encouraging new investment decisions.  Infact, the RBI has maintained a retail inflation target of 8% by January 2015 and 6% by January 2016. The Consumer Price Index inflation falling below the 6% target considerably earlier than anticipated may prompt the RBI to begin its easing cycle sooner than later. There are however doubts on the trajectory of inflationary expectations. Inflationary expectation surveys are conducted by the RBI periodically by eliciting opinion of households on their future price expectations. This influences consumer behaviour and consumption pattern. According to the latest Inflation expectation survey of the RBI, the inflationary expectations over the next three months and one year are at 14.6 and 16 percent compared to 12.9 and 15.3 percent in March 2014. Many however doubt if these findings are realistic in nature in determining interest rates. There are also apprehensions on whether the decline in prices of food or fuel is transitory in nature or sustainable. The decline in interest rate has to be sharp and steep to make a difference by signalling that the worst is over also in making investment decisions more viable.

Second, there is a broader issue of refocusing on long-pending reforms with inflation having moderated significantly.  It offers an opportunity and considerable flexibility for politically sensitive subsidy rationalisation apart from number of other economic changes. These reforms can be fast-tracked now including the distortionary regime of price controls and cross-subsidies on LPG, Kerosene and Fertiliser to mention a few. Having eliminated under-recoveries in diesel that amounted to Rs 62,837 crore in 2013-14, the government needs to target the Rs 77,000 crore-odd subsidy on cooking fuels next. It should do this by making all consumers pay the market price for LPG and kerosene, and transferring the difference directly into the bank accounts of actual beneficiaries. The latter must be carefully identified, to include only low-income or vulnerable households deserving of subsidy. The fertilizer subsidy remains a key burden on government finances which is currently estimated at Rs 70,000 crore.  There is therefore need for a rationalistic approach towards pricing of fertiliser and the most commonly used soil nutrient Urea.  Moderating Food prices offers a window of opportunity to fully decontrol sugar and reform the public distribution system to roll out the Direct benefit Transfer scheme. Similarly, prices of public utilities, including electricity, transport and rail passenger fair and freight rates can be progressively freed given the favourable circumstances. The market share of Indian Railways in total freight traffic has been falling consistently and this calls for rationalization of cross-subsidies between passenger fares and freight rates to remove distortions. This is therefore a historic opportunity to fast-track these reforms to make the economy more competitive.

Finally, moderating inflation is also an opportunity to reform the tax regime to make it more progressive and to strengthen the public finances. Moderating inflation is positive news for the government as lesser subsidy outgoes on food and petroleum products and lower costs of borrowing can improve the fiscal health of the economy. Lower input costs and interest rates can boost private investment in infrastructure projects.  With the Wholesale Price Index at zero and the Consumer Price Index at below 5% level, the Indian economy should start picking up steam. But this would largely depend on the pace of fiscal and expenditure reforms which took a back seat in the previous years.

 

The power of zero is a far reaching power. It is a signal of change which affords an opportunity for undertaking long-postponed reforms. Not only has Modi won a historic but the external circumstances have also turned favourable unthinkable only few months ago. Economists may view the free fall in inflation with lots of caution but this could not have come at a more opportune time for India especially with several reform issues hinged on the behaviour of headline inflation. The power of zero must therefore be fully harnessed. Coming few months will be keenly watched on whether we are able to make the most of it.