External assistance can rescue the economy

A little history on economic growth – a major worry – can help provide perspective to today’s concerns. The incidence of annual downturns in growth (in constant terms) show a marked variance before and after 1990-91 in the Republics short economic history.

Jagged growth in the first four decades

Over the thirty-nine years prior to this marker, growth remained below 4 per cent per year 49 per cent of the time – five of these years were periods of de-growth or negative growth (FY 1958; FY 1966 and 67 when famine stalked drought-hit Bihar; FY 1973 just after the war to liberate Bangladesh which coincided with the first global oil shock and drought in Maharashtra and in 1980, during India’s first experience of khichdi rule under the Janata government, which came to power in 1977 in the after-math of the emergency. However even in this early period, growth exceed 6 per cent per year during 26 per cent of the time.

Growth stabilizes post liberalization

Post 1990-91, economic liberalization drove a dramatic shift in growth. Over the twenty-nine years since then, growth remained above 6 per cent per year 66 per cent of the time; below 4 per cent just 14 per cent of the time and there were no instances of negative growth.

FY 2020 an outlier

Sadly, FY 2020 will not be one of those years when optimism peeks out from every corner. After a drab 4.75 per cent growth in the first half of the year, the expectation is of ending the year with sub 5 per cent growth. Better prospects might await in FY 2021. But much depends on how the government proposes to manage the crisis India is in presently.

The demons of FY 2017 had spin-off benefits

Demonetization scorched the economy in FY 2017. On the plus side it branded Modi 1 as a determined government which was willing to take extreme steps to achieve its goals. It also showcased the light footedness of government when it converted disaster into victory by following up demonetization with a massive financial inclusion initiative covering 40 per cent of the population which had remained unbanked – 100 million households. Combined with the bio-metric unique identity facility Aadhar widespread financial inclusion has enabled big data analysis for tax purposes and improved monitoring of tax evasion.

GST proved demonic in its short term impact

The implementation of the Goods and Services Tax barely six months after demonetization, from July 2017, dealt a double blow to those whose revenue models comprised principally of evading tax or for whom the compliance burden became overwhelming.

The extent of the black economy being at least 40 per cent of GDP implementation of GST shut down industries and businesses at the lower end where tax evasion was the norm. But this move to cleanse the tax system also gave birth to today’s economic slowdown. The medium and small sector has suffered the most in which two thirds of the industrial workforce is employed. Unemployment or reduced earnings in construction and small industry has impacted consumption across urban and rural areas.

The GST was agreed through a process of cooperative federalism. But State governments  have always been wary of sacrificing existing revenues for the revenue buoyancy anticipated by ending the cascading impact of taxes.

The genesis of slowing growth

Today the economic slowdown emanates from stagnating exports partly caused by a highly overvalued INR (approx 10 to 15 per cent); climate-induced shocks in agriculture; declining industrial growth and the pessimism spread by the continuing defaults in the NBFCs and dubious practices continuing within banks to evergreen stressed loans or lend against evidently fraudulent securities, as in the case of share broking firm – Karvy.

The fiscal crunch

The Union government just does not have the firepower to recapitalize banks and indirectly capitalize NBFCs. On top of that Rs 500 billion is now said to be owed to the states as compensation Cess – a carrot the Union government had to dangle to get them to agree to GST which guarantees an annual increase of 14 per cent in GST revenues for states relative to revenues collected in 2017-18.

This appeared manageable then with the economy growing at a healthy 12 per cent per year in nominal terms. With growth declining in constant terms from 8 per cent to 4.5 per cent (8.5 per cent in nominal terms) over the last six quarters this has become an impossible target.

Declining tax revenue

Corporation tax and GST account for 60 per cent of the total budgeted revenue receipts of the Union government (including the states’ share of taxes). The short fall in GST and in Corporation taxes against the budgeted Rs 15.2 trillion is expected to be around Rs 3 trillion (1.5 per cent of GDP). Some of this might be met from buoyancy in imports, courtesy increased tariffs. But stagnating tax revenue shall be the leitmotif of this fiscal.

Counter-cyclical public expenditure boost

Whilst revenues stagnate at marginally above last years’ levels public revenue expenditure and capital expenditure are both 13 per cent higher than last year till October 2019. There is no option except to significantly expand the fiscal deficit. Expectations are for the fiscal deficit to reach 6 per cent of GDP (against the targeted 3.3 per cent). This is where we were in FY 2012. So, it is not uncharted territory.

Brave but chancy gambit

It was a trifle brave of the Union government to attempt to implement GST without first putting in place a large enough back-stop facility to make up for the expected negative shock from a tax reform as transformative as GST. Increasing the GST rates to gather more revenues would be bad tax logic in a downturn.

Leave GST rates unchanged except to rationalize inverted structures

One can only hope that GST tax rates are left unchanged for the rest of the fiscal year barring cases where rationalization to do away with inverted tax rates – tax on the final product being insufficient to recover the input tax credit available from intermediate suppliers.

FY 2020 simplify processes and rate levels to reduce the compliance burden & the aggregate incidence of GST

Any large-scale change in tax rates during the next fiscal should be towards bringing more products into the GST and reducing the incidence of tax. This is the only sustainable way to enlarge revenues without compromising on the competitiveness of make in India.

Multilateral external finance can provide a back stop to deep financial reform

More compellingly, India should approach the IMF for a stand-by facility and the World Bank for budgetary support to stabilize and reform the financial sector through deep reform. Multilateral resources of around $50 billion (1.5 per cent of GDP) can allow implementation of an efficient GST system over the next three years and clean up the clogged balance sheets in the financial sector even as the IBC/NCLT recognize, restructure and resolve the balance sheets of stressed individual corporates. If China and Europe can borrow from multilateral agencies for stabilizing their economies why not us?

Creating a New India needs a new play book- one which melds state power and markets and integrates India deeper into the global economy. We are too big not to matter. Lets’ start using some of that leverage.

Also available at TOI Blogs December 16, 2019 https://timesofindia.indiatimes.com/blogs/opinion-india/external-assistance-can-rescue-the-economy/