governance, political economy, institutional development and economic regulation

Posts tagged ‘15th Finance Commission’

Union taxes are scraping the bottom

old men

The introduction of a 10 per cent tax on capital gains (with effect from April 1, 2018), accruing from the sale of equity, after holding it for at least one year, has generated a great deal of angst. But it is unconscionable that stock market investors who have earned windfall gains of 30 per cent over the past year should mind paying three percentage points out of that windfall as tax.

The government has gone further and “grandfathered” from the tax all equity-related capital gains accruing till January 31 — the day prior to the Budget 2018-19 proposals being made public. The stock market slid by about six per cent thereafter. Future gains will depend upon better profitability in Indian corporates; the options for alternative risk-free returns in developed markets (US treasuries, for example, which are likely to have higher spreads) and growth in India.

Even wealthy Indians dislike taxes

The new long term capital gains tax is not onerous in the present context. But at the heart of the discontent with it, is a corrosive aversion to pay tax, even by the very wealthy. There are good reasons why we are habitual benders of the rule of law.

To find the reason for this national shame, look no further than our political leaders. The Election Commission turns a Nelson’s eye to the yawning gap between actual election expenditures and the income of parties on the books. The recently introduced Election Bonds are unlikely to bring about a transformative reform.

No crony capitalist wants to be identified while buying these bonds from designated banks. Privacy of information arrangements are easily breached, to ferret out who contributed how much to which party.

Demonetisation did throw up big data on the ownership of cash. But following up on suspected tax evaders is quite another matter. The options of bribing their way out or legally delaying a final decision reduces the incentive to respect the rule of law. We are then back to square one. During the demonetisation of November 2016, 99% of the cash came back into the banking system, because tax evaders innovated, on the fly, to escape the tax net.

No wonder then, that the tax revenue at the Central level is stuck at just below 12 per cent of GDP with an additional 10 per cent in the states and local governments.

scraping bottom

Growth need higher public spends

The conundrum is that higher growth needs higher public spends of around 6-8 per cent of GDP on infrastructure, health and education. India has underinvested in these for decades. The real problem is that tax revenues are difficult to increase with 40 per cent of the population being either poor or vulnerable to fall into poverty.

China innovated best-fit solutions to boost public revenues

China had the same problem. Their solution was to decentralise development decision-making within a broad party line of priorities. Local government and local party offices worked together to monetise government assets — principally land — for private development projects. The proceeds from such monetisation generated the resources to finance infrastructure and increase spending on health and education. Without a doubt, the dynamics of working with the private sector also lined the pockets of party and government officials. But both were held to account if there were failures in achieving development targets.

India too is turning away from template solutions

The good news is that India is changing. Prime Minister Narendra Modi has made chai vendors respectable. Our next Prime Minister may do the same for pakora sellers — much derided today by some, who look down their noses, at anything but formal sector jobs. But Shekhar Shah, director-general of NCAER, a New Delhi economics think tank, cautions that formalisation, China style, can be a double-edged sword.

Formalisation of work and rising inequality

Yes, formalisation does improve work conditions and facilitates production at scale. But formalisation is often linked to capital intensive production, which results in disproportionate benefits to those, with access to capital. Unless managed with great care formalisation takes away from rewarding livelihoods for people in the bottom 40 per cent with traditional or low-level skills. President Kagame of Rwanda — till recently a darling of donors, because of his rapid adoption and implementation of the “doing business” type of performance metrics — runs a spotlessly clean capital, Kigali, with neat markets. But this is at the expense of street vendors who were priced out by the prohibitive cost of a licence.

Innovations in public finance lacking

We need to innovate, to increase government revenue, without trying to copy China. The 15th Finance Commission could be crucial in tweaking the transfer of resources to states and local government in a way which incentivises them to generate more local revenues. That is where a significant contribution to aggregate government taxes can be made, as suggested by the Economic Survey 2018-19.

Every Rs 100 spent from the budget can leverage an equal amount from the private sector.

The mantra for government spending is simple. Big ticket public development spending (both revenue and capital) must generate at least a similar level of private investment as extra-budgetary resources. Funding the premia for providing health insurance to 100 million poor families is one such scheme which can change mindsets and provide the forums for productive collaborations between the Central and state governments and the private sector. There is enough fat hidden away in the 2018-19 Budget to fund the scheme.

The National Health Insurance scheme can lead by using insurance permia to establish private or not-for-profit hospitals  

A ready market already exists — in urban and peri-urban areas, covering around 40 million poor families, as private hospitals are accessible. With an annual premia amount of Rs 20,000 crores, a similar sum as private investment can be leveraged in new healthcare facilities. Insurance companies, which will enjoy the bonanza of publicly-funded premia, will need to work with the healthcare industry to enlarge access to hospital facilities in under-covered areas. Similar state-level health insurance schemes should be allowed to lapse. States should divert their funds instead, to primary care, nutrition and public health.

Government should pull out of being the interface with citizens for service provisioning 

The government must, in a sequenced manner, pull out of the business of direct provisioning of services, except in disaster situations. Central,  state and local governments must learn to use the power of public finance to leverage private capital and management. A big push for outsourcing public services might be the only way to fill the financing gap between aspirations and today’s sordid reality.

Adapted from the author’s opinion piece in Asian Age February 13, 2018

Exports – India’s Achilles heel

children airplane

Before the world became flat in 1990 — to borrow the title of Thomas Friedman’s 2004 book on globalisation — developing countries were locked into twin traps of low access to foreign currency and low levels of domestic savings. India’s anxiety about foreign exchange, to fund imports, goes back to those desperate times when export pessimism was rampant and import compression all the rage.

Externally strong but domestic trip-wires aplenty

India has come a long way since then. Standard and Poor’s, the international rating agency (November 24, 2017 rating action), considers India’s external position to be the strongest aspect of its aggregate credit profile. Foreign exchange reserves are more than a year’s imports; external debt levels are modest at around 20 per cent of GDP and the foreign exchange gap between earnings from exports and remittances and the outflow on imports has narrowed to less than one per cent of GDP (2016-17). This is a tribute to India’s prudent external account managers.

Export of goods key laggard

Indian goods exports (excluding services) are 12 per cent of the national income. Manufactured goods (including textiles, clothes and gems) have a share of 76 per cent; minerals and agricultural products account for around 12 per cent. Petroleum products account for the remaining 12 per cent. The dissatisfaction has been with the trend value of exports. Over the last three years, this has lagged GDP growth significantly. The Trade Policy (2015-20) target of increasing our share in world trade from 1.5 to 3.5 per cent is unlikely to be realized anytime soon.

The world in the slow lane is unhelpful


This was never an easy target. World growth is yet to recover from the slowdown. Protectionist barriers, related to the loss of domestic employment and increasing inequality, are finding favour, including in our largest trade partner: the United States. In this unsupportive ecosystem, increasing our share of world trade pie needs a calibrated strategy to target markets and product lines where Indian goods are most competitive. Five initiatives can be considered.

Focus on niche markets, South Asia & Africa

Expanding bilateral trade within South Asia and with Africa should be the first order of business. Some trade is already round tripped via the Gulf, adding intermediary margins, which are denied to both the original exporter and final importer. Trade relationships tie regions together. The Indian Ocean littoral needs targeted attention via specific product chains.

Higher agri exports protect jobs

Primary products, particularly agricultural goods, were overweight in our export basket in the 1980s. Their share has shrunk post liberalisation. Legalising commercial leasing of large tracts of land for farming can revive agricultural production for export markets and protect domestic jobs.

Regional air connectivity initiative can bring export markets closer

The recently-launched progressive policy of regional air connectivity offers an opportunity for embedding export orientation even in hitherto inland, poorly connected locations. Air connectivity adds value to the local economy by kickstarting business around newly-serviced airports which are logistic nodes, connected to hubs in metros.

Long on diversity but short on volume

The Economic Survey 2017 notes that India exports a wide range of products. We export 97 per cent of the top 100 items traded worldwide at the four-digit nomenclature level and 83 per cent at the six-digit nomenclature levels. But the volumes exported are low, at just 1.6 per cent of the total value of world exports.

Joined up policy formulation and implementation needed- Committee for Investment and Trade (CIT)

Prabhu Modi

Exports need to be supported by a trade policy developed collaboratively with state governments. The Goods and Services Tax committee provides a role model. A similar federal trade and foreign investment committee, with all state governments on board, could provide a structure for joint policy formulation and implementation. Consider that meat exports have declined as state governments failed to sanction goons extracting “rents” from the movement of cattle — other than even cows — for slaughter. This also imposed a direct loss in domestic income of $1 billion — small beer, perhaps, in the larger scheme of things. But unnecessarily disruptive for one million people employed in the leather, dairy and meat industry. Significantly larger income loss is inevitable if the 40 million rural households who keep milch animals for boosting nutrition and for profit are dissuaded from doing so.

Link devolution to export effort – 15th Finance Commission

State governments lack incentives to promote exports. The recently constituted 15th Finance Commission could help by tweaking the fiscal devolution to include export effort as a carrot for enhanced devolution. Direct incentives are more empowering for states than Union government-funded schemes. Landlocked states, which have fewer options for exports than seaboard states, could be incentivised for narrowing the gap between themselves and the exports to GDP ratio at the national level.

Realistic exchange rate for ending the incentive to import and push exports

India has, perversely, become a world leader in initiating action under anti-dumping measures. In 2016, out of a total of 145 actions by all countries, India initiated as many as 69 actions. Maybe, if we were to fix the rupee exchange rate more realistically, so many anti-dumping actions may not be needed. Domestic producers are already hurting from the turbulence, admittedly temporary, from the recent tax reforms. But they also remain handicapped by an appreciated rupee. A “strong” rupee is bad for exports. It is also bad for domestic producers, since it makes imported goods artificially cheaper.

We are not the US – capital flows to plug the trade gap is not sustainable

Prudent management of the external account has chuffed investor confidence so much that surging capital inflows (other than debt) have obscured the desperate need to enhance exports to plug the foreign exchange gap, emanating from the trade imbalance.

Watch the oil price closer than your enemy

We have benefited from the continued low prices for imported oil by around $50 billion. But our inflows, via remittances from Indians working in the Gulf and elsewhere, have suffered a collateral damage of $10 billion. The net effect is a benefit of $40 billion.

But betting on oil prices is worse that betting on the monsoon being on time. Our dependence on imported oil, to fuel growth, shall continue, till solar power becomes the primary fuel for transportation. But that future is at least a decade or more away, even in developed economies. In the near term, we must make our trade balance resilient to the possibility of an oil price increase.

agri india

Exports, economic growth and good jobs are organically linked. We are ahead on growth. But the two other legs also need to catch up.

Adapted from the authors opinion piece in The Asian Age, November 29, 2017

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