Sunday Anchor

The inheritance of loss

“I have taken over the reins of the country in circumstances where there is nothing left behind by the previous government. They left everything empty. The country’s financial health has hit the bottom,” said Prime Minister Narendra Modi in Goa last Saturday.

Four days before that, Union Finance Minister Arun Jaitley declared in Parliament, “We stand today in a challenging situation … we have seen a decade of jobless growth. The credibility of the Indian economy has been hurt. Investors had stopped looking at us. Investment cycles, both domestic and international, have been broken. If there has been no investment, there will be no jobs, no revenue, no infrastructure.”

Using official data, Mr. Jaitley delineated the state of the dysfunctional economy: the UPA has left behind a growth rate of sub-5 per cent for two consecutive years. The fiscal deficit is abnormally high at 4.5 per cent of the Gross Domestic Product (GDP). Inflation is at a high of 8.9 per cent. Tax buoyancy has suffered and the tax-to-GDP ratio is 10.1 per cent, below even the budgeted 10.8 per cent.

That the government’s coffers are empty is not far from the truth. In his interim Budget, the then Finance Minister, P. Chidambaram, estimated that the new government would have to devote up to 43.3 per cent of the tax collections in 2014-15 to pay interest on borrowings for the United Progressive Alliance government’s expenditure over the past years. He also estimated that the new government would have to expend on subsidies Rs. 2,55,708 crore, or 26 per cent of the tax collections. These two spending heads — interest payments and subsidies — along with pension costs of government employees, according to Mr. Chidambaram’s estimates, will exhaust 80 per cent of the Centre’s net tax revenues, leaving barely 20 per cent for the new government to devote to governance and development.

A ​June 19 Moody’s report explains the damage uncontrolled expenditures and low revenues have inflicted: the wide budget deficits have kept India’s inflation high and contributed to a widening current account deficit between 2011 and 2013 which heightened exchange rate volatility and interest rates. These trends, says the report, have exacerbated the slowdown in GDP growth since 2011. To determine the sovereign rating outlook for India, Moody’s says it will watch the Budget for measures that address the low revenue base, high current expenditures, and exposure to commodity prices. It warns that in the absence of measures to reduce the fiscal deficit, the future high growth rates many forecast for India may not be realised.

Growth needs industrial and infrastructural investments

In less than four weeks’ time, Mr. Jaitley will present the Modi government’s first Budget, which, as Moody’s says, will give cues on how long and painful the path to economic recovery will be.

Both the Prime Minister and the Finance Minister have said that the problems of the Indian economy being so deep and wide call for “sacrifices” in the immediate term. They have indicated that it won’t be before a couple of years that a turnaround would be discernible.

Growth, especially the kind that will create jobs, needs industrial and infrastructural investments and new factories. For this, the Modi government must, as it has already indicated it will, put project clearances on the fast track, taking forward the UPA’s Project Management Group (PMG) that was well received by the industry. The Confederation of Indian Industry (CII) has estimated that projects estimated at Rs. 6.5 lakh​ crore are waiting to happen in the States that can get going by replicating the PMG-style push.

Transaction costs

Cutting paper work and streamlining procedures and approvals would lower transactional costs and make manufacturing competitive. According to the CII, whereas transactions costs in China constitute 3-5 per cent of the total cost of manufacturing, in India, this is 10-12 percent.

The revenue crunch will make it tough for the Modi government to consider tax incentives for spurring select sectors. Before giving in to demands for “growth-promoting” tax breaks, the Finance Minister might want to seek an analysis of such hand-outs in the past. Official data show that India forgoes Rs. 74,613 crore, or 0.74 per cent of the GDP, every year in just corporate tax incentives. Include excise duty exemptions, and this figure rises to about 2-3 per cent of the GDP. Now is the time to ask how many new jobs and investments these handouts have yielded.

Because of the exemptions, the average effective tax rate in India is merely 22 per cent. The Finance Minister would not be surprised that among the lowest taxed category are property developers and estate agents who are paying at the rate of 19.97 per cent and 18.64 per cent. The politician-real estate nexus has cost the fiscal, but has it contributed enough to growth?

Mr. Jaitley must make this the criterion for giving in to every demand for sops.

Rate rider

But ultimately none of the investments or projects will fly unless investible funds become affordable. Wide fiscal deficits and inflation have made the Reserve Bank of India keep interest rates high for too long. And so, for investments, the Modi government will have to start with cleaning up its own Budget books and attacking inflation first.

The dysfunctional economy’s turnaround is made tougher by new challenges that lie outside the Modi government’s control.

Even if the inflation-attacking steps such as exports restrictions that the Modi government recently announced do cool onion and potato prices temporarily, addressing the persistent issue of price rise needs structural changes. The close to 10 per cent food inflation will ebb only with an expansion in assured supplies. This will need Mr. Modi to deliver on his manifesto promise of putting agriculture on a high growth path.

Mr. Modi hit the bullseye in Goa last weekend: the good days are still a faraway dream.

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Printable version | Apr 22, 2021 5:52:05 PM |

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