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Need to inject demand into the economy, says India's Chief Economic Advisor Arvind Subramaniam

Need to inject demand into the economy, says India's Chief Economic Advisor Arvind Subramaniam

Chief Economic Advisor Arvind Subramanian's mid-year analysis of the Indian economy indicates that while the country has done well in macroeconomic stability, a lot more needs to be done to boost growth and investments.

Arvind Subramanian, Chief Economic Advisor (Photos: Shekhar Ghosh) Arvind Subramanian, Chief Economic Advisor (Photos: Shekhar Ghosh)

Immediately after taking charge as India's Chief Economic Advisor (CEA) in October 2014, Arvind Subramanian had identified macroeconomic stability and spurring investments as top priorities for the Centre. CEA's mid-year analysis of the Indian economy indicates that while the country has done well in macroeconomic stability, a lot more needs to be done to boost growth and investments. In an exclusive interview with Business Today's Joe C. Mathew and Sumant Banerji, Subramanian explains why India's growth indicators are mixed. He also asserts that the Goods and Services Tax (GST) can be the best enabler of economic growth. Edited Excerpts:

The mid-year economic review is giving mixed signals in terms of growth...

Let me first emphasise on macroeconomic stability. Inflation is down, our external situation is good (due to increase in foreign exchange reserves and comfortable level of current account deficit), and the quality of our expenditure has improved. We are going to more than stick to the (fiscal) target set for this year, not just at the Central level, but also at the state level. There is growth in indirect taxes. So, macroeconomic stability is there. At the same time, while there is recovery, it is not easy to judge the pace and the breadth of the recovery. You look at the tax front. Indirect tax has done well, but direct tax has not. Consumer loans have gone up, but industry loans are going down. So, it is mixed.

The reason for this is favourable (low) oil prices that helped boost growth. Low oil price means more money in the pockets of the people. The government has more money, firms have more money, so they spend. But then, exports have pretty much collapsed because of what is happening internationally. Private investment and exports are weak. It is basically consumption and public investment driving the economy.

Given the trend, what will be its near-term growth impact?

Our position is quite remarkable especially if we compare it with other countries. But then, the economy is soft. Looking ahead, the growth outlook and the fiscal outlook are challenging. While we need to keep doing all the things on the supply side, we also need to look at where the demand is going to come from. That's what we are saying through the fiscal and monetary policies.

Most of the stakeholders believe that it might take another 12-24 months for private investments to pick up in real earnest. What is your view?

It's true that private investments have been weak. The growth of real private investment is 2-2.5 per cent. When the economy was booming, private investment growth was 8-9 per cent. We can't give a date to when that level of growth will happen again. I do think it is a slow process. What adds to the challenge is that a lot of it is related to the legacy of bad assets, and cleaning that up is going to take some time. That's why we say that you cannot expect private investment to recover quickly; we need to think about how to inject demand into the economy.

India's Chief Economic Advisor (CEA) Arvind Subramanian

"The beauty about the GST is that it is selfenforcing. It goes after corruption, but not in a heavy-handed manner like other legislations"

You are highlighting the importance of stepping up public investment. Do you think the government should focus more on spending at this stage, even if that means a slight slippage on fiscal prudence?

These are all decisions to be made in the context of the next Budget. What we are saying is that we are committed to a certain fiscal path, and many of the reasons why we set that path remain valid. Government has to have credibility and a medium fiscal target. Borrowing costs of the government are very important, but at the same time, the circumstances have changed and there are other considerations now. So the question is about how to balance that. Those are the decisions to be taken.

Indirect taxes have picked up, but direct taxes have not. Why?

Let us be clear. If you look at the headline 35 per cent increase in indirect taxes, it is a bit misleading because this includes the revenues from new taxes too. If you take that away, the growth is still quite good at around 10.5 per cent. I think the growth projection we have made in the case of indirect taxes, at 18 per cent or so, was quite optimistic. If you look at actual performance on that basis, there is a slight shortfall. Similarly, we find that some of the increase in direct tax collections was because of high corporate refunds last year. Stripped of that, direct taxes are not as strong as indirect taxes - they are probably growing at 6-7 per cent. And that is consistent with the fact that the corporate sector has not been doing very well; their profits have not been increasing much.

The government has not been able to pass the GST Bill in the winter session. How big a disappointment is it for the reform process?

Of course it is disappointing. But I am still hoping that it gets done sooner rather than later. It's true that passing GST is very important, and that passing GST will not solve all the problems. We need to introduce it for many reasons as spelt out in the GST report we have prepared. At the same time, there are so many other things that also need to be done. So, reforms are a multi-dimensional, multi-pronged effort.

Assuming that GST Bill gets passed in the Budget session, by when can it be rolled out?

If it gets passed soon, technically, we should be able to roll out GST by September 1, 2016. That is because GST is a transaction tax and you don't have to wait for the next calendar or fiscal year to collect it. So, if we can move quickly, we can still aim for September 1 (deadline).

Let us consider the other extreme. What if GST does not get passed at all? To what extent can the elements of GST be implemented through executive action in such a situation? Say a half-GST?

That's certainly on the agenda. That's being discussed.

Introduction of GST has a lot to do with pruning of exemptions. Do you think the Centre and the states can come together on this account?

The agreement in the empowered committee is that since the Centre has a much bigger exemption list than the states, it has to bring that down to the level of the states. That is something the Centre can do.

India's Chief Economic Advisor (CEA) Arvind Subramanian

"FDI is doing well and that is the kind of capital we want, not the hot money that comes in and goes out"

You have stated that the government expenditure has increased in sectors such as agriculture. Can you give a Centre-state break-up of the expenditure?

In the case of public investment, we have calculated that the ratio has been 60:40 - 60 per cent Centre and 40 per cent states. We have not been able to do a similar break-up in agriculture because of some classification issues in the data, but the good thing is that, finally, it is India as a whole that has to spend, and it seems to be happening.

So, going ahead, we should expect states to spend more?

That is a fair expectation. If you devolve more untied money to the states, they have to spend on important policy priorities. It is a tricky question as to how much the Centre should influence that. After all, the whole point of decentralisation is that states should get to determine their priorities. But then, we also have a sense that some subjects are very important and the Centre should try and influence the states to focus on such areas.

The critics of the GST say that it takes away the autonomy of the states. How do you react to that?

That is not quite right. Look at international examples: the Centre collects tax in Australia; on the other hand, Canada (like India, today) gives powers to both Centre and states. My honest view is that the Indian GST, if passed, will be the cleanest dual VAT (value added tax) in large federal systems. The design of the Indian GST is very nice as it balances the two. In the current version, the states can still tax alcohol and other things like electricity. So there is lot of freedom, maybe too much freedom. That's why it should get implemented quickly.

"Looking ahead, the growth outlook and the fiscal outlook are challenging"

It is often said that GST can turn black money prone sectors such as liquor and real estate more accountable. By keeping liquor and real estate out of GST, are we not really killing a chance to address some of the core problems of the Indian economy?

Real estate, gold and alcohol should be in for all the reasons. Normally, where there is a law, and if you don't abide by it, there are punitive measures. The beauty about the GST is that it is self-enforcing. It goes after corruption, but not in a heavy-handed manner like other legislations. GST can only be better if there are more sectors. But we don't want the best to become the enemy of the good. We cannot say we will have a perfect GST and we will implement it. So something that's good, but not perfect, gets implemented, and you learn from your experience, and you change. That's how GST implementation should happen in India.

Your report points out the possibility of a short to medium term inflationary pressure when GST gets implemented. Do you expect inflation to be too high?

First of all, if you look at a revenue-neutral rate, there should not be any price increase at all. We have carried out a sector by sector assessment of what could be the impact. Our assessment is that the impact on inflation will be very minimal. That's partly because the existing CPI (consumer price index), a huge part of it, is taxed at very low rates. So, by definition, there will not be much increase. But there could be some sectors where this could happen. We know there will be difficulties in the early stages of implementing GST. It is a new thing and involves a lot of systemic process changes. Inflation could be one issue, compliance could be another. So the question is how to minimise these teething issues.{mosimage}

How can it be done?

We have said two or three things. One, we must get a revenue neutral rate, but on balance it is probably slightly better to err on the lower side than the higher, because you can always increase the rate later. To maximise the chances of GST becoming a success, it is better to keep the rates at a lower side. If there is a shortfall, we can always make up, or we can make up by increasing taxes over time. We should realise that teething trouble will always be there, and we must not overburden that. If revenue goes down in six months of introduction of GST, you should not be saying 'GST is bad'. You need to evaluate this after a certain period of time, say after 12 to 18 months. These are very important to the design of GST.

"We are very well cushioned to absorb the impact (of the Fed rate hike). We have reserves... Also this hike could be very gradual"

How disappointed will you be if the one per cent inter-state tax remains in GST?

I will be very disappointed. I think that to 'Make in India', you need to make one India. It (the inter-state tax) violates the spirit of GST. It is a consumption tax, not a production tax. The one per cent will be a production tax and is against the concept of GST.

Some industries are cyclical. Will GST leave some room to do something for sectors?

You don't want tax rates to go up and down in a cycle. You cannot have tax policies in a cycle. One has to figure out other ways to help industries that are going through difficulty. But not through changes in GST rates.

What is your personal opinion about the Congress' demand to cap the rates in the Constitution Amendment Bill?

We have said in the report (on the Revenue Neutral Rate and Structure of Rates for the GST) that it is very problematic. No Constitution says that a tax should be fixed at 18 per cent. There may be situations, like a national calamity, where you are compelled to raise this rate. So, to put it in stone for all times is not correct. I think from all points of view, it makes little sense to put this in the Constitution; no country does that.

Did you factor in any growth impact that GST will bring in while arriving at the rates?

No. Just to be on the conservative side, we said we are not going to factor in any growth impacts. The truth is that it is not easy to measure what will be your growth impact. But we did factor in some compliance benefits of GST.

Why have you recommended the inclusion of health and education under GST? How does it serve the government's social objective of providing affordable healthcare and education?

We have actually done some very deep calculations on this. You generally want to exempt sectors which are consumed a lot by relatively poor people. It turns out that most of these health and education services are consumed by richer households. That's the reason we said that private medical services and private medical colleges should be taxed. Why should they be exempted? It was based on that analysis, and not on any philosophy or ideology.

What will be the impact of the just concluded global climate change agreement and WTO ministerial meeting on India's medium and long-term growth plans?

I think the climate change deal is a very good step forward, where all countries came together and realised that it is an important global objective. All countries have made contributions. Not a perfect agreement by any means, but I think it is a step forward in the right direction. I am still studying the impact of WTO, but I think that the agreement itself reflects that there are a lot of differences among member countries.

People talk about WTO agreement's adverse impact on agriculture, on export growth, etc?

This is not the time to go into it, but I think many of these things are vastly exaggerated. At some point, if I find time, I want to write about it.{mosimage}

How crucial is the Bankruptcy Bill that has been tabled?

It is very important for the medium term. One of the big problems for companies in India is exit. But the question is whether we need to do more to help the existing stock of assets which are stressed. That will help solve future problems.

Many of these assets have to be sold, but there are some assets which should be made operational. We need that expertise. So, it is not about selling assets alone, it is about assets coming back to life again. That also is part of the problem.

How do you see the US Fed rate hike?

We are very well cushioned to absorb the impact. The markets have been expecting that for a long time. We have reserves as cushion. Also, this hike could be very gradual.

While there has been a surge in FDI, the Indian equity market has also seen the third largest FII outflow in Asia. Is it a worrying factor?

The net FDI has been doing quite well. There were some capital inflows in the first half of the year and some reversals. This is what the capital markets are all about. They get over-exuberant and then over-pessimistic; it is part of the game of being integrated with the international capital market. So, instead of following this on a month-by-month or quarter-by-quarter basis, we should look at the broader message. I think there is a lot of investor interest in India. FDI is doing well and that is the kind of capital we want, not the hot money that comes in and goes out. As long as we can keep attracting the real good stuff, that's all we need.

Inflation has been down. But food inflation is still up. How can that be tackled?

On the food side, cereals have not been an issue. We have stocks. The problem is with pulses. We have begun to address this by increasing the minimum support prices for pulses quite a bit, combining that with procurement. The other thing is how we create a common market. These are the two distinct challenges and both will have to be addressed to handle food inflation.

Published on: Jan 16, 2016, 1:41 PM IST
Posted by: Gurpreet Kaur, Jan 16, 2016, 1:41 PM IST