Debroy tells Business Today's Joe C. Mathew that a stimulus is neither feasible nor desirable and a clear and credible roadmap for fiscal consolidation is the need of the hour. Edited excerpts:
How bad is the economic slowdown? Is the lack of structural reforms the root cause?
This year we are going to have GDP growth of about 5 per cent. I expect next year to be about 6 per cent. If one is talking about structural reforms, there are all kinds of people, particularly from my fraternity, who keep coming up with an agenda for structural reforms. If you look at those items, they have been on the reform agenda since 1991 or 1993. So, no one is denying the importance of those structural reforms. They have been pending, and there are reasons for that. Most of the pending reforms are actually state subjects, and there are legislative issues with some others.
There was a period when India grew 9 per cent for four successive years. If you look at those years, the export to GDP ratio was about 20 per cent, and exports grew some 15 per cent in dollar terms. A back of the envelope calculation would say exports added at least 3 per cent to GDP. If you take out that 3 per cent, you are doing 6 per cent (in GDP growth).
There is no reason to suddenly expect that exports will take off. At 6 per cent, exports will depend on the exchange rate, the supply side, and the demand side. On the supply side, the government has taken measures. On exchange rate, unfortunately, there are pressures, because if you mess around with the exchange rate, it would be seen as currency manipulation. So, the story is that in exports, you can't do very well. You are back to 6 per cent. A lot of people say it doesn't matter, we have plenty of indigenous sources of growth, so we should be able to do 8-9 per cent. But all-India growth rate is an aggregation of state-level growth rate. If you take out defence and railways, 90-95 per cent is state. Therefore, if half the states are doing 6 per cent and some are doing more, we are on a band of 6-6.5 per cent in the next couple of years. Maybe inching up to 7 per cent, but that is the kind of band we will be in.
What has been the impact of some policy interventions by the government?
Several of the government's initiatives have been an attempt to clean up the system. These are also structural changes, depending on how you define structural change. If I have an old way of doing business with a nexus of the politician, the businessman and the bank manager, and I am breaking that, that is also structural. If a lot of businesses function on the basis of kutcha receipt and I am breaking that, that is also structural. It's a myth to say that structural reforms do not have short-term growth costs. They lead to efficiencies in the longer run, and they have led to a short-term growth cost. It is not quantifiable, but still, if we are talking about the possibility of a 6-6.5 per cent growth band and a current growth rate of 5 per cent, maybe that 1 per cent is where we are bearing the cost of structural growth.
Another point, rarely stated, is that financialisation has to be in tandem with what is happening outside, whether you argue about the lack of financial penetration or agree with the creation of a bond market. In the last two decades, growth of the financial sector has been disproportionately high compared to growth elsewhere. Many say that the financial sector is getting a reality check; you cannot expect the financial sector to grow like that.
The Finance Minister has been hinting at a fiscal slippage.
Everyone is expecting a fiscal slippage. Even the markets are expecting it. The reason is simple. Fiscal deficit is expressed as a ratio of GDP. Revenue growth is not as high as budgeted. So, even if I don't compress my expenditure, the ratio will be lower. Whether it is going to be 3.8 per cent or 4 per cent, I don't know. We will have to wait for the Budget numbers. No one will probably bother too much if there is a credible roadmap for fiscal consolidation at the time of the Budget. I don't think there will be a violation of the FRBM (Fiscal Responsibility and Budget Management) Act as such.
The critical issue is that having stated that this is the fiscal deficit, and this is the plan to reduce it in three or five years, the Budget should very clearly have the fiscal map - one that is believable, that is credible.
What should be the Budget's thrust?
Traditionally, we have looked at the Budget because it announces changes in tax rates and changes things in expenditure. But today, expenditure is almost frozen in the short run. Since 2014, centrally sponsored schemes have also been on the basis of a basket agreed upon with states in a committee chaired by the then Madhya Pradesh Chief Minister Shivraj Singh Chauhan. These would have normally come to an end on March 31, 2020, but since the 15th Financial Commission has got a six-month extension, these would also be extended. So, expenditure is more or less already known.
On taxation, indirect taxes are under the purview of the GST Council.
The government has already stated clearly that it is going to privatise. But it is a process, and there is a timeline. For the budgetary process, I need receipts. For most public sector enterprises (PSEs), the most valuable asset is land, but land typically is not owned by PSEs, but leased out by states.
Essentially, one is looking at the Budget not for tinkering, but in terms of what the government is planning to do - on deficit, fiscal consolidation, privatisation... all of that.
What about direct taxes?
If the corporate tax rate has been reduced, it stands to reason that at some point, personal tax also will be reduced because unincorporated enterprises pay personal income tax. However - and this a big however - on the corporate side, you have a choice of tax with exemptions or (lower tax) without exemptions. Most personal income tax payers want both. But, logically, both cannot happen. FM is the best person to decide this. The fiscal situation is a bit difficult now, but whenever rates reduce, it will have to be along with withdrawal of exemptions.
How can the economy be revived? In what ways can tax collections be increased?
The slowing economy will remain so for some time. Anything artificial we try can be counterproductive. I may decide to give sector specific exemptions, but these are counterproductive as they lead to distortions. As an economist, I say let us not have any sector specific exemptions. There is a certain macro, and there is a negativity that is over and above that. Data is two or three months old as it comes with a time lag. There are sufficient indicators to show that the worst is over. Not enough months have passed for it to be robust enough, but several indicators say that from November, there is improvement. I am stretching it too much as I myself said data is not robust at the moment. Give it another quarter or two, GDP will grow up to 6 per cent-plus from 5 per cent. The moment that happens, youll find some negative sentiment - which is more than what is warranted by the actual state of the economy - going away.
Is a tweak in GST needed?
When GST was introduced, it was supposed to be such that the average rate could be revenue neutral. And at that time the assumption was that the average revenue neutral rate would be 16 per cent. Today it is 11.6 per cent. So obviously revenue has taken a hit. There have been reports countered by the FM that GST rates are going to be hiked. A hike in GST rates will lead to further slowdown. It is a realignment of GST rates that is needed; 11.6 per cent is not tenable. It is primarily happening because compensation has been guaranteed to states and states have no problem having a large number of items in the zero per cent category. All the rates should be rationalised, though not in the midst of the slowdown.
Revenue compensation has created a perverse incentive and many state finance ministers want the present condition to continue indefinitely. That is an untenable proposition. This is for the GST Council to decide.
Shouldn't we have more items under GST?
Eventually, one would want everything under GST. The most obvious things being fuel and real estate, and I would even say liquor and tobacco. But GST (adoption) has taken many years in many countries. So GST will take many years (to stabilise). It cannot happen overnight.
So you don't want to raise GST rates, or tinker too much with the economy.
Yes. It will return by itself.
What about asking banks to transmit rate cuts to consumers?
I do agree that the real interest rate is too high. Therefore, the real cost of capital is too high. On the same note, for inflation we have got a band of 4-6 per cent. I don't see any serious inflationary cost if one says let's recognise this is the band and that monetary policy has been unnecessarily tight even though central banks are overly cautious.
We have a problem with the financial sector, banks as well as NBFCs. We also have a credibility issue. We also have an issue because the RBI has an imperfect regulatory oversight over them. So this is a medium-term thing. The limited issue that the government can look at is to identify specific NBFCs and ensure that they don't go under. The NPA (non-performing assets) problems of NBFCs can't be as large as that of banks.
But in lending rate, there is a risk-free lending rate, and a risk premium. So, the rate at which a bank will lend will differ. The band of the risk premium has increased. This is over and above the core real cost thing. There is risk aversion, so the lending rate is high. That really is a commercial decision. The problem with what I say is that even if it is a public sector bank, it is a commercial bank. What business do I have saying lend at this or at that, to so and so. It is no different than saying give loan to so and so.
Do you want to set Budget expectations low from the consumer and industry perspective?
Yes. Industry wanted a reduction (in taxes); then they quietened down because they figured that tax rates with exemption were low enough. Similarly, in personal income tax, if the FM could say I am giving you a choice - present rates with exemption or lower rates without exemptions - most people would go for exemptions. If you remove the exemptions, there won't be much of a revenue impact, but there would be political flak.