How To Steady A Wobbly Economy
Team BT January 7, 2020
Budget 2020 will be presented in the shadow of one of the longest spells of slowdown - six quarters so far - in more than two decades. That poses a host of challenges for Finance Minister Nirmala Sitharaman as slowing tax collections have left practically no leeway for fiscal stimulus out of the government's balance sheet. On top of that, exports have stagnated, private investment has ground to a halt and consumption is still reeling under the effect of demonetisation, GST, lack of jobs and public sentiment. Just public expenditure seems to be driving the economy for now.
Business Today hosted a Pre-Budget Panel Discussion to debate how to steady a wobbly economy. The panelists were Gopal Krishna Agarwal, National Spokesperson of BJP on Economic Affairs; Sumant Sinha, Chairman and Managing Director, ReNew Power; Rahul Garg, Senior Partner, Tax and Regulatory, PwC India; D.K. Joshi, Chief Economist, CRISIL; and Dinesh Kanabar, Founder and CEO, Dhruva Advisors. The discussion was moderated by Rajeev Dubey, Editor, Business Today. Edited excerpts:
Rajeev Dubey: How do you see the economy in 2020? We are in the middle of one of the longest spells of slowdown - six quarters and counting.
Sumant Sinha: The ongoing slowdown is partly cyclical and slightly structural. Several things have happened over the past one-and-a-half years that hit economic growth. But now when I look at metrics coming out, my sense is that we are bottoming out. In automobiles and power demand, the rate of deceleration has decreased. We'll see a pick-up. On the headline rate, economic growth will be better in 2020. How much better, only time will tell.
The government has taken several measures that are long-term in nature. It is not as concerned about short-term results such as fiscal stimulus, as it is to get the economy structurally back on track. It will take time. One key metric moving in the right direction is NPAs (non-performing assets). It'll put more money in banks. And with the decline in provisioning, we will see more lending from banks. This will have a big impact on the economy. Coupled with front-loaded investment programmes (the recent infrastructure announcement), we should be looking at better economic growth going forward. Finally, if global factors are supportive, we'll see faster growth; otherwise it will hover around 6 per cent.
Gopal Krishna Agarwal: Challenges are always there in the economy. The government handled legacy issues between 2014 and 2019. At present, macroeconomic parameters are fine. We are in a position to leap forward.
There are global issues, too. Petroleum prices, China-US trade war, for example.
The government is focussing more on domestic demand. Export-oriented growth model may not work for us. We have to preserve our domestic market. The government has made structural reforms such as RERA and GST. We are moving fast on digital platforms also - RuPay, BHIM, FasTag. I accept that there are some implementation challenges. Once these are tackled, the economy will move ahead.
There are twin risks in the economy. We have tackled the supply side of credit availability through bank reforms (restructuring, recapitalisation, focus on repo rate), but it is not sufficient. There are risks from lenders' point of view too. The government is trying to meet consumer demand through infrastructure investment, but investment zeal is required from the private sector too. The economy cannot run on government investment alone.
Borrowers and lenders both are risk averse. We are working on decriminalising Company Law, changing the Insolvency and Bankruptcy Code (IBC) and bringing the FRDI (Financial Resolution and Deposit Insurance Bill) resolution mechanism on financial institutions. Negotiations on RCEP (Regional Comprehensive Economic Partnership) and FTA (free trade agreements) are going on. The government is open to suggestions.
Rahul Garg: Economic indicators show that the growth is not as good as it could be for a country like India. The growth rate may still be acceptable by some global standards, but not by the standards that India aspires for its economy. On a structural basis, fundamental things have been done over the past six quarters. So, we shouldn't get impatient. Seeing a plant everyday doesn't make it grow any faster. If you nurture it well, it will become a strong tree. A balance between long-term and short-term is needed. The balance in the current regime is leaning towards long-term. There is a lag, but with some supportive measures, we should be able to create a strong base to catapult to the next level.
D.K. Joshi: Let me point out three indicators which are turning a tad positive. The PMI for manufacturing at 52.7 in December was the highest since July. And the fact that food inflation has started rising itself is bad news from interest rate perspective, but good for farmers. The terms of trade for the farming community are becoming somewhat more favourable. The third factor is that the pace of deceleration in auto sector and exports is slowing. If you combine all these, it gives a sense that things are somewhat improving. But the picture on many other parameters remains hazy.
The pace of recovery in 2020 will be very weak. I don't think it's going to test the levels of 7 per cent (the trend rate of growth) any time soon. The financial sector is going through a clean-up phase and the cost of that is slow growth. We experienced that in the late 1990s and early 2000s. The two key instruments for firing up the economy -monetary and fiscal policies - have little juice. So, there's little space for the government to spend its way out of the slowdown next year.
The monetary policy is not effective as transmission is weak and banks are not willing to lend. The reason for that is weak sentiment and risk aversion. Unless these are sorted out, a strong recovery is unlikely.
The 2019/20 GDP is expected to be around 5.1 per cent. So the base is very weak. That will give a statistical boost next year.
In the medium-term, there are three drivers that are emerging. The corporate sector has deleveraged. It will continue to do so. And with the corporate tax rate cut, whenever the cycle turns, their ability to push investment would be better.
The second driver is the banking clean-up. The ability of the financial sector to lubricate the rest of the economy would improve.
And finally, the reforms such as GST have not added to GDP so far; once that is streamlined, it can lead to efficiency-led spurt in growth over the medium run.
Dinesh Kanabar: There are two parts - what the numbers such as GDP are talking about and the other is sentiment, that is, if the investment cycle is reviving. Recently, I happened to converse with promoters of two large conglomerates who are in steel, power, coal etc. They said they expect the next quarter to be better. If there is definite improvement in sentiment, I see hope.
While some companies are yet to take advantage of the corporate tax cut to 25 per cent, they will soon move to the new regime. It will release more funds.
Besides, the effective tax rate of 17 per cent for manufacturing companies is attractive enough for many US multinationals facing heat in China to move their manufacturing base to India. Through IBC, a great platform, cases such as Essar and Ruchi Soya have put smiles on the faces of bank CEOs.
Dubey: Can we trigger growth through the four engines of the economy - exports, consumption, private investment and public investment - considering the first three are dysfunctional?
Garg: In exports, the global economy will stay like this for some time. But that does not mean that we cannot push exports further. The reduction in the tax rate to 17 per cent, hoping that American and other western companies would get attracted to do in India what they were doing in China, is a good bet. There can be state-Centre level coordination to create clusters. That would not be short term; it may be mid-term and a good way of promoting exports, because you have provided an economic playing field in the form of lower taxes. If you are somehow able to offset the higher cost of doing business in India by clustering the place together, you may be able to raise exports, not necessarily those led by Indian businesses, but those led by investments.
In public investment, we need to focus on where the multiplier is higher and keep the balance right, be it agriculture, tourism or construction. But where are the funds for public investment? Relaxing FRBM (Fiscal Responsibility and Budget Management Act) could be considered.
In private investment, what is the sentiment? Long-term confidence is needed. Currently, beyond the policies, there are so many things on the ground where the confidence of business is shaken. Look at the recent announcement of the government on the corporatisation of ordnance factories. The whole thing is such a mammoth exercise. Everybody in any industry can participate in the projects rolled out. There is a good opportunity and market but the sentiment has to change so that people move into these with confidence.
India has a great consumption story. Having tackled many things from the supply side, this Budget will also look at things from the demand side. You need to leave money with the people rather than with the government. If DDT (dividend distribution tax) goes away, you have 20 per cent more money with the people who are shareholders. But, private investment also depends on the rigour of implementation of the plans.
An area where India has great potential is to be a financial services or a services hub. Whether we are able to export the manufactured goods or not, we can definitely export services. We have the track record of IT services. We can do it for financial services and other services as well. When the global services of a company are being rendered from India, especially from the management side, do those companies become liable to pay taxes in India? Making India a services hub for exports is a good bet. We have an amazing number of programmes for start-ups.
Dubey: Are you suggesting a tax cut?
Garg: No, not tax cut. It is basically about leaving money in the hands of people. Change in tax slabs is one option. At the time of paying tax, a person should be able to exercise his option of making an investment in government bonds, or paying taxes.
In indirect taxes, we are not in a position to reduce the tax rate. Instead of multiple tax slabs, look at combining some of them. This month over April (April-December 2019), there has been an 11 per cent increase in numbers - this is a great sign that even when tax collection has not increased, the tax payer base for indirect taxes has increased. Some of this is partly fuelled by GST bringing in more transactions into the tax net.
Agarwal: On the export side, we need to renegotiate many of the FTAs. They have definitely created certain problems for domestic industries-small, medium and large. They have to be renegotiated. We should look at the way Chinese manufacturing is shifting so that our domestic industry can grow into the global and regional supply chain. We have to develop clusters of industries which can integrate because now the industrial structure across the globe is more of a collection of various countries.
On public investment, disinvestment has to be taken. There is no alternative. If you talk of Air India, the problem is not that it can go through IBC; it has a debt of more than Rs 50,000 crore. The issue is who will take that cut? If you remove debt from Air India, it has a full chance of being a viable, running airline. IBC is effective only if an entity is interested in running the business. If IBC is seen as an instrument to recover money, it will fail completely. Public investment will come through disinvestment and fiscal expansion.
On private investment, company law needs immediate de-criminalisation. The (Company Law) Committee has given its report with 46 recommendations. The sentiment in the private sector is being hurt because white collar activities are being made into criminal activities.
The bond market is required because we don't have private capital. Only bank loans will not help. The focus of the whole financial sector is only on equity markets. Globally, financial markets have more vibrancy with bond markets.
Private investment can come through a level playing field. But land is an issue. Cost of land is too high. In our projects, 50-60 per cent of the cost is land.
Joshi: There are three sets of factors that are responsible for slowing exports. One is the global environment which is becoming more inward looking and outside our control. Two, we've lost competitiveness. Three, GST has also created hassles for exporters, particularly because of the refund issue. That hit hard because of the tight liquidity scenario. Part of it has got corrected but it needs to be streamlined further.
To be competitive, you cannot have a closed mindset; you will have to look at treaties like RCEP. That will allow you to be part of supply chains. The fear from RCEP is that it will flood us with imports. That's because we lack competitiveness. That needs to be addressed. It's not something we can do in a day. It requires reforms in land, labour, and many facilitations. India ranks 163 in contract enforcement and that needs to be the focus of improving ease of doing business and promoting manufacturing and exports.
Finally, since the government has come out with such a large plan for infrastructure spending, without the active role of private sector, it will be very hard to deliver on that. For the last four to five years, the share of private sector in infrastructure has been sliding down. That needs to be reversed by balancing the risk sharing mechanisms between government and private sector.
Kanabar: We don't need new initiatives. What we need is implementing what's already on the table. There is an issue with the bureaucracy. There is more power with the bureaucracy than it has probably ever had in the past. There is also reluctance on the part of bureaucracy to make decisions.
The 17 per cent tax rate (for manufacturing companies) is a great platform. Somehow, as a nation, we have understood that lowering the rate of tax is tax reform. It's an important aspect but a tax reform is all about implementation. And I still see a lot of gaps out there. For example, revenue officers are chasing targets. In that process, they make additions. One of the reasons behind reluctance to make new investments is this inherent fear that everything we do is being challenged. There is nobody to help in the process but everything is being questioned. There was a committee set up for Direct Tax Code. How does one resolve tax disputes?
I will narrate a specific instance. Immediately after the corporate tax rate was lowered, I met the global CEO and CFO of a Fortune 500 company, which has a huge manufacturing base in India. I told the CEO that with reduction in rate of tax, I was sure he would expand their manufacturing base in India. He looked at the CFO with a smile and the CFO produced a paper with some 62 long-standing tax litigations that they had.
If we are able to successfully implement this 17 per cent tax regime, then people will use India for manufacturing. The moment you do that, you're creating employment, capital investment and you're going to kick-start the economy.
In the last Budget, we saw a 43 per cent rate of tax. For corporates it was reduced to 17 but for individuals you've gone all the way to 43. There is a particular point of time where people may start looking at ways and means of avoiding a higher rate of tax.
Sinha: One issue is of interest rates, which is not in the hands of the government, but of the RBI. When we have inflation of 3.5-4 per cent, we are supposed to have an accommodative interest rate policy. Yet our repo rate is 5.15 per cent. Why should we have a leverage of 2 per cent when we have a slowing economy?
If transmission is not happening then offer larger cuts. We have had an interest rate reduction of only 1.35 per cent. I can't understand that. At this point we should have a repo rate of 2-3 per cent. That will certainly drag down the cost of borrowing, which is constraining both investment and consumption demand.
There has been a big improvement in corporate taxes. There has to be further tinkering to revive consumption demand, whether through higher fiscal deficit or some other way.
There has to be some sort of massive privatisation drive. Privatisation of a strategic nature takes time. If you start something now, it may be completed by the end of the fiscal. The stock market is doing very well. So, we can also privatise through the stock market.
Dubey: Taking cues from the past five-and-a-half years of this government and the finance minister's recent moves, what is likely to be the orientation of this Budget?
Agarwal: Some of the areas that are important with respect to the Budget, and which the finance minister will definitely focus on, because everybody agrees that the government needs resources for the outreach and for the infrastructure investment focus include bond market reforms and debt management. We don't have a vibrant debt market and the government needs it to supplement its own investment. We have even been talking about fiscal expansion as a need of the current situation because of resource constraint. Reforms and disinvestment of PSUs is one major resource area which will see more focus, whether it is Air India, BSNL or any other company. The problem with private investment is seed capital requirement. IBC and NPA issues have deleveraged the corporate sector.
We need certain measures for capital formation in the private sector. In sectoral initiatives, first time on the party platform, we have taken a big initiative, to meet individual sectoral leaders and associations, and we are compiling their requirements to find out the areas where policy decisions can be taken outside the Budget. Some sunrise sectors such as pharma, where India has a lot of potential, are facing various issues, which can be tackled by the government, without facing any financial obligations. Even the automobile and real estate sectors can have sector-specific reforms. We have identified the sectors that we think have strong potential for growth. We will compile those suggestions and send them to the finance minister and the government. Resource generation, disinvestment, bond market reforms, debt management and fiscal expansion are also some of the issues that we are looking at, along with some measures of private capital formation like reforms in the company law. The government wants to bring changes to company law because we find there is a bottleneck in private capital formation. The Budget itself is not only about matching expenditure and revenue, but is becoming more of a policy statement. We will see a lot of new initiatives.
Garg: On the supply side, there have been specific interventions. On the demand side, government spending would continue and perhaps get focused in areas where money is reaching the people. Everybody would get something because any class that gets something has a ripple effect on other classes as well.
A little bit of balancing will be required between rural economy versus agriculture versus investments - which will be a higher multiplier for the economy. As we know that not all infrastructure creates a similar multiplier effect, so some attention has to be paid as to where the investment should go.
Sinha: I don't know if the FM has so much room in the Budget. The biggest action will be micro reforms across different sectors to make sure that the investment environment in those sectors improves. Those are the things that can be done and should be done outside of the Budget. The government is trying to do these, but a lot more can be done. In the power sector, a lot can be done. Those dont require the Budget but can unleash a large volume of new investments in the country. In power and other sectors too, like textiles, tourism or automobiles, the government needs to find a way of identifying issues and then making sure that those are resolved quickly and accurately.
In terms of fiscal deficit, should the FM say, look, I'm going to take 1 per cent extra this year, as a deviation from the FRBM, and spend that? The 1 per cent would be about $25 billion. Its not insignificant. It can be used in multiple areas. But it would have to be clearly articulated as being a one-time exemption.
Kanabar: It is expected that over the next three months, multiple committees will be set up specifically to focus on certain sectors - steel, cement, power, etc, - with participation from industry as well as bureaucrats, who will take specific feedback. It's a great initiative. But we have to see how well we implement the strategy.
It is one thing for the finance minister to talk about projects worth Rs 1.02 lakh crore being taken up for implementation, but where are the resources to take those projects to a logical conclusion? So, rather than announcing a slew of new projects, the government needs to focus on implementing many of the very good projects that have already been announced, and taking them to fruition. In taxation, some very specific things can be done, which will impact the economy and not be mere tinkering. The first thing is long-term capital gains. For example, if the IPO market were to revive, you will see many companies accessing capital markets. A few basic things need to be done to create the (right) environment. For example, there is a negative perspective among promoters looking at IPOs because they don't get the grandfathering that other investors gets. We have a very complex regime of long-term capital gains? we have multiple rates, multiple years. The finance minister has spoken at length about the need to do away with the DDT. She said it was a regressive tax introduced by the predecessor government, etc. It should be looked at because it will give money back into the hands of corporates. Leave it to the recipient to pay tax. To my mind, this is a virtually revenue neutral measure but will ensure that money goes into investment.
Joshi: Let me deglamourise the central Budget a little bit. What is going to happen outside of it is more important as the state governments spend more than the central government. Having said that, there are some key areas that the Budget can look into. One is reviving demand, which essentially means making PM Kisan (Yojana) more effective, (increasing the) social safety net through MGNREGA in rural areas, and finally (boosting) the construction/real estate activity, which absorbs a lot of unskilled and semi-skilled labour from the rural economy, whether it is irrigation or housing, or roads or rural infrastructure. The kitty is limited so we need to create more revenue and in a slowing economy, generating tax revenue is a tough job. In the previous fiscal, we did well in non-tax revenue; this fiscal, we are lagging. A focus on faster divestments will allow you to channelise the money towards these activities in the coming fiscal.
The Budget can focus on some sort of a plan for de-stressing the financial sector so that it can lubricate the economy. It's going to be a very tough journey without de-stressing the financial sector.
Joe C. Mathew (BT): The Budget is also about messaging. What would you like to hear from the Budget speech? Are more Direct Income Transfer schemes possible?
Garg: The message in this Budget is going to be about inviting businesses. It will say, look, we are there with you, please go ahead and play fully in this economy. The key part of the messages would be to change the sentiment in the mind of private investment and private consumption. And in terms of direct income transfers, it will depend on if there is enough kitty available. In my mind, it is not there. In terms of expanding the tax base, the government already has very extensive programmes of using GST data and analytics. It will take some time but you will have a much larger part of the economy formalised. Whether you recognise it or not, the collection of direct tax is getting impacted by a larger formal economy coming in through the GST net.
Sinha: The messaging has to be very deep. This government is very focused on economy. It is their single biggest agenda point right now. As the Prime Minister said in his Red Fort speech, that wealth creation is not a bad thing, it is essential for the country and the economy that wealth creators be celebrated rather than penalised.
Agarwal: I would say that hand-holding is a message that the Budget needs to convey; that the government supports the private sector in every nook and corner. The Budget should also acknowledge some of the challenges in the economy. Instead of targeted tax collection, the Prime Minister's focus on technological driven compliance is a message this Budget can give.
I may not call fiscal expansion a reform, but that is the need of the hour. FRDI should be a major reform at this point. With labour reform, the government may face resistance but it is needed.
Kanabar: One thing which worries me (is the policy flip flop). I was in Singapore recently and was talking to the government there and the single largest negative was what happened in Amravati, Andhra Pradesh. A total flip flop of policy. We saw something similar in the bullet train project. The Maharashtra government is saying that it wants to take a relook at it. So, the message that the government needs to give out, which will give confidence to foreign investors and revive investments, is that there will be no flip flop on policy.
Joshi: I would agree that the passage of FRDI Bill is critical. The issuers in the corporate bond market, the financial institutions, contribute almost 70 per cent of the subscription. They also need a resolution process.
As far as the direct benefit transfer kind of schemes are concerned, I would still prefer a targeted approach, which is being done currently, rather than a universal approach. We are not ready for it as yet.
The third thing which we need to introspect on is what kind of fiscal targets we want to keep. I have been hearing about 3 per cent of fiscal deficit of GDP (for many years). That target has only been met once in 25 years. Is it correct to keep chasing that? Maybe we need to rethink.
The fiscal deficit road map is proposed by the N.K. Singh committee. They are talking about looking at targeting overall debt levels. If that is the case, it should be something which is attainable.
Dubey: States would actually be spending more from hereon than the Centre is spending. How can resource generation and resource sharing be more synergetic?
Agarwal: The problem is coming from GST. The higher commitment of 14 per cent growth every year should be linked to the economy or revenue growth across segments. The issue is also about implementation of GST. The whole cycle is getting out of the GST network. Therefore, there is an issue of input tax credit. A lot of demand on the credit side is coming where the audit trail is incomplete. The industry demand is that if you delay the credit cycle, there is a larger working capital requirement. If the government goes for ad hoc credit allocation, then the question will be who is ultimately responsible for the gap in the credit. So the government needs to be more focused on establishing a complete audit trail.
The reconciliation of input tax credit, cycle of credit and certain segments that want themselves out of the GST network is a challenge. The efficiency of GST is based on everybody getting into the system; then online credit allocation and other things can happen. But the government has to focus more on GST network and that will support the transfer to states from the Centre.
Garg: We shouldn't disturb the logic of the full chain being maintained. To make life easier for those people whom we want to support, let there be somebody on an outsourcing basis who does that.
Joshi: If you look at the revenue and the expenditure behaviour of the central government and the states, the revenue position is bad for both. For the state, it's a double whammy as part of the taxes are shared. If the central kitty reduces, the share to states also comes down. The central government has been maintaining its expenditure and has not cut capital expenditure, according to October data. But state governments have harder budget constraints. They have cut capex and their revenue expenditure is sticky. The slowdown has brought the Centre-state tax sharing issue to the front again. The casualty is capital expenditure, particularly at the state level, and that accounts for the bulk of the capital expenditure from the government.
Dubey: What is a realistic fiscal deficit target?
Joshi: It is hard to say. The government can always meet the target by cutting expenditure. That is what happened in the last fiscal. It can inch closer to 4 per cent for 2019/20, if the current expenditure momentum is maintained. You can achieve the number or reduce the slippages by postponing expenditure or delaying payments or whatever. There are various ways Budgets have done that in the past. Maybe it is time now to look at how Budgets are made.