Credit ratings, GST and the ease of doing business
The upgrade of India’s sovereign rating by Moody’s in mid-November lifted the national mood. Even people in Delhi paused in the midst of gasping in toxic air, and cheered feebly. In financial terms, the rating upgrade does not make a huge difference. It was more in the nature of a follower action to the confidence reposed in India by global investors, after nearly 14 years of no upgrades, with an interlude in 2012 when there was threat of a downgrade.
Both the 2012 threat and the earlier upgrade in 2004 had to do with fiscal metrics. In 2004, it was a reward for having enacted the first Fiscal Responsibility and Budget Management Act, although the Act was actually notified only by the successor government after the general election. The decision by Standard and Poor’s not to upgrade in 2017 also had to do with fiscal metrics, which in their judgement did not look sufficiently promising.
Rating agencies themselves have had bad times after the 2008 global crisis, faced with the collapse of financial instruments to which they had given an A grade. They are more cautious today, and when it comes to emerging countries like India, give high priority to legislated fiscal limits. Of course, fiscal rules do bite needed nutrition and education provisions, while leaving untouched politically protected spending. But it is not as though relaxing deficit and expenditure limits will be sufficient to improve the quality of expenditure.
The recent Moody’s upgrade was actually just a predictable follow-up on their earlier shift to a positive outlook, which was an expectation that ratings would improve. But now at the new notch India is rated stable rather than positive, indicating that things are not seen to get better very soon. Moody’s has even taken on board a likely worsening of the fiscal deficit in the current year, on the expectation that the debt path will move downwards in the medium term. The other two initiatives which worked were the bank recapitalization bonds (although that merely eases the bank situation for two years, and carries an immediate annual fiscal cost on bond interest) and the bankruptcy code, which provides a distant glimmer at the end of the bank non-performing assets (NPA) tunnel. In the background lies the demographic advantage India has.
Moody’s upgrade, in their words, is about “greater confidence that the high level of public indebtedness which is India’s principal credit weakness will remain stable, even in the event of shocks, and will ultimately decline”. For that promise to be realized, there has to be robust growth in output and job generation. That in turn calls for the investment climate to improve, and not just at the upper end of the scale spectrum. Improvements of the kind measured in the World Bank’s annual Ease of Doing Business (DB) survey do not go far enough. Investment is deterred also by things like the November spike in air pollution over Delhi, and annual floods in Mumbai and Chennai.
Even though the severity of November pollution in Delhi this year may have been added to by dust from the Gulf, crop stubble burning after the kharif harvest is the endogenous core. No political party in India seems to have grasped the nettle of cross-party cooperation towards a common goal—not the Congress party in power in Punjab; the Bharatiya Janata Party in Haryana; nor the Aam Aadmi Party in Delhi.
There have been reports that fund transfers from the Centre to the states to head off stubble burning did not reach the farmers because no mechanism could be developed to ensure they did not just take the money and burn the stalks anyway. Surely local government is well positioned to check on something as easily observed as a fire. Why have no partnership linkages been built between local and state governments, to be invoked at such times?
Some companies from both the private and public sectors are reported to have come forward to buy the crop residue and turn it into biomass pellets for energy generation. However, if crop residue burning is done by farmers to prevent pest transmission from the kharif to rabi seasons, the three governments will still have to cooperatively resolve that problem before farmers will consent to have the stubble pulled out. No supervisory bodies like the National Green Tribunal will solve anything until governance in India recognizes that it is lack of attention to the last mile that thwarts effective outcomes in all spheres.
The last-mile problem can be understood only with ground-level surveys which give us the worm’s-eye view. The World Bank’s DB survey does indeed do that. But there are several levels of ground. The DB assesses only two cities in India—Mumbai and Delhi. In most other countries they just do the biggest business centre. They look at every country at its best point.
The DB survey is also explicitly focused on formal sector economic activity, predicated on the premise that lowering barriers to formal sector entry will act to discourage informal activity, with all the disabilities that entails, including limited access to credit. However, what the DB survey fails to take on board is that informal business cannot easily migrate to the formal sector as long as barriers to formal sector entry remain, even if those barriers are slowly coming down. Therefore, the survey does need to take cognizance of whatever makes doing business at a small scale harder. The goods and services tax (GST) has done that, despite the very welcome reforms introduced at the last two meetings of the GST council.
Ease of paying taxes is one of 11 indicators which together determine a country’s DB overall standing. Paying taxes was one of the indicators on which India got an upgrade. Paying taxes is mostly focused on the corporate income tax and statutory payments like provident funds. However, two of its four sub-components also look at indirect tax payments like VAT (value-added tax), which unlike direct taxes are collected from others and forwarded (GST had not yet kicked in on the reference date of the latest survey which was 1 June). One of the two looks at the number of tax payments required, but basically stops counting the number of filings for any one type if the payment mode is fully electronic. In that case, “the tax is counted as paid once a year even if filings and payments are more frequent”. The movement of Employees’ Provident Fund (EPFO) payments to an online platform was key to the upgrade on this measure.
If the World Bank stays with its present system, and if we are just playing to the test, the monthly filings required for businesses above Rs1.5 crore turnover in the GST as it is presently configured, will not penalize India, at least on this count. But we will get penalized on the other sub-component which looks at delay in getting return payments like input tax credit. It is here that the present configuration of GST will handicap us, because of the disjunction between quarterly filing below and monthly filing above the turnover threshold, as long as voucher matching is retained (voucher matching has actually been suspended for the remainder of the present fiscal year, but threatens to kick in after that).
So for this reason, if no other, we need to move to uniform quarterly filing for all. This has been endorsed by a ministerial sub-group of the GST council and I still hope and expect it will happen. The GST council is now seized of the problems caused by having configured procedures differently from the state-level VAT, which was accepted by taxpayers. One of those was payment of GST on generalized advances paid by wholesalers to manufacturers of consumer goods, which had not been a feature of VAT. That has now been rectified.
We need scale neutrality in a tax like GST. Although quarterly filing for all will even out the playing field greatly, small business will still be handicapped by voucher matching, if and when it happens. For the current year, businesses can base their payments on a consolidated form, GSTR 3B, a self-declared and unverified summary of GST collected and paid. They also have to submit GSTR 1, the voucher-based report of collections on outward supplies, but this will not be used to deny input tax credits until end-March 2018.
Any value-added tax system can yield its advantages only if there is certainty of getting tax credits. Only then can businesses price their product taking inputs at cost exclusive of tax paid. With voucher matching, input tax credit becomes conditional on verification and therefore uncertain. Verification can fail either because of fraudulent suppliers who collect the tax but fail to forward it or system failure. Formal sector businesses will secure themselves by engaging with a closed ring of trusted suppliers. This robs the GST of its core attraction, which was the opening up of supply chains to new and lower-cost suppliers.
The current system in place requiring filing of GSTR 1 along with GSTR 3B, offers a basis for a test of whether credit claims match collections in aggregate. This reporting could be extended indefinitely beyond March 2018 while the system finds its feet.
Meanwhile, the turnover limit for the voucher-free composition scheme with quarterly filing and payment at 1% of turnover has been raised to Rs1.5 crore. Restaurants (with some exceptions) have also been folded into the composition scheme, with a higher rate of levy. The scheme, despite its simplifications, does not really help small businesses, since buyers from across the composition divide will not want to engage with them in the absence of a matchable voucher.
Voucher matching is needed for all payments involving IGST (integrated GST), since cross-state transactions are where the possibilities of fraud are highest. Only when it is dispensed with for all other transactions can the GST conceivably claim to have become a scale-neutral tax.
Indira Rajaraman is an economist.
Comments are welcome at firstname.lastname@example.org
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