There is this growing feeling that perhaps this government is not as interested in doing tax reforms which stimulate growth
The approach to black money, including demonetization, has had a dampening effect (on the economy)
Arvind Virmani served as the chief economic adviser in the finance ministry (2007-2009) and was India’s representative to the International Monetary Fund (2009-2013). Virmani is also a prolific commentator on macro-economic matters. In an interview, Virmani talks about the current economic slowdown, where things went wrong and how to reverse the trend. Edited excerpts:
Most economic indicators are pointing towards a sharp slowdown in economic activities. Will gross domestic product (GDP) growth this year settle below 6.8% achieved in the last financial year?
That’s a million dollar question. Growth has been on a slowing trend and there is no doubt about that. Now, when we think about what is the likely growth, my bottomline is, unless we do something to change it, we are moving from the 7-7.5% range which we had for several years now to the 6.5-7% range. That would be very sad. When so many people have been talking for last five years about raising growth beyond 7.5%, 8% and 8.5%, clearly for me 6.5-7% growth for next five years is not acceptable.
What you think could be the reasons behind this sharp slowdown in growth?
Normally, we talk about three categories: short, cyclical and trend changes. The most important factor in my view, the short-term factor, is the decline in automobile demand because to my memory this had never happened. We had fluctuations in growth rates but never an absolute decline in demand and consequent production. There are three or four factors that are visible. One is introduction of BS-VI norms. That’s a big technological change and we know from past experience that when such changes happen people tend to postpone purchases. Second identifiable element is there was some increase in cost of insurance and fluctuations in oil prices in the past. The third factor which is more intangible and which is happening in all major markets like China, the European Union, US—there has been this negative demand. One must think that it has something to do with introduction of electric cars. May be that has played some role in India. One of the conclusions that rises immediately is that we should not be foolhardy. We cannot mess up the macro-economics for the long term. We should introduce these things gradually and carefully. My judgement at this point would be it is a temporary phenomenon which probably will be over by next year.
Now shifting to the longer term trend growth, what is a little worrying and it has surfaced after the last budget, though it has been building up for last two-three years. There is this feeling which has grown that perhaps this government is not as interested in doing tax reforms which stimulate growth as against following the old approach in which you announce more programmes, you raise more revenues by levying taxes and (think) everything else will take care of itself. The first approach, which came into being certainly from the 90s was that you do tax policy reforms, growth accelerates, compliance improves that raises revenues and you have more money to spend on welfare schemes. Whether it is correct or not, this feeling has grown and it is a bigger long term problem. I don’t want to leave the impression that the budget was all bad. In fact, the Part A of the budget was largely positive and even some parts of Part B which tried to introduce ease of business in taxation was good, but there is this feeling that the approach is wrong.
You talked about fall in demand for automobiles, but it’s not limited to that. GDP growth is at a five-year low. The June core sector data showed it’s lowest in 50 months. So, there is more to the current slowdown that only automobiles.
In most of these things, there is a structural part and a cyclical part. The other thing is this construction and real estate sector. One may think we do good things by catching black money operators and driving them into jail, but it has effects on the economy. And shutting one’s eye does not solve the problem. I don’t believe a purely danda (stick) type approach can ever be sustained in India because corruption is endemic in the system. It is not a matter of individuals. It’s not a matter of saying we are the good people and we will clean out everything. It does not happen like that. You may be able to do a little bit better, no doubt about that. But you can’t solve the problem by imposing danda upon danda upon danda. So this whole approach to black money with greater emphasis, including demonetization, add up and have had a dampening effect (on the economy).
So are we paying a price for the ill-thought out demonetization and ill-conceived GST?
Absolutely. Among my solutions, the most immediate and easiest solution from the government side which will give both political and economic dividend—I am puzzled why it’s difficult and I think some ego issue is involved here—is a three-level system of GST. The bottom level is exemption with zero rating of exports. The second part is there is only one general rate. We are saying revenue neutral rate is 15%, 16%. Pick that rate. This applies to everything except the exempt goods. The third is surcharges. What that means is the (invoice) matching becomes deadly simple. You can trace everybody.
Second is the Direct Tax Code (DTC). I can understand there can be differences of opinion. A week before I left finance ministry in 2009, the last official meeting I attended with the finance minister was on DTC. Why can’t you just decide! There will be two or three mistakes, does not matter. Let’s change the code, it is a 1960 code! I am not even saying you reduce the taxes right now. Everything else you can reform. Easy. No political problem.
But the counter argument which this government has been putting forward is that a single-rate GST will be inflationary and inequitable.
I call it a completely specious argument. We went by the leftist, communist approach that everything has to be progressive. It’s the most idiotic idea that we have ever given. I have a few years left. I have to say it, who else will say it. It’s the system which has to be progressive, not every tax. That’s exactly why we got into this trouble in the first place. This is the Indira Gandhi idea—she was the worst economic prime minister in India. She was great in other things, but not in economics. About 50% of common man’s expenditure is food and food items are exempt from GST. That’s huge progressiveness! I don’t understand why people can’t get this simple fact.
Do you think this government lacks smart and intelligent economic policy advisers?
Let me put it very carefully because it is important for a solution not that I am afraid to say. I see two things which have been missing. One is there is too much dependence on doers versus thinkers. Emphasis (on doers) is needed, but not overemphasis to the neglect of the other. By thinkers, I don’t mean general thinkers. If you want to do something new and different like the GST reforms, you talk to people who have studied it. Second, somehow this feeling has come that you don’t talk to people on the ground. You can’t manage an economy of the size of India hoping to be a $5 trillion economy unless you do these two things.
How much of further monetary easing you think will help in revival of demand?
Monetary policy is clearly important. I have been saying, Surjit (Bhalla) has been saying that the real interest rate of 3-4% of repo rate is just too high. The question is what is the repo rate we want to be at. In a way for monetary policy, the repo rate is base line. My conclusion is as long as inflation is projected to be 4%, real repo rate for us should be less than 1%, preferably zero. Zero means your nominal repo rate should be same as your inflation target: 4%. So there is big scope for reducing repo rate. Second is the issue of (monetary) transmission. In an emerging market economy like India, the financial markets are not perfect. They are fragmented with large informal sector. You have to make sure that the monetary base—what we call M0—is expanding at an sufficient rate. Of course, it is related to credit, liquidity but research in 2019 has shown this is critical to transmission. So, that must be sufficiently expanded.
On the budget proposal of overseas sovereign bonds, the House is divided. Where do you stand on this?
The economics of it is clear. International borrowers have country limits. You can’t borrow more as a country unless your credit rating goes up. All this will do is four things. First, it will establish a sovereign benchmark. People borrowing overseas through ECBs don’t have a benchmark. The pricing of those private borrowings are arbitrary. What the sovereign debt will do is it will establish a benchmark. Second, it will increase international scrutiny of the government. Third, the impact will be of substitution. The government will borrow more foreign and some of those private guys will shift to domestic borrowings. That will actually lower the country’s interest payments. Fourth, because the government’s interest payments will go down, they can now meet their FRBM targets by spending more.