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GS Paper: GS3-03.Government Budgeting

  • A plan for the aftermath

    Context

    Everyone is agreed that the whole world is hurtling towards an unprecedented economic recession. India, already facing a massive slowdown, is going to get hurt perhaps more than the others, because our economic immune system is already weak.

    Three things that we must do in the present situation

    • The first is containing the spread of the virus.
    • Apart from the manpower, medicines, protective equipment for frontline workers and other methods, it will need massive resources to tackle it.
    • Second, the poor are already suffering in more ways than one, including the daily wage earners. They will have to be taken care of, again needing massive resources.
    • Third, economic activity will have to be revived as soon as conditions return to normal or near-normal, for which businesses will have to be helped, again needing massive resources; both in terms of revenue foregone and actual cash outgo.
    • The question, therefore, on everyone’s mind is how much money will be needed for all this and where will it come from?
    • What the government and the RBI have done so far is clearly awfully inadequate. Other countries have done much more. India can be no exception.

    Where will the government will get resources?

    • Partly from market and partly form RBI: Broadly speaking, resources will come partly through market borrowings and partly from the RBI.
    • Manmohan Singh had decided in 1994 that in future the government of India would not monetise its deficit; in other words, would not borrow from the RBI but go to the money market and borrow from there.
    • Borrow from the RBI: In these unprecedented times, we may take leave from that very sound principle, which all governments have followed religiously since then, and borrow from the RBI.
    • What does it mean? This means printing of more currency notes with all its attendant problems including inflation.
    • Government of India will have to take the steps necessary to tackle the after-effects to the extent possible. It must ensure that the supply chains work smoothly.

    How will the money be spent?

    • The Important role of states: The states will have to play a very important role in this, as much of the work will have to be done by them.
    • Responsibility of finance commission: Since the finance commission continues to be in existence and has a clear idea of the state finances, it should be immediately tasked with the responsibility of discussing this matter with the state governments and making its recommendations available within a period of one month.
    • The task force under the finance minister could work out the needs of businesses and the government of India both in the short as well as the medium term.
    • Spending money properly and efficiently: It should not be wasted and each rupee spent creates its own multiplier effect.
    • Our system leaves much to be desired. And the moment it is known that funding is not a constraint, the system can go berserk.
    • We must guard against that and ensure that rules are in place, specially at the field level to ensure the proper use of resources.

    Role of banks, financial institutions and MGNREGA

    • The banks and other financial institutions will have to be provided with resources to help the private sector, especially the agricultural and MSME sectors.
    • In the rural areas, we must ensure that durable assets are created out of the funds made available.
    • The rules governing the MGNREGA scheme should be tweaked to the extent necessary in order to ensure that more material than labour is used wherever necessary.

    Conclusion

    India should and can come out of the present crisis with as little damage as possible if we tackle it together. We cannot control what happens in other countries, but we can surely learn from them and adopt their best practices. We must also play our role in defining the new global order because the world is more intertwined now than ever before.

  • Financing the pandemic rescue package

    Context

    The priority for India is to ensure that it overcomes the COVID-19 pandemic and kick-starts GDP growth.

    Financing strategy for the 1.7 lakh crores package

    • Rather than fix the weaknesses in the macroeconomy: a high fiscal deficit of 7.49% and government indebtedness that was 69% of GDP in 2019, the government wants to overcome the pandemic.
    • When COVID-19 cases began to increase, the Government of India (GoI) swung into action by announcing a 21-day national lockdown and a ₹1.7-lakh crore (approximately $22.59 billion) rescue package.
    • Financing strategy: Available in the state disaster relief fund is ₹60,000 crore, comprising ₹30,000 crore of the outstanding balance and the Central government’s allocation of a similar amount for FY2021.
    • Hence, the GoI needs to raise an additional ₹1.1-lakh crore,e., 65% of the rescue package outlay.
    • Its financing strategy should be to raise long-term funds at cost-effective rates, with flexible repayment terms that allow it to take tactical advantage of market movements.
    • Following are some of the options that the government can explore to raise the required amount.

    1. GDP-linked bonds

    • The GoI may issue listed, Indian rupee-denominated, 25-year GDP-linked bonds that are callable from, say, the fifth year.
    • What GDP-linked means? The coupon (interest) on a GDP-linked bond is correlated to the GDP growth rate and is subject to a cap.
    • The issuer, the GoI, is liable to pay a lower coupon during years of slower growth and vice-versa.
    • The callable feature from the fifth year till maturity allows the GoI to effect partial repayments during high growth years and when it earns non-recurring revenues such as proceeds from disinvestment of public sector enterprises (PSEs).
    • The listing of bonds provides investors with an exit option.
    • Examples from the world: Costa Rica, Bulgaria and Bosnia-Herzegovina issued the first pure GDP-linked bonds in the 1990s.
    • Argentina and Greece issued warrant-like instruments similar to GDP-linked bonds in 2005 and 2012 respectively. India could learn from their experience.
    • Timely GDP data is a prerequisite: Publishing reliable and timely GDP data is a prerequisite for the successful issue of GDP-linked bonds, which the GoI may use to part-finance the COVID-19 rescue package and to diversify its borrowing sources.

    2. Streamlining PSEs

    • The 15 largest non-financial central PSEs (CPSEs) in the S&P BSE CPSE index contributed approximately 75% of the GoI’s ₹48,256.41 crore dividend income from PSEs in FY2020.
    • The Union Budget projected PSE dividends to increase by 25% to ₹65,746.96 crore in FY2021.
    • This milestone is unlikely to be achieved in the current environment.
    • The 15 CPSEs have accumulated sizeable non-core assets including financial investments, loans, cash and bank deposits in excess of their operating requirements, and real estate.
    • The return on these assets (excluding real estate) is around 200 basis points lower than the returns on their core businesses.
    • These CPSEs owe the government ₹25,904 crore as of end-March 2019.
    • These non-core assets must be monetised to repay statutory dues and upstream dividends to GoI.
    • Formation of HOLDCO: While loans and excess cash and bank deposits may be monetised within three months, streamlining investments and selling real estate is a time-consuming process.
    • It is imperative for the GoI to form a PSE and public sector bank holding company (‘Holdco’) along the lines of Singapore’s Temasek Holdings and Malaysia’s Khazanah Nasional Berhad.
    • The Holdco will enable PSEs to monetise their non-core assets at remunerative prices, maximise their enterprise value and focus on their core businesses.
    • The ₹30,168 crore loans that CPSEs have extended to employees, vendors and associates may be securitised or refinanced, with CPSEs guaranteeing loans extended to weak counterparties.
    • Excess liquidity with PSEs: It is essential that businesses maintain liquidity, especially during a downturn. However, the outstanding cash and bank deposits of the 15 CPSEs (₹64,253 crore) is in excess of their operating requirements.
    • CPSEs must determine the cash they require to meet, say, six months of operating expenses and use the excess cash to repay statutory dues and upstream dividends to the GoI.
    • Banks must extend to CPSEs committed lines of credit that the latter may draw down during exigencies.
    • Financial investments of PSEs be transferred to HOLDCO: The 15 CPSEs have accumulated ₹93,562 crore financial investments comprising listed and unlisted debt, equity and mutual fund units.
    • These exclude investments in associates and joint ventures.
    • The CPSEs ought to transfer these investments to Holdco, which can manage the portfolio and transfer the returns to the original investors.
    • Real estate holdings of PSEs: One important non-core asset, whose value is likely to exceed the combined value of other non-core assets, is the real estate holdings of PSEs.
    • In September 2018, the GoI identified properties of nine PSEs (Air India, Pawan Hans, Hindustan Fluorocarbons, Hindustan Newsprint, Bharat Pumps & Compressors, Scooters India, Bridge and Roof Co, Hindustan Prefab, and Projects & Development India) to be divested.
    • The GoI must mandate all PSEs and government departments to transfer their non-core properties to Holdco, which can opportunistically sell these properties and transfer the proceeds to the owners.

    Refrain from asking RBI to pay more dividend

    • The Reserve Bank of India (RBI) has allocated ₹1 lakh crore to carry out long-term repo operations in tranches and has reduced the repo rates by 75 basis points to 4.4% to help banks augment their liquidity in the wake of the pandemic.
    • Recognising the RBI’s liquidity requirements, the GoI must refrain from asking the RBI to pay more dividends that it can viably pay.
    • During the five years ending on June 30, 2019, the RBI paid the GoI 100% of its net disposable income, with its FY2019 dividends more than trebling to ₹1.76 lakh crore from ₹50,000 crore in FY2018.
    • The Bimal Jalan panel constituted in 2019 to review the RBI’s economic capital framework opined that the RBI may pay interim dividends only under exceptional circumstances and that unrealised gains in the valuation of RBI’s assets ought to be used as risk buffers against market risks and may not be paid as dividends.

    Conclusion

    The Bimal Jalan panel recommendation must be adhered to in letter and spirit. The GoI may finance the COVID-19 rescue package by issuing GDP-linked bonds, tapping PSEs’ excess liquidity and monetising non-core assets.

  • A different economic approach

    Context

    The Covid-19 pandemic and subsequent 21-day lockdown by India has forced us to resolve the public health versus economic health trade-off.

    The debate over lockdown

    • No clear idea on number of lives saved: As it fights COVID-19 with its meagre healthcare resources, India has chosen to bring the economy to a near halt with no clear idea of how many lives can be saved in this manner.
    • What is going to be the cost of this decision? The 21-day lockdown will reduce the gross value added (GVA) during this period to near zero.
    • More than half the GVA is contributed by the unorganised sector.
    • A disproportionate burden of the economic cost has fallen on this large segment.
    • Debate: The suffering of the stranded migrant labourers has set off a debate: is the disruption and the economic pain justified?
    • Is it worth sacrificing the economy to save lives?
    • And at the core of such questions is a policy dilemma: should public health matter more than economic health?

    So, what should be the policy objectives?

    • In time, a vaccine will become available. But the economy cannot remain shut until that happens.
    • A prolonged lockdown will extract a huge economic cost.
    • Therefore, the policy objective must be to find ways of ensuring that the lockdown ends early without compromising on public health.
    • Following are the policies that could ensure the twin objective of not ending lockdown without compromising on public health.

    1 The policy of aggressive testing and isolation

    • The economic cost of combating COVID-19 can be reduced by combining aggressive testing and isolation, a strategy proposed by economist Paul Romer for the U.S.
    • For it to work, people must be tested in large numbers.
    • Those who test positive must be isolated. This will make it unnecessary for the rest of the population to stay home and it will allow the economy to restart.
    • After ending the lockdown too, testing of randomly selected people must go on in large numbers, so that those found infected can be isolated.
    • Eliminating the fear of isolation: The success of this will depend on eliminating the fears associated with isolation. Such fears can be reduced only if isolation facilities are good.

    2 Ramp up the manufacturing capacity

    • The second precondition is the substantial ramping up of manufacturing capacities for medical-grade masks, gloves, gowns, ventilators, testing labs, etc.
    • This ought to be on a scale large enough for domestic use and, if possible, for exports for costs to be low.
    • The strategy calls for fully operational hospitals to be constructed in every district of the country in a matter of weeks.
    • Problem-solving of an unprecedented order will be required.
    • Recently, garment manufacturers in Coimbatore were asked to explore the possibility of re-purposing production lines to make masks.
    • There’s been no progress on this front, as the special-grade fabric required is difficult to source.
    • What about the funding? In normal times, governments wrestle with dilemmas such as whether to allocate the limited available tax money to education, health, public transport or a sop that could change the outcome of the next election in their favour.
    • But during a public health crisis, all resources must be used to ramp up healthcare capacities.

    Way forward

    • Investment in healthcare can resolve trade-off: Since the state of the lockdown is not a normal condition, the usual policy levers become ineffective.
    • Loan moratoriums and cash transfers can fend off bankruptcy and defaults for a few months and buy time on non-performing assets in banks.
    • But they cannot make good the GDP lost due to the economic shutdown because liquidity and cash released by monetary and fiscal policies cannot get transmitted to the real sector during an economic shutdown unless they are funnelled into the sector that is still active, which is healthcare.
    • If the public health sector can be the economy’s main engine for six months, the public health versus economic health trade-off can be resolved. The spread of COVID-19 will slow down.
    • The economic pain of combating the virus will reduce.
    • There will be jobs, including for low-skilled construction labourers. If planned and executed smartly, the severe health infrastructure deficit will get addressed.
    • Remove the price controls: Sadly, India’s economic policies for fighting COVID-19 are the opposite of what’s needed.
    • In a crisis, the first instinct of policymakers is to slap controls. Just about everything from masks to kits has been placed under price controls.
    • This has removed the incentive for private labs to ramp up capacities.
    • The government should fully subsidise testing: At zero MRP, more people with symptoms will come forward to get tested. Private labs will quickly ramp up capacities if they don’t have to worry about losses. The number of suppliers will increase. Costs will reduce. Private enterprise and technological innovations will come up with cheaper tests that produce results quicker.

  • A niggardliness that is economically unwarranted

    Context

    The Centre can afford to step up its COVID-19 assistance to a higher scale; fiscal deficit is no worry.

    Comparison with the US

    • Unemployment benefit in the US: In the United States, for instance, where the lockdown has raised the number of persons filing unemployment claims from 2.8 lakh to 6.6 million in a matter of days, those affected can fall back on unemployment benefit.
    • Comparison of packages: The US government has approved a package of ameliorative steps costing roughly 10% of that country’s GDP to cope with the crisis.
    • In India by contrast, the Finance Minister’s package comes to less than 1% of its GDP; and much of it is just a repackaging of already existing schemes.
    • New expenditure comes to just a little over half of the ₹1.7-lakh crore earmarked for the package.
    • Migrant workers are not the beneficiary: Besides, none of the steps will help the migrant workers; not even the larger foodgrain ration which in principle could, because most of them would have ration cards back home rather than in the places where they stay.

    What can be done?

    Consider the cash transfer

    • Many economists and civil society activists had suggested a cash transfer of ₹7,000 per month for a two-month period to the bottom 80% of households to tide over the crisis, in addition to enhanced rations of foodgrains and the inclusion of certain other essential commodities within the ration basket.
    • The cost of their proposed cash transfers alone would come to ₹3.66-lakh crore, which is more than 10 times the cash transfers provided in the Finance Minister’s package.
    • Providing assistance on the scale proposed by civil society organisations is necessary; it will no doubt pose logistical problems, but not financial problems.
    • Two possible effects of cash transfer: Even if all of it is financed through a fiscal deficit for the time being, the economic implications of such an enlarged deficit would not be forbidding.
    • These implications can manifest themselves in two ways: one is through inflation, and the other by precipitating a balance of payments problem. Let us consider each of these.

       Effect of cash transfer on inflation

    • As long as supplies of essential commodities are plentiful and these are made available through the Public Distribution System to the vast majority of the people so that they are insulated against the effects of inflation, any inflation per se should not be a matter of great concern. This is the case in India at present.
    • Foodgrain stocks with the FCI: The supply of the most essential of goods, food grains, is plentiful. Currently, there are 58 million tonnes of foodgrain stocks with the government, of which no more than about 21 million tonnes are required as buffer-cum-operational stocks.
    • This leaves a surplus of 37 million tonnes which can be used for distribution as enhanced ration, or for providing a cushion against inflation.
    • The rabi crop is supposed to be good; as long as it is safely harvested, this would further boost the government’s food stocks.
    • Rise in demand of other commodities: Likewise, the supplies of other essential commodities which consist of manufactured goods and where output has been demand-constrained all along will get boosted in response to higher demand; and in special cases, imports may have to be resorted to.
    • There is in short no reason to think that inflation of a worrisome magnitude will follow if the fiscal deficit is increased.
    • What about the multiplier effect? There is an additional factor here. The increase in total demand caused by an initial increase in demand, which is financed by a fiscal deficit, is a multiple of the latter.
    • Now in a situation like the present, when even if the lockdown is lifted social distancing and restrictions on social activities will continue, the value of the multiplier will be lower than usual.
    • People, in short, would hold on to purchasing power to a much greater extent than usual because of the continuing restrictions on demand, which would act as an automatic anti-inflationary factor.
    • Of course, there will be shortages of some less essential commodities and also hoarding on account of such shortages. But since these shortages will be expected to be temporary, a result of the pandemic unlikely to last long, there will be a damper on hoarding.

    Effect of cash transfer on deficit

    • The price rise of non-rationed commodities: If inflationary expectations are strong and persistent, then the prices of non-rationed commodities may rise sharply for speculative reasons.
    • How the government can prevent the price rise? But the government can prevent such expectations, by adopting measures such as bringing down petro-product prices, taking advantage of the collapse of world oil prices.
    • A larger fiscal deficit, therefore, need not cause disquiet on account of inflation.
    • Balance of payment issue: On the balance of payments front, the worry associated with a larger fiscal deficit is financial flight caused by frightened investors.
    • Some financial flight is already happening, with the rupee taking a fall.
    • Rush to dollar: This flight is not because of our fiscal deficit but because, whenever there is panic in financial markets, the tendency is to rush to dollars, even though the cause of the panic may lie in the United States itself.
    • Using foreign exchange reserves: India has close to half a trillion dollars of foreign exchange reserves. These can be used, up to a point, to check the flight from the rupee to the dollar.
    • Restriction on capital outflow: If the flight nonetheless persists, then India will have a legitimate reason for putting restrictions on capital outflows in the context of the pandemic.

    Way forward

    • The Centre must not worry about its fiscal deficit; and since the State governments will bear a substantial expenditure burden on account of the pandemic.
    • The Centre must make more resources available to the states.
    • The centre should raise their borrowing limits, perhaps double their current limits as a general rule, apart from negotiating the magnitude of fiscal transfers it should make towards them.

    Conclusion

    If the hardships of the people are not ameliorated through larger government expenditure, because of the fear that the larger fiscal deficit required for it would frighten finance into fleeing, then the privileging of finance over people would have reached its acme.

     

  • States at centre

    Context

    Concerned over the impact on their revenues, several state governments planned cuts in salaries of government employees.

    State finances showing the signs of stress

    • The fiscal crisis stemming from the disruption in economic activity due to the coronavirus is now beginning to show.
    • Concerned over the impact on their revenues, several state governments planned cuts in salaries of government employees.
    • The stress to state finances stems from multiple sources.
    • First, as economic growth falters, their own income streams, for instance, revenues from petroleum products, real estate transactions, will slow down further, as will GST collections, and the amount collected through the compensation cess will not be enough to meet budgeted expectations.
    • Second, as the Centre’s own revenues also slow down, transfers to states will take a hit. It is quite likely that tax devolution to states, which has been budgeted at Rs 7.8 lakh crore in 2020-21, will not materialise.
    • Collectively, state expenditure far outstrips that by the Centre, with revenues falling short, any cutbacks in their spending, at a time when there is a need for a bold fiscal expansion, will further aggravate the economic stress.
    • Need assurance of adequate resource: Thus, states, which are at the frontline of fighting the public health crisis, need to be assured of adequate resources.

    Increase in the WMA limit will not address the issue

    • Limit increased by 30%: The Reserve Bank of India decided to increase the ways and means advances (WMA) limit by 30 per cent for state governments.
    • What is WMA? The WMA is a temporary liquidity arrangement with the RBI which helps governments tide over their short-term liquidity woes.
    • A short term measure: While states have been averse to opting for this facility in the past, and the new WMA limits may need to be revised further if the mismatch rises, this is a short-term measure, and does not address the underlying issue of significant revenue slippages.
    • Contradictory impulse: Under the existing fiscal deficit constraint, the collapse in revenues will force states to cut back on spending, imparting a contractionary impulse to the economy.

    Way forward

    • The Centre must take several steps to ensure an adequate flow of resources to states.
    • First, it must immediately clear all its pending dues to state governments.
    • Second, while it is cheaper for the Centre to borrow and transfer to states, even though the spreads between state and central government bonds have now widened, making state borrowing more costly, states must be allowed to borrow more.
    • Third, as some state chief ministers have suggested, the fiscal deficit limits imposed on states must be relaxed.

  • Opportunity in the Covid-19 crisis

    Context

    Coronavirus pandemic offers a trigger to fundamentally strengthen the Indian economy, and protect the vulnerable. This requires cooperation between the Centre and states.

    Opportunity to do things good for the medium term

    • Minimising the impact on the vulnerable: The current crisis is so terrible in its toll of life and livelihoods that the need of the hour must be minimising the health, humanitarian and economic costs, especially for the most vulnerable.
    • Rising expenditure may force hard choices: Rising public expenditures to help tens of millions of workers and their families alongside plummeting resources will inevitably force hard choices.
    • Appropriately, much of the policy discussion and the government’s first response have focussed on addressing the immediate imperatives.

    This crisis is also an opportunity to do things that are not only good for now but for the medium term as well. Few are discussed below.

    1. Revamp macro-fiscal framework

    • Massive fiscal expenditure may require: If the pandemic follows the exponential trajectory seen in other countries, the crisis is going to entail massive fiscal expenditures, perhaps up to 4-5 per cent of GDP, much more than what the government has announced.
    • Macro-fiscal targets have to be exceeded: Consequently, the basic macro-fiscal framework — for example, the Centre’s FRBM target of 3.5 per cent of GDP, and the revenue and deficit estimates for 2020-21 — has been fundamentally overtaken by events.
    • Allow states to exceed deficit targets: The Centre should immediately announce that even the states will be allowed to exceed their fiscal responsibility legislation targets because they will be in the front line of taking action against the pandemic.
    • Opportunity to review the FRBM: The crisis is an opportunity to revisit the entire framework.
    • The focus on unattainable targets, the fact that the FRBM has been honoured only in the breach, and the consequences in terms of loss in budgetary integrity and transparency need serious review, even overhaul.
    • Once the crisis ebbs, India might be looking at overall deficits well in excess of 10 per cent and debt levels much greater than those today. If the starting point is going to be so different, the old goals and targets won’t retain meaning.

    2. Remake finance and adopt a data-driven lending model

    • Going into the crisis, India’s corporate and financial sector were under severe stress — the so-called Four Balance Sheet problem.
    • This crisis will, unfortunately, add consumers and small and medium enterprises to that This will be an extremely hard — but critical — problem to address.
    • A takeover of bad loans will be unavoidable: To allow banks to revert to normalcy, a largescale takeover of their bad loans will be unavoidable not least because the current bankruptcy process will be severely inadequate.
    • Opt for the tech. driven lending model: This crisis opens the door for the new lending model proposed by Nandan Nilekani i.e. technology-driven lending.
    • What is Technology-driven lending? It uses data rather than collateral, allowing the 10 million-odd businesses with deep digital footprints (for example, based on GST invoices), to get loans from the thriving ecosystem of new financial players.

    3. Complete JAM

    • One of the major achievements of the government was to create the plumbing — Jan Dhan, Aadhaar, and Mobile (JAM) — to augment weak state capacity.
    • How JAM is proving helpful in this crisis? The state could now make cash transfers swiftly, with reduced leakages, whether as income support, scholarships or pensions, and potentially eventually implementing a Universal Basic Income.
    • In the current crisis, it is proving to be an important part of the social safety net that is helping to cushion the most adversely affected groups.
    • JAM is not complete yet: But the JAM plumbing is still incomplete because there is a “last mile problem”.
    • Not all those with bank accounts can access money either because of difficult geography or because bank functionaries give incomplete or misleading information.
    • Opportunity to fix the shortcomings: This crisis is an opportunity not just to leverage JAM to enhance cash transfers, but to empower citizens. This will require the government to identify remaining weaknesses on a war footing and fix them.

    4. Re-shape Indian agriculture

    • Need to create one market for agriculture: The need to preserve supply chains in agriculture in times of crisis reinforces the need to create one market for agriculture across India.
    • This requires eliminating legislation like the Essential Commodities Act and the panoply of resulting restrictions.
    • Phase-out subsidies and opt for DBT: Second, the crisis has shown the possibilities created by JAM and direct transfers.
    • Phasing out in cycles: Building on PM-Kisan and various state-level schemes, pernicious subsidies, especially for fertilisers and power, could be phased out over 5-6 crop cycles.
    • This could be done through small but frequent increases in fertiliser prices (the technique used to eliminate fuel subsidies).

    5. Focus on Make in India

    • The critical source for almost all the essential Active Pharmaceutical Ingredients (API) used to manufacture drugs, the ability also to fight death, is largely made in China.
    • India was once a major producer of such APIs but lost ground to China.
    • Frame intelligent industrial policy: The crisis should be the opportunity to go on war footing to do intelligent industrial policy — incentives, regulatory help, trade policy — that would resurrect India’s manufacturing capability.
    • Previous Make in India attempts have shown lackadaisical results.
    • Focus on the pharmaceutical sector: The crisis creates the momentum to focus the effort on one sector, pharmaceuticals. As a result, the ability to save lives could be Made in India, again.

    6. Establish migrants as full citizens

    • Need to change the place-based benefits to person-based benefits: The plight of migrant workers reinforces the need to move from immobile place-based benefits to mobile person-based benefits, which is possible as the JAM infrastructure is strengthened.
    • Portability of benefits: This will require portability of benefits, including access to the PDS, Ujjwala and Ayushman Bharat.
    • The crisis has highlighted the travails of migrant labour and their second-class status.
    • The large gap between the organised and unorganised sector worker: It reflects a broader chasm between the few securely employed in the organised sector and the vast majority subject to the vicissitudes of the unorganised sector.
    • Differences not just in the levels of income but in their volatility as well as differential access to social insurance (healthcare, pensions) distinguish these two classes.

    7. Upgrade Health

    • Weakest state capacity in health and education: State capacity over 70 years in India has been weakest in the areas of education and health.
    • The COVID-19 pandemic must lead to a serious strengthening of the health infrastructure for dealing with pandemics.
    • Set up an apex institution on the lines of US’s CDC: To start with, India needs an apex institution like the US’ Centers for Disease Control with a network across all the states.
    • They should invest in disease surveillance systems, set up diagnostics labs, be able to gather real-time data and analyse them etc.
    • The Taiwan model, which has been so successful in this pandemic, could be studied.
    • More fundamentally, the crisis is a wake-up call to address India’s severe limitations in the provision of basic health.
    • Focus on basic public health: Creating tertiary health facilities must be subservient to strengthening basic public health and early childhood care.

    8. Build a National Solidarity Fund

    • The severe downturn in economic activity ahead will savagely hit the informal poor.
    • How would the Solidarity fund be set up? The government should consider a Solidarity Fund with a one-time annual contribution coming from the wealthy and the employees in the organised sector.
    • Contribution to the fund: This contribution can take the form of taxes or elimination of middle-class subsidies identified in the Economic Survey of 2016.
    • The wealthy could contribute via a wealth tax with thresholds set by property values say above Rs 5 crore.
    • Salaried employees in the public and private sectors could contribute via a small, progressive tax on salaries and pensions.
    • Middle-class subsidies that could be eliminated include interest and tax deductions for small savers, favourable taxation of gold and other luxuries.
    • Wealth taxes and elimination of subsidies for the rich should, in any event, be part of the long-run reform agenda to reduce growing inequality.

    Conclusion

    These examples illustrate how the crisis can be converted to an opportunity to fundamentally strengthen the Indian economy, and protect the vulnerable. A common thread to many of these actions — indeed prerequisites for their success — is cooperation between the Centre and states. Central direction combined with flexibility and nimbleness in the states and local bodies is India’s way through the crisis and beyond.

  • Pull out all the stops

    Context

    Though there is coherence in India’s response to the Covid-19, still there is more that needs to be done.

    Sense of coherence in India’s response

    • Since last week, a sense of coherence is settling over India’s response to the COVID-19 outbreak.
    • The national lockdown, the incomes and credit support, and the three-month debt moratorium announced by the government and the RBI are the needed first steps to contain the outbreak on the one hand and lessen the economic impact on the other hand.

    Uncertainty in two important factors

    • Several laundry lists of measures have already been proffered by many, however, these are not of much help.
    • Uncertainty: Given the extreme uncertainty clouding how long and intensely social distancing policies will need to be pursued, the attendant economic impact and, crucially, how quickly and strongly the recovery can take place.
    • 1. The answer to the first depends on how much the outbreak tests the capacity of the already-stretched public health system.
    • Extending the social distancing policy: If the lockdown does not slow the spread of the virus to a rate that the healthcare system can handle, then the social distancing policies, in some form or another, will need to be extended.
    • Destruction of demand: The longer such containment measures last, the larger will be the destruction to (of) demand and the bigger the collapse in output and incomes.
    • 2. Then, there is the question about the pace and strength of the recovery.
    • Much will depend on how much damage the eventual output loss inflicts on households’ and corporates’ balance sheets.
    • Lower consumption: For example, even if a worker starts earning once the lockdown is lifted if one has incurred large debts in the interim, one’s consumption demand will naturally be much lower than before the crisis.
    • The same holds for corporates, both big and small.
    • No help from global demand: What makes the situation worse is that there is not likely to be much help coming from global demand.
    • Growth estimates: It is now expected global growth would decline to 5 per cent (annualised) in 1H20 (first half 2020), considerably more than during the global financial crisis, and rebound only partially in 2H20, leaving global GDP 2.5 percentage points below its pre-crisis level at the end of this year.

    How the uncertainty makes policy response calibration difficult?

    • Difficulty in assessing economic damage: Given these extreme uncertainties, it is very hard to assess the economic damage with any degree of conviction.
    • In fact, in last week’s policy review, the Monetary Policy Committee refrained from providing any projections for future growth and inflation, breaking from its normal practice.
    • So, if the outlook is so uncertain, how does one calibrate the policy response?
    • 1. Under-support the economy: One can easily under-support the economy, which could prolong the slowdown.
    • 2. Or over-support the economy, which could end up stoking inflation (as it did in 2010-13 when the massive monetary and fiscal easing during the global financial crisis was not withdrawn quickly) or creating asset price bubbles.

    What is the way out in such a situation?

    • Don’t try to calibrate: The way out is not to even try calibrating policies under such extreme uncertainty but to let the size of the support be determined endogenously by the extent and nature of the economic damage.
    • Falling back of first principles: This requires falling back on first principles. We know that the economic damage could be very large.
    • Delay in recovery: We also know that if the damage to households’ and firms’ balance sheets is substantial, then the recovery could be delayed and weakened.
    • Give extensive income support: This calls for extensive income support through existing government Jan Dhan and Mudra accounts to households and SMEs, and temporary tax cuts or deferments to the larger corporates.
    • Tax cuts needed: It also needs substantial cuts in indirect taxes (GST) when social distancing is relaxed.

    Problems with RBI measures

    • RBI providing support: The RBI has begun to provide support via its liquidity facility (TLTRO) and regulatory forbearance that allows banks to offer a debt moratorium to their customers for the next three months.
    • But both these measures work through banks.
    • The problem of bank turning risk-averse: Given that banks have turned substantially risk-averse because of the restructuring and bad debt problems of the last few years, the RBI likely needs to start providing liquidity directly to corporates, as recently announced by the US Fed.
    • At the same time, any debt moratorium will reduce profit and, in turn, capital, banks might be reluctant to extend it to all their customers.
    • Accommodate capital shortfall in the bank: Consequently, the RBI also needs to change regulations to accommodate possible shortfalls in bank capital because of the debt moratorium.

    What should be the scope and size of the policy support?

    • Support should be based on the extent of the damage: The scope and size of such policy support need to be determined by the extent of the economic damage, and not by perceived limits about what India can afford or those imposed by existing institutional arrangements and practices.
    • It is quite possible that the size of the economic damage ends up requiring support that widens the fiscal deficit substantially.
    • India clearly does not have the fiscal space to provide any material economic support when measured against standard benchmarks of fiscal prudence.
    • Directly funding the budget deficit: The market is on edge, and fears of eventual large government borrowing has spiked long-term interest rates despite large cuts in short-term rates by the RBI, which are likely to delay and weaken the recovery.
    • Any large bond auction by the government, even if it is offset by the RBI through open market operations, is not likely to calm market nerves and bring down lending rates.
    • The government should invoke “natural disaster” clause: What is needed is for the government to invoke the “escape” or the “natural disaster” clause in the fiscal responsibility act (FRBM) that allows the RBI to directly fund the budget deficit without having to go through market auctions.

    Conclusion

    Such a proposal is likely to raise the hackles of any fiscal conservative and there is the natural question about how rating agencies might react. As long as the government credibly commits to reversing the action as soon as the crisis is over, rating agencies and fiscal conservatives alike will likely treat this kindly, as it is a response to a crisis caused not by poor economic policies, but by an act of nature.

  • The sudden return of quantity planning in the wake of covid-19

    Context

    We could take a leaf out of a booklet by Keynes in our effort to tackle some of the challenges posed by the covid-19 pandemic.

    The Crisis-Keynesian Mode response mode to pandemic

    • What is the war economy? One of the defining features of a war economy is that economic thinking is focused on quantities rather than prices.
    • Much of the ongoing global response to the covid-19 pandemic is still in crisis-Keynesian mode.
    • What is a crisis-Keynesian response: The nation-state has become the income supporter, financier and consumer of last resort.
    • However, there are also clear signs of war economics as well.
    • Signs of war economics: The decision by US President Donald Trump to use America’s Defense Production Act to force General Motors to make ventilators is one resonant example.
    • Just consider some of the key questions that are being asked right now.
    • How many ventilators are available? Are there ample food stocks? Can more hospital beds be made available? How many masks be produced in the next few weeks? Can the production of testing kits be ramped up? It’s all about quantities, quantities, quantities.

    Historical background and impact of a shift in economic strategies

    • Impact persists in subsequent decades: Such big shifts in economic strategies are usually not reversed overnight. Decisions taken in response to a particular emergency tend to remain with us in subsequent decades.
    • World War II example: What happened in India during World War II is instructive. Many of the controls that were introduced during that global conflagration formed the basis of the later interventionist state that sought to control who produces how much. Here are a few examples.

    1. Quantitative import controls

    • One of the first moves by the colonial state was to impose quantitative import controls in May 1940.
    • There were two reasons why this was done—to conserve foreign exchange as well as ensure that shipping capacity was used to bring in only what was essential to the war economy.

    2. Food rationing

    • Food rationing was also introduced during the war years.
    • Over 700 towns were covered by some rationing scheme or the other by the end of the War.
    • The government also brought in measures to buy surplus grain from farmers at administered prices.
    • Various forms of rent control were also instituted. Most of these controls continued after India gained independence.

    3. Balance of payment crisis in 1957

    • India was hit by a balance of payments crisis in 1957.
    • The massive investment thrust in the Second Five Year Plan had severely strained the country’s foreign exchange reserves.
    • The Indian government, once again as a temporary measure, imposed stringent controls on imports.
    • Many of these were quantitative in nature. They survived well into the 1980s.
    • In fact, the entire trade policy approach since the 1957 crisis was to minimize imports in a bid to preserve foreign exchange.

    Will the government opt for automatic monetisation of the deficit?

    • Money creation by the RBI to fund deficit: There is now a growing consensus that the Indian government will have to fund part of its growing fiscal burden through money creation by the Reserve Bank of India.
    • What about inflationary consequences? The inflationary consequences will be muted—for now—because the velocity of narrow money is most likely set to fall on account of weak demand conditions under a lockdown.
    • Precedence: The automatic monetization of Indian government deficits was part of the policy playbook after the 1950s till it was thankfully discontinued in 1997.
    • The main instrument for that was ad hoc treasury bills.
    • These were introduced in 1954 as a temporary measure to replenish the cash balances the government maintains with the central bank.
    • What was ad hoc treasury bills? Ad hoc treasury bills were not introduced through any formal law but as an arrangement between mid-level bureaucrats in New Delhi and Mumbai (i.e. RBI).
    • What began as a temporary measure to smoothen government cash holdings had become a near-permanent feature of Indian macroeconomic policy by the 1970s.

    The uncertain future

    • Longer the war more profound will be the changes: The longer the global battle against the pandemic lasts, the more profound will be the changes across the economic landscape.
    • In an insightful article in Bloomberg, Andy Mukherjee uses the lessons of history to look into the uncertain future.
    • Among the possibilities he mentions are the contrasting ones of an economy run by robots and algorithms but with little labour, or an economy in which labour has clawed back the power it lost in the second age of globalization.

    Managing the resources in the time of war

    • Managing the resources: In 1940, John Maynard Keynes wrote a little booklet How To Pay For The War, Keynes essentially argued that the main challenge was not how to finance the war effort, but how to manage real resources to produce the arms that the UK needed to defend herself.
    • Suppression of consumption: He then argued that war production would necessarily involve suppression of consumption, either through higher taxes or some scheme of deferment.

    Conclusion

    The war against the covid-19 pandemic is very different from the military war that Keynes was thinking about. Yet, his booklet offers useful lessons on how to think about some of our current challenges—and also about what we can expect once the situation returns to normal.

  • A prescription for revival

    Context

    The root cause of the present malaise in our economy is the “death of demand”.

    How demand matters for growth?

    • The relation between demand and growth: Growth in any economy depends on the growth in demand, both for investment as well as consumer goods.
    • How slackened demand leads to a vicious cycle: If demand slackens, then the installed capacity will not be fully utilised, the fresh investment will not take place, employment will slacken and the economy will get caught in a vicious cycle, as we are experiencing today.

    What needs to be done to break the vicious cycle?

    • What sequence to follow in reviving demand? The basic challenge, therefore, is to revive demand in the economy in a sequence where the revival takes place first in the investment goods sector, automatically followed by a boost in demand for consumer goods through enhanced employment opportunities.
    • Past precedents: This is the prescription we had followed in the Atal Bihari Vajpayee government when we were faced with the East Asian crisis and the post-Pokhran global economic sanctions soon after the government assumed office in March 1998.

    Demand in India

    • No dearth of demand in India: In a developing country like India, there is no dearth of “good” demand.
      • We still have to provide so many goods and services to our people in order to improve their “quality of life”.
    • Need to create new infrastructure: Simultaneously, we have to create new infrastructure and improve the existing ones to reduce the transaction cost in our economy and make it more competitive.
    • How infrastructure creation lead to the creation of demand: The emphasis on the construction of roads of all kinds — rural, state and national highways, the new telecom policy, the investment in railways, the emphasis on housing construction and development of the real estate, the improvement in rural infrastructure and reform in the agricultural sector were all meant to lead to the creation of demand in the economy.
    • Creation of the virtuous cycle: The creation of demand should be in such a way that the demand for investment goods picks up first and faster, which creates the virtuous cycle of full capacity utilisation.
      • Demand for consumer goods: Demand for investment goods is followed by fresh investment for new capacity creation, larger employment opportunities of various kinds — unskilled, skilled and highly skilled — which reached money into the pockets of people leading to a surge in demand for consumer goods.

    How the government should deal with the situation

    • Deal with the demand side instead of supply-side: All commentators are agreed now that instead of tackling the demand side government is dealing with the supply side.
      • Tax relief to corporates: For instance, if, instead of wasting a precious amount of Rs 1,45,000 crore on tax relief to a limited number of corporates the government had spent that money on rural infrastructure and agriculture and a part of it on railways and highways, it would have led to the creation of demand both for investment goods as well as consumer goods.
    • Issue of sticking to the fiscal deficit target: There is also the issue of resources. The government claims that it has stuck to the fiscal deficit targets.
      • But the provisions of Fiscal Responsibility and Budget Management (FRBM) Act have been treated in a cavalier manner by all subsequent governments.
      • What was the basic purpose of the act? The basic purpose of the act was to eliminate the revenue deficit completely within a short period of time and live with a limited fiscal deficit.
      • The original FRBM Act, therefore, mandated that revenue deficit should be eliminated completely and the rest of the fiscal deficit should be limited to one per cent of GDP.
      • In special circumstances like today, the fiscal deficit should be allowed to go up to even two per cent of the GDP, which will mean an amount of Rs four lakh crore.

    Figures of the latest budget and need for the reforms

    • Fiscal deficit figures: The government has taken credit in the Budget for the fact that it has successfully restricted total fiscal deficit for this fiscal to 3.8 per cent and for next fiscal at 3.5 per cent of the GDP.
    • The issue involved in fiscal deficit figures: The revenue deficit for the current fiscal is 2.4 per cent of the GDP and for the next fiscal it is 2.7 per cent. In other words, minus the revenue deficit the fiscal deficit is only 1.4 per cent of GDP for this year and for the next year, it is 1.7 per se.
    • Need for managing the expenditure: So, the real villain of the piece is revenue deficit and not fiscal deficit per se.
      • Need for the reforms: It is clearly the government’s responsibility to manage its expenditure and carry out reforms in it, including austerity in expenditure.
      • How will the reforms help? Controlled fiscal deficit will make more money available in the market for private sector investment and help RBI in reducing interest rates — things which will have an overall benign influence on the economy.

    Conclusion

    A lot of other things apart from austerity majors will have to be done, no doubt, like preventing companies, especially banks from failing, to further strengthen the growth impulses but in the present situation, the key is government spending and in the desired sequence.

  • No gains for taxpayers

    Context

    Loss expected from lower tax rates may be countered by gains from the settlement of cases, higher dividend taxes on top incomes, and the wider scope for taxing international incomes.

    Simplification and providing ease to the taxpayers

    • Fiscal constraints leaving no room for a lower rate: Ahead of The Union budget, taxpayers had anticipated a wide range of measures that they hoped would stoke demand.
      • These ranged from lower tax rates to a more even tax structure on income from various sources.
      • As the former was less feasible given the fiscal constraints, the budget proposals focused on simplification and providing ease to the taxpayer.
    • Simplification in personal tax: The recalibration of personal income tax slabs was suggested as a step towards simplification.
      • However, its uptake is contingent on the preference for new slabs.
      • Who will not opt for a new slab? Switching over to the new slab rates is not beneficial to-
      • An individual currently claiming full exemptions.
      • An individual with incomes comprising largely of capital gains.
      • It is possible, however, that individuals do not claim such exemptions or deductions.
    • How switching to new slab impact revenue? An analysis of data published by the Central Board of Direct Taxes suggests that for the assessment year 2018-19, it suggest improvement in the collection.
      • 1% improvement: If individuals do switch over to the new regime, it may translate to a 1 per cent improvement in tax collections, rather than a loss.
    • Limited takers of the new slab: It can be inferred that this option may be exercised by few individuals, if at all, since the potential gains from foregoing exemptions and the intended simplification is expected to be limited.

    Tax disputes

    • The new scheme proposed: A common concern among taxpayers is protracted disputes. To reduce litigation, a new scheme has been proposed.
    • Importance of precedence in disputes: 39 per cent of the cases made a reference to a similar case in the previous year. This underscores the importance of precedence.
    • In such cases, the settlement is not a superior option as the waiver of the penalty and interest does not offer any advantage against a decision that would impact future assessment.
    • Success rates of disputes: The success rate of the tax department is 27 per cent at the Income Tax Appellate Tribunal (ITAT) and the Supreme Court and 12 per cent in appeals filed in high courts.
      • Given the odds of success, an assessee may thus be tempted to pursue litigation.
    • Incentivising the settlement: Taxpayers may choose to settle for the waiver of interest and penalty in cases where it is one time and does not set a precedent for future transactions.

    Dividend Distribution Tax (DDT)

    • What is DDT?  It is one of the significant change is in the taxation of dividends.
      • The dividend distribution tax is a unique levy on distributed profits and is payable by the distributing company.
      • What is the shortcoming in DDT? The shortcoming of such tax is that foreign investors can’t claim the credit.
      • Additional 10 % of DDT: In an effort to make the tax progressive, an additional dividend tax of 10 per cent was introduced for domestic investors receiving dividend in excess of Rs 10 lakh.
    • Dividend pay-out decreased after DDT: Changes in DDT were accompanied by a decline in dividend pay-out – the proportion of profits paid as dividends declined from 30 per cent in early 2000s to 22 per cent in 2019 (BSE 500 companies).
      • Chance of improvement in pay-outs: It is expected that the reversion to the classical system may improve dividends pay-outs.
      • However, this will benefit individual taxpayers with incomes below Rs 5 lakh as the slab rate applicable is less than the existing rate.

    Taxing cross-border income

    • In the international arena, India is determined to tax cross-border incomes.
    • Taxing digital companies: The addition of explanation 3A to the Income Tax Act reinforces India’s commitment to taxing digital companies.
    • What comprises the business with nexus to India: The proposed amendment clarifies that incomes related to the advertisement, sale of data of a person residing in India and sale of goods and services based on the data of a person residing in India, may be attributed to a business with nexus in India.
    • Taxing citizen not taxable anywhere: To tax Indian citizens that are not taxable in any other jurisdiction, the Act will now deem such individuals as resident taxable in India.
      • While the application of the law may be challenged giving rise to disputes, it is a step forward.

    The proposal of Citizen’s charter

    • Charter on rights and obligations: The finance minister also referred to introducing a citizen’s charter that incorporates taxpayer’s rights and obligations.
      • Limits of charters: International experience shows that charters have limited enforceability unless adopted in primary legislation.
    • Supporting charters with legislation: Introducing charter to the statutes may, therefore, prove to be a positive initiative.
      • Faith can be built through enforcement of the charter.
      • However, the penal provisions must be well-thought-out so as to avoid adding another contentious element.

    Conclusion

    • Lack of uniformity: The budget proposals aimed to provide simplicity, yet much remains to be done, given the lack of uniformity in the taxation of incomes such as capital gains.
    • Limited revenue implications: The success of schemes proposed is contingent on the traction they gain. As for the revenue implications, the impact of these measures may, in fact, be limited.
    • Countering loss through gains from settlements: Loss expected from lower tax rates may be countered by gains from the settlement of cases, higher dividend taxes on top incomes, and the wider scope for taxing international incomes.