GS Paper: Indian Economy

Context

• Notwithstanding the likely slowdown in economic momentum in the second half of the year, the Union government’s tax collections are on track to surpass its budgeted target by a significant amount this year.

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The current status Union government’s tax collection

• Gross tax collections have already touched the target: Data released by the Controller General of Accounts last week shows that gross tax collections have already touched 58 per cent of the full year’s target, growing by 18 per cent in the first seven months (April-October) of the current financial year.
• Healthy growth in corporate tax collection: Under the broad rubric of taxes, direct tax collections have grown by a robust 26 per cent in the first seven months of the financial year, with healthy growth being seen across both corporate and income tax collections.
• Higher than the nominal GDP growth: While the pace of direct collections has eased during July-October when compared to the first quarter, it continues to be higher than nominal GDP growth in the second quarter.
• Healthy indirect tax collection: On the indirect tax side, GST collections continued to witness healthy growth, recording an increase of 11 per cent in November.

Memory shot in short: Types of Direct Taxes

• Income Tax: Depending on an individual’s age and earnings, income tax must be paid. Various tax slabs are determined by the Government of India which determines the amount of Income Tax that must be paid. The taxpayer must file Income Tax Returns (ITR) on a yearly basis. Individuals may receive a refund or might have to pay a tax depending on their ITR. Penalties are levied in case individuals do not file ITR.
• Wealth Tax: The tax must be paid on a yearly basis and depends on the ownership of properties and the market value of the property.
• Estate Tax: It is also called Inheritance Tax and is paid based on the value of the estate or the money that an individual has left after his/her death.
• Corporate Tax: Domestic companies, apart from shareholders, will have to pay corporate tax. Foreign corporations who make an income in India will also have to pay corporate tax.
• Capital Gains Tax: It is a form of direct tax that is paid due to the income that is earned from the sale of assets or investments

What the Healthy tax collection imply?

• Higher devolution to states: Higher tax collections at the level of the central government imply that devolution to states will be higher than the budgeted amount of Rs 8.16 lakh crore. The months of August and November have in fact witnessed double instalments as the Centre has stepped up devolution.
• States can increase fiscal expenditure: Along with the interest free loan scheme extended by the Centre, higher devolution implies that states have considerable fiscal room to increase capital expenditure. However, this has not been the case so far. Capex by states has been rather muted.
• Provides comfort to governments fiscal arithmetic: As per recent statements by revenue secretary Tarun Bajaj, the government is now hopeful of exceeding the budgeted target by nearly Rs 4 lakh crore. With its spending also likely to surpass earlier expectations by a considerable margin, higher tax collections will provide some comfort to the government’s fiscal arithmetic.

Challenges on the expenditure side

• Increased subsidy bills: On the expenditure side, the Union government is facing a massive increase in its subsidy bill.
• Spending is more than actual budget: Actual spending on the food and fertilizer subsidy and also on LPG will be significantly higher than what has been budgeted for. This is likely to make the fiscal situation challenging.
• Effective utilization is necessary: Considering that the central government has maintained the momentum on its capital spending, growing by around 60 per cent in the first seven months of the year, the overall general government fiscal impulse will depend on how effectively states are able to utilise the extra space available to them.

Conclusion

• Calls for increasing spending to support the economy during this uncertain period will only gain traction as the budget approaches. The government must however resist the temptation. It should stick to the glide path of fiscal consolidation.

Mains Question

Q. In a time of possible economic slowdown, India’s tax collection is on a healthy path. Discuss what good tax collection means for economy?

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Context

• India’s economic growth slowed to 6.5 percent during the July-September quarter because of a fading low-base effect. For the full year, the economy is expected to grow at 7 percent, with risks tilted to the downside. This implies that the second half of the year (October–March) will see growth slow down to 4.6 percent, again largely due to the base effect and slowing global growth.

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Background: The COVID Pandemic, geopolitical tensions and the Prospects

• This was the second consecutive quarter with no functional disruption of economic activity caused by the COVID-19 pandemic.
• Since October, Google, too, has stopped reporting mobility indicators, which had become one of the most tracked data points for analysts and policymakers since the pandemic struck.
• This suggests that COVID-19 is unlikely to come in the way of growth for most parts of the world, with China, which is following a zero-COVID policy, being the key exception.

Performance of Indian economy amidst the current global slowdown

• Spill over effect in India: In an interconnected world, Geopolitical tensions, high and broad-based inflation in many parts of the world and sharp increases in policy rates in developed countries amid a looming recession will continue to confront the global economy. These effects will spill over to India as well, despite its structural strengths.
• Slow growth of contact- intensive service sector: Growing at 14.7 per cent, contact-intensive services such as trade, hotels and transport continued to be key drivers of the growth momentum in the second quarter. This segment had borne the brunt of the pandemic because of recurrent lockdowns, and is showing a strong rebound because of pent-up demand, a trend that is likely to continue this year.
• Strong private consumption: Private consumption was quite strong in the second quarter, growing by 9.7 per cent, and now 11.2 per cent above the pre-pandemic level.
• Rising domestic demand, good for the economy: The resilience of domestic demand will shape the contours of GDP growth in coming quarters as the global growth momentum is anticipated to lose steam. Advanced economies, whose growth is expected to slow sharply next year, account for almost 45 per cent of India’s merchandise exports.
• Strong and firm Agriculture sector: Despite climate-related disturbances, agriculture surprisingly held its ground in the second quarter.
• Healthy tax revenue: So far, healthy tax revenue collections have allowed the government to finance its bloated subsidy bill and investments without much pressure on the fiscal deficit. Led by government capex, investments grew 10.4 per cent in the second quarter.
• Good corporate balance sheets: strong corporate balance sheets not only cushion them against global headwinds but also provide an opportunity to kick-start the investment cycle once uncertainty subsides.

The current status of India’s manufacturing growth

• Slowed growth: Manufacturing GDP growth slowed rather sharply due to the base effect and margin pressure on manufacturing companies. This is somewhat contradictory to the relatively strong signals from the Purchasing Managers’ Index (PMI) which, at 55.9, was in the expansion zone during the July-September quarter, while also being slower than the IIP growth of 1.4 per cent in the same quarter.
• Support from the government: Currently, manufacturing is finding some support from government spending on infrastructure, particularly in sectors such as steel and cement. The production-linked incentive scheme has incentivised private investment and fast-forwarded manufacturing investments in electronics and pharmaceuticals.
• Overall demand is low except few high value segments: The festive season-related production and the continued strong demand in the automobile sector (especially in high-value segments), was not enough to prevent an overall slide in manufacturing.

The current status of Agriculture sector

• Strong and firm Agriculture sector: Despite climate-related disturbances, agriculture surprisingly held its ground in the second quarter. Although rains were 6 per cent above normal this year, they were quite lopsided and led to a drop in rice acreage in some of the rice-growing regions on account of rainfall deficiency and some damage to crops from excess unseasonal rains in October.
• Inconsistency in rainfall may affect kharif: In fact, October rains were 47 per cent above the long-period average. Rain shortfall in some regions, excess in others, and unseasonal excess rains point towards some hit to kharif production.
• Rabi crops look in good swing: That said, the prospects for the winter crop (rabi crop), which is largely irrigated, look good owing to favourable soil moisture conditions and healthy reservoir levels. While rabi sowing was initially delayed on account of unseasonal October rains, it is now progressing well, with sown area until November 18 about 7 per cent higher than during the same period last year.
• Overall agriculture growth prospects: This trend, if sustained, should offset the hit to kharif production to some extent. Overall, we expect agriculture to grow at 3 per cent this year, lower than the decadal average of 3.8 per cent.
• Food inflation: Abnormal weather has also triggered food inflation, particularly in cereals, which will cool off only when the prospects for rabi crop become clear. While fall in inflation in October was largely due to a high base effect, core inflation continues to be sticky and food inflation risks persists.

Conclusion

• India’s growth cycle has become well-synchronized with those of advanced economies. So, a sharp slowdown in these countries will spill over to India and the maximum impact of domestic interest rate hikes on growth will play out next fiscal given that monetary policy impacts growth with a lag. The key policy challenge for India will be to manage a soft landing amid the possibility of a hard landing in advanced countries.

Mains question

Q. COVID pandemic disrupted the global economy, moreover the geopolitical tensions are adding to the existing slow growth. In this context, discuss the current status of Indian economy.

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Context

• The Indian rupee has been quite the controversial newsmaker this year. Having fallen more than 11 percent against the US dollar so far in 2022, the rupee breached the much-feared 80-mark in July and went on to set record lows, touching 83 to a dollar late in October.

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Impact on trade

• Widening trade deficit: The first phenomenon is one of the biggest worries caused by a falling rupee, a rise in import costs, threatening higher inflation and a widening trade deficit.
• Advantage for export: However, there also exists a ray of hope, a depreciated currency implies cheaper, more competitive exports and therefore, a possible export-led boost to the domestic economy. The net effect of these opposing forces would determine the impact of a depreciating currency on an economy.
• Robust Purchasing Manager’s Index (PMI): The import bill has risen not only on the back of a raging dollar and hardening crude prices but has also been spurred by strengthening domestic demand and manufacturing, as evidenced by a robust Purchasing Manager’s Index (PMI) of 55.3 in October.
• Subdued merchandized export: Although service exports have done fairly well in FY 2022-23, merchandise exports have remained subdued and could soon worsen due to economic downturns in Europe and the US.

Impact on foreign investment

• Weak rupee low foreign portfolio investors (FPI): The rupee has a complicated relationship with the moody foreign portfolio investors (FPIs). A weaker rupee can discourage FPIs. In turn, FPI outflows can further push the rupee to depreciate.
• Falling NRI deposits: With the rupee losing value against the dollar, and interest rates around the world rising, NRI deposit flows also fell in the five-month period from April to August 2022, down to US$1.4 billion from US$2.4 billion a year ago.
• FDI is Rising: Net FDI flows have remained positive and are set to grow, with April-June 2022 seeing an inflow of US$13.6 billion, higher than the same period last year. Even Indian stock markets have remained resilient, particularly on the back of large net-purchases by domestic institutional and retail investors, offsetting the equity sell-off by foreign investors.
• Negative foreign investment: Net foreign investment (FII) flows did turn negative for a few months in 2022, and while rebounding FPI and resilient FDI do point to a more optimistic opinion of India among foreign investors, foreign investment is absolutely crucial at this juncture in India’s growth story and must be watched closely.

Efforts taken by RBI

• Use of forex reserve: In an effort to defend the rupee, the RBI has intervened and sold off some of its foreign exchange reserves. The reserves stood at US$524.52 billion as of 21 October 2022, witnessing a fall of over US$115 billion since the beginning of the year.
• according to RBI external situation is better: RBI has stated that most external indicators such as external debt to GDP ratio, net international investment position to GDP ratio and the ratio of short-term debt to reserves reflect India’s relatively comfortable position in meeting its external financing requirements–even in contrast to other emerging economies.
• Careful intervention: Over-tightening of monetary policy and excessive intervention in the currency market can pose significant risks to the country’s growth prospects and the RBI must be careful to intervene just enough to quell volatility, without expending an inordinate amount of reserves.

Opportunity in crisis

• Leveraging the growth rate: India has the chance to leverage its relatively healthy growth rates and rising infrastructure and capital expenditure to attract foreign investment, spurring growth and strengthening the capital account.
• High investor confidence: Investor confidence has been steady, with the country seeing a record high of annual FDI inflows of US$84.8 billion in FY2021-22 in spite of the pandemic and volatile geopolitical scenario.
• Stability in growth: This confidence needs to be leveraged and by positioning India on the international stage as a thriving and stable haven for investments, both the country’s growth and forex needs can be met.
• Sufficient policy support is needed: Although the falling rupee has caused worry for a few economic indicators, with sufficient policy support, the domestic economy could emerge as an outlier in a global downturn.

Conclusion

• With the United States (US) on a war path to curtail inflation and the supply side stifled by the conflict in Ukraine, even historically strong currencies like the euro and the British pound have plummeted against the raging dollar, more than the rupee. Government and RBI must stay on course of steady growth of economy.

Mains Question

Q. Discuss the impact of falling rupee on Trade and foreign investment in India? How India has unique opportunity for growth amidst the crisis around the world?

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Context

• The recent data seems to indicate that retail inflation has possibly peaked and is now likely to trend downwards. But, it would be wise to exercise caution. The latest data, while providing useful nuggets of information about price trends in the economy, challenges some of the widely held conceptions about inflation, and gives mixed signals about its trajectory.

What is a simple definition for inflation?

• Inflation is an increase in the level of prices of the goods and services that households buy. It is measured as the rate of change of those prices. Typically, prices rise over time, but prices can also fall (a situation called deflation).

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Inflation Rate

• Inflation Rate is the percentage change in the price level from the previous period. If a normal basket of goods was priced at Rupee 100 last year and the same basket of goods now cost Rupee 120, then the rate of inflation this year is 20%.
• Inflation Rate= {(Price in year 2 – Price in year 1)/ Price in year 1} *100

Five broad trends emerge to consider as reasons behind high inflation.

• Russia- Ukraine war:
• The sharp rise in commodity prices as a consequence of the war is considered to have been largely responsible for the spurt in inflation this year, pushing it beyond the upper threshold of the RBI’s inflation-targeting framework.
• For instance, India’s crude oil import price rose from $84.67 per barrel in January to $112.87 in March, and further to $116.01 in June. The ripple effects of higher commodity prices have been felt across the economy.
• Inflation generalized in formal and informal sectors:
• There are indications that inflation is getting more generalized across both the formal and informal segments of the economy.
• One indication of this comes from the clothing and footwear category, a highly fragmented industry with the presence of both formal and informal segments. Another possible indication comes from rentals.
• Rental inflation in India had tended to remain largely range-bound over much of the past few years. But as this category has the highest individual item-wise weight in the inflation index, any movement in either direction, however small, would have a large impact on core inflation.
• Supply side disruptions during the pandemic: During the pandemic, supply-side disruptions had caused goods inflation to rise, even as services inflation remained relatively muted owing to risk-averse behaviour by consumers and restrictions on high-contact intensive sectors.
• Competition and the pricing mechanism in the economy:
• Prices are rigid on the downside will depend not only on how demand fares now with monetary conditions having been tightened, but also on the extent of competition in the economy, among others.
• After all, greater market concentration creates conditions for greater pricing power. A badly damaged non-corporate sector (MSMEs) would have led to ruptures in the low-cost economy, increasing the pricing power of the corporate sector during this period.
• Wage- price spiral:
• Inflation in India is not a consequence of a strong economy. Wage growth in the large informal rural economy has been lower than inflation.
• While some skill-intensive segments of the urban formal labour force may be able to exercise some bargaining power, the labour force participation rates suggest continuing slack in urban labour markets.

What are the concerns?

• Commodity should have come down over the period: If high core inflation in the months after the beginning of hostilities was an outcome of the passthrough, either in part or completely, of the Ukrainewar, then the decline in commodity prices since then should have led to a moderation in core inflation
• Services inflation vs goods inflation: But as activities normalised, there was an expectation that services inflation would see a strong pick-up. The recent data indicates that this has not been the case. While services inflation has risen, it remains considerably lower than goods inflation, perhaps owing to a combination of lower cost-push pressures, more slack and less demand.

Conclusion

• While inflation may have peaked, it is far from being quashed. The RBI expects inflation to edge downwards from 6.5 per to 5 per cent in the first quarter of the next financial year (2023-24). But RBI ca not afford to underestimate the price pressures in the economy.

Mains Question

Q. What is inflation?  Some of the new emerging trends are considered while measuring rising inflation in the current scenario. Discuss.

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