GS Paper: GS3

Context

With the Indian economy caught in the middle of a socio-economic upheaval, the government needs to make its focus on the economy clear and pronounced.

India in the middle of a socio-economic upheaval

• Weakening economy: The economy has been weakening for a couple of years now.
• Social upheaval: The social upheaval is new but its seeds have been fermenting for a while.
• Consequences of the two: The social and economic sides of an economy are not divorced from each other.
  • Each influences the other and the current quagmire threatens to unleash the worst type of feedback between the two.

Consequences for the employment

• Most severe consequence due to the interaction between the social and economic sides is unemployment.
• Rising unemployment disproportionately affects the young.
• India’s job market: India whose median citizen is in the 30s and which is inducting 10 million new young people to the job market every year.
• Demographic dividend turning into a curse: This dynamic, popularly hailed as India’s demographic dividend, can rapidly turn into a demographic curse if the employment situation doesn’t improve.

Falling investment rate, increased risk perception

• Where will the jobs come from? The job creators are entrepreneurs, conglomerates, and multinationals.
  • It is in their nature to take investment risks as long as the returns are high enough.
• Investment rates below 30: In India, investment rate fell well below 30 per cent a while back.
  • Falling returns: The returns on investment were not compensating entrepreneurs for the risk.
  • The recent social upheaval is only adding to the perceived risk.
• Wait and see approach: The more investors adopt a “wait-and-see” approach, the worse the job situation will become.

Way forward

• Structural reforms: The government needs to announce a clear plan and timeline for structural reforms.
• Prioritising domain competence in staff: The government has to start staffing technical positions by prioritising domain competence and empowering these hires with policy relevance.
• Maintaining the integrity of institutions: The government need to maintain the integrity of institutions tasked with the regulation of corporations and banks, monetary policy management, data collection/dissemination and law enforcement.
• Accommodate dissent: The government also needs to desist from trying to drown out protesting voices with state muscle power.

Context

In theory, the shift to GST made eminent sense, yet in practice, some of these expectations have been belied.

Why have GST collections not measured up to expectations?

• This could be due to a combination of three factors:
• First:  The tax rates under GST are lower than in the earlier regime-GST was not revenue neutral, to begin with.
• Second: There has been massive tax evasion due to under-reporting, input credit scams and fake invoices
• Third: A slowing economy has impacted firm revenues, and thus tax collections.

GST should have been revenue-neutral but it is not

• Fitment exercises not carried out: The fitment exercise should have been undertaken in a manner so as to ensure that collections pre and post GST are the same.
  • But, this fundamental principle was not adhered to, and other considerations dominated.
  • Revenue neutrality Vs. Multiple objectives: The GST council began its deliberations not with the single objective of revenue neutrality, but with multiple objectives in mind.
  • Closeness to existing tax: Council wanted to ensure that rates were close to the existing tax incidence (accounting for cascading); to ensure minimal impact on inflation.
  • Not regressive: The council also wanted the proposed rate structure was not regressive in nature.
  • The council wanted that items of mass consumption were not taxed at a higher rate.
  • Achieving all these objectives simultaneously proved a difficult task.

The issue of tax evasion

• It is difficult to arrive at firm estimates of the scale of the problem but there are some indications of its size.
• In West Bengal, it was estimated that the value of goods (July 2017 to March 2018) entering a state appeared to be under-reported by around Rs 50,000 crore.
• Rs 60,000 crore in Madhya Pradesh, and Rs 1,50,000 crore in Maharashtra.
• Numerous cases of tax fraud and fake invoice scams have also been detected since then

Problems involve and possible solutions

• Invoice matching:  It is argued that invoice matching will help if implemented it from the beginning.
  • It could have helped plug the loopholes.
• Issue of under-reporting: It is debatable whether invoice matching can end under-reporting (collusion) and fake invoices.
• Limit of state capacity in handling cases: The Central and state administrations can intervene in only about 3 lakh cases in a year.
  • Their capacity to track lakhs of transactions on a daily basis is questionable.
• Slowing economy: Already existing structural issues have been compounded by the slowing economy.

Way forward

• There are certain options available to the government.
• First: Either recalibrate the expectation or carry on the efforts to plug the loopholes and the shortcoming in the system.
• Second: Lower the cut-off for composition scheme. A higher level simply encourages business “splitting”.
• Third: Reduce exemptions.
• Fourth: The council must deliberate on the rate structure, bringing it in line with pre-GST levels.

Context

High inflation has reduced the fiscal space available for a rate cut.

RBI target of 6% breached.

• CPI at 7.35 %: Retail inflation, as measured by the consumer price index (CPI), has surged to 7.35 per cent in December 2019.
• Latest inflation data seems to corroborate fears articulated by the Monetary Policy Committee (MPC) in its December meeting.
• In the meeting, MPC refrained from cutting the benchmark repo rate.

Consequences for the economy

• Reduced scope for fiscal slippage: High inflation reduced the space for further easing of policy rates.
  • Even after clarity over the extent of the Centre’s fiscal slippage emerged.
• Rise in yield for 10-year securities: The 10-year G-sec yields have reacted sharply to these developments, rising to 6.67 on Tuesday.
  • Offsetting operation twist: Rise in yield resulted in offsetting the impact of the RBI’s recent open market operations.
• Inflation targeting under stress: The combination of weak economic activity and higher than expected supply-side inflationary pressures has put the inflation-targeting regime under test.

Reasons for the inflation rise and chances of easing

• Food prices rise: Much of the rise in the headline inflation number can be traced to higher food prices.
  • Food inflation has risen to a near six-year high of 14.12 per cent in December 2019, up from 10.01 per cent in the previous month.
  • Vegetable prices have surged to 60.5 per cent in December, contributing nearly 3.7 percentage points to the headline numbers.
• Chances of ease in coming months: While vegetable crop cycles tend to be short, and supply-side pressures may ease in the coming months.
  • The stickiness in prices of protein items is likely to provide a floor for food inflation.

Bleak outlook for inflation easing

• No short-term return to normal level: Food inflation is unlikely to revert to previous levels in the short term.
• Household inflation expectations, a key metric in the MPC’s assessment, are more responsive to food inflation, this will further exert upward pressure on MPC.
• A factor of hostilities in the Middle East: The uncertainty over oil prices on account of hostilities in the Middle East, adds to the bleak outlook for inflation.

Conclusion

With limited fiscal space for a meaningful stimulus, the government intends to support the economy during this rough patch, and return growth to a higher trajectory.