There are four and half reasons why the Indian economy decelerated when the world economy picked up pace , according to chief economic advisor Arvind Subramanian. But, in a conversation with ET editors, Subramanian said he saw a directional change in the economy in the July-September quarter. Edited excerpts:
Moody’s has given India an upgrade but the recent data have been a bit of a wobble–the entire matrix of inflation rising, worry about fiscal deficit, higher oil prices and high trade deficit.
I feel part vindicated because when I contrasted how they treated India and China, two months later they downgraded China and three months later they have upgraded India. The way they treated China and the way they treated India, it made no sense at all. So, some of it was just long overdue because there was a lack of consistency. Their call from what they said was institutional change and deeper structural reform had been enacted and that was the reason why really, whether it really eases of doing business whether GST, the whole JAM agenda, so they focused on those institutional things which I think was what finally convinced them.
Directionally, the second-quarter numbers have been better than the first quarter whether it is the IIP, the quarterly earnings, also the export numbers. So, let’s see how the numbers pan out, but the hope is and the expectation is that directionally things will be different this quarter than last quarter. There is some sign credit is also picking up.
Is there a concern about the jobs situation, losses due to demonetisation? Where is the economy headed?
We should step back and see how the economy is doing and then look at employment. Again, let’s distinguish the broader employment picture from any kind of demonetisation impact. I think many indicators have pointed to a slowdown in economic activity since about the second quarter of the last year. That was what was worrying everyone. Three-four, maybe even five quarters, we had various indicators, GDP growth, investment, credit growth, IIP, all these were decelerating and that was what was causing concern. Why is it Indian numbers were slowing down when in fact around the world last two quarters they were picking up. There are four and half explanation for this.
Two are the transitional factors. Growth started slowing down from before, demonetisation and GST have kind of exacerbated that deceleration trend. Those are two factors. Third, if you look around the world and if you compare real interest rates in India and the world. Until before a year, our real interest rates were not so off the others. But, in the last one year, our real interest rates have become higher than the rest of the world. Cost of capital and associated strengthening of the rupee created a dampener on activity in a directional sense.
Fourth, I would say was a much more structural thing which I think in some ways (is a) fundamental diagnosis of why we are slowing down. We’ve had a classic, what is called, balance sheet recession. That’s is when you have a boom, afterwards, you have a slowdown. It’s just that we should not call it a recession in India because, in advanced countries, you actually have negative growth or very low growth, we have decelerated relative to potential. So, balance sheet recession in India over the last two-three years has taken the form of growth which is much slower than potential. That’s been going on for some time. That has also been a factor. The longer you don’t act on balance sheet recession, progressively the cost becomes greater.
Final half reason and I‘ll tell you why I call it a half reason. We have forgotten that oil prices in the last two years declined very sharply. Now, in the last two-three quarters, oil prices have started increasing again and we know that oil price increases are a dampener on activity. I am saying this is only half a reason after all as this cannot explain the difference in direction between India and the world because net oil importers also face this.
So, going forward, if these two are behind us, if we are doing the recap and if world exports pick up then again, I don’t want to be too categorical or too rosy-eyed. Maybe we are going to see a pickup in activity again. But oil prices are going in the other direction, which we need to take account of.
Did you think around June 15 that GST would contribute to deceleration or were you surprised when it did? (GST was rolled out July 1.)
If you look at the Economic Survey that we wrote in July, front page, the fourth factor was the transitional impact of the GST. I spoke in the Survey about deflationary impact from agri, from loan waivers and transitional GST challenges.
From your four and half factors, demonentisation is behind us, GST will be. Ultimately, for the growth potential to be met, real interest rates /exchange rate will need to be addressed, leaving oil prices aside.
I don’t want to by any means say that this is the only thing holding back growth at all. There are lot of things which the government will have to do. Remember, the recap and resolution have just begun. If you talk about the agenda going forward, whatever additional or new things we may have to do, there is still a huge implementation agenda ahead. Going forward, GST still has to stabilise. We still have to simplify it further for MSMEs (micro, small and medium enterprises). We still have to get land, real estate, electricity into the GST. Resolution and recap are going to take time. In terms of policy agenda, there is a lot–cost of capital is one thing.
On the job front, though the economy is picking up, is there something more that can be done, or do we just wait for the tide to turn? For example, we have replaced people with vending machines at Delhi Metro.
You have to get over all the dynamism—investment growth, credit growth, export growth. That’s probably 75% of job creation. Then you have to see over and above what you have to do. For example, we have this package for the textile and clothing sector. We have been talking about also extending it to other labour-extensive sectors. You create overall dynamism, you may need to favour some of these sectors with these incentives. We can’t fight technology. The reason why to some extent we are getting substitution of robots for labour is because we have not created situations for easy hiring of labour and for small to become big.
Those are the kind of regulatory challenges, if we address, will help these. You want targeted policies, but there is a limit to how much targeting we can do in our system given our administrative capability. But I think some of those can be done through addressing these regulatory challenges. If we can make it easier to hire, allow firms to become big, those will help us, because I don’t think we can fight technology. And… This whole robot replacing the thing, it worries me. I hear robots have started cutting soft cloth. It is a cause for real worry. We still have a window of 10-15 years where China is vacating space, we have to do everything to occupy it. It’s not happening as much it should. Looking at clothing numbers for Bangladesh, Laos and Vietnam. We need to seize that opportunity.
Exporters will say our wages are higher, cost of capital is higher and after the land acquisition law, land is more expensive. If all three are more expensive, then how can India be competitive?
I think there are many dynamic exporters in India. If this was uniformly true, then there would be no exports from India. Why is it that some firms in some situations do and others don’t. It is true that we have burdened ourselves with some of these things—cost of capital is one, connectivity needs to improve a lot. And something which we are addressing is even after GST, there are many embedded taxes on exports which we could easily relieve. Electricity taxes, for example, are not input tax creditable. They are still part of embedded and not part of GST. On the policy front we can do more and we will do more. I think there are parts of India, if state governments cooperate… Odisha, Jharkhand, UP, we would be setting up textiles factories left, right and centre as labour is still cheap.
Do you think we continue to be obsessed with a stronger rupee? Isn’t this hurting us?
There are parts of the political class which like a strong rupee. I think that’s something that’s true and that’s something that we need to deal with. If you look at what happened after the Asian financial crisis, ASEAN said never again will we go to the IMF. We want to self-insure, we don’t want insurance and they wanted to build up reserves which they did. But what people don’t understand is that that the self-insurance motive very soon translated into using the exchange rate as an engine of growth. So, what began as a financial objective clearly morphed into a growth and a mercantilist objective. And many countries used the exchange rate as an instrument for export growth.
In India, we don’t seem to share that across the spectrum. I don’t why that is the case but I can say and this is across the political spectrum for the last 15-20 years and this has been one of my pet peeves against all policymakers in India of all stripes, is that we just seem to love foreign capital of all sorts. Every time there is a crisis, we open the capital account even more and the more you open the capital account the less able you are able to control the exchange rate. That’s just a fact of life and we seem to love foreign capital. Well if you love foreign capital then you have to pay the price for it. There is no free lunch in this business.
One idea thrown up by an NGO was demonetisation. Another one is a banking transactions tax and doing away with income tax. What is your view?
Doing away with the income tax is one of the most silly ideas that one can ever come across. People forget that over the course of development, income tax and taxes like that are what create the connection between the citizen and the state. Best example are all those countries which get aid or resources from oil–they have terrible institutions, terrible governance, lots of corruption.
We are looking to encourage manufacturing here. How do you see trade liberalization–do you see scope for further reduction in import duties? Can that make manufacturing more competitive?
Trade is a genuine engine of growth that maybe hasn’t fired our collective imagination as much as perhaps it should. When people start saying we must focus on the domestic market, that’s a totally a historic statement. No country in the history of humanity has grown 8% plus without 20-25% export growth.
It’s another matter whether the world can accommodate it or not but from our part that’s what our strategy should be. That notion that we can get some import-substitution-led 8-10% growth is fantasy. Trade has to be an engine of growth. What does it mean? In the old days when you looked at it, it was all just making it down in tariffs or whatever. Now it’s being part of value-added chains, which is stuff goes in and out several times, then every transaction has to be done at the lowest possible cost. So, on the whole, being part of value-added chains means not just low tariffs and barriers but also the whole logistics and the connectivity part has to be much more emphasised.
Just as we aspire to go up the ease of doing business index, I think we should have equal mission mode on the ease of trading indicators that we need to jump. We need to fully absorb the idea that if you want to export more, we have to import more as well and import with fewer restrictions, fewer costs as well.
People forget when we grew at 9% our exports were growing at 25%, not just services but also manufacturing. So, we have a stake in keeping the world system open. Of course, if you want an open trading system, you also have to open ourselves.
The transactions tax, I haven’t thought about it. The origin of some kind of transactions tax internationally goes back to the Nobel Prize winner James Tobin who said it more in the context of preventing hot flows of capital, that you need to put what he called sand in the wheels. It’s actually called the Tobin Tax. After the financial crisis in the US, that kind of idea has been resurrected as well because there is a sense that finance has become too big. So, while I don’t have a strong view on the transactions tax, I think in the case of India the reasons for a transactions tax of not allowing finance to get too big is probably not an overwhelming consideration, which means that the downside efficiency cost of a transactions tax can be quite high.
If this is going to be the last regular budget, then what kind of populism would you regard as permissible?
We need to maintain the path of macro stability. The government has benefited from it, it has acted out of conviction on macro stability and I think we should continue that but whether there is scope for doing big reforms now.
At the recent banking conclave, you spoke on the issue of consolidation….
There are two or three things that are important–recognition, resolution, recap and reform. Recognition, I think we have made progress. Resolution is proceeding, recap we are doing. But I think, if you want this problem not to recur, just putting in money will not help. Second, we are putting in money at great political cost–either crony capitalism or genuine bad decisions, whichever way you look at it. You need to ensure you are getting enough value if you are incurring this kind of political cost. Therefore, reforms have to accompany this. Probably, three categories of reforms are important. One, the fundamentally unviable have to shrink. That’s absolutely essential. Two, we have to be open to, and it’s not just my view but others as well, much more majority private sector ownership in public sector banks. Here, lest I be accused of being mentally un-Indian and rampant capitalist, let me say why there is a need to be open about it.
Public sector banks are hampered in their HR practices by being part of the government. There is overabundant caution in private sector banks, which is not there in public sector banks. I think public sector ownership has created that. In the boom years, we had a lot of public to private lending, which has become toxic.
Exiting from public to public is easier then exiting from private because at the drop of a hat you will be accused of favouring someone. So, for all these reasons, we should look with more non-ideological eyes on greater private sector ownership in public sector banks, which is more easier said than done. In the public sector banks themselves we need to get better risk-management practices and getting better people, better incentives. But, consolidation per se is neither here nor there. What is the gain from joining a good with a bad… there are no real gains there. Consolidation is over-emphasised as a long-term measure.
What is your view on the fiscal situation and consolidation roadmap?
This has been kind of transitional year with two major policy actions with demonetisation and GST. So, let’s see how revenues evolve and in light of that we will have to look at the fiscal math. I think broader point over last three years, the government has been consolidating. Macrostability is conviction of government. How its translated into targets, glide path, that you will know in the run-up to the budget.
What about recap bonds? Will they be part of the fiscal deficit?
Every year, the IMF’s number is different from ours because of different accounting practices. They are very consistent. Privatisation receipts they put below the line, but we take it above the line. The recap bonds, we haven’t yet decided the manner it will be done–indirectly, timing, how much—all this is to be decided. There is a reason as to why the IMF puts privatisation receipts and recap bonds below the line, which is an asset swap. It does not affect demand in the short run, which is why they put it below the line. So, they don’t affect short-term macro.
Second, if you believe the diagnosis that twin balance sheet problem is one of our binding concerns, then how can it not have positive impact? Third, we forget that the government is already on the hook for the unrecoverable value of loans given by public sector banks. It’s only a matter of being honest, transparent and explicit, taking it on earlier rather than later. So, what we are doing is codifying and recognising the reality.
There is some talk of shortfall in state GST collections.
The way to think about how GST is performing is to look at what was the GST revenue last year–central excise, value added tax, services tax, which have now come under GST. We are getting Rs 93,000 crore on an average every month. It is net of input tax credit. We are doing a growth of 12-13%. Broadly, we are in line and states are not going to see a shortfall. We are doing well on cess collections and will be enough to compensate.
There is some worry on the fiscal front because of uncertainty over GST collections.
Let us distinguish two things—one, the anxiety for the fisc that is coming from GST and the other is the fiscal situation. They are two different things. I think broadly on GST we are not doing badly. On the overall fiscal situation, let’s wait. We are still looking at numbers–in a few weeks or month we will get a better sense of the fiscal situation.
On GST, we are gradually moving to 18%. We can go to a dominant two-rate structure and we are arriving there faster than we thought.
I think that we are certainly heading in the right direction. I am very encouraged on that score. But let me tell you where we are and where we are likely to get. On 28%, which I never liked, which I think has created some of the transitional challenges, I think we are very close to making 28% just for demerit goods. There are two set of goods which are still there, which are not demerit, which are cement and stuff and white goods. We are going a bit slow on that because we have to balance revenue with this but we will get there. Then 28% will be demerit goods. Then we are left with core rate and what we call poor man’s rate. In India, we will never get one slab. We have too much of a socialist mindset and for good reason.
I don’t mean to use the word socialist pejoratively. What we are going to aim for is one ‘poor’ slab and one ‘plus’ for demerit, which we are getting there, and one ‘minus’ for merit goods, which is the 5 and 0%. I think 0% and 5% has quite a lot of tax base and there I think we will not be able to make that much progress as we have to protect the poor. But in between we have the 12% and 18% that at some point can be combined in the forseeable future into one rate. Then we get close to my ideal.
The revenue-neutral rate (RNR) suggested by your report was 15.5%.
We need to look at numbers more carefully. Remember these numbers will also depend on compliance gains and what the base expansion is going to be. At the risk of sounding a little bit overenthusiastic, I think we would be pleasantly surprised about how much the base can expand. Base is going to expand on GST going forward. If you look at the registrants, or if you look at the implied tax base, even next six months, we are going to look at bigger tax base than we thought before starting this enterprise.
How soon should we see real estate and petroleum and alcohol come into GST?
(For) alcohol, you will have to change the constitution. If you think about it, if gold, land and real estate and alcohol are in GST, three big sources of corruption in the economy are going to be part of it. On the specific question, land and real estate, the pressure is building up. Last time it was on the agenda, we couldn’t discuss it, but I think it will be on the agenda. There is a lot of buzz building around bringing that in. There are still some states of course that are not happy with that. We will have to work that through. But I think that will happen sooner rather than later.
I want electricity to come in very early on because land and real estate needs to come in because of cleaning up and transparency. Electricity needs to come in more for the competitiveness and kind of Make in India objectives because they get embedded in exports and so on. Energy–I think I have been surprised by the calls for energy to come in. Already, we had a discussion on whether to bring in natural gas or not but I think a month and a half ago many of the truckers were saying they wanted petroleum to be part of GST. If those pressures build up, I think these things will happen sooner rather than later. But land and real estate and electricity and natural gas I think can happen even sooner than the others.
With something like GST, everything is getting digitized, so how do you capture that data, what is the reliability of that data?
I am just salivating at what the GSTN data going to do in terms of how much it is going to improve our understanding of the economy. GSTN data is going to give us an insight into the economy that we probably never had before. For example, in last year’s Survey, we actually used the GSTN data to show for the first time that trade within India was much greater than what people thought it was. So many such insights are going to come out from GSTN data–size of the economy, informality, inter-state trade, so many things are going to get a fresh perspective with this new GST data. In that sense, digitalisation is going to be a huge bonus for the statisticians.
The government has laid out a corporate tax reduction road map. With uncertainty about GST revenues, how fast can that progress?
The government had a glide path for the corporate tax rate as well, steadily coming down to 25%. I think we are on course for that. Often hyperactivity is also something that we should be careful about. We need to recover from the two big policy experiments that we have had and there is ongoing agenda of the recap, the banking system. That path (the reduction in rates) government will follow. There doesn’t have to be anything incremental above what we have already committed to.
Lately there has been lot of noise from fringe elements. Is it not ironical when we are talking about growth and development this sort of thing is also there? How would that impact India’s growth and image?
The broader point, the lesson from economic development, is that the less the social conflict and better the ways of managing social conflict, the more long-run economic development is going to be.
Why don’t we hear much on pollution from the central government?
In the Economic Survey, I am hoping we will have something on that. To me the experience of GST says that there is a lot more scope for using cooperative and competitive federalism for tackling so many issues in India. To me it’s a travesty that 70 years after independence, we are not one market for power. It’s an absolute travesty. So, whether it is power, whether it’s creating one common market in agriculture, whether it’s pollution, all these cross-border issues are eminently prime candidates for the use of cooperative federalism to solve.
With the CEA’s team, Niti Aayog and the Prime Minister’s Economic Advisory Council, how does providing inputs for policy work? Is there a broad coherence?
I don’t think that complete coherence is desirable. I think there should be broad consultation and we provide inputs and then the decision-making bodies digest all this and take their call. So, a lot of consultation but not necessarily convergence on all issues. I remember two budgets before where we had this ferocious debate on the fiscal deficit, whether we should go down from 3.9% to 3.5% or not. To me it was a fantastic example of deliberative decision-making where there were violently opposed views all the way up to the top. I don’t think that’s a bad thing, that’s how it should function.
You have analysed some very interesting ideas in the Economic Surveys. What do we see next?
You can interpret this as ‘I am a crazy guy’ but I think you can work on the Indian economy for the next 20-25 years and every year have five interesting things, important things to look at. In that sense, the Indian economy is fascinating partly because it is such a complex diverse country and also because there are so many distortions that there is lot to write about. Also, data is becoming more and more available. In the last survey, for example, not just inter-state trade, we used railway passenger data to show how much took place in India in a way that has never been done. People thought India was such an immobile country, but we showed based on passenger data, we were three times as mobile as people thought and only may be 50-75% less mobile than China in terms of internal mobility.
What about the idea of a universal basic income (UBI)? You dealt with it last year. Where are we one year later?
The one thing to add to what we said is that the beauty of India is that those are the discussions that don’t have to take place only at the central government level. We have 29 states, and these are policy experiments that can also happen at the state government level and indeed a few states are thinking about this very seriously, actively. And what is interesting is that apart from the fact that different states can do this, what’s interesting is that there is a very nice Centre-state dynamic here as well. If the Centre has to finance this, say, it has to find resources. But in the case of a state trying to do this, there is this extra interesting dimension that the state can tell the Centre look, you are giving me money. I am not asking for more, give me the same money but don’t tie it to your pet schemes. That becomes an additional source of financing which state governments have and that kind of dynamic begs something like a UBI experiment at the level of a states more possible and plausible as well.