It is okay to bite the bullet on fiscal deficit for a mega reform like this: Arvind Panagariya
Impact of the cut on fiscal might be not as large as it is being estimated right now.
The finance minister has been announcing one major reform after the other. The latest corporate tax cut, last announced four years ago with certain path and direction, finally has taken place. Is this a major boost and the big bang reform that we have been talking about?
My answer is completely unequivocal on this. This is a bit of a reminder of the 1991 reforms to some degree because it is really a very clean reform. All exemptions are ended and the tax rate reduced to effectively what will be about 25% including the surcharges; for fresh investment, it has been brought down to 15%. This is truly a mega reform. I am delighted.
What happens from here on? The finance minister has explained that the revenue forgone because of this measure and others including rolling back a tax on buybacks, will be about Rs 1.45 lakh crore. What happens to the fiscal deficit target of 3.3%? Can we really afford this kind of a loss in revenue at this point?
I have two responses to that. First, if we take the estimate as the likely impact, it would increase fiscal deficit, there is no doubt. But if there is ever a good reason to bite the bullet and let it be, it is this. This is a huge reform.
My second response is not to underestimate the power of the reform itself. Number one, tax revenues may not fall as much if the growth really does pick up. I admit these effects happen with a bit of a lag. Immediately, we may not see the impact. But over the longer run and even medium or even shorter than medium run, we will see some impact on economic activity.
I suspect that it will cut down some of the evasion that goes on once the tax rate is more reasonable. The incentive to evade tax payment declines as a result. Also remember that in our country, a lot of bribe taking goes on and when the tax rate is reasonable, then people will prefer to pay tax rather than evade it by paying bribes. So, all that could eventually help in raising revenues also. Therefore, the impact of the cut might be not as large as it is being estimated right now.
My third point is that the impact of this announcement on the sentiment is huge. This step is being taken at a time when the economy is a bit low and therefore it was a very powerful move.
Is this mostly a sentiment booster? Where does it go beyond being a sentiment booster? Big corporates have a cushion now but what they do with that cushion is the question.
I am an economist. I believe in prices. If you get larger profits, you invest more. It is like demand curve sloping down, meaning if the price falls, we all buy more. If that principle fails, then we are in a lot of trouble, so that is one.
More seriously, where I see really big prospects is that I hope we can carry this reform a bit forward. Right now, we have excluded the foreign companies, so supposedly this is applying to domestic companies only. But even so, foreigners can also incorporate in India and become a domestic company.
So foreign investment could get boosted big time. For those foreign multinationals currently operating in China who are looking for alternative locations -- both because of the ongoing US-China trade war and because of high wages -- , this could really be a big game-changer. So what would matter is for those companies that relocate to, whether the system provides enough flexibility to be incorporated as a company in India and take advantage of the low rates. Currently, of course they can take advantage of the 15% rate for new manufacturing units. So, it could be a huge game changer and for foreigners which have companies that are already incorporated as domestic companies in India, there would be greater incentive.
This coincided with the 25% bps interest rate cut in the United States which also changes the incentives a little bit in favour of India as opposed to the United States. All in all, I see this as a substantive impactful reform. It is not going to be just limited to this sentiment effect alone.
After the tax cuts in the United States in 2017-2018, a large number of corporations did not boost investments as was hoped for. They did not increase employment as it was hoped. This could happen in India as well. How can one ensure that the corporate tax cut really makes a difference? Also, what do you do to improve consumption demand?
Let me take the consumption side first. A very important thing that the companies need to become competitive is export more. The world economy is very large and if you become more profitable and you feel domestic consumption demand is not strong enough, go to the global market. The global export market is six or seven times the size of our economy.
So be competitive, sell there and surely, if profitability has gone up, it is not that profits will accrue to you only if you sell in the domestic market to domestic consumers; your profits will also be subject to the lower taxation when you are exporting. So go export; that is what the companies have to learn.
Even within the auto sector, Rajiv Bajaj says that I export 40% of my two-wheelers and therefore if my domestic demand is a bit tepid, I go more aggressively in the export market. Indian passenger cars sector has 0.9% share in the global market and so you know they have not done their work and they have been not competitive enough. So, either they shape up or make way for other industries that are more competitive for manufacturers who can perform in the global markets. This is a message that needs to go to the industry also. This whole attitude of our industry that somehow it is the government’s responsibility to boost consumption demand is all wrong. Why should the government always have to boost consumption demand?
The government has given this sort of a tax cushion right before the festive season. At least, some companies can pass this on in the form of deep discounts and push demand over there but you need wage growth also. In this situation, when they are turning the wheels, they have to look at that side as well. What do we need to do on the consumption side, on the demand side?
If policy needs to play a role there, I would do it through the financial markets. One of the sources of weakness currently has been from the financial markets, both the banking as well as the NBFC sectors. They have been in a weak stage and reforms have been ongoing but we cannot underestimate the impact of the NPAs on the financial sector. It is huge because on the one hand those who previously were able to borrow just because they were well connected can no longer borrow and so the banks are looking at the projects much more carefully.
Similarly, the banks also have to do better evaluation and therefore there is an issue there. Likewise, the NBFC sector has been in difficulty, but that is where the effort has to concentrate. The finance minister was right to do the Rs 70,000-crore recapitalisation as a part of earlier packages. But perhaps we can do more of that.
I do not like the government intervening at the sectoral level to address these demands because I would rather that the consumers make that decision that they want to spend and choose the product they want to spend it on. But insofar as borrowing impacts the consumption demand, one can go in and do something in the financial markets. That is where I would focus.
Why are you so tough on the auto sector? You are saying their claims are not credible. They have been crying for a GST cut which they have not got.
But the government never said that they will cut the GST rate for the auto sector. If people are waiting, it is because the auto industry itself has conveyed that message to the people. So they cannot blame it on the government for that.
But look, I am for a full GST reforms.I would like to actually see us move to two GST rates -- 12 and 18%. I certainly do not think that we have to do it for a specific sector. I know that you are picking this in the lighter vein but the auto industry does need to shape up as they are highly protected.
If they cannot really be competitive even 30 years after liberalisation, then the time has come that consumers should get to import these cars.