GST: Some Questions

Q1: What in your opinion are the key challenges that need to be addressed before the GST regime is formally rolled out early next year?

A1: The most important thing is to view it as a historic opportunity. It is the first major economy related reform of the Constitution that has happened. It is also an opportunity to create a 21st century tax system. Of course, this is one part of the indirect tax system so we are really not touching the corporate or income tax. Let’s say even if you call it half or even two-third or three quarters of the tax system, there is an opportunity to put in place procedures, rules and administrative systems which we can be proud of. Now there is a bit of trade-off here because it has been decided to introduce it by April 01, 2017. This is a good thing in general. But my only fear is I hope the deadline will not override the first point I am making. Once you put in place the structure of tax collection, it becomes very difficult to change it because vested interest develops. So that in my view is the biggest challenge in the structural sense.

Q2: What are the vested interests that might come into play?

A2: Well the vested interests are already there because within the existing tax structures, which are going to be merged to form the new GST, you have 29 state tax administrations. I don’t think the vested interests at the central level are strong as the Prime Minister and the Finance Minister are sitting on top of them. And already the effort towards e-governance, Digital India and all the related things is pretty strong. So I don’t think there will be any problem in the Central Board of Excise and Customs (CBEC) etc. But out of 29 states, who knows where the vested interests are stronger and where they are weaker. But I am sure that among the larger states, there are many vested interests. And we know what these things are. They generally have to do with poor governance and corruption. So those are the vested interests or what we call “tax terrorism”. One of the issues directly related to this that has recently come up is what kind of registration and payments system are you going to have. Now it is very clear that if you are setting up this whole electronic system of collection, it should be totally digitized. What does that imply in structural terms is if we have a company ‘A’ which operates in ten different states, all that it needs to do is register once. That registration should automatically go to all those ten states. It should not be like in the old days where we had to register in every single of those ten states. The registration can always be updated and automatically sent to everyone concerned.

Q3: Following the very interesting observations that you have made, at the first meeting of the GST Council held on September 29, the Centre and states agreed to an exemption threshold of Rs20 lakh for all states, which has been set at Rs10 lakh in case of North Eastern states. The Council also adopted a cross-empowerment model for tax administration to compensate states and agreed to subsume all levies into the new tax. How do you see these developments?

A3: I gave the overall challenge, but there are specific challenges from my perspective as an economist who has worked on these issues for 15 years. And those have to do with two or three different things. One is the variation from uniformity. We talked about this broad rate. If you want to talk about the standard rate, or whatever else you may want to call it, and then there are exemptions on one side and higher rates on the other. The two challenges associated with this are always to make that standard rate as broad as possible and to minimize the two ends, so to say, the lower rate and higher rate. And the second one, which has been widely discussed in the media is to make it revenue-neutral. Now I find that a lot people are confused over the term revenue-neutral rate (RNR). Revenue-neutral always applies to things that this new tax is replacing. Just to give you an example, if liquor or petroleum is out of this system for the time being, revenue neutrality has nothing to do with that. So you are talking about the set of taxes which will go away when the GSTN is introduced from April next year and not what will happen in 2018, 2019 or 2020. That liquor part is not in the system so it’s totally irrelevant to this calculation. Similarly, as of today at least, the petroleum is not inside it. So that has no relevance to the RNR which is going to be introduced from April 01, 2017. Having said that, what is generally in transition is useful to minimize disruption. If you adopt that principle, it becomes very simple. The exemption part then is probably most efficient at this point at least as of April 01 to keep the things that are already exempt. They are two or three major ones. One is education and the other two are certain types of well-defined healthcare issues and certain government transactions. The government part I am not so sure as it is a big organization and it should be able to take it. So that government part is still an issue. I don’t know what the government and GST Council will decide. In my view, the government should pay the taxes and get the thing back as the money goes to them only. But they may decide to follow the principle that applies to private goods also to government. It’s understandable though one would prefer it to be changed. Currently, government-to-government transactions don’t pay taxes such as excise and stuff. Actually, in a proper system, all of that should be paid because you are getting the money and then you use it whatever way you want as against education and health which are private. The other issue I believe is sadly a self-created problem. I had actually recommended a uniform rate and about four or five sales taxes so that there is no higher rate. Why is higher rate a problem? Because if we collect the items that have the highest five rates they are all different. In my system that would have been easy. You take six items and to start with, you keep the same rates, with some adjustments. But now what they will have to do is make that uniform. Again, sad but feasible. The second challenge is to focus on that higher rate and to be able to take that adjustment which will then have to happen in the people who actually pay the taxes. And the third one is actually the trickiest because we are also integrating the service type of taxes with the goods type of taxes as part of this GST. And that’s actually the most difficult for the consumers so to say. What we know is that on an average the final sales tax is lower than the final goods tax. So when you have a uniform rate in the standard category, the average service tax will go up and the average goods tax will go down. But it’s not as simple as that. The goods people will also get input credit on services and service people will get all input on goods. So actually the real increase in services will be less than what appears to be so. And that’s a challenge. The challenge is to make the people understand, both the producers of the services that you are getting some rebate back so don’t charge in full. Let’s take a simple example. Let’s say the existing service tax is 12% but the revenue neutral rate is taken as 18%. In principle they would think of raising it by 6%, but they are also getting an offset. So actually if you are paying 18% to the government, you should not raise it by 6%. You should in some case raise it only by 2% to 4%. So this is the real challenge. And it really will have to be the government, industry bodies and service associations, which will have to educate producers of services who have to levy this so that they make a revenue neutral calculation. The idea of introducing is not for companies to make money but to put in place a revenue neutral rate, which over time is going to benefit everyone, including the producer, consumer and government. So these three are the specific challenges besides that overall thing which really concerns the centre and states.

Q4: Will the GST regime help in reducing production costs by eliminating cascading nature of taxes on the Infrastructure Sector?

A4: This question is easier to answer in generality than specifics. I will tell you why. All the things in the infrastructure sector which are specifically related to the good and taxable services, which we have just discussed, they actually stand to benefit. But the difficulty here is the third element. I had mentioned here certain goods like education, health and government-to-government transactions. But the construction part of the service sector is unclear. Who taxes it? What happens? To what extent it comes into the GST net? We took three challenges. This is the fourth challenge: how that comes into the GST net? But right now it’s kind of ambiguous. As things stand, it’s not clear even in the existing system. So that is where it could go either way. For some infrastructure sectors there could be a marginal increase, for others there could be effective decrease and for still others it may remain more or less the same. I don’t have any specific answer as of this point as we don’t know what will be the change on treatment of various construction services.

Q5: There seems to be a clear division within the Indian Infrastructure Sector on GST’s service tax component. While some have gone so far as to claim that it’s a negative aspect of the new tax regime others term it overall positive? What is your own take on this issue?

A5: There are two reasons why it is definitely positive. One is, as I indicated to you, having a single rate makes accounting very easy. That is why I told you, I would have preferred a single rate across the board, with a few sales taxes which separate out because the trail becomes very easy to follow. You just need two numbers: how much you bought and how much you sold, and the rate is the same. If you have three different rates, you are going to have three different channels and it becomes 3 X 3 = 9. So a single rate is actually a tremendous benefit, which is why I have long argued for it. Unfortunately, I lost the argument to my friend Vijay Kelkar who proposed this structure. It’s his committee report which is being followed. Why services benefit, as I said earlier, they don’t get this chain. Once the chain is there, then they will get the offsets also. That’s one. And it will make both export and import of services much smoother. The second reason is, in India, people have long complained that our economy is much more heavily service oriented than manufacturing oriented. What this will do is change that bias. And this is something that people are not understanding. If the effective tax rates on good, which is basically manufactured goods, goes down and services goes up, then the bias towards services will be corrected. People forget that and start complaining. They complain in one bucket and then in the other one they complain again. But these things are linked. If the tax on services goes up by as little as 2% to 4%, that’s a good thing because the structural bias towards services and against manufacturing will be corrected. This is something which people should focus on.

Q6: So how can India Inc. gear up to take advantage of this new tax regime?

A6: There are two types of people. One is those companies which are already operational across the system. If registration and other things are simplified in the manner which I have suggested, then what they will set up a much more efficient cross India structure to ultimately benefit consumers. Initially they will, of course, improve their efficiency and profitability, but over time with competition it is going to benefit consumers. Once that system is made clear by the government over the next six months, then there will be programs. It’s connected to what I said earlier. If there are hundred different rates it becomes very complicated. If you reduce it to three, including zero rate or whatever, the level of complexity goes down tremendously and it becomes easier to write these programs. You just need to enter in each requirement and everything will come out nicely. It’s a different issue for smaller firms. Initially those who are not digitized will face some difficulty, but then they stand to gain a lot in the long term. They have to make this effort now or get left out of the digital economy. The government has to communicate to them that it’s in their long term interest as the whole country and the world are going digital. There are firms who are operating on inter-state borders and for whom it was a huge effort to register in one state to other state. Let’s say you are on the Punjab-Haryana or Uttar Pradesh-Bihar border. For all such firms located on state borders it becomes easier to legally sell their goods across the border. I hope again that people are sensitized to this and the process of registration is made easy. I anticipate smaller firms, once the system is functioning smoothly, to gain significantly. And that’s good as we all keep talking about promoting small and medium sized enterprises.

 This interview on the GST regime is published in the October 2016 issue of India’s premier B2B magazine Infrastructure Today.

http://www.infrastructuretoday.co.in/News.aspx?nId=o%2FhfySjqj8UT3JqUacnrtA%3D%3D

 

Interview to Business Today on October 24, 2016

Q1: How much do you think the inflation worry is playing in the mind of the government as it decides on the GST rate? How inflationary do you think an 18% uniform GST rate would be?

A1: A revenue neutral is not inflationary at all. The inflationary concerns arise because some States are asking for much higher standard rate. The Union govt must be supported in resisting such pressure from States.

Q2: Would a four-slab GST regime be a disaster even if it is just a temporary arrangement? Do you think it would be a smooth transition to GST regime with a four-tier tax rate?

A2: The key gain from GST is the replacement of a dozen indirect taxes by I single debt. In the National VAT I had recommended there were exempted good as in GST and only one Standard rate for all other goods & services. However, I had recommended retention of few final consumer sales taxes (~6) on specific goods such as liquor, tobacco products, polluting fuels & 2-3 consumer goods like cars. This would have made monitoring of the tax set off chain much simpler. 

  The Proposed rates for GST are messier, but won't be anywhere near a disaster. There are always transition problems but I don't expect them to be surmountable given a positive attitude of tax bureaucracy.

Q3: Another issue is reaching consensus on compensation package especially when each state has already floated their loss figures? How much do you think the compensation package impact the central government's exchequer?

A3: Base for compensation has been agreed. Calculation of compensation shouldn't be a problem. The potential compensation will be calculable only after the rates & items are decided.

Q4: Do you think the idea of cess on certain goods under GST is central govt's way of ensuring that it does not face revenue shortage due to compensation to states?

A4: The center wants to impose a temporary cess to raise funds for compensation, to protect against the need for rate changes in near future. This will also ensure greater certainty for Union govt budget allocations/expenditures.

 

Brexit, Monetary Policy & RBI

Q&A: Financial Express (25/6/16; Appeared on Monday 27th June 2016)

Q1: Britain's exit from the EU and its impact on the rupee, India's foreign trade, capital flows in and out of the country, the bond markets and the overall economy.

A1: The immediate effects of the referendum (1-2 days) are due mostly to the forecasting error made by the betting markets (those who put their money on the line). Most of the short term capital movements viz India will be adjused in a couple of days & wont be very significant. The Rupee dollar rate will depreciate by approximately the same % as the US dollar depreciates against the broad index.

    Unlike earlier shocks, this shocks was known but its probability was underestimated. I believe that many observers are over estimating the direct economic effects of Brexit based on earlier economic shocks. The heightened risk in this case arises mostly from the uncertainty in predicting adverse politico-economic developments in the EU and in the US elections. These will of course have economic consequences: Increased risk will likely result in lower real investment and consequent further weakening of growth impulses in the developed countries. This will have little net effect on India because of the offsetting effect of slower rise in oil prices and continued weakness in demand. If economic reforms continue at steady pace, there could be a larger surge of capital inflows into India, "reverse safe haven" or "relative economic opportunity" effect. 

 Q2: How should the government and RBI deal with the likely eventualities?

A2: RBI and other Central Banks have had many experiences of shocks and by know well how to minimize any financial contagion by ensuring liquidity.

Q3: How serious is the possibility of competitive devaluation of currencies?

A3: Most countries will let the markets adjust to the new expectations. Some like China which do not really have a market determined exchange rate, may use this occasion to nudge their exchange rate a little lower, but not enough to cause widespread alarm.

Q&A (Bloomberg News: 25/6/16)

Q1: How do you see the Brexit and what impact do you see this having globally and especially for India?

A1: The immediate effects of the referendum (1-2 days) are due mostly to the forecasting error made by the betting markets (those who put their money on the line). Unlike earlier shocks, this shocks was known but its probability was underestimated. I believe that many observers are over estimating the direct economic effects of Brexit based on earlier economic shocks. The heightened risk in this case arises mostly from the heightened risk of adverse politico-economic developments in the EU and in the US elections. These will ofcourse have economic consequences: Increased risk generally results in lower real investment and consequent further weakening of growth impulses in the developed countries. This will have little net effect on India because of the offsetting effect of slower rise in oil prices and continued weakness in demand. If economic reforms continue at steady pace, there could be a larger surge of capital inflows into India, "reverse safe haven" or "relative economic opportunity" effect. 

Q2: What's your outlook for the rupee going forward? What are the factors you think will be weighing on the rupee?

A2: The Rupee dollar rate will depreciate by approximately the same % as the US dollar depreciates against the broad index.

Q3: Can you please share a level for the rupee by the end of September and Dec.-end?

A1: No

Q4:  Do you think a weaker rupee is good for India given global central banks weakening their currencies, and hence its support for exports? Or how do you see it?

A: A competitive rupee, as defined by the real effective exchange rate is good for India. This means the smaller the inflation differential the less the nominal depreciation of the rupee that maintains competitiveness.

Q5: What's your outlook on inflation and interest rates? Do you think surging price pressures means the RBI is done with rate easing?

A5: As I forecast in March 2016, end year 2016-17  inflation is likely to be between 4 and 5% with 70% probability. Interest rates will depend to a much greater degree than earlier, on the Monetary Policy Committee to be appointed by end-August.

Q6: How do you view Governor Rajan's departure and what it means for the rupee and rupee stability?

A6: His departure is now a given and its short term effects have already been incorporated in market reactions. What happens in future depends on the credibility of the new Governor.

Q&A (Dalal Street Investment Journal 22/6/16: Appeared in Vol 31, No 15, 10 July 2016)

Q1. How would you rate current RBI governor and his term on the face of his policies and activities than a person?

A1: The RBIs performance during the past 3yrs was better than that during the previous 3-5 yrs. 

Q2. Looking at the current mounting NPA’s of public sector bank, does it looks possible that bank balance sheet will look clean by 2017? Do you think RBI under his leadership swung into action little late when it comes to cleaning the NPA mess? 

A2: The NPAs mounted from 2010 to 2013, they are being recognized and revealed over the past few years. Both RBI & Govt (with respect to Public sector Banks) were a little slow in focusing on them.

Q3. Dr Raghuram Rajan was successful in bringing down the CPI index which is the indicator of inflation-has he made the right move by adopting CPI as a inflation index and ignoring WPI index? If he has not, then can you suggest what could have been the right ones?

A3: The creation of the national CPI was initiated, when I was CEA. Once it was created it was necessary to switch over to it as per global best practice. Unfortunately global deflationary forces have opened a large gap between CPI and WPI, which complicates the change over. A more pragmatic approach would used this indicates in setting a lower value for the neutral real repo rate target.

Q4. Amid his achievement, when he started with his rate cut cycle he did very little to give liquidity to the money market? Do you agree with the statement that Dr Rajan kept the money market gasping for a long time?

A4: Monetary policy in an less developed financial market like India doesn't work like the Near perfect markets of US or UK. Thus the Repo rate is an inadequate instrument. Traditional measures like reserve money, money supply/credit growth continue to be relevant.

Q5. Dr Rajan has been successful in stabilizing the rupee – dollar price in a range of Rs 66 to 68. However, on the other hand, it also made Indian imports a bit expensive. Your comments on this.

A5: From macro-economic perspective, the important rate is not the RS USD, but the real effective exchange rate, which depends on the inflatin differential between India and the world. A real appreciation of the rupee, as happened under the previous Governor, is bad for competitiveness of Indian economy. 

Q6. It is widely believed that Dr Rajan has been successful in curbing the inflation which was the prime agenda when he took the office. However, Dr. Rajan has been accused of keeping interest rates higher for too long. Do you agree?

A6: Governor has been successful in curbing inflation expectations. Most of the decline in deflation is due to declines in commodity prices, global deflation & better management of food economy. However, real policy rates have risen sharply during this process, resulting in a tightening of real monetary policy in a period when the large corporate sector is weak. I have argued for faster easing of monetary policy for the last 12-18 months.

Q7. From a borrower’s point of view how efficient is the MCLR, (Marginal Cost Lending Rate)? As the new borrowers are postponing the home loan in anticipation of much lower interest rates. On the other hand, existing borrowers are worried that banks may charge hefty conversion fees to shift them from Base Rate to new lending rate i.e. MCLR.

A7: I don't think there has been much impact either way.

Q8. The markets on the REXIT has not reacted much, the issue of REXIT was wider than the policies which he implemented? Was the discussion by the corporate leaders and general public valid? Is it reflects an individual is bigger than the institution?

A8: Most of the issues have a short term effect, but what matters in the medium term is the policies adopted, now & in future.

Non-Alignmet 3.0?

History

   Even the votaries of non-alignment have either forgotten or don't seem to understand the original concept. It almost seems to have become a mantra which is chanted periodically. It is a concept developed in the context of the Cold War between USA and USSR that followed World War II. The battle lines were drawn between the USA and its non-Russian WWII allies and the USSR and its acquired territories in Eastern Europe. India and other newly independent countries were not the object of hostility from either side. They were however being asked to join the "Cold War" on one side or another. The issue of joining one side or the other and fighting the Cold War or joining neither side and staying out of the Cold War were genuine issues. The Cold War ended with the collapse of the USSR in 1990 as did the issue which it addressed.

Non-alignment post 1990

  With the Cold War ended, what was the war that anyone was aligned for against or neutral towards. The "Non aligned Movement (NAM) " became a secular mantra for the left, socialists and communists. For a wide swath of intellectuals it become a substitute for rethinking their foreign policy in the light of a changing India and changing world environment. Indian growth accelerated sharply during the 1980s and further after the 1990s reform. As India's economic heft in the global economy increased during the 2000s it became impossible to resist a re-evaluation of India's foreign policy. The response of our ruling intellectuals was a hybrid called Non-alignment 2.0, an attempt to disguise the evolution of foreign policy in the 1990s & early 2000s, and reassure the left that the pre-1990s Bipolar World was alive and well, with their favorite socialist country as one pole. 

   The geopolitical situation had, by 2007-8 been completely and fundamentally transformed from the perspective of India and several Asian countries, though perhaps not for many Latin American, Caribbean, and African countries. Even these countries have been actively making deals with old and new powers, while continuing to use this forum to have a voice in the multilateral institutions. For a while the four largest non-G7 countries tried to do the same through the informal grouping named BRICs. China's global stance started changing from passive to aggressive around 2006 and more so since the Global Financial Crisis in 2008. This has transformed it into a protagonists of the US over the last five years, with the US responding with its "Pivot to Asia". The anticipation of an emerging cold war between China and USA has revived the outdated & irrelevant concept of non-alignment in India. 

      But this is not some distant war fought in the battle fields of Europe, but an expansion of a war that has been fought against India by one of the protagonists China for more than half a century, while the other protagonist USA did everything it could for 30 yrs to help this protagonist become economically strong. Belatedly the USA recognizes the threat to itself from China, a threat India has faced with varying intensity, for decades. China has continuously endeavored to undermine our security since 1960s by proliferating nuclear and missile technologies to hostile neighbor Pakistan (and other terrorist nations). It's hostile actions since 2006 are too many to list in this short note, but a significant one was the declaration of Arunachal Pradesh as South Tibet and the personal abuse of the President of India for speaking there(by the Chinese Ambassador to India).  

 National Interest and Beneficial Deals

   How can one be "non-aligned" between a country willing to help us strengthen our economy, defense forces and strategic presence (albeit at a price) and a country working to undermine our national security (while extracting economic gains through non-market means).  The mind boggles at an attempt to define the concept of non-alignment between a group of friendly countries and another group of hostile countries.  Unless of course the underlying idea is to appease ones enemies to avoid getting too close to anyone we dislike for ideological reasons, even if it professes friendship. 

   The issue here is not the 1950s issue of alignment versus non-alignment, but of how best to use the capabilities of a super-power to accelerate our economic growth and strengthen defense and strategic capabilities, while minimizing any adverse reaction from an aggressive, hostile power which happens to be our neighbor.  This requires using our rising economic & strategic power to make deals that further our national interest (economic, technological and strategic) and promote our security. Doing something merely to avoid getting punched by the local bully is appeasement not mutually beneficial deal making.

Conclusion

  Foreign policy starts with a clear definition of national objectives and a realistic appraisal of which countries interest are most closely aligned with ours (potential friends)) and those countries which are most hostile to our interests (potential enemies). One cannot be non-aligned between friends and enemies so defined. One can however promote overlapping interests together and make deals with all countries (friendly, neutral, hostile) if and only if they promote these identified national interests. Constantly looking over our shoulder at what our enemies will think and not doing deals that provide an overall net benefit to us merely because the enemy will react negatively, is appeasement, not pragmatic promotion of one's interest in peaceful developmen.
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A version of this note appeared in DPG Policy Brief Vol. I No 5 at  http://www.delhipolicygroup.com/publications-detail/dpg-policy-note-vol-i-no-5-non-alignment-30-or-strategic-relevance.html