From Financial Express, September 13, 2013

Getting India back on track

 In my last column (An Indian Spring? FE, August 22, http://goo.gl/hwW9cw), I raised the possibility of India descending into an Egypt-like situation. It probably will not get that bad, since India’s recent history and its societal makeup are sufficiently different. But there is one large commonality—a surplus of young people relative to decent jobs. That basic mismatch between demographics and economic opportunity can drive substantial waves of social unrest. One only has to think back to the early and mid-1970s to realise that India, for all its democratic resilience, is not immune to severe social and political instability. In an earlier column (Can India grow faster again? FE, August 19, http://goo.gl/8E9iwS) I listed some steps that India’s leaders need to take in the medium run: effective vocational training, removing constraints on electric power generation, and more devolution to the states and to cities. But before that, there is a short run crisis facing the country. Here are my thoughts on how to turn things around quickly and effectively. 

The immediate problem is a crisis of confidence. This is partly what has driven the plunge in the rupee, although the strength of the US and European economies has also contributed to the rupee depreciation. The erosion of confidence has been gradual, with multiple instances of government corruption and fiscal and monetary policy mistakes over the last couple of years. Fixing this will not be easy. The measures undertaken so far have smacked of panic: sudden promises of relaxing foreign direct investment caps, a grab bag of import controls, and derailing financial markets to curb “speculators”. All these measures, in my view, simply reaffirm the view that the government is adrift and that troubles will continue. The latter two types of measures also go against the basics of a coherent economic reform strategy, which should be built on promoting well-functioning markets in a global setting. 

With respect to the rupee, the Reserve Bank of India’s (RBI’s) initial response of trying to reduce speculation by making short-term borrowing harder simply sabotaged the working of short-term credit markets, and had no effect on offshore traders. Markets became thinner and more volatile. Instead, if RBI wants to prevent further overshooting downwards of the rupee’s value, it should follow an assertive and transparent (but feasible) intervention policy (something along the lines suggested by Kaushik Basu, announcing a schedule of intervention). Given what has happened, it may be mostly too late. One thing RBI should do is to raise its policy rate, as other emerging economies have been doing. Yes, this could further slow down growth, but the short run benefits of an interest rate hike, in terms of stabilising expectations about inflation and currency depreciation, seem to make this a worthwhile option. Reversing such rate hikes is easy and quick, and they do not have the deleterious impacts of unexpected changes in the rules governing the functioning of markets. 

With respect to the current account deficit, what the government needs to do is to use the opportunity of the rupee depreciation to push exports. The obvious areas are in information technology and related services, tourism, and possibly some kinds of consumer goods (including apparel, health and beauty items, and processed foods). Essentially, India’s products are suddenly a bargain, but some rapid and concerted marketing efforts are required to make sure that rich world consumers take advantage of these bargains. India’s embassies and missions abroad should be going into overtime, working with Indian businesses to seize the opportunity presented by the fallen rupee. Promoting exports, while more work and slower to take effect than restricting imports, will have a much larger medium term benefit. One of the easiest, most immediate opportunities is promoting foreign tourism, since the supply constraints are less problematic. 

On the domestic front, the politics of the looming national election make progress difficult, but if the government were to push harder to reach a grand bargain on the goods and services tax (GST), convincing the array of opposition parties that they will all benefit from a broader, more robust tax system, this would provide the prospect of a corrective on the fiscal front. My reading of some of the crisis of confidence is that it was driven by the government’s attempts to raise revenue through ad hoc, discretionary and retroactive measures, in turn driven by the need to reduce the fiscal deficit. But those policies hurt confidence, growth and government revenues, just the opposite of what was desired. 

The three examples I have suggested are policies that signal that the government is in charge, and is capable of providing leadership to the country. In contrast, most of the governmental responses to the crisis so far have seemed to signal desperation, weakness and lack of control. Much of the recent Indian policy debate has been reduced to finger pointing (evil speculators, heartless global capitalists, incompetent and venal politicians) and crying over spilt milk. It does not have to be so, and India’s leadership has to act as if it is worthy to lead in these challenging times.

Financial Express, July 1, 2013

A reform success story for India

 We are used to highlighting the shortcomings of economic reform in India, both in process and outcomes. These shortcomings are particularly apparent now, when the economy is struggling on several fronts: growth, inflation, and the external balance. In this context, it is good to revisit an ongoing success story of Indian economic reform: its tax system. In the last two decades, India has made tremendous strides in terms of reforming income taxes and consumption taxes. These reforms have included improvements in tax policy as well as in administration. The former has helped the latter: rationalising tax policy has made tax administration easier to conduct effectively, but there have been direct improvements as well in the technology of tax administration.

Better tax policy has meant cutting inefficiently high rates, whether in the income tax structure, or in areas such as import tariffs. In the case of consumption taxes, it has meant replacing a complicated tangle of sales taxes and duties, often piled on each other, with a simpler, more transparent value added tax (VAT). As the VAT nomenclature implies, this avoids the problem of taxes being applied to quantities that already include other taxes—a cascading effect that can create unintentionally high rates, and multiple inefficiencies. Better tax administration has been built on the foundation of new information technology systems, which support mechanisms such as deducting income taxes at source for those who pay them, and tracking of purchases and sales required for VAT credits along the value chain. 

The goods and services tax (GST), which is inching toward implementation, represents an important new step in the process of Indian tax reform. The sooner it is put in place, the better for the economy. In particular, there is some reason for thinking that the GST will give the central as well as state governments a firmer, broader revenue base, which is less subject to political distortions than is the income tax: the GST is a VAT, better coordinated than the present system, and applied more broadly and consistently. A key institution in the process of introducing the GST, as it was earlier for introducing the VAT and for managing state sales tax incentives, is the Empowered Committee of State Finance Ministers (EC). This EC met in May, and then, on June 7, its chairmen met with representatives of industry associations and consulting firms, where an EC paper formed the basis for discussion. This discussion paper is a model of clarity, and illustrates how this complicated process of introducing a major overhaul of the tax system is proceeding. There are several facets of the process worth noting.

Technical policy formulation: There is a clear understanding of the technical issues involved in introducing the GST, including changes in revenue receipts at different levels of government, trade-offs involved in specifying tax bases in different ways (based on turnover levels), and mechanisms for administration (especially across different levels of government). One might expect this clarity, given the time it has taken to get where we are, but time has not been a guarantee of quality in other cases of policy formulation. There is also a clear use of technical inputs from the main national source of such expertise, the National Institute for Public Finance and Policy.

Political management: There is a clear understanding of the constitutional issues involved in introducing the GST, of course, but also a polite and pragmatic statement of the needs of the states in terms of some protection against revenue uncertainties that might come with the reform. In this context, the national government appears to have been somewhat lax in its political management of a complex Centre-state issue—the compensation being requested by the states seems to be quite small relative to central tax receipts, or even as a percentage of the fiscal deficit.

Institutional innovation: The creation of a GST Network (GSTN), which will be a non-profit company with ownership shares of the Centre, states, National Securities Depository Limited, and three selected financial institutions. The GSTN will provide a common IT infrastructure to support the introduction and implementation of the GST. As the EC discussion paper elucidates, issues of monitoring and control versus costs of compliance, can all be dealt with effectively with a combination of the right policy framework and a solid information infrastructure.

One hopes that the EC discussion paper, which distils many years of discussion and analysis, marks the end of the process of agreeing on the details of the GST, and the beginning of efforts to make it happen. The GST will be a major milestone in Indian economic reform. Tax reform has not been perfect. There is much left to do. For example, the GST, in coordinating taxes on the same bases (in this case, business sales) may provide a model for reform of the income tax system, allowing States along with the Centre to tax personal incomes. The GST use of information infrastructure might point the way to methods for strengthening property tax systems across India’s creaking, bursting cities, as well as other aspects of local tax systems. Tax reform is important, and it is very much alive in India.

Financial Express, March 8, 2013

Betting on India

 At my university, I help run a new initiative that focuses on finance, and we just hosted a visiting speaker, a prominent statistician known for some innovative algorithms for analysing data. He is also apparently a lifelong—and successful—bettor on horse racing.

He was asking me about India’s economic prospects and, in formulating my answer, it struck me that the metaphor from his passion is apt: it is time to bet on India.

Why do I now think so? For the past few months, I have been gloomy about India’s policy paralysis and missteps. Indeed, many of the core problems are still there. But there is evidence that India has turned the corner. The place to begin is with the Economic Survey of India. (By the way, our visitor to UC Santa Cruz has been a long time colleague of India’s present Chief Economic Advisor). The first two chapters of the Survey lay out India’s current situation and long term growth prospects with unprecedented clarity. The quality of the overall analysis itself is cause for optimism. If this analysis truly begins to guide policy, India will be getting on the right track.

The Economic Survey predicts growth of 6.1-6.7% in the coming fiscal year. This is conditional on a decent monsoon, moderating inflation and reasonable global growth. Barring problems on these fronts, the prediction seems a reasonable one. Even a moderate improvement in growth can make a big difference to confidence at this stage. This growth projection feeds into the numbers used for budget estimates, so it is a critical number.

In addition to the factors mentioned, economic policy decisions will also be crucial. This brings me to the Union Budget.

Writing a few days after the Budget has the advantage of being able to see a slew of more immediate reactions. Most of the reactions were positive, from mildly so to enthusiastic. Some comments were simply based on relief that there were no new government giveaways of the scale and kind that have strained the fisc in recent years. Indeed, the budget was circumspect in this regard, with the need to reassure investors, both foreign and domestic, that the government is serious about managing its finances. A major negative comment was driven by the view that the revenue projections are wildly over-optimistic. If they do not pan out, the budgeted expenditure would be veer into unsustainable territory. But in the current year, it was the ability to pull back on expenditure (especially plan expenditure) that allowed the government to rein in the fiscal deficit despite lower than projected growth and revenues.

This kind of pulling back is not the best way to achieve fiscal consolidation, but my guess is that the coming year will be better. First, the GST keeps getting closer, and the steps that lead to it also have positive impacts. Second, if growth does recover next year, that should help revenues. Third, my overall sense of the tax proposals is that they contain few gimmicks and nothing like the major misstep of last year. They pay attention to principles such as maintaining broad bases for taxation. There are a few proposals here and there that will enhance revenues without too much distortion. The revenue side may well provide good news in the coming year.

On the expenditure side, the main welcome feature of the Budget, as noted, is the restraint shown in expanding transfers or subsidies. This restraint may come under pressure as the general election nears, but for now, it is the official position. The quality of expenditure remains problematic, and one misses the promises of a few years ago to monitor outcomes and test the effectiveness of public expenditure, but perhaps that should be outside the budget in any case.

Tax expenditures seem to be a strong feature of the budget, with several policies intended to spur investment in manufacturing. Similarly pro-growth are measures to streamline regulation of areas such as foreign investment. Indeed, the finance minister has promised more measures along these lines through non-legislative actions outside the Budget’s legislative process.

Overall, then, my sense of this Budget was that it is one of the better ones I have seen, in terms of avoiding silly policy measures, taking a host of small steps in the right direction, and most of all, being intellectually consistent with the rigorous analysis of the Economic Survey. It is still possible that political calculations of the worst kind will derail the possibility of progress. But I am betting that the ruling political elite have realized how far things were going wrong. They have also been given a clear picture of why they have been going wrong (the Economic Survey is again an excellent summary source, presented with clarity and directness), and seem to be betting themselves that they can do better politically by performing rather than pandering. If this is right, then it is time to bet on India once again.

From Financial Express, October 30, 2012

Signs of hope for India’s economy

The latest World Bank report on the ease of doing business in 185 economies provides a mixed picture of India, but with some glimmers of hope. India’s overall rank based on a composite index has not changed from last year. It remains at 132, still firmly in the third division of the ease-of-doing-business league. But since most countries are making improvements on this front, India’s stasis in the relative rankings is consistent with some absolute improvements.

Since 2005, the greatest percentage improvements — measured in terms of distance from the global best-practice frontier—in India’s standing in various dimensions of doing business have come in getting credit, dealing with construction permits, and procedures for starting a business. But it still ranks 173rd in starting a business, and 182nd in dealing with construction permits. To the extent that what matters are the levels of various hurdles to doing business, absolute improvements are good. But low rankings matter wherever global competitiveness is an issue.

Comparisons in rankings and levels of barriers across developing countries for different aspects of doing business do not reveal any obvious patterns, or necessarily a tight link between ease of doing business and growth performance. Where India ranks close to dead last, however, is in enforcing contracts, and the major contributor to that ranking is the length of time taken. This suggests that the state of India’s judicial system, particularly with respect to contractual disputes, is a major weak spot for its business environment.

Fixing the judicial system requires a concerted effort by the central government. It has been weakly on the reform agenda, but without making much headway. The sad part of this is that the resources needed to reduce judicial delays in India are probably a fraction of those being thrown by the government at other areas of the economy.

In other cases, there is more hope, because positive change can come at the state level. A recent story in the Washington Post, by Simon Denyer, rediscovers the possibility that, despite the central government’s difficulties in moving economic reforms forward, individual states have considerable leeway to progress, and have been doing so. Arvind Panagariya, quoted in the story, reminds us that decentralisation of economic control was a major theme of the 1991 reforms—he himself is working on a major study assessing the comparative performance of India’s states. Ajay Shah, in the same newspaper story, notes the competition for investment among some states, but also the slow diffusion of lessons on best practices in governance.

Part of the problem is that even when one gets down to the state government level, decision-making is top-heavy. How a state does seems to depend on who is at the top, and discussions of good and bad performance focus on personalities, whether it is Narendra Modi, Jayalalitha, Nitish Kumar, Chandrababu Naidu, or Prakash Singh Badal. Anecdotes abound about the way in which state leaders shape the culture of administration, and set the tone for how civil servants (the elite Indian Administrative Service in particular) carry out their duties.

Of course, leadership matters, but governance at the state level can display over-centralisation, just as at the national level. Ajay Shah notes the need to devolve power to city governments, in the Washington Post story. The 74th amendment set the stage for this 20 years ago, but actual progress has been limited. One of the key problems is the lack of political autonomy, with state-level politicians and bureaucrats able to interfere too much at the local level. Another is a lack of funds.

To some extent, the lack of funds is endogenous—with local politicians finding it easier to rely on trickle-down transfers, however small and unreliable, rather than making effective decisions on taxing at the local level. The urban property tax, in particular, has been eroded by corruption in the real estate market and in local tax administration. The national and state governments need to make a concerted effort to improve the design and administration of urban property taxes, while giving cities more leeway in setting rates—as well as allowing them to piggyback on a future GST—as I argued in my last column.

As I argued earlier, getting the states to decentralise to the local level will require giving them more autonomy and revenue authority. States are exercising de facto autonomy in competing for investment, and that can be good for improving conditions for doing business, but it is important that this not lead to competitive reductions in tax effort, with the expectation that the national government will cover the gap. As the government sets up the 14th Finance Commission, rethinking the inter-governmental transfer mechanism in concert with reconfiguring tax authorities should be an important part of the commission’s mandate. The goal should be to improve marginal incentives for revenue collection at all sub-national levels of government.

From Financial Express October 18, 2012

The virtues of tax reform

Last month, I introduced the idea of virtuous growth, which includes the fairness objective of inclusive growth as well as an additional goal of building positive human values. I gave the example of local government reform in India as a practical step towards virtuous growth. Giving people more responsibility over public spending at the local level has the potential to increase the quality and level of civic engagement.

The issue of local government reform in India actually requires a rethink of India’s structure of tax authorities. Currently, the system in operation gives the Centre more tax authority than the states. Local governments have very little scope for taxing their constituents. These statements need to be qualified, of course. State and local governments in India actually tax less than their power to do so. One reason for this is that there is an elaborate system of sharing central tax revenue to the states, and state tax revenue to local governments. There is some justification for collecting taxes at higher levels of government—it can be more efficient, and less distorting of individual economic decisions. But transfers distort the revenue-raising decisions of the recipient state governments.

One way to get the efficiency advantages of higher-level government tax collection and the incentive advantages of a lower-level government tax authority is to allow piggybacking of lower-level governments on the higher-level government’s taxes. This has not really been done in India. The Constitution of India assigned different tax bases to different levels of government. For example, the Centre was given the authority to tax non-agricultural income, while the states were given the authority to tax agricultural income. This was one of the worst features of India’s tax system, since the states lacked the political will or capacity to tax farmers, even rich ones, and it also provided a route for disguising non-agricultural income and evading tax on that income.

In any case, the idea of different governments taxing the same base did take hold in India, using loopholes in the constitutional language. For example, state-level sales taxes and central excise duties were imposed on the same goods. This turned out to be very inefficient, since there was no coordination or transparency, and because one government’s taxes were imposed on values that included taxes by another government. The value added tax (VAT) system introduced in India a few years ago began to deal with this major inefficiency. The planned goods and services tax (GST) will extend the efficiency principles of the VAT to a broader array of commodities, and include services as well.

The details of the GST still need to be worked out and bargained over. Since it replaces existing taxes, the state governments, in particular, are worried about losing revenue as tax rates and tax shares are adjusted. The Centre needs to do more to sort out these problems and create a winning coalition for reform. One feature retained by the GST is likely to be fixed tax rates for the Central and state portions of the tax: the 13th Finance Commission follows the GST Task Force in recommending rates of 5% and 7%, respectively.

A piggybacking approach would allow states the possibility of increasing their individual rates up to some maximum level. One state might choose a rate of 8%, another of 7.5%, for its GST portion. The GST structure easily allows for this possibility. Piggybacking can go further. Urban and rural local governments could be allowed to add their own surcharges, up to some maximum. For example, one city might choose an additional 0.25%, another 0.5%. The point of these surcharges is that the lower-level government decides the rates. Surcharges can be determined by elected representatives or by referenda—the key idea is that, at the margin, the residents of a jurisdiction decide to tax themselves to finance public goods within their jurisdiction.

One could potentially extend piggybacking to the personal income tax, but the GST is an easier place to start, and the occasion of introducing something new like the GST can open the door for this additional innovation. The key idea is that piggybacking allows communities to make public revenue decisions at the margin, rather than relying only on transfers from a higher level government. Civic engagement should not be just about spending, but also about financing that spending. A modern information system for administering the GST would allow local surcharges to be collected and distributed. All of this is done in the US, for example.

One of the big problems in India’s governance is that individuals do not see the connection between the taxes they pay and the services the government provides. Individuals can see this connection better if they decide on taxing themselves at the margin, in small enough constituencies so that their decisions have weight. Piggybacking on a broad tax base avoids the problem of only being able to tax small activities, and reduces the cost of administering and collecting local taxes. It may even make it easier to get a consensus agreement on the GST, giving states more flexibility as well. Freedom combined with responsibility can be a virtue.
 

Breaking the spiral of despair

 

From Financial Express, June 23, 2012

Breaking the spiral of despair

Like it or not, India is on the world stage. Its achievements are being celebrated, but its shortcomings are also being dissected as never before. India has shown enough promise as a successful example of democracy and development that the chance of failure looms larger than it did a decade ago. The Economist magazine recently had an editorial lamenting India’s lack of leadership and the immense human costs of slower growth. Soon after, the magazine’s Asia column, “Banyan”, featured reflections from an unnamed senior government official, which seemed to boil down to the need to boost growth with a surge of infrastructure spending.

Banyan also reported on a speech by Kaushik Basu, the Indian government’s chief economic advisor, which boldly stood up for economic reform, openness to the world economy, and economic growth as a path to raised living standards. Dr Basu acknowledged that India’s current problems are of its own making, and that a “spiral of despair” must be broken for India to “come out on top” in a few years.

How can that happen?

A few years ago, I suggested that India’s Prime Minister displayed “Level 5 leadership”, a paradoxical blend of personal humility and intense professional will. One saw this in the nuclear deal. One sees it in the dealings with Pakistan. Domestically, one can only guess as to the constraints that prevent such leadership being exercised for economic policymaking. Perhaps India’s new president will display the same traits once elected. On the whole, though, this kind of leadership has been sorely lacking in India, despite the amount of talent near the top. Professional will is often present, but distorted by an over certainty of views, leading to a failure to incorporate all ideas and information that may be useful or relevant. In other cases, both will and humility are absent, in politicians who are mainly concerned with personal gain. India needs level 5 leadership, right away.

Even the best leaders cannot make all decisions unaided. India has been suffering from not having the right people on board, in the right positions. If the PM has to manage the finance ministry as well, or one person has to deal simultaneously with two immensely important ministries such as telecom and education, one cannot expect that each job will receive the attention it deserves. If senior bureaucrats do not have years of specialised expertise pertaining to their positions, decisions will not be made optimally. On the other hand, fresh ideas can come in if the expertise was developed outside the “government hot-house”. India needs more of the right people in the right positions, right away.

Banyan commends Dr Basu for supporting openness, globalisation and economic reform, but suggests that India’s politicians shy away from doing so. This is not quite true. The PM and all the senior economic team have repeatedly stood up for these principles. The problems have been in implementation, in doing the deals that will move things forward. Many reforms have been creeping along in the background. But what is needed is a prioritisation and focused push. Perhaps reforms like FDI in retail, cutting fuel subsidies, and overhauling land acquisition laws are politically too challenging for the moment. But there is one single reform that can strike at the root of several problems besting India. The central government has been desperate to raise revenue, and reverted to old-style discretionary, if not extortionary, taxation methods. It should focus on the tax overhaul that would do the most good, the rapid introduction of a simple, comprehensive Goods and Services Tax. If the states need to be brought on board politically, this is an opportunity to give them a higher tax share, and the greater spending autonomy that comes with revenue authority. The states are where effective government spending decisions can be made for many things that matter, like health and education. India’s central government should focus on a few things, get them done right, and get them done quickly.

Top leadership, the right team below that leadership, and focus on one or two really major structural reforms. These are obvious ideas for India, as it battles a spiral of despair. Meanwhile, the country of over a billion will keep lurching along, with day-to-day decisions to be made, as well as long-term plans, across a wide range of economic and social issues. Whatever happens with India’s leadership and governance, it will benefit from a more concentrated, focused and interactive attention to this entire range of issues, by the top minds working on India’s economy. Under Dr Basu, the Economic Survey of India has begun to give a sense of how to bridge the gap between rigorous economic theory and empirical analysis on the one hand, and policy prescriptions on the other. This is something that needs to happen in a more general and continuous way. Ultimately, this bridge of ideas will be crucial to breaking the spiral of despair.