Recent data for imports and automobiles shows a contraction in both real and nominal terms. The sales of formal sector companies in manufacturing and services show a nominal decline in recent months.
The data is not just showing a slowdown, there is a contraction in production. Structural reform accompanied by short-term expansionary macroeconomic policies are needed.
The sharp fall of 5 per cent in GDP growth for the April to June 2019 quarter over the same quarter last year is likely to lead to year-on-year GDP growth slipping to about 4.5 per cent in the July to September quarter. Seasonally adjusted quarter-on-quarter data for sales of non-oil, non-financial firms is showing a negative growth of -1 per cent of nominal sales. If inflation is 2 to 3 per cent, then sales in real terms show a contraction of about 3 to 4 per cent.
The fall in GDP growth needs to be reversed before it becomes a sustained downward spiral. It is critical that this Diwali sees high spending and consumption demand. Sharp tax cuts can help. Tax policy must move away from today’s high tax rate-low compliance-tax raid system to one with a low tax rate-high compliance-no tax raids.
Puzzling sudden slump
What is striking about the growth data this time is that instead of the long and sustained decline in 2012, from which there was a recovery after the BJP formed the government at the Centre, this time, the immediate post-election period has seen a sharp and sudden slump.
The GDP numbers have been intriguing since the new series came out. Earlier, the suddenly high numbers did not make sense; now, the sharp decline in consumption in the midst of the general elections is equally puzzling.
The one big event in the April-June 2019 quarter was the national election. As some observers have commented, elections often lead to an increase in demand and activity, and certainly not a contraction. It remains a puzzle why election spending failed to boost growth as it had done in previous years.
It is difficult to attribute the contraction in the last quarter to demonetisation or GST, as some observers have tried to do. There is no obvious one-to-one relation or a good research study showing this.
Most macro models typically see the effect of a shock fade away with time. The one we see, where the big impact of the shock happens after many quarters, would be very difficult to explain in standard macro models.
Alternative explanations attribute the slowdown to the reduction in finance for the automobile sector — for both consumers and dealers. While this may be part of the explanation, the broad-based decline in the growth of consumption expenditure, which fell to 3.1 per cent, is puzzling.
Impact of lower growth in 2019-20
Since a large and increasing share of GDP is accounted for by formal sector firms, and their sales have declined, the July-September quarter GDP growth is likely to be pushed downwards.
If GDP growth for the July-September quarter falls to 4.5 per cent or below, it could affect a number of other estimated variables. For example, estimates for GST collections for the year should fall if firm sales are down. In the present fiscal situation, that is a very important variable.
In 2018-19, GST collection estimates were higher by Rs 1.7 lakh crore than what was ultimately collected. Estimated tax revenue will be lower and fiscal stress will be greater if growth is lower in 2019-20.
With low GDP growth, high tax rates and low compliance, the tax system is in danger of turning into a tax inspector raj. If tax inspectors create terror in the lives of businessmen, then one firm at a time, they have the capability to destroy business and investment in the country.
If the vision of the government is to respect wealth creators, the first step is to stop tax raids. At the same time, the policy framework has to move away from the high tax rate-low compliance-tax raid raj to a low tax rate-high compliance-no tax raid regime.
The government should repeat the message given by former Union finance minister Jaswant Singh to tax officers — that no civilised country engages in raids to collect taxes.
Low tax rates
Reducing fear among businessmen and stopping tax raids needs to go along with a policy of cutting tax rates. This would increase compliance and reduce the need for tax raids. At the same time, the board tax cut for income tax, corporate tax and GST will provide a fiscal stimulus.
This will work much faster than infrastructure spending plans, which can take a long time to implement. By the time the government borrows and finds the right provider, contraction may set in.
The case of Japan tells us that a recession with low demand and deflation is a far more difficult problem to solve than inflation. At the risk even of higher inflation, the important thing now is to prevent the present contraction from becoming sustained. This Diwali festive season needs to be one of high sales and consumer spending.
The author is an economist and a professor at the National Institute of Public Finance and Policy. Views are personal.