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Fall in GDP growth needs to be reversed before it becomes a sustained downward spiral

The fall in GDP growth needs to be reversed before it becomes a sustained downward spiral. Sharp tax cuts can help, as can a move away from the tax raids policy.

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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.

Also read: India is in a ‘quasi-recession’ and growth remains elusive, report says

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.

Tax raids

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.

Also read: Modi’s bank mergers have come too late to avoid an economic crisis


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  1. But one cannot judge a bank by one parameter alone here the author is looking only at deposit vis a vis market capitalisation. In a falling equity market it is but natural that share prices are affected by bearish sentiment and hence market cap is affected in such a scenario. It is also common that in the absence of stability in investment avenues like share market, gold, real estate and nbfc bonds the natural flow of savings is into bank deposits. In such a scenario which is prevailing now in the country deposit growth is being measured against a lower market cap position thus leading to an unfavorable ratio. It is but natural that those Pvt sector banks which have higher shareholding with foreign investors will have a higher equity base. As per the government’s policy, foreign investors — foreign direct investment, foreign institutional investors, and non-resident Indians combined — can invest up to 74% of paid-up capital in private sector banks. Hence those banks with higher FDI investors have higher equity than those Pvt sector banks which have only domestic investors. This is not a major concern as a bank’s health is determined by its profitability, NPA ratio and capital adequacy ratio.
    The Basel III norms stipulated a capital to risk weighted assets of 8%. However, as per RBI norms, Indian scheduled commercial banks are required to maintain a CAR of 9% while Indian public sector banks are emphasized to maintain a CAR of 12%. All banks in India have to follow Basel III norms for computation and reporting of capital adequacy ratio. One of the so called weaker bank as per this sIlly article is Federal bank which had reported car of 14.14% as at mar-19. Incidentally the bank also reported its highest ever quarterly Net profit of over 400 crs for the second quarter ended sept 2019. The only loss making private sector banks that can be termed weak are LVB, SIB and CSB

  2. Can’t subscribe to writer’s views.Stock market is nothing but gambling or you can say, the market decides the value.But if you buy shares worth ,say 400 crores of SIB , in open market for next 10 days ,the price will jump at least 10 times.What I have done is , squeezed the liquidity of the share .This will bring Sib value from 34 to 3-4

  3. I have been following this author’s writings on the economy for some time and generally they are quite balanced but this one is slightly out of tune. The word “puzzling” has been used atleast 4 times without making any attempt to discern any causes for this puzzlement. I daresay the fact that the entire economic data being cooked is a strong possibility but perhaps the author does not want to openly say it. That may possible explain why even experts are puzzled at what is happening. Let us remember that this government was given a mandate to fix the economic problems experienced as an aftermath of the 2008 global slowdown. Now with the trade war between the US & China and a fresh global economic slowdown on the horizon, India is experiencing the effects far early in the cycle. That should be worrying to anybody.
    The lesson for the ruling party is a. Raids on political opponents do not always come with benefits. These people have deep networks and it spooks all the elements of this network. It has risks as well which need to be thought about. b. Good politics can win a government multiple elections but poor economics can create a reputation – which may outlast the current generation and stick to the party as a whole. This can become a serious stick to beat the party for generations to come. c. If reputation has to be maintained for times to come, then sacrifices at this time are necessary. Serious consideration should be given to stop coercive methods (even at the risk of letting some political opponents get away for now) and trying to co-opt and seriously fix structural issues. Manmohan Singh’s prescription is not unwise. Use expertise now, empower them, even at the cost of poor politics, to fix problems and avoid the ignominy of having twiddled thumbs while economic fires were burning.

  4. Every single Diwali since 2014 has been progressively more “ thanda “. I have compiled my own index, in terms of gifts that we exchange with friends on this joyous occasion. So it comes as a genuine surprise to me how the official acknowledgment that there is an economic slowdown has come only post Budget. There is a celebration of 100 days. All of governance has become a procession of PR events and glitzy messaging. Governance is serious, not always glamorous, stuff. For five years, effective mentoring of the economy has been the least of anyone’s concerns. The results are showing.

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