The GST Fire

An exhibition of tanks by DRDO coincided with
the passage of the GST BIll in Rajya Sabha

The Goods & Services Tax which India has voted to bring in from April next year,  may while uniting the fragmented Indian market to the delight of India Inc., also exacerbate that `Elephant in the Room’ which the country’s economy has been grappling with for decades now – Inflation.

Global experience has shown that GST brings in its wake a rise in prices all around for at least a year before, prices settle down and even decline. Knowing India, and the way our businesses work, one cannot doubt that it would indeed be a small miracle if prices come down after rising. India Inc., is obviously happy with the tax as it means a uniform tax regime all over the country and an end to the hassles of delayed shipments due to Octroi queues at state borders. However, those who will have to bear the burden of the tax may not be as happy despite the news media trumpeting how the tax structure will make India more competitive.

That dreaded word which every retiree living on a fixed income and every salary earner whose increment is slower than the rate of price rise fears, is inflation. Will this fear which if and when proven true,  turn voter ire into a raging resentment around the time of the 2019 General Election ?

Are we already paying too high a price ?

Malaysia which adopted GST in 2015, saw an increase in retail inflation despite careful planning and leaving out many essential products from the taxation altogether. Australia’s John Howard Government almost lost the general elections after bringing in GST.

Canadian Conservative Prime Minister Kim Campbell actually lost the 1993 elections after the electorate protested price spikes induced by her predecessor Brian Mulroney introduction of the GST.   The Indian example is nearest to Canada with its two stage GST rate – one levied by the state and one by the Centre.

The Congress while demanding a cap on the nation-wide GST tax’s median rate, is possibly taking a leaf out of economic history and trying to position itself for the next General Elections, when it may well look to channel protests against  the initial bout of inflation which GST may usher in.

Former Finance Minister P Chidambaram has already made it clear that the Congress will campaign throughout the country demanding a low GST median rate. In case, (and it looks like they will), the Government chooses a higher median rate  and an even higher rate for luxury and sin goods, rest assured the Congress and other political parties who would include the BJP’s own allies, will lose no time in pillorying the ruling  party for its folly in unleashing the Inflationary monster.   

Goldman Sachs in a research note found that Asian countries which brought in GST between 1977 and 2015, all reported an average increase in inflation of 1.1 %  higher on average in the year of its implementation. Sachs also estimated, based on cross-country evidence and the evidence from state VAT implementation, that retail inflation in India could rise 0.9 percentage points if the GST rate were to be 20 per cent.

With retail food inflation having built up over the years, any further increase in inflation is likely to prove to be an incremental burden on the populace. Consumer price index was just shy of the 6% mark in June. Even more worryingly, Retail inflation in rural areas has consistently outpaced urban areas in the past 18 months, hitting 6.20 per cent in June, well above 5.26 per cent in cities such as Mumbai.

Reserve Bank of India Governor Raghuram Rajan’s harsh inflation targeting, which often led him to refuse to bow down to pressures to ease interest rates had put him at odds with successive finance ministers looking to pep up Indian growth suffering from a global industrial slowdown.

As a response to that `Nay-saying ' by Rajan, a new mechanism which the Government is ushering in may give the Finance Ministry a larger say in setting interest rates. Not so judicious decisions lowering interest rates to unleash growth may well upset the battle against rising prices and with GST fueling the price spiral, it would not give rise to just another academic Growth Vs Price Rise debate but perhaps another political Tsunami which would have the potential to shake not merely Mr Narendra Modi's government but also upset other apple-carts in forthcoming state elections to a number of key states. 

Inherited Problems for Modi's Economy Czars

After the Tsunami of celebrations, the time to address immediate economic problems for the yet-to-be sworn in Narendra Modi government, has probably started even before it takes office.
Top mandarins say the BJP will inherit not only the iconic red sandstone buildings on Raisina Hill, which stand at the heart of Delhi’s power corridors, but also the myriad economic `time-bombs’ which the Manmohan Singh Government will be leaving behind.


Gas Wars
Possibly the first challenging decision which the new BJP-led government will have to tackle will be  the gas pricing conundrum, which the Manmohan Singh regime will be leaving. Earlier this year, gas prices were sought to be hiked to over $ 8.40 a mmBtu, double the current rate.
The move which was stalled by the Election Commission as part of its code of conduct, will if accepted by the new Government, mean an immediate increases in the price of electricity, fertiliser, gas used by public transport, and plastics with its longer term knock-on effect on the price of almost every good and service in the country. 

For a government which would be trying to consolidate its recent massive mandate, any sudden price rises could translate into quick dampening of support and a reversal of voting trends in key state elections which would be coming up in the next two years.
However, not allowing any increase could damped investor sentiments in the oil and gas sector, which hasn’t seen any major discoveries in  recent past. Besides, the Reliance Industries Ltd, which was instrumental in seeking the rise in the first place, has sought arbitration proceedings on stalling of the price hike. The Government would have a legal fight on its hands which again would not exactly help build investor confidence, especially foreign investor confidence, something which the BJP-led government is believed keen on.
A possible way out would be to go in for staggered increase in the price of natural gas which could help keep prices under the lid and yet at the same time solve the possible legal tangle with the country’s largest industrial house, which many say is also close to both the new and former ruling parties.

Battle Over Money

The Yaksha & Yakshi Sculptures Guarding RBI
 

If India Inc., which so lustily cheered Narendra Modi’s victory on Friday, has any one demand they want fulfilled as of yesterday, it is a cut in interest rates. Their bitter complaint has been that high interest rates have locked out investment in new factories and projects and their one point demand in repeated meetings with finance ministry mandarins has been steps to reduce interest rates, to help drive back growth. India’s GDP grew by just 4.7 per cent last fiscal after falling to a decade low growth rate of 4.5 per cent in the year before.
However, with inflation still raging high, the country’s central banker, Raghuram Rajan favours continuing using interest rates to combat price rise. The country’s consumer-price inflation quickened in March for the first time in four months to 8.31 per cent from a year earlier, forcing Rajan to leave untouched key policy rates unchanged in the last review on  April 1, this year.
Speculation is already rife that this could lead to a battle royal between Rajan and the new Government.
In the run up to the elections, Rajan had told an audience in Switzerland that he “determine(s) the monetary policy. Ultimately, the interest rate that is set is set by me.” In response,  BJP leader Subramanian Swamy had reportedly lashed out at Rajan and his interest rate management and offered the advice : “We need to immediately drop interest rates.”
The BJP has however in recent days indicated that it would defend the RBI’s autonomy and Rajan’s job was not at risk.
How to manage the monetary policy to tweak growth and at the same time get Rajan to agree with the BJp's priorities, will be a concern for the Modi government. That could spell either the first public `war’ over economic policy-making or the first successful wooing of a `Congress’ econo-crat into the BJP fold.

Golden Goose

Raw Gold Bar

The government had increased the gold import duty and other curbs on the yellow metal to deal with the current account deficit, the difference between inflow and outflow of foreign currency, which had touched $88 billion during 2012-13. The curbs had brought down the yellow metal imports significantly to $32 billion in 2013-14. 
However, high duty of 10 per cent and insistence on minimum export before importing more gold has hit the gems and jewellery industry, which has been stridently seeking review of the policy. One of India's big ticket exports, this sector's sales to the world market have fallen 11 per cent in 2013-2014 to $ 34.79 billion after having grown at an average of 15 per cent over the last  5 years.
The BJP led government by Narendra Modi, coming from Gujarat, which is the epicentre of the gems and jewellery sector, is certain to seek changes in the policy. However, the government is expected to adopt a cautious approach and go in for a staggered duty cut.

Coal Bill

Open Cast Coal Mine
 

Part of India’s growth story dimming is because mines which feed India’s factories have been forced shut by environmental cases. While new mines have been stalled by red tape.
India, which has one of the largest coal reserves in the world, with some 293 billion tonnes of coal under its forests, farmlands and deserts. However, with the mining sector shrinking by nearly 3 per cent during the last two years, India has been forced to import coal worth $ 15 billion last year and is expected to import another $ 17 billion during the current year. Similarly, mining of iron ore, vital to India’s steel mills which seek to ratchet up output to 300 million tonnes over the next ten years, has been stalled in much of the country by environmental and legal activisim.
The Modi Model has long claimed that its problem solving capacity is far greater than the long drawn out consensus approach favoured by Manmohan Singh’s UPA Government. Many say the silent mines will be this Model of Governance’s real test.

Reforms & Dismal GDP Forecasts



Amul ad poking fun at the Sensex

India’s dismal early forecast for 2012-2013 financial year’s economic growth, at a decade low of 5 per cent, should have meant glum faces at North Block, home to the country’s finance ministry.

However, strangely, not too many of the Mandarins who work in that cavernous red stand-stone Raj-era building seem too worried, rather they seemed perversely pleased. Probably, because the figures could actually come in handy for finance minister P.Chidambaram and his economist boss, Dr Manmohan Singh, when the duo argue for tough reform measures with cabinet colleagues and Congress party leaders, who ahead of crucial general elections early next year, want to see more populist measures and less of belt-tightening reforms.

Data released by the Central Statistical Organisation places growth forecasts far below an earlier 5.5 per cent prediction by the Reserve Bank and an optimistic 5.7-5.9 per cent target set by the finance minister P.Chidambaram and far average growth rate of 8-9 per cent, achieved through the last decade.

Singh-Chidambaram duo

The Singh-Chidambaram duo will have the advantage of this gloomy picture to force reluctant colleagues into agreeing to slash oil subsidies and fat defence budgets as well as steering opening up of the economy to more foreign investment and cutting red tape in doing business. 

The schism within the cabinet had often spilled out in the open in the last few months, with tough decisions like subsidy cuts being pushed on the backburner several times at cabinet meets, before being finally accepted. Spats over auctioning gas blocks between petroleum and defence ministries and opening up coal mines between steel and environment ministries still remain unresolved despite the Prime Minister chairing meets to sort out such rows.

No wonder Indian industry has been talking of policy paralysis.

To make things tougher for the Congress leadership, BJP’s poster boy and almost certain prime ministerial nominee Narendra Modi, has begun selling the `Gujarat development model’ with slogans like “minimum government and maximum governance” and "inculcate skill, scale and speed to compete with China”.  

Singh and Chidambaram desperately need now to show that they do have a `Delhi  development model’ up their sleeves and that too speedily!

Narendra Modi sells Gujarat Model

Yesterday’s data forecast said farm sector could grow by just 1.8 per cent in 2012-2013, compared with 3.86 per cent in the previous year, while manufacturing could slow down to 1.9 per cent from 2.7. This is the slowest pace of growth for the manufacturing in the past 14 years. Even the services sector which for the better part of the last decade grew in double digits, could grow by 8.6 per cent.

In the first half (April to September) of the financial year, the economy grew at 5.4 per cent, today’s data indicates that the economy may have grown by just 4.2 per cent in the quarter ending December 31, 2012 and may grow by 5 per cent in the current January to march quarter.

This data points to the desperate need to bring in reforms to boost infrastructure and manufacturing growth. Industry chamber Ficci has already flagged: “Quicker implementation of the National Manufacturing Policy, speedier decision making under the aegis of the Cabinet Committee on Investments, ushering in the Goods and Services Tax regime, passage of the insurance and pension bills in the next session of the Parliament and bringing greater competition in the coal mining sector” as ways to get ahead.

The industry wish-list more or less tallies with Chidambaram’s reforms-to-be-taken-up list, with additions like less largesse on populist subsidies and tax reforms which help Indian firms stand up better to foreign competition.

Finance Ministry officials want to redraw duty structure so that domestic capital goods, electrical gear, telecom industries and even steel which have been facing import pressure can again revive.

Proposals in the offing would place higher duties on imports in these sectors, while reducing duties on raw materials such as iron ore, coal as well as components which go into making electrical or telecom gear and having a tax structure which encourages domestic telecom and electric equipment.

India had drawn up a tax structure which imposed high duties on finished cars imported into the country, less taxes on semi-finished cars and far lower taxes on cars which were at least 70 per cent indigenous. A similar structure is being looked at for the telecom equipment industry.

However, what industry captains really want is ground level reforms such as setting up a coal regulator. India has long been debating setting up an independent coal regulator as besides the single monopoly coal producer – Coal India – a large number of firms have been given captive coal blocks and some have been allowed to trade surplus production.

Amul ad on Coal scam

The government is also expected to step up the gas and put up some 54 coal mines up for auction to a limited field of buyers –iron and steel factories and cement and electricity plants - over the next four months. The auctions, speeded up by allegations of scams in earlier allotment of mines, are expected to yield precious revenues to state government coffers and much needed coal to fire coal-burning furnaces and power plants.  

The Government has cut base prices for another round of telecom auctions, which should bring in some more money into government coffers and at the same time give telecom firms more radio-waves to base future mobile connection sales. India has about 935 million mobile connections for 1.2 billion people, and unless better connectivity and services can be ushered in, growth may soon flatten-out after slowing down to just 2.25 per cent on a year-on-year basis.

Officials say Prime Minister Singh is also pushing them to clean up a Direct Tax Code, which could jiggle tax rates, while enlarging the tax base. The DTC is expected to simplify tax laws, lead to less legal disputes over taxes and ultimately bring better compliance. Industry says any tax reform measure always helps business grow and bring more of the `parallel’ economy over-ground, with more businesses declaring their tax liability. 

However, two reform measures promised to industry at large and foreign investors in particular could remain in doldrums unless the government does a better job at floor management inside the parliament.

In the last parliament session, the government was unable to go ahead with voting on the insurance bill as no agreement could be reached in back-room parleys with opposition and supporting parties on a clause which seeks to raise FDI to 49 per cent.

Officially the debate will be shifted to the next session of Parliament. The BJP had earlier agreed to help pass the insurance bill, provided the foreign investment cap was retained at the current level of 26 per cent.

Linked to this is the fate of the pension regulator bill, which gives teeth to the regulator and allows foreign investments into pension funds. The FDI limit in pensions is linked to the limit in insurance firms. It could be taken up separate from the insurance bill and passed, allowing foreign pension funds to buy up to 26 per cent stake in Indian pensions for starters, but a final call on this could depend on how the voting numbers stack up in the coming Parliament session.

Super Thursday Reforms Burst

Manmohan Shining

The Congress-led Government unleashed a Super Thursday  reforms burst – ranging from raising the cap on foreign investment in insurance, allowing foreigners to invest in pension funds, allowing options in commodities markets to clearing a Competition law, a new Companies law which would see more independent directors on corporate boards and clearance to the country’s 12th five year plan.
The rash of cabinet clearances comes on the back of a pull-out by former ally Trinamool Congress which had among other things opposed plans to raise foreign investment in insurance firms to 49 per cent and to allow foreign-held equity in pension funds besides introduction of options in commodity trading. The break had come when the Manmohan Singh
However, passing the twin financial sector bills- Insurance Amendment bill and Pension Regulator’s bill – will be a tough job given the fact that the UPA government does not enjoy a majority in the upper house.
“We will now discuss the passing of the bills with principal opposition parties,”  finance minister P.Chidambaram said cryptically after the reform moves were cleared by the union cabinet today.
The principal opposition party BJP had agreed to help pass the insurance bill, provided the foreign investment cap was retained at the current level of 26 per cent.
With this agreement junked tonight,  BJP made it clear that it would oppose the bill. The UPA holds 95 seats in the upper house which has a strength of 245. If it can ensure the votes of BSP, SP and the RJD together have 27 members, then it can sail through with the bill.
Otherwise, the only way the government can get over this hump is to declare the bill, a money bill which would necessitate passage by just the Lok Sabha. Money bills, which vote in new taxes or cesses or allocate expenses from the Consolidated Fund of India, cannot be held back by the upper house under the Indian constitution.
Officials said as the bill stands today, the Insurance Amendment bill cannot be defined as a money bill, which would mean it would have to be passed by both houses of Parliament. However, the original IRDA Act which the new bill seeks to amend was a money bill as it voted for a cess to be imposed on insurance firms. Law ministry officials said if the new amendment bill is technically declared a money bill because of the cess element, then the Government could hope to by-pass Rajya Sabha, where the UPA is in a minority.
Finance ministry officials clarified that the cap on foreign investment will be raised to 49 per cent, including both foreign direct investors as well as foreign institutional investors.  Officials also said that the foreign investment cap will not apply to PSU insurers where foreign direct investment was not yet allowed.
The pension bill will have a clause which will state that the foreign investment cap in that sector will follow rules in the insurance sector. Which means if the insurance bill is passed by Parliament, then the foreign investment cap in the pension sector would also be 49 per cent, otherwise it would be set at 26 per cent.
“I hope the management of consensus in Parliament is successful … the government is doing its Dharma, now it’s up to Parliament,” said plan panel deputy chairman Montek Singh Ahluwalia.
The IRDA Amendment Act already stands introduced in Parliament and a standing committee has given a report on it which recommended that the FDI cap should not be raised but agreed to go along with other changes. The government was supposed to study the recommendations and re-introduce the bill with changes it thought were needed, but had dithered till now for want of a consensus.
The re-introduction will not necessitate the bill being sent to a standing committee. However, the Lok Sabha could, if it so chooses send it back to the committee for a fresh study. Officials said this was likely to be a last ditch strategy, if the government was unable to muster the majority needed to clear the bill.
The other changes which will be brought to the IRDA ACT, call for allowing Lloyd’s of London to open an insurance trading floor in Mumbai, somewhat akin to a stock market, and to permit foreign reinsurance firms such as Swiss Re and Munich Re to enter India besides giving a green signal to public non-life insurance companies to raise capital by selling minority stakes. Changes which are not being contested by any party except the Left parties.
The pension bill too faces the same situation. The BJP opposed raising the foreign investment cap beyond 26 per cent, but it was the Left and Trinamool which objected to the very bill itself with its ingrained logic of allowing private funds to manage pensions.
Similarly, it was the Trinamool which nixed another step taken by the cabinet today – introduce options trading in the commodity market. A step which is in line with the thinking of the Left front against which it is pitted in West Bengal.
Options trading allows a trader to buy or sell a commodity at a future date at a price which he expects will rule around that time.
In July, Trinamool Congress Supremo Mamata Bannerjee had forced the Prime Minister to defer the move citing fears that it could raise farm produce prices.
Options trading and even trading in commodity exchanges have  in the past been blamed for speculative price spirals but the cause and effect was never clearly established. However, it has always been a popular villain, in Left narrative, something which the Trinamool Congress follows keenly, despite political differences.