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.

The `Fault Line' Man

Its official now. Chief Economic Advisor Raghuram Rajan will be the next Governor of the Reserve Bank of India after the current Governor D Subbarao retires in September.

Raghuram Rajan

"Prime Minister has approved the appointment of Dr. Raghuram Rajan as the Governor of Reserve Bank of India (RBI) for a term of three years, vice Dr. D. Subba Rao upon completion of his (Dr. Rao's) tenure …" the bland statement said.

However what it left unsaid was the great amount of politiciking which went on behind the scenes before 50-year-old Rajan was given the job of heading India's central bank at a time when GDP has slowed down to 5 per cent from an average of 8-9 per cent through the last decade, inflation remained high at nearly 5 per cent and the Rupee value against the dollar has come down by some 12 per cent in just over a month.

In the last few weeks, Rajan who has earlier served as chief economist with the World Bank and taught at University of Chicago's Booth School of Business, was locked in a race with Arvind Mayaram, secretary in the finance ministry for the job after Subbarao told finance minister P Chidambaram that he was not keen on another term.

Subbarao who may have said otherwise, had little choice but to move on as  signals coming out of New Delhi made it quite clear that he may not be the man the UPA Government wants at this crucial stage.

Finance Ministry insiders say that Rajan, was always the favourite for the slot, with Chidambaram himself backing him for the job. While prime minister Manmohan Singh, who himself had been an RBI Governor, too preferring giving an economist a shot at the job at this crucial juncture.

D Subbarao

The powerful Indian Administrative Service (India's civil service's upper echelon) lobby was however seen backing Mayaram for the job as it was possibly keen that the country’s top money manager’s job remained with it. Subbarao too had been an IAS officer as had been his predecessor Y.V.Reddy.

Rajan does not really have much administrative experience but is considered one of the brighter young economists having earlier forecast the coming global financial crisis in a lecture made to the world's central bankers at their annual retreat in Jackson Hole, Wyoming, USA in August 2005. Not something which the central bankers exactly appreciated at that time.

Writing later in his bestseller `Fault Lines: How Hidden Fractures Still Threaten the World Economy’, Rajan described the situation as :  "I exaggerate only a bit when I say I felt like an early Christian who had wandered into a convention of half-starved lions."

His colleagues at North Block said that might exactly be how he might feel when he goes to run one of the most complex and powerful central banks of the world from next month on as he has at many times been arguing exactly the opposite of what the RBI has been doing, especially on cutting interest rates.

North Block and Subbarao had not seen eye to eye for quite a long time with Subbarao refusing to toe the finance ministry line that economic growth should be the top priority by arguing that inflation remained his primary concern and delaying cutting high policy interest rates or by reducing interest rates in small driblets of 0.25 per cent.

The problem, officials claimed was that Subbarao who has earlier served as finance secretary felt the finance ministry had no business telling him what to do as he knew both the jobs, while the UPA government felt the RBI Governor did not understand the political imperatives of creating new jobs and raising growth rates in a pre-election year.

While the tension between the Ministry and RBI had remained contained during President Pranab Mukherjee’s tenure as finance minister, it was in the words of one North block top honcho “quite palpable”, after Chidambaram took over.

Both the RBI and the government knew that a foreign exchange cloud was on the horizon as early as the beginning of this calendar year. Indian companies have to pay back $ 170 billion in short term debt by March-end 2014, while its forex reserves are just about $ 280 billion. However both seemed to be crossing out the others’ suggested solutions to the problem. When the government which has always been conservative over sovereign bonds thought about it, the RBI opposed it openly. The RBI on its part delayed taking steps to tighten controls over foreign exchange markets which could have reduced speculation on the rupee.

The Iconic RBI Building at New Delhi

Rajan after getting the news that he was the chosen man for the big job, said he has “no magic wand” to solve the slowdown but advocated close coordination between the government and RBI in handling the ongoing crisis which has seen the rupee slip to below Rs 61 to the dollar levels frequently and Jan-March 2013 GDP growth slipping to 4.8 per cent. This `co-ordinated' approach was something which the Government and markets wanted to hear. The Indian Rupee recovered shortly after his appointment was announced.

At least one thing is assured, say colleagues, Rajan will act. "The cost of doing nothing," the economist had written in his seminal book `Fault Lines’ on the global financial crisis and its causes, "is perhaps worse turmoil than what we have experienced recently" because "unchecked, the fault lines will only deepen."