The quality of the stimulus matters as much as its size and type. Therefore, here’s what the Modi government could do instead.
If 2015 was the worst year for the Bharatiya Janata Party (BJP) and Prime Minister Narendra Modi politically, the year 2017 is turning out to be their worst as far as the economy is concerned. The demons of demonetisation played a critical role in slowing down the economy in the fourth quarter of the last fiscal (January-March 2017) and the first quarter of this financial year. Just when the economy started recovering from the big-bang disruption of the cash ban, uncertainty and massive destocking carried out in June by companies ahead of the rollout of the goods and services tax (GST), from July, took it down further. Incidentally, the country’s gross domestic product (GDP) growth decelerated to 5.7 per cent in the first quarter. On top of that, resolution of bank non-performing assets (NPA) is in progress, and until full cleanup is done, private lending and investment are not expected to take off. First-quarter numbers also showed how manufacturing has done poorly.
This scenario is giving many economists nightmares, and that is understandable. To calm everyone down, the Prime Minister announced the formation of his economic advisory council with Bibek Debroy as its head. But one doubts much will come out of it; Debroy’s advice was always available to Modi if he wanted it.
Interestingly, most economists are clamouring for a fiscal stimulus. A small fraction of those opposing it are reasoning that stimulus is already on. With weak consumption and investment and exports just beginning to rise on a low base, it’s government spending that is keeping growth afloat. Ninety-two per cent of this year’s fiscal target has already been accounted for in the first quarter itself. While those opposing calls for stimulus on grounds that the government shouldn’t fritter away the gains from last three years of fiscal consolidation are wrong, one wonders how much a boost of Rs 50,000-60,000 crore spread across five to six areas can be of help.
The government should make haste slowly on this front. The quality of stimulus matters as much as its size and type – especially the type. Here’s what it should do instead.
First, hold the thought of stimulus for now. Sit tight. Advance the budget to 15 December from 1 February. This way, the government will be able to pack a sixth full budget in its term. It can present the next one on 1 October 2017 and then shift to a January-December fiscal year from 2019 onwards. The growth is most likely to be higher in the September quarter. What’s the virtue in not waiting for a couple of months?
By 15 December, it will also have the second-quarter numbers, depending on which it can take a call on the size of the stimulus.
Second, cut income tax rates across the board. This is long overdue and should have been followed up after demonetisation. However, only one slab (10 per cent) was cut to 5 per cent. In the December budget, it should restructure all the slabs and have four rates: 5 per cent, 10 per cent, 20 per cent and a top rate of 25 per cent for income above Rs 1 crore. The government shouldn’t worry about a loss of Rs 1-1.5 lakh crore of revenue from such an exercise as a part of it will go in boosting consumption and in turn growth. It can consider it as a part of its stimulus package.
Finance Minister Arun Jaitley should finally deliver on his promise of cutting corporate tax to 25 per cent for all companies, small or big.
Third, the GST rates should also be cut. The 12 per cent rate should be reduced to 10 per cent, which will give a leg up to the tottering manufacturing sector. The 18 per cent rate should be reduced to 15 per cent. The services industry has been hit due to the constant increase in taxes over the last three years. In 2014, the tax on services stood at 12 per cent. Now it’s 18 per cent. No wonder Nikkei PMI (Purchasing Managers’ Index) for services is in the negative territory for the last two months (July and August).
To compensate for the loss of revenue from these two rate cuts, the GST Council can do away with the exempt list and put them in the 1 per cent rate category. Currently only 7 per cent goods are exempt from the GST, so its impact on inflation will not be much. Additionally, it can raise the top bracket from 28 per cent to 30 per cent and do away with the cesses.
Fourth, bank recapitalisation is a must. There could be two reasons why the government has been hesitant in taking the easy road and why this wasn’t done when the NPA problem wasn’t as big (say in 2014-15) as it has now become. One is due to opposition’s charge of “suit boot” sarkar and second is that the government probably didn’t want to keep the weak banks forever in play by providing them easy capital. Now, only the strong banks can survive while the weak ones can either be privatised, merged with stronger public sector banks (PSBs), or shrunk in size, as this Swarajya column had argued.
Currently, a sizeable portion of NPA resolution is underway and some may be closed by the time a mini budget is presented on 15 December (14 December has been fixed as the deadline, thanks to the new bankruptcy code). Most of the big culprits will be covered in the first two phases of the resolution process, and thus announcing a Rs 50,000-60,000 crore recapitalisation of the top eight to 10 strong PSBs will be politically saleable too.
Fifth, and this will depend on how the oil prices move in the coming months. The recent oil price hike was in part due to adverse impact of Harvey and Irma cyclones on oil production. So, in all likelihood, it will be back to hovering around $50. However, if it doesn’t, then the government should announce cuts in excise duty to the tune of Rs 3-5 per litre. Currently, the central excise on petrol is Rs 21 and Rs 17 on diesel.
According to Citi Research, every Re 1 per litre decline in excise duty (for both diesel and petrol) would result in a revenue loss of Rs 13,000 crore for the government. So, cutting excise can hit government revenue by another Rs 50,000-60,000 crore. The government can consider this too as part of its fiscal stimulus. This is more of a political suggestion than an economic one because from the pure economics perspective, Swarajya had argued in detail why high oil taxes are good for India. Indians are too sensitive about price hikes in oil, pulses, onions and tomatoes. So, the government should not allow the opposition to make a mountain out of a molehill one year before the general elections and when so many important state elections are just around the corner.
The best stimulus deal right now is tax cuts. This is the only way to have a direct and visible impact on the economy and be politically popular at the same time.
Go for the budget in December and make room for stimulus (via tax cuts) of Rs 1.5-2 lakh crore. Until then, wait and watch. Keep calm and push reforms in labour and land through states.