The Indian Economy Limbers Up

As the BJP and Congress internalise the lessons of the 2017 Gujarat assembly election, two questions arise. First, how will Prime Minister Narendra Modi calibrate his strategy for the final year of  his tenure? Second, can he balance the urgent need to focus on the economy with the task of  leading a strong campaign for a slew of eight state elections due in 2018?

Clearly, the economy will weigh on his mind. Jobs are critical. Restoring growth to 7.5-8 per cent is equally vital. Gross Domestic Product (GDP) growth in 2017-18 will probably be around 6.70 per cent. That is a disappointing number but statistically the most likely outcome at the end of a difficult year. The GDP growth in April-September 2017 averaged six per cent. Assuming an average 7.30 per cent growth in the second half of the current fiscal (October 2017-March 2018), full-year GDP growth will at best settle at 6.70 per cent.

An uptick in the economy can be driven when four factors converge: one, a rise in the savings rate; two, a spurt in consumer-led consumption; three, a rise in exports; and four, renewed bank lending to corporates to spur private sector investment.

Recent figures on the economy present a mixed picture. Growth in the Index of Industrial Production (IIP) slowed to 2.2 per cent in October 2017 after recording a healthier 4.1 per cent growth rate in September 2017. The November 2017 IIP, following the festive season, could deliver better numbers. An early indication of that is the spurt in car sales in November 2017. A total of 19,39,671 vehicles (passenger, commercial, two-wheelers and three-wheelers) were sold in November 2017 against 15,63,658 vehicles sold in November 2016, a rise of 24.05 per cent.

Since the latter half of  November 2016 was affected by demonetisation, the comparison isn’t entirely fair. However, rising car sales do point to an overall increase in economic activity and consumption. This has a spin-off effect on ancillary industries that supply the automotive sector: steel, aluminium, rubber and carbon black. A key statistic in the November 2017 numbers for vehicle sales is the 50.4 per cent surge in commercial vehicles. This points to confidence in the transportation sector as government spending on infrastructure, including road building, gathers pace.

The most important economic news revolves around jobs. According to the Manpower Group Employment Outlook Survey Q1/2018, hiring sentiment has strengthened for January-March 2018, albeit marginally. Clearly much more needs to be done to provide jobs for the millions streaming out of colleges and vocational institutes every year. The informal economy was severely hit by demonetisation and the rapid-fire rollout of the Goods and Services Tax (GST). It has still to fully recover. The formal economy is better off with FMCG companies like Hindustan Unilever (HUL) recording strong sales growth.

Exports remain a worry. They are still below 2013-14 levels. Exports had peaked at $30.50 billion in March 2013. In October 2017, they fell to $23.10 billion. The GST has affected exporters severely. Before rules were tweaked on refunds, exporters suffered a huge backlog in delayed GST refund payments from the government.
With crude oil prices rising, India’s trade deficit is widening. In a Bloomberg-Quint analysis, Azman Usmani wrote: “The trade deficit stood 25 per cent higher compared to last year at $14 billion, according to data released by the ministry of commerce. The trade gap had stood at $8.9 billion in September. The value of outbound shipments in October fell 1.1 per cent over last year to $23.1 billion. Indian exports have been on a downtrend since 2014-15, adversely impacted by a global slowdown, a sharp fall in commodity prices and currency fluctuations. It started recovering in July 2016 and had been on the rise since, but the growth was offset by India’s large import bill led by higher import of gold and oil.”

In an intensely political year, the Prime Minister needs to bring back the focus on the economy. The Union Budget, due on February 1, 2018, will be the last in which Finance Minister Arun Jaitley can inject significant reforms. He has little elbow room. By committing to a fiscal deficit target of 3.2 per cent of GDP when tax revenues, especially through GST, are straining to meet targets, spending on development schemes could atrophy.

Corporation tax is set to come down to 25 per cent for all companies while individual income-tax rates will endure their customary annual tinkering. Jaitley’s five Budgets so far (including the July 2014 interim Budget) have been underwhelming. In 2019, the Budget, which will be presented just before the April-May Lok Sabha election, is likely to be a vote-on-account. So whatever economic vision the government wants to show will need to be displayed on February 1, 2018.

The Confederation of Indian Industries (CII) has suggested a flat corporation tax rate of 18 per cent. The United States is set to move to a corporate tax rate of 21 per cent (from 35 per cent). By removing complex exemptions, a clean flat tax rate is easier to administer and will boost compliance. The revenue loss will be less than imagined. Companies today, with countless exemptions, pay an effective average tax rate of 24.5 per cent. A flat rate of 18 per cent would lead to a relatively small loss of revenue. Total corporate tax revenue in the 2016-17 Budget was Rs. 5.39 lakh crore. Shaving 6.5 per cent off that (24.5 less 18) would cause a loss of Rs 35,000 crore in tax revenue. Better compliance with a flat corporation tax rate of 18 per cent would make up this notional loss.

Similarly, individual income-tax rates need to be simplified. The government has a tendency to complicate rather than simplify matters of revenue. This was starkly evident in the initial rules governing GST. Several tweaks later, GST is simpler, though much more needs to be done to reduce the number of tax slabs. Complexity increases the discretionary power of bureaucrats. Simplification reduces that power. It is the single most important reason that India’s tax code has resisted change over the years.