Modi’s New Reformist Agenda

Prime Minister Narenda Modi’s second term promises to be significantly different from his first. In May 2014, he inherited an economy with high inflation, a bloated fiscal deficit and low GDP growth. Corruption was endemic. A banking crisis, then hidden from plain sight, loomed. 

Five years later, the economy presents a mixed picture. Inflation is low, the fisc is under control but GDP growth has slowed alarmingly to 6.8 per cent for 2018-19. Corruption cases relating to the UPA decade linger. Bank balance sheets are awash in red ink. Not only were NPAs camouflaged during the steroid-driven UPA years, but persistently high interest rates during the Modi government have deflated the economy.

With banks forced by the Reserve Bank of India (RBI) in 2015 to recognise NPAs under tough new guidelines, lending to corporates stalled. A knock-on effect was the collapse of private investment. The task that thus confronts Finance Minister Nirmala Sitharaman is onerous. She has to, first, urge the RBI to cut interest rates. Companies need to lower their borrowing costs so that they can start investing again. Ms. Sitharaman’s second urgent task is to boost consumption. This means putting more money in consumers’ pockets to revive spending which has sagged since demonetisation and the initial compliance-heavy introduction of the Goods and Services Tax (GST). Her first Union Budget, due on July 5, will set the tone for her tenure. 

Cutting tax rates will give the economy the boost it needs. Taxpayers with taxable income below Rs. 10 lakh a year anyway pay very little tax if they use the investment exemptions available to them. A simplified flat tax regime without cesses could lift consumer confidence. Incomes below Rs. 10 lakh should be tax-free. Three slabs of 10 per cent, 20 per cent and 30 per cent (no cesses) should apply to incomes between Rs. 10-20 lakh (10 per cent tax), Rs. 20-30 lakh (20 per cent tax) and above Rs. 30 lakh (30 per cent tax). 

By implementing a flat tax regime, Ms. Sitharaman will see greater tax compliance and lower administrative costs of monitoring marginal taxpayers. It will put more money in the hands of the middle-class. That will drive consumption and help the economy rediscover its animal spirits. Meanwhile, lower bank interest rates will incentivise corporates to invest in new projects. Lower EMIs for cars and houses will revive the automotive and housing industries, two key components of the economy. Pointing to constrained consumer demand, the country’s top four automakers – Maruti, M&M, Tata Motors and Honda – reported a sharp 20 per cent fall in sales in May 2019 over May 2018.  

At the first cabinet meeting of the new government, Modi extended a Rs. 6,000 annual payment to nearly 150 million farmers (beyond the initial beneficiaries with a maximum holding of two hectares). This should boost rural spending. The slowdown in the sales of Mahindra tractors as well as the stagnation of automobile sales are evidence of a cash crunch across demographies in urban and rural India. Easing monetary policy with lower interest rates and kickstarting consumption by reflating the economy with cuts in income-tax rates are Ms. Sitharaman’s most critical priorities.

Apart from revitalising the economy, the finance minister will need to engage in delicate negotiations with the United States following the end of 44 years of tariff exemptions by Washington under the generalised system of preferences (GSP). The several thousand items of Indian exports to the US that will no longer receive tariff exemptions, however, amount to just $6.35 billion, two per cent of total Indian exports and around 12 per cent of Indian exports to the US. 

As defence minister, Ms. Sitharaman negotiated intensively with US Secretary of State Mike Pompeo and former Defence Secretary James Mattis on the impact on India-US relations of New Delhi’s purchase of Russia’s advanced S-400 anti-aircraft missile system. She is therefore familiar with the hardball tactics US interlocutors employ. As a former minister of state in both the finance and commerce ministries, Ms. Sitharaman is also well-equipped to deal with complex trade and economic issues. She worked with PricewaterhouseCoopers and a local public policy think tank before entering politics in 2006. 

Significantly, Railways Minister Piyush Goyal now holds additional charge of the Commerce and Industry ministry. He too is a skilful negotiator and will be a close ally of Ms. Sitharaman in the complex negotiations with the US that lie ahead. Additionally, Hardip Singh Puri is Minister of State in the Commerce Ministry. Puri, an Indian Foreign Service (IFS) officer, was India’s permanent representative at the United Nations and has handled several international negotiations in his 40-year career. The Sitharaman-Goyal-Puri team will need to work in close coordination to mitigate any damage the US withdrawal of GSP rights will have on India’s already comatose exports. 

US President Donald Trump is tariffphobic, to coin a new word. As The Economist reported recently: “Donald Trump is not the first American president to promise a tougher line on China, but is the first to make a trade war sound like a rent renegotiation. ‘I am a Tariff Man,’ he tweeted last December, boasting that America is taking in billions of dollars, thanks to tariffs he has imposed (never mind that tariffs are a tax, mostly paid by American consumers). Mr. Trump makes America’s markets should like a valuable piece of real estate which foreigners should pay more to access. Or as he puts it: ‘When people or countries come in to raid the great wealth of our Nation, I want them to pay for the privilege of doing so.’”  

Paradoxically, the US is enjoying a jobs boom, with unemployment down to a half-century low of 3.6 per cent. Most advanced economies are seeing a jobs surge, driven by technology. The old chestnut that robots would take away human jobs has been buried. Robotic technology is in fact creating, rather than destroying, jobs in a host of ancillary industries. 

There is a lesson in all of this for India. To create new jobs, India must reflate an economy starved of demand and supply. That is Ms. Sitharaman’s immediate challenge.