Economic challenges for the new government

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June 18, 2019 2:07 AM

The four major challenges are fixing the country’s financial sector, especially its banks; continuing to reform the tax system; reducing outflows of funds due to loss-making or inefficient government enterprises; and truly reforming the agricultural sector.

Economic challenge, new government, NDA government, NDA second term, GDP ratio, GDP, Reserve Bank, Reserve Bank India, RBI, GSTEconomic challenges for the new government

Narendra Modi and the NDA won a famous electoral victory last month, consolidating political power in a manner that many had not imagined was possible in contemporary India. The country of a “million mutinies” seems to be increasingly aligning with a particular vision of national identity. But political power is no guarantee of success in economic policy. Improving the material well-being of India’s long-suffering masses will require focused attention to the nation’s economic challenges. What are they?

The foremost challenge, I would argue, is fixing the country’s financial sector, especially its banks. Finance is both the fuel and the lubricant of the economy’s engine: fuelling growth by channelling funds to productive investment, and lubricating transactions and day-to-day economic activities. The overhang of debts that are on the balance sheets of banks and other financial institutions, but will almost certainly never be repaid, prevents new investment taking place to the degree it needs to. The new bankruptcy law, and the Reserve Bank of India’s attempt to make it operational and effective, has run into obstacles, which, if not removed, will allow the situation to linger and even worsen, rather than the hoped for improvement. In that case, the skyrocketing ranking in the World Bank’s Ease of Doing Business measure will be meaningless. Whether additional new laws or new regulations are needed is up to the experts, but clearly there has to be political will to move quickly through a process that will inevitably be painful.

The next challenge lies in the country’s tax system. India is closing in on three decades of reform of what used to be a devastatingly inefficient tax system. But it remains an underperformer in terms of its tax-to-GDP ratio, adjusted for its per capita GDP. The goods and services tax (GST) still needs to be simplified and implemented fully. Simplification, and possibly even lowering of rates, can improve both compliance and enforcement. Continuing to broaden the income tax base, and working out an effective and non-capricious way of collecting corporate taxes—especially from multinational corporations—both have to be done. Recent governments have resorted to retroactive tax judgements that undermine certainty and trust, and will only discourage investment. While local and other subnational taxes can often be inefficient, the Centre should consider allowing local and even state governments to increase their tax authority, even by piggybacking income tax surcharges on central collections. This last measure would need a constitutional amendment, but improving the assessment and collection of property taxes requires no legislative change, just political will and administrative competence. Property taxes are relatively progressive and should be difficult to avoid. In any case, increasing public resources in ways that are non-distortionary and non-extortionate is an imperative. The need for these resources to clean up the financial sector mess adds to the urgency.

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On the other side of the government’s accounts, reducing outflows of funds due to loss-making or inefficient government enterprises is a third urgent challenge. Air India is the most obvious case, since it burns taxpayer money in a market that serves the relatively well-off. But there are problems across many sectors, including electric power, hospitality, and, of course, banking. There is a vicious circle at work here, since there are many existing jobs at stake, while new jobs are not being created rapidly enough. But it is better to sell off such enterprises with restrictions on immediate job cuts, than to perpetuate value destruction: creative contracts are needed. This avenue of reducing government ownership will be important for a sustainable financial sector, beyond the short-run clean-up of balance sheets.

A fourth challenge lies in the agricultural sector. Rural India, where the majority still reside, remains relatively poor and is falling further behind. Restrictions on marketing and trade often constrain the ability of farmers to get the most value for their crops. Intermediaries continue to exert disproportionate power in markets for inputs and products. Crop procurement schemes are inefficient and also subject to intermediary capture. Insurance that reduces risk and uncertainty barely exists, exposing farmers to unsustainable debts that, then, lead to fiscally costly loan waivers. Agricultural extension has not kept up with the needs of modern agriculture. Thus, the government intervenes inefficiently and in the wrong places, often not doing things where it could really add value. This has been a common theme in Indian economic policy, but agriculture has reformed the least, under cover of protecting the poor, but actually keeping them in relative poverty.

There are other challenges as well, of course, but even tackling just the above four effectively would make an enormous difference. The vice-chairman of NITI Aayog, Rajiv Kumar, spoke of a priority list of “big bang” reforms right after the election results. It included much of the above list, along with other reforms such as ones aimed at labour and land laws. So nothing in the above is particularly original. Further, he spoke of making progress in the first 100 days, which would be remarkable if it happened. Of course, proper formulation and implementation can take time, but even strong public commitments to tackle specific challenges can be useful.

Having a strengthened government with significant continuity of expertise and decision-making can certainly help in moving forward more expeditiously than is typical for India. Perhaps we will see some truly positive developments in economic policy over the course of the monsoon season.

The author is professor of economics, University of California, Santa Cruz

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