India’s economic slowdown is visible. With a lag of two quarters, so are attempts to reverse it through policy fixes. And the markets that had fallen in the prelude to policy actions or in reaction to anti-entrepreneur economic stances have more than made up in an equal and opposite direction, almost as if Newton’s third law is overseeing India’s capital markets.
The slowdown first. With four quarters of consistently falling growth of gross domestic product (GDP), from 8.0% in the quarter ended June 2018 to 5.8% for March 2019, the slowdown is clearly visible. For countries such as Italy, whose corresponding GDP growth rates are a fraction of India’s (see table) this may not seem to be such a disaster. In fact, a growth rate of even 1.0% for Italy looks aspirational today.
Source: Government of India, OECD
But for India, that has barely begun to grow, and one that has 75 million people living on less than $1.90 per day, such a fall hurts its citizens directly. On the flip side, a 1% increase in GDP per capita can decrease poverty by 0.78%, according to Pradeep Agarwal in a 2015 paper, Reducing Poverty in India: The Role of Economic Growth. In other words, 1% increase in GDP per capita can pull 3 million people out of poverty, wrote Shruti Rajagopalan, concluding that delivering a faster GDP growth is a moral imperative. To give a context, India’s per capita income is a little more than $2,000, while Italy’s is a little less than $34,500, a difference of more than 17 times.
The biggest most visible expression of the slowdown is being driven by falling auto sales, which are not slowing down but contacting. The industry, in all its segments that include commercial and passenger vehicles, is in the middle of its biggest-ever recession, facing falling sales for 9 consecutive months, according to Society of Indian Automobile Manufacturers. While carmakers, component suppliers and dealers have already let go of 350,000 people, the industry may need to cut more jobs. As a sector that comprises 7.1% of GDP, 26% of industry GDP, 49% of manufacturing GDP and employs 29 million people, its impact is as much political as it is economic. In varying degrees, other industries and sectors are facing similar pressures.
On the policy side, the social and hence the economic system of India that includes the government, the lawmakers and the judiciary, wilfully or intentionally, continues to have institutional suspicion for wealth creators and hurt entrepreneurs – the recent crisis management steps notwithstanding. This is a legacy of the post-Independence socialist years, from 1947 through 1990. While the mechanics of India’s reforms story have changed after the economy opened up in 1991, the spirit of contempt for doers, for businesses, for wealth lingers on. The increase in income tax rate for individuals whose taxable income is more than Rs 3 crore and Rs 5 crore (385,000 euro and 642,000 euro) in the Budget 2019 – rightly termed an eat-the-rich budget by Monika Halan – is merely one such policy reflection, possibly a political counterweight to the announcement of strategic sales of public sector enterprises.
But as alerted earlier, there is no possibility of wealth redistribution if it is not supported by wealth creation. And before the consistently-slowing economy turns into a contraction and possibly a recession, the government has finally acted to fix the problem. There are several policy prescriptions that Finance Minister Nirmala Sitharaman has initiated, of which the cut in corporate taxes on 20 September 2019 has been the most effective in short-term outcomes and the most far-reaching in medium- to long-term impact.
Through the Taxation Laws (Amendment) Ordinance 2019, Sitharaman has reduced the corporate tax rate for two kinds of companies. First, in an attempt to attract new investments into manufacturing through a policy nudge, she has lowered the corporate tax rate to 15% (17.01% after taking surcharge and cess into account). This will apply to companies that get incorporated after 1 October 2019 and commence production before 31 March 2019. Second, the rate of tax for existing companies has been reduced to 22% (25.17% post surcharge and cess). In both cases, the condition is that these companies will have to give up on all incentives and exemptions and pay no minimum alternate tax (MAT). Until these incentives and exemptions expire, the companies can pay MAT at 15%, down from 18.5%.
In the short-term, the Bombay Stock Exchange Sensitive Index (Sensex) – an index of India’s 30 largest and most traded companies – has jumped 3,000 points in two straight sessions. It had fallen by 3,400 points to 36,000 between the announcement of Budget 2019 on 5 July 2019 and 19 September 2019. Following the cuts in corporate tax rates the next day, the Sensex has reclaimed its 39,000 level, just 1,000 points short of its all-time high of 40,000 on 23 May 2019 that reflected the enthusiasm around the Narendra Modi government returning to power for a second term, with a larger 303-seat mandate.
While lower taxes do help smoothen business decisions, in themselves they are not enough. In the medium- to long-term, governments – at the Centre but more in the States – need to ensure that the bureaucracy understands the urgency of the slowdown and stops tying up entrepreneurs with its infamous red tape and its outrageous and corrupt rent-seeking. The few large BJP-governed states can initiate the change, following which entrepreneurs, both domestic and foreign, can action what they do best – bring capital, talent, products, innovation and markets, and create enterprises, jobs and wealth.
The cuts in corporate taxes have brought India closer to the world average: against the average global corporate tax rate of 23%, the Indian rate now stands at 25.01%. Prior to the cuts, India’s corporate tax rate, at 35%, was the fifth-highest in the world. As India globalises and strengthens its resolve to attract global entrepreneurs, these rates will align themselves further.
Other than this latest cut in tax rates, Sitharaman has, over the past month, initiated and powered other policy initiatives. These include:
- Fixed term employment – a precursor to labour reforms – web-based inspections and faster inspection reports, self-certification for start-ups in six labour laws.
- Shifting 16 offence sections to monetary penalties only, free from imprisonment.
- Violations in corporate social responsibility law will no longer be treated as criminal offences, only civil.
- All notices and summons by income tax authorities after 1 October 2019 to be issued through a centralised computer system.
- Ensuring that banks launch repo rate or externally-determined benchmark linked loan products, such that interest rates charged to consumers rise – but more importantly fall – with changes in benchmarks.
It is heartening to see the government taking the slowdown seriously. The earlier problem of putting more pressures while in the slowdown seem to have gone for the moment. Whether they will return with growth is a question that we address with cautious optimism. Stepping back, for India to grow when the rest of the world is slowing down would be a misguided expectation. Further, the structural reforms undertaken by the government, particularly the introduction of the goods and services tax and its subsequent compliance simplification, the financial inclusion schemes such as the Jan Dhan Yojana, or the potentially increasing velocity of transactions as a larger number of Indians adopt digital payments, should show benefits going forward.
It’s not that pressures on growth and the potential slowdown are restricted to India alone. The growth of world output is expected to be 3.2% in calendar year 2019, down 0.4 percentage points from 2018, according to International Monetary Fund. While growth of the US will fall by 0.3 percentage points to 2.6%, China’s by 0.4 percentage points to 6.2%, the Euro area’s by 0.6 percentage points to 1.3%, and Italy’s by 0.8 percentage points to 0.1%, India’s growth is expected to rise by 0.2 percentage points to 7.0%.
Even if we were to shave off a few percentage points, India will remain the world’s fastest-growing large economy. And if the resolve of the government to boost growth further sustains, its focus on removing operational hurdles of red tape and corruption endures, and its policy direction to attract entrepreneurs remains on course, India will continue to be the go-to destination for investors.