By Priya Saraff
A report by HSBC shows an India caught between two worldsthe first is a story of slowing GDP growth and the next is one of revival. For the FY18, FY19, the report says that the GDP growth will only be 6.5 percent and 7.0 percent, respectively. Reasons for this include confusion about GST, weak exports, and low investments. The “second” India will emerge in FY20, with a GDP growth rate of 7.6 percent. By then, reforms such as the Bankruptcy Code and the Real Estate (Regulation & Development) Act will help stabilise growth. It is also predicted that GST alone will add up to 40 bps to the GDP growth rate.
GST effect on the GDP growth rate
GST confusion is a result of several tax rates, hindrances while filing, and uncertainties when it comes to input tax credit. Multiple tax rates lead to more classification and an increase in the complexities of administration. The frequent changes in rates have been hard to keep up with, as companies constantly have to update their internal systems. The GST portal has many glitches, making the paying and filing of returns a slow, cumbersome process, especially as traffic increases. Delays in filing have led to the government constantly extending the deadline. There have also been uncertainties regarding the input tax credit. This is the mechanism through which a person can offset the tax they have already paid on inputs, against the tax they are supposed to pay for sales or services provided. This prevents the cascading effect of taxes (paying tax on tax) and is one of the most important features of GST.
However, a firm depends on its supplier’s compliance to report the inputs sold, against which the firm can claim credit. In case of any mismatches between what was reported and what was bought (for example, a supplier reporting the selling of five units of raw material instead of the ten that were actually sold), firms have only two months to rectify it, which may be too short a time period. There is also confusion surrounding input tax credit for input services of immovable property. An example of this is when a company puts up its employees in a hotel. The GST paid for the hotel services cannot be used to claim credit unless the company has GST registration in the state in which the hotel is located. With registration comes the burden to file tax returns every month, which can discourage companies.
In the medium term, the impact of GST is estimated to add 40 bps to the growth of GDP. This is down from a previous estimate of 80 bps, again due to the multiple tax rates and the long list of exemptions that could deter the input tax credit mechanism. However, GST is expected to boost productivity by improving the ease of doing business, creating a single market, and making India more attractive as a foreign investment destination, according to Moody’s. Rana Kapoor, MD and CEO of YES Bank, has listed some advantages of the tax reform such as a shift in business from the informal to the formal sector. As digitisation and formalisation strengthen, financial institutions will begin to cater to the needs of Small and Medium-sized Enterprises (SMEs). Reducing compliance burden on these firms will lead to more efficient businesses.
Other factors that may work for the ‘second’ India include stable prices with normal monsoons, inflation within the target, and increase in private investments as a result of increased public capital expenditure and more conducive atmosphere for investments with the Bankruptcy Code in place.
The current account deficit
The report has said that the current account deficit (CAD) is expected to widen over the three years: 1.7 percent in FY18, 1.9 percent in FY19, 2.1 percent in FY20, but remaining within the safe zone of 3 percent (all percentages are on GDP). This is due to a stronger rupee valuation, weak export orders, and expectation of higher import demand.
The CAD jumped to a four-year high in the first quarter of FY18, to 2.4 percent, due to an increase in gold imports (pre-GST) and prices of oil. While CAD has decreased, there is no denying that exports face certain deeper issues. The report says that the export growth fell to 1.2 percent year-on-year from 10.3 percent last quarter. GST (rather, its administration) has created problems for exporters as they are yet to receive the tax refunds (paid on inputs) from the government. This has led to the blockage of a huge amount of their working capital. Apart from this, Crisil, the rating agency, has found that the labour intensive industries of India have low export competitiveness, a problem that has persisted for a decade. Solutions include R&D support from the government, favourable trade agreements, and reduction of the cost of logistics.
Inflation
Inflation will be within the RBI’s target of 4 percent and will be averaging 3.5 percent in FY18, ending the year with 4.2%. This consistency is a result of low global prices, slow demand, and low food prices. However, if the investment recovery remains sluggish, inflation could climb due to supply-side constraints.
India’s ‘twin balance sheet problem’
One of the biggest challenges to this positive outlook is the twin balance sheet problem, explained by Chief Economic Advisor, Arvind Subramanian, in a speech at Shri Guru Tegh Bahadur Khalsa College, Delhi University as, “Overindebtedness in the corporate sector which makes them unable and unwilling to borrow, depressing the demand for spending and investment; and on the other hand to stressed bank balance sheets especially in the public sector banks (PSBs) that make them unwilling and unable to supply credit to finance spending by the corporate and household sectors.” This problem creates a clog in the economy, and directly leads to a lower Aggregate Demand, as private investment falls.
Banks see their Non Performing Assets (NPAs) increasing and profitability declining with low-interest payments and excess provisioning. Large industrial sectors such as infrastructure, mining, and power & telecom are also witnessing a decline in profitability. Therefore, it is the private investments which must be boosted to spur the projected growth, to create the ‘second India’.
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