Former chief economic adviser Arvind Virmani says that the upcoming Union Budget should focus on big-ticket tax reforms in order to boost the economy.

By Sagar Sen and Tushar Chakrabarty

NEW DELHI - The government should focus on 'big-bang' reforms in the direct tax system in the Budget for 2020-21 (Apr-Mar) to help address the slowdown in growth, said Arvind Virmani, former chief economic adviser in the finance ministry.

"...important measures which can be characterised as big-bang reforms are the reform of the direct tax system. We need to provide an incentive for them to move to the white economy," he told Cogencis in an interview.

Virmani said that the corporate tax rate cut announced by the government was needed to restore credibility.

"Finance Minister (Arun Jaitley) in his 2015 Budget promised corporate tax rate reduction and that was not achieved in the first term. That was a huge loss of credibility," Virmani said.

In September, the government slashed the corporate tax rate to 22% from 30% for domestic companies.

"The popular thing is that reduce it (personal tax) for the salaried people. I don't think that is important for revival," he said.

Below are the edited excerpts of Virmani's interview:

Q. What are the measures that the government should take in the Budget for 2020-21 in order to address the economic slowdown?

A. I think the GDP growth has bottomed out by Oct-Dec given the various actions taken by the government and the Reserve Bank of India. But the issue is about the shape of the recovery.

My analysis shows that there were underlying causes and there was a trigger which set this of. This episode in my view is kind of a J-curve of institutional reforms. The three basic underlying causes (of the slowdown) are change in the monetary policy framework and credit regulations, somewhat ad-hoc changes in taxation to keep and the campaign against black money or corruption in the economic sphere.

But in the short-term these have some negatives to it which came together and made the economic situation weak. The triggers were the collapse of IL&FS and the co-operatives that fed into everything before the underlying problem had been sorted out. The second trigger in my view was the Part B of the Budget where the people perceived that the government was not really into tax reform.

So that brings us to the measures that need to be taken. The most important measures which can be characterised as big-bang reforms are the reform of the direct tax system. We need to provide an incentive for them to move to the white economy. The popular thing is that reduce it for the salaried people. I don't think that is important for revival. It maybe important for many other things and maybe desirable in the medium or the long term.

The second one is the GST. We have to simplify the thing drastically. What I would expect from the Budget is some indication from the finance minister that recognises the importance of simplification and rationalisation. The final action depends on GST Council but I feel that the finance minister can give an indication.

The third element is more difficult. I have less expectation of it happening in the Budget. But it is connected to the Budget which is a shift in fertiliser and similar subsidies to something which is more efficient. Part of this money could go into NREGA, part into PM-KISAN. But this basic structural change, in some sense, has to be in Budget because it is a money matter. I don't think a full reform will happen but perhaps some indication of a move in that direction.

The fourth one which has been discussed and some has been done is the unclogging of the credit channel. Action has been taken, but I think it needs to now be resolved within the next six months or so. I am hoping there will be some clear direction in the Budget. People have talked about bad banks, asset reconstruction companies, takeover and sale of real estate assets. There are all these ideas, good ideas but there has to be some mechanism setup in my view.  My recommendation is to form a committee which will give a report in three months or something and then just act on that. There are also political issues involved that they will be criticised for anything they do. So I think a professional committee should look at the whole issue.

Q. Despite several government measures, the economy continues to be plagued by lack of credit off-take. What more can be done to address these concerns?

A. The way to do it is that you have to take the worst assets because they are risky. Each bank is afraid to do things on its own. It is a systemic problem. There has to be a systemic solution. The government has tried some of these things, the RBI has been trying. The government, for example, set up this fund for real estate. So all those things are being done but you need a comprehensive solution. Now the problem is they are politically sensitive. So that is partly why the government has been hesitating. My suggestion is to set up a highly professional committee which will then make some of these technical decisions. Then the government can accept some of the decisions that the professionals have said.

Q. Given the current scenario, should the government look to relax its fiscal deficit target?

A. When you have a decline in GDP nominal growth, revenues go down, your denominator goes down. So automatically, that fiscal deficit goes up. What sounds plausible to me is that 0.3 to 0.4% of the current (fiscal deficit target) is already up. The real question is should you try to counter it now? You can’t. It will be a disaster. That will be like shutting down the government now. I think that is not the right question for this year. The real issue is what is the flexibility in the Fiscal Responsibility and Budget Management Act. The government has to figure out what is it that they can do legitimately in the FRBM.

For the next year there is an issue because that will be a choice. Actually the FRBM target is a debt-to-GDP target, it is not a fiscal deficit target. But connected to the debt is a so called glide path to get that debt-to-GDP. Given that, I think there is enough scope economically. But I would think that it would not be out of line and would probably help that up to 0.5%. But I always start by saying the question is not how much the fiscal deficit should be but why it is higher. My position is very clear that if you do things like direct tax reform, GST reform and reform of the basic subsidy structure, in the long term your fiscal target becomes easier to manage. So if, for example, you do direct tax reform and include some tax reduction which raises the fiscal deficit in one year, I think that is totally acceptable because in the medium-term you are going to get a much higher buoyancy of tax revenues.  

Q. Do you think that the corporate tax reduction will be able to revive animal spirits among investors?

A. One must remember that the finance minister (Arun Jaitley) in his 2015 Budget promised corporate tax rate reduction and that was not achieved in the first term. That was a huge loss of credibility.  I mean you make a commitment and you are unable to achieve it in five years, it is a huge loss of credibility. So it was absolutely essential in my view to restore credibility there was no other way to restore credibility. You cannot say and keep postponing for five years. I think it was a good move.

Now what are the implications, you will see the implications in capital flows. It has already jumped. Foreign direct investment in capital flows in 2019-20 (Apr-Mar) have already jumped, you will see that happening. You say but it is not adding to demand, well we can analyse what is demand and consumption and investment part. It will ease your liquidity problem, it will reduce interest rates, it will reduce the cost of capital, you will see the effects, they are going to happen this year. So I don't agree with those who say it should not have been done.

Q. With inflation again picking up, do you see further scope for the RBI to cut interest rates?

A. I've been saying for a long time that the real repo rate must be brought down to 0%. With this rise in CPI, I really cannot argue for further reduction at this point. But the second thing I've been saying was that you have to look at the monetary base.  

The key will now be, some people call it liquidity but there is big difference between short-term overnight liquidity and medium-long-term. The latest research is showing is that it is also important for transmission. It is the monetary supply what used to be called in the good old days when I was around, now we can focus on the monetary base, the amount of money in the system, it also affects your liquidity, it affects your expectations of liquidity.

So do I expect a further reduction in the repo rate, not right now but I expect it as soon as they can confidently assert that the rates are going to go down four months from now, they may be very cautious. Most forecasts say they will go down but my guess is that they will be conservative when everybody says the food blip, it is a blip in my view by the way, is over then I think they will reduce.

Q. Do you think that the economy is staring at stagflation?

A. There is a blip in food prices, which is temporary driven by vegetables.

Q. Do you see the government's strategy to consolidate public sector banks leading to greater synergies? Do you think this is the right time to privatise some state-owned banks?

A. There is a huge case for privatising banks but the problem is that the political system is not ready. So earlier suggestion for privatisation used to be--instead of giving 15 new licences why don't we sell five of the worst public sector banks to five of these people with licences. But that is out now because the whole strategy is now different so no point in discussing it because it is not happening. So now the only hope can be that once these banks can show that there are actual synergies and get their act together, which is not an easy thing, in my view. So the hope would be that they can start reducing stake, I don't expect now at this point that they will outright sell any bank. Though there are those five banks left which are in pretty bad shape so yes there can be two options one would be to sell one or two or privatise them or second is to start expanding private equity in large banks.

Q. This year the government is likely to miss the divestment target by a huge margin. But the way the government has gone about its disinvestment strategy, is that the right path to follow?

A. What should be done is very clear which is to at least sell the chronically loss-making PSUs because you get a double benefit. You immediately stem the losses which are every day and second you get some asset. The objective is not just fiscal and you get the third benefit the whole point is to increase efficiency of the industry and the economy because these are dragging down the whole industry. So you get a triple benefit actually.

Somebody asked me do you oppose sale of profit making companies? No.

The primary objective from the beginning is to increase efficiency and if you can sell it to a private sector person who will increase the productivity and efficiency that is the primary objective, fiscal objectives are secondary.

Q. Many have claimed that the trade tensions between the US and China presented an opportunity for countries like India to get a larger share in exports. However, that has not happened so far. What should be the focus areas to boost exports?

A. I've said from the beginning, from end of 2018, that this is a once-in-a-generation opportunity for India to attract value chains. India's exports have not done well because we are not part of the supply chains, this has been shown by many studies. So really that opportunity was there, it is still there to be exploited.

In my judgment it is more beneficial for us exactly because of the supply chain issue to do a foreign trade agreement with EU, the UK and the US in that order instead of Regional Comprehensive Economic Partnership. I think the problem with Regional Comprehensive Economic Partnership for India is the China factor. China is a non-market economy it has very obscure non-tariff barriers which no other country has. So given that complication in Regional Comprehensive Economic Partnership we already have free trade agreement with Japan, South Korea and Association of Southeast Asian Nations, the issue really is China. The fastest growing trade now will be replacement of China's exports to EU, UK and US. We have to be in that game.  End

(This story is part of a series of Cogencis special stories in the run-up to the Union Budget 2020-21, to be presented by Finance Minister Nirmala Sitharaman on Feb 1)

Edited by Arshad Hussain