The 6 Economic Sins We Still Have to Pay For

Economic growth is at its lowest in a decade and the new government wont have
too much room to meaneuver, since it still has to grapple with six awful policy
decisions of the last administration.
By Deepak Shenoy | Grist Media 9 hours ago


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We will soon have a new government. And like all new governments, this one will have to live with
the sins of the past meaning the past governments deeds which it might not agree with, but the
consequences of which it will have to live with.
The next government comes in with economic growth at its lowest in the last decade, under 5 percent
a year. Consumer Price Inflation has been consistently above 8 percent. Industrial Production and
Manufacturing have been growing very slowly, at even lower growth percentages than the 5 percent
GDP growth. We have just seen four years of very high fiscal deficits.
The current account deficit has been controlled largely by banning gold imports, which has seen a
sharp rise in the number of people caught trying to smuggle in the yellow metal from abroad.
Organized smuggling has become very lucrative, and in the past it was what built the empire of the
Mumbai mafia dons such as Haji Mastan. Mastan then tutored Dawood Ibrahim, another mafia don
who reportedly funds and organizes terrorist activity in India.
The terrorism of the dons has been a result of bad policies in the past, and partly due to banning
legitimate imports of gold. That policy, which was only dismantled in the 90s, gave us a legacy we
still have to live with 20 years later.
The next government, too, will inherit the impact of poor policy measures taken by the previous
government. Lets call them the Six Sins six things the next government will have to fix as a result.
Their impact can be quantified in some measure by the financial damage they cause, but each one
has a qualitative impact as well ranging from the potential inflation it will create to its impact on
other parts of the economy as collateral damage. Lets take a deeper look.
1. Oil subsidies have been rolled over yet again this year in the interim budget, just as they have in
the previous three years, transferring Rs 35,000 crore to the next financial year. Business
Standardreports that the rollover of oil, fertilizer and fuel subsidies is likely to cross Rs 1 lakh crore
(Rs 1 trillion).
This is just a continuation of the earlier bad policy of rolling over subsidies to subsequent years. In
2013-14, the government inherited Rs 45,000 crore of oil subsidies from the previous year. Food
subsidies are fully provided for only after the Food Corporation of India is audited, which will only
happen in the subsequent financial year. (Before that, only a part of the subsidy is released, so whats
provided for in a subsequent year is effectively a rollover.)
Subsidies will hurt the economy in the long term. The taxpayers pay for the preferential treatment of
a few, and they also have to pay the interest on the money borrowed to pay for that subsidy, or pay
for it with higher taxes. Fuel subsidies, for instance, keep diesel cheaper than it should be and strain
government finances the government could be using that money, for instance, to build better roads
that would effectively make for more fuel efficiency anyhow. Food subsidies end up fattening some
middlemen, but make food more expensive since the government buys so much of the produce and
leaves it to rot, while the rest of us pay more for the limited amount thats left.
Who will bell this cat? The next government will have to choose between taking the hit, or just like
the past governments, kick the can down one more year.
2. The new government will also inherit expenses and collateral damage. Natural gas pricing
agreements with natural gas producers, including Reliance Industries, is supposed to be renewed at
double the price $8.4 per million metric British thermal units (mmBtu) instead of the earlier price
of $4.2 per mmBtu. While the Election Commission has put this price doubling on hold for now, the
Ministry of Petroleum and Natural Gas has ordered that once the period for the model code of
conduct is past, this price hike will be made valid retrospective from April 1, 2014. This has caused
outrage, even though we pay foreign companies prices higher than $8.4 per mmBTU for imported
gas. The new gas pricing agreement should have only been for the interim and should expire when
the new government comes in. Since this is not so, the gas prices will now remain at $8.4, making it
difficult and distasteful for the next Ministry of Petroleum and Gas to renegotiate the terms.
This will impact the large oil companies that have to pay heavily for gas. Companies like GAIL and
Indraprastha Gas are government-owned, and they will lose money when gas costs double. And if
they choose to pass this forward, the gas prices in the economy will go up, leading to higher inflation.
One expects a marginal increase every year, but a 100 percent increase in gas prices is sudden and
disruptive.
The government will also benefit from taxes on a higher price, and from its own companies that
produce gas. However, the impact to the economy is larger, and this decision should really have been
left to the next government.
3. The Food Security Bill, passed last year, will result in a large infrastructure change for the
acquisition, storage and distribution of food. Much of this infrastructure will have to be built and
managed with future money. Estimates of the impact range from Rs 60,000 crore to Rs 300,000
crore, but the real impact will be in the reduced quantity of foodgrains available to the rest of us who
have to buy in the retail markets. As that supply falls, prices will go up. The concept of food security
is, of course, an illusion, because the government has always bought and hoarded grain, leaving it to
rot, while the poor who really need the food have been unable to cross the entry barriers (like identity
proof or address proof) required to access subsidized grains.
However, in this case no new government can shed tears, as most of our politicians across parties
voted for the Bill and made it an Act.
4. The global financial crisis of 2008 caused the financial world to run away from long-term debt. It
was then that India decided to issue relatively shorter term bonds, maturing largely between 2014
and 2019. As that debt matures, the new government will have to issue new debt to repay it, and also
issue new debt to pay for the ongoing fiscal deficit.
In the next five years, over Rs 10 lakh crore (10 trillion) worth of government bonds will mature, and
with the RBIs help, repayment will be Rs 1.4 trillion in the next year and Rs 1.8 trillion in the second
year, while the remaining years will see more than Rs 2 trillion being repaid each year. Thus, the new
government will have to borrow more than Rs 11 trillion over the next 5 years. The banking system
already created Rs 11 trillion last year, of which Rs 5 trillion was eaten up by the government as fresh
net borrowing, or 45 percent of all new money created. As the government repays old debt and
borrows more, the government borrowing will crowd out private credit, since banks are more likely
to give money to the government than they are to you or me.
The new government will inherit the maximum impact of that crowding out because repayments
have not been significant until recently. Its ability to make fiscal adjustments like borrowing to
invest in infrastructure, reducing taxes, providing for a one-time hit by retiring government
employees early will be all the more difficult as it is going to have to borrow even more, in an age of
high interest rates and high maturity repayment of debt.
5. In many infrastructure projects, the government has guaranteed banks much of the money lent to
private infrastructure companies. These loans added up to more than Rs 5 trillion in December
2012,according to former RBI Governor KC Chakrabarty. Many such projects have stalled or failed,
such as the Airport Express Line in Delhi, which was taken over by the Delhi Metro Rail Corporation
after the developer, Reliance Infrastructure, backed out from the project. Such failures could result
in a large bill if these guarantees are invoked or if centrally funded institutions like the India
Infrastructure Finance Company Limited (IIFCL), which funded these projects, have to take the hit.
One way to make projects commercially viable is to change their metrics. A higher toll fee, or more
concessions, or even a longer recovery period (such as extending the period from 20 years to 30)
might help. But attempting to change the metrics of such agreements will involve investigations,
since the public now assumes that the government has been bribed to benefit the developer. And
where there are failures, the government will have to ensure the accounts were clean and that the
money wasnt diverted before paying up.
Inheriting this mess will put the new government in a dilemma. Should it favor existing developers
with even more concessions to allow them to finish, and face allegations of graft? Or should it let
them fail and take the financial hit, thus jeopardizing its own finances and potentially scaring away
other developers in the future?
6. There is also the massive confusion about the implementation of a Common Goods and Services
Tax (GST), which has been pushed by the previous government for the last three years but hasnt
seen universal agreement with all states, which need to agree in order to make it applicable across
India. States ruled by different parties than the Congress have flimsy but deal-breaking arguments
against the GST and its not apparent how they will save face if those same parties were to run the
government.
A GST will simplify procedures substantially for everyone, including the government and make rent-
seeking more difficult for state-level officers who currently have substantial discretionary powers.
Secondly, with known tariff rates its easier to predict how much a business has to pay, compared to
different and constantly changing state level taxes that currently exist (octroi, purchase tax, CST,
VAT and so on).
Income tax reform, too, suffered a lot of dilution in the past few years in the form of the proposed
Direct Tax Code changes created by the last government, many of which will need to be undone
before we can call it a simplified version of what we currently follow. The Direct Tax Code was
supposed to reduce exemptions and tax rates, thus making tax collection effectively easier and
increase compliance.
One of the prime concepts was to widen tax slabs, taxing income between Rs 3-10 lakh at 10 percent,
10-20 lakh at 20 percent and more than 20 lakh at 30 percent. This was rejected because it was felt
the government would lose Rs 60,000 crore in income, compared to the current slabs where income
above Rs 10 lakh is charged at 30 percent. But it is more likely that the loss in tax income will be
made up by greater spending when people have more money in hand through indirect taxes (which
are now higher than direct taxes). And by more people declaring their incomes because the tax
impact is lesser.
This is now going to go through another round of discussions under a new government, and will
probably get delayed by another year.
Luckily, its not all negative. The last government was unable to dislodge the strength of our
institutions, including the Supreme Court and the Reserve Bank of India. Many key infrastructure
decisions were simply not taken, and that might be a boon to the new government to start with a
clean slate. Some of the worst international financial problems may be behind us, with the brunt of
the damage borne between 2009 and 2013.
That the public agrees that the last government was incompetent or myopic gives the next
government a ray of hope. It can borrow even more and increase the fiscal deficit, saying this is a
one-time hit we need to take in order to fix everything the last government bungled up. Given our
penchant for asking, Well, how much worse can that be? it might just get away with it. But no
matter how things turn out, you can bet that a lot of our future problems are going to be blamed on
the last government.
Deepak Shenoy is a founder at Capital Mind, a financial data, commentary and analytics site, and
lives in Bangalore with his family. You can reach him at deepakshenoy@capitalmind.in and follow
him @deepakshenoy.
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