Reorienting India’s Trade Policy

It is vital that India’s trade policy, while taking cognizance of GST’s nitty-gritties, also realigns domestic trade infrastructure with the altering global trade landscape

India’s commerce ministry is conducting a mid-year review of its trade policy to closely align it with the roll-out of the goods and services tax (GST) on 1 July. Truth be told, GST is important but probably too narrow a peg to hang India’s trade policy from; it might make more sense to re-anchor the policy in the shifting framework for global trade and the rapidly evolving nature of globalization.

Deep resentment against globalization’s misaligned distribution effects, a widening wage gap and increasing inequality have given birth to an aggressive brand of nationalism. Strands of these have now found utterance in the economic and political policies of many countries. Brexit in the UK was sold as regaining economic independence from the European Union. US President Donald Trump’s executive decisions on trade (withdrawing from the Trans-Pacific Partnership, restricting H1B visas, threatening the North America Free Trade Agreement) or geopolitical moves (hectoring European leaders or abandoning the Paris climate change agreement) were custom-built to address localized grievances. The sharp pivot by both countries—main actors in constructing the post World War II global trade, financial and security architecture—has made globalization a guessing game, bereft of its earlier certainties and confidence. Both countries are now seen as flag-bearers of a neo-isolationist doctrine.

Australia, New Zealand and Singapore are also following in the US’ footsteps, complicating India’s traditional trade matrix. The picture is further muddied by two momentous shifts occurring in the subcontinent’s neighbourhood. One is the ambitious Belt-Road initiative, a vehicle designed to rejuvenate China’s surplus domestic capacity and to give expression to its expansionist aspirations. The second is the recent schism in the Gulf with Saudi Arabia, Egypt, Bahrain, the United Arab Emirates, Libya, Yemen and the Maldives collectively imposing informal sanctions against Qatar by shutting down transport links and choking essential supplies.

All these developments are bound to reorder the global trade system. Therefore, it is imperative that India’s trade policy, while taking due cognizance of GST’s nitty-gritties, also realigns domestic trade infrastructure with the altering global trade landscape. It is also perhaps the perfect opportunity for the policy to be more of a strategy document rather than a manual. The statement accompanying the 2015 Trade Policy states: “Change has been a constant in the global economy, not least in the international trading landscape.” Never was a truer word spoken, and never has there been a better time to factor this truism into the national trade policy.

Three areas demand trade policy’s attention.

One is to prepare for less reliance on traditional trade partners in the West while increasing India’s trade and investment footprint in alternative markets, such as the African continent. India started looking at Africa seriously after the launch of economic reforms in 1991 and then with renewed vigour after the 2008 crisis. However, promises to increase two-way trade between India and Africa to $90 billion by 2015 have remained largely unfulfilled. India’s trade with Africa touched $56.7 billion during 2015-16, down from $72 billion in 2014-15. The drop is largely due to the fall in oil prices, which contracted India’s import bill with Nigeria. Meanwhile, China-Africa two-way trade touched $215 billion during calendar 2014.

India has intensified its relationship with Africa, which includes initiating several high-level visits since 2015. Prime Minister Narendra Modi, President Pranab Mukherjee and vice-president Hamid Ansari have between them visited 16 countries, with senior cabinet ministers visiting the remaining countries on the continent. During May, the African Development Bank held its 52nd annual meeting in Ahmedabad.

More needs to be done, of course. Trade policy can examine how coordinated action between commerce, finance and external affairs ministries might help in expanding India’s trade efforts; for example, a larger presence of Indian banks outside the conventional East African theatre can help reduce export credit costs. This includes reducing delays in implementing projects under Lines of Credit, India’s flagship instrument for development diplomacy.

Second, there is a need for a clear link between India’s trade policy and Make In India, including strategic linkages through global value chains. Policy clarity will be required whether India desires domestic manufacturing platforms that double as supply hubs for a global market, or assembly units that can be folded up and relocated elsewhere when cost arbitrage dries up (Chinese mobile units are perhaps a good example). Trade policy may be able to play a role here.

Finally, there is trade in services. There seems to be a concerted move within the rich countries—through the Organisation for Economic Cooperation and Development—to open up trade in services, including movement of professionals. This has been India’s longstanding demand because trade in services has been asymmetric so far—high in capital flows, information and communication technology, but low in free movement of professionals. Rising unemployment, particularly in Europe, could be driving Western agencies to prise open employment markets elsewhere. India’s demand (and strategy) for trade facilitation in services should find some articulation in the revised trade policy.

The above article was originally published in Mint newspaper and can be read here as well

Optics All The Way: Budget 2017 has brought to fore the astute lawyer-politician in Arun Jaitley

India’s finance minister Arun Jaitley has lived up to his credentials as a lawyer-politician adroitly: he has presented a budget for 2017-18 that pleases everybody but satisfies very few.

The capital markets investor class, including the foreign portfolio investor (FPI), is certainly happy. The movement of the stock market index reflected joy at being left alone: at closing time, the 30-share benchmark sensitive index was up 485 points in a relief rally. Investors were pleased that a rumoured restructuring of long-term capital gains tax was avoided. FPIs, who bring liquidity to India’s shallow markets, were spared additional tax blushes under something called the “indirect transfer provision,” which required tax to be paid on transfer of shares overseas if the underlying assets are located in India.

In the end, budget 2017 seems to be more about being seen to be doing the right thing rather than doing it. Jaitley’s thrust can be summed up in his own words: “My overall approach…has been to spend more in rural areas, infrastructure and poverty alleviation and yet maintain the best standards of fiscal prudence. I have also kept in mind the need to continue with economic reforms, promote higher investments and accelerate growth.”

This requires walking a fine line and Jaitley has husbanded all the political smarts he could muster.

Delicately balanced

On one side, the impending state assembly elections (in Uttar Pradesh, Punjab, Goa, Manipur and Uttarakhand) which begin on Saturday (Feb. 04) was bound to cast a long shadow on his plans. On the other side, Jaitley had to present a political budget without breaching the election commission’s restrictions.

Jaitley also needed lots of political nous since the budget had to be drafted in the backdrop of some momentous changes: demonetisation (which has dealt a severe demand and supply shock to the economy), the planned move to goods and services tax (GST), political developments in leading developed countries which could lead to severe economic consequences for India and other emerging economies. In addition, the fiscal responsibility and budget management committee’s report tied his hands by advocating fiscal prudence, barring exceptional situations.

On sum, though, there are a lot of announcements and political grand-standing but little by way of on-the-ground impact. For example, total expenditure planned for 2017-18 is up only 6.57% over the Rs 20,14,407 crore actually spent during 2016-17. That barely covers the rate of inflation. What’s even more disappointing, capital expenditure is budgeted to go up by only 10.7%. The country needs public expenditure to kickstart economic growth, especially in the absence of any private sector investment. Strangely, even though Jaitley has acknowledged this in his budget speech, he has failed to walk the talk.

Revenue could be a legitimate constraint. Tax revenues are expected to grow by only 12.7%, while non-tax revenues are actually budgeted to drop. Total revenue, including capital receipts, is expected to rise only 9.7%. One reason for the conservative estimates could be the expected shift to GST from July. The demand compression arising out of demonetisation could be another reason.

Political imperatives

Despite these limitations, the electoral imperative seems to have forced Jaitley to make numerous announcements for farmers, rural areas and allied sectors. In this, Jaitley has chosen to follow the footsteps of his predecessors by announcing grand schemes and allocating large sums. For example, he announced a Rs10 lakh crore agricultural credit target, against Rs9 lakh crore in 2016-17.

It’s curious that successive finance ministers chose to make this proud proclamation in the budget document when the money will actually be lent by various agri-lending agencies, such as the National Bank for Agriculture and Rural Development. There’s another strange twist: while the government promises to bear the interest subsidy on these concessional loans, the money kept aside for meeting the interest subsidy bill remains unchanged from last year. If the loan volume is likely to go up by Rs1 lakh crore, surely the subsidy element should also rise correspondingly?

Jaitley’s made another strange claim: he maintained that the pace of construction of rural roads under the Pradhan Mantri Gram Sadak Yojana had reached 133 km per day during 2016-17. This fact sits uneasily with roads minister Nitin Gadkari’s admission a couple of months ago that his ministry was unable to meet the highway construction target of 40km every day.

The political framework also probably stayed the finance minister’s hand from slashing corporate tax rates further, as had been promised in last year’s budget. In a year when demonetisation has affected millions of livelihoods and the ruling Bharatiya Janata Party wants to win Uttar Pradesh elections, the optics of helping large corporates could be a recipe for electoral hara-kiri.

He has instead cut tax rates for micro, small, and medium-scale enterprises with annual turnover up to Rs50 crore. His contention: their effective tax rate is higher than large companies and it is these units which actually create employment at the grass-roots level.

Arun Jaitley’s budget for 2017-18 pushes the political messaging of demonetisation further. He has painted a multi-hued picture that appeals to the stock market investor, because a rising stock index is often mistaken for economic health. His brushstrokes also strive to attract voters in various states by not only promising employment and income opportunities but also by painting the government as pro-disenfranchised and anti-privileged.

The above article was published in www.qz.com on February 2, 2017, and can also be read here

Poll Bound: Narendra Modi’s Currency Play Has More Political Value Than Economic Benefit

The Narendra Modi government’s decision to demonetise the Rs 500 and Rs 1,000 notes in circulation will have three distinct political outcomes, two of which will be advantageous for the ruling Bharatiya Janata Party (BJP).

The first, and instantly visible, impact of the late evening announcement on Nov. 08 by prime minister Modi himself is a reversal of the news cycle. Dire discussions on the polluted Delhi air and its impact on foreign investment? Gone. The unfortunate ripple effects from the army veteran’s suicide? Buried. Doubts over the BJP’s chances in the forthcoming state elections? Dismissed.

Elections to state assemblies in the first half of 2017 are crucial for the ruling party, especially since they have been smarting from the defeats in Delhi and Bihar in 2015 and West Bengal this year. The battleground states this time include Uttar Pradesh (UP) and Punjab. UP, as things stand, will see a four-cornered battle.

Demonetisation immediately changes the narrative. The BJP has been trying to stitch together a patchwork support base among the Dalits, Muslims and other disenfranchised segments of UP; their votes are crucial to winning the state. Demonetisation will, in some limited fashion, help in providing a new talking point, one that takes potshots at the privileged and mendacious classes.

Given the fact that the government and the Reserve Bank of India now plan to re-introduce the Rs 500 and Rs 1,000 notes, albeit with a new design and enhanced security features, along with the creation of a new Rs 2,000 note, the entire objective of the exercise seems to be targeted at blindsiding counterfeiters, not so much hoarders of cash. Whichever way you look at it—“surgical strikes” on either counterfeiters who aid terrorism or black-money merchants—it is a narrative ripe with opportunity for rhetoric and election sloganeering.

State elections also point to advantage no. 2. The element of surprise will probably inconvenience the other three parties. The use of cash in Indian elections is an accepted fact and some of the parties are rumoured to be large users of cash. This surprise element would have surely nixed their ground-level strategies. In short, it will be back to the drawing board for most of these parties.

It can be argued that this is a problem for even the BJP. Modi emphasised in his speech: “Secrecy was essential for this action. It is only now, as I speak to you, that various agencies like banks, our offices, railways, hospitals, and others are being informed.” But, the question remains: would he have taken such a momentous decision without consulting the BJP’s command-and-control centre, the Rashtriya Swayamsevak Sangh (RSS)? In many ways, strands of such a policy action have been appearing in the media for a while, as editorial advice or even harking back to the example of the USA which discontinued high-denomination currency notes in 1945.

The question over the consultative process gains further momentum when viewed from a political survival standpoint. The demonetisation exercise will adversely affect small traders and shopkeepers, a segment of society which has traditionally remained a strong BJP vote bank. Most businessmen in this segment depend on cash transactions and PM Modi’s move is bound to discomfit their operations. Given this bloc’s importance, there must have been some serious back-room calculations about going ahead with such a measure.

And a calculated move it is. One probable clue lies in the fresh issuance of Rs 500, 1,000 and 2,000 denominations after a brief hiatus. So, if you ignore the short term spike in chaos, inconvenience and rhetoric, the cash economy is bound to make a comeback in a couple of months, albeit in the form of newly-designed currency. That should give the traders and small shopkeepers some succour.

But, it will require the party apparatus to reach out to various trade associations and federations to communicate with them, assuage them, and address their concerns in the short term.

This will be doubly necessary given the other three-alphabet headache that’s hurtling towards small businesses at breakneck speed: GST. The new tax system envisages a complete overhaul of tax assessment, calculation and reporting. That chaos is in the not-too-distant future, it will create huge turmoil with the trading class having to register with the tax authorities, re-skilling themselves in figuring out the new tax structure, as well as chasing tax credits from authorities. As an example, shopkeepers and small businesses in Malaysia took to the streets early this year, frustrated at the complexity involved in complying with GST.

This is political issue No. 3 for the BJP and its spiritual bosses at RSS.

In the final analysis, the whole exercise seems designed to replace, rather than demonetise (which is to suck out completely and abolish), high-value notes. Counterfeiters will be hurt, middle-class families will be discommoded, and some currency hoarders will be disrupted, but the cash economy will return to a new normal in a few months. But, only after the UP elections.

This article originally appeared in Quartz on November 10, 2016, and can also be read here

The Politics of GST

While GST implementation will revolutionize taxation in India, it will also upend power hierachy in the tax bureaucracy, fiscal federalism and corruption template

The goods and services tax (GST) juggernaut has now begun its journey and there is no looking back. The new tax system promises to revolutionize life for the entire value chain starting from goods and services producers all the way to consumers. But the GST also promises to upend many other established systems—such as the power hierarchy in the tax bureaucracy, the known fiscal federalism model and the prevalent corruption template. These changes, in turn, will dictate the final shape of the new tax regime.

The first signs of impending trouble can be found in the notification regarding the GST council. The press release announcing the creation of a GST council, under the provisions of the Constitution (101st Amendment) Act, 2016, states the council will be chaired by the Union finance minister, with his junior minister and finance ministers from states as members.

The fun and games begin thereafter. The secretary (revenue) in the finance ministry is the council’s ex-officio secretary, and he will be assisted by one additional secretary and four joint secretary level officers. The chairman of the Central Board of Excise and Customs (CBEC)—a body created under Central Boards of Revenue Act, 1963—has been reduced to a permanent invitee.

This has set in motion a power struggle between officers from the Indian Revenue Service (IRS) and the Indian Administrative Service (IAS) for control over the council. This is manifestly a fight to gain oversight over what will inarguably become the country’s richest financial pipeline. Although finance minister Arun Jaitley has assured IRS officers that their grievances will be heard the first round seems to have gone to IAS officers.

Similar signs of the IAS cadre inserting itself into the fiscal framework can be found in the GST Network (GSTN), an information backbone for the new tax system. The network has been set up as a not-for-profit company with shareholding from the Centre, states and financial institutions. The company’s website calls it a “non-Government, private limited company”. Both the chairman and chief executive officer’s posts are occupied by former IAS officers, as are many other board seats. Of the total 13 board members, there is only one CBEC representative.

Smooth GSTN operations will be critical to the GST’s success. A lot will hinge on registering all buyers and suppliers, calculating and crediting input tax to intermediary stage producers on time to induce more producers to register with GSTN.

Excise and customs officers have planned a series of agitations, which stretch all the way to budget day in February 2017. Interestingly, the power struggle spilled overinto the direct taxes domain in July when income-tax officers rebelled against the secretary (revenue)—this required the finance minister’s intervention.

With the oversight of the financial pipeline changing, there are no guarantees that corruption will be completely eliminated. There has been a lot of discussion on the likely corruption model that will replace the legacy structure. The earlier indirect-tax regime had many loopholes, inserted by the industrialist-politician-bureaucrat nexus. Tax experts have pointed to some gaps created at the GST’s birth. One springs from the threshold fixed for exempting goods and services from GST, Rs20 lakh, which could motivate many assessees to break up operations into an informally connected web of small units. Second, allowing states to exercise oversight over units below Rs1.5 crore annual turnover might open up another escape hatch. This is an evolving space; tax officers have already put the new code through the wringer and alerted seniors about possible loopholes.

Finally, GST has altered the fine balance of India’s federal structure by reshuffling taxation powers divided between the Centre and states in the Constitution. It is quite likely that states will attempt to regain some of this equilibrium through the GST council. The amended Act gives the council members enough powers to decide on which goods and services will be subjected to or exempted from GST, to decide the differential GST rates, and much more.

The catch is in the decision-making process. All proposals will be decided through a voting system, with the principle of one-state-one-vote. Under the voting formula, the Centre has one-third weightage of total votes cast, with the states apportioned two-thirds weightage. Any proposal needs a majority of at least three-fourths of the weighted votes cast. Assuming a full house present (quorum requirements are 50%), a Centre-sponsored proposal can succeed with 18-19 state votes.

The current National Democratic Alliance (NDA) combination rules over more than 10 states (either singly or in coalition) and has the support of three regional state governments. The fate of Arunachal Pradesh hangs in the balance. Five states—Goa, Uttarakhand, Uttar Pradesh, Manipur and Punjab—go to the polls in 2017. Another seven states will battle it out in 2018. Of the 12, if NDA manages to win six-seven, they will have enough firepower to push through proposals in the council. This gives a completely new meaning to the concept of fiscal federalism.

Intense politics preceded the birth of GST. But it would be a mistake to think that only good economics will henceforth guide the remaining workload to get GST off the ground. The real politics starts only now.

This article originally appeared as part of my column, General Disequilibrium, in Mint on October 19, 2016. It can also be read here.

Key GST Lessons From The World

The long march to implement the long-awaited Good and Services Tax in India has just begun. It is instructive to understand how other countries introduced this tax and cherry-pick lessons from their experiences

As India gets ready to celebrate the 70th anniversary of its independence, it is also preparing for another important milestone. Great hopes have been pinned on the Goods and Services Tax (GST), which will liberate Indian citizens from the tyranny of multiple levies and tax rates. This tax will unite almost all state and central indirect taxes into one single category, thereby creating a true single market in the country.

The passage of the Constitution (122nd amendment) Bill on 3rd August in the Rajya Sabha marks the crossing of the first hurdle in implementing the transformational GST regime. However, there is still substantial legislative work to be done – apart from the amendment (which will now travel to the Lok Sabha, the President’s office and state assemblies for ratification), Parliament will have to vote in two further bills to make GST a reality.

Beyond the legislative workload, Indian administrators and businesses will need to do their homework before this reality sets in. There are approximately 140 countries in the world that have introduced GST (also called VAT, or Value Added Tax), and there are manifold lessons to be drawn from their respective implementations.

Malaysia was the most recent country to implement GST in 2015, having announced its intention to do so in 2009. Malaysia’s experience highlights how inadequate preparation can hamstring the tax’s speedy implementation from the outset.[i]Malaysian businesses and tax authorities had a harrowing time adjusting to the new system, which was riddled with uncertainties and teething problems. The Malaysian government had to contend with street protests by small businesses and traders who were confused by the new system—whether in calculating the correct value-added rates, or in seeking tax credit refunds. Unsurprisingly, opposition political parties found it opportune to fish in these troubled waters, adding to the government’s mounting operational woes.[ii]

There was another layer of complexity. Malaysia had a multiple GST rate structure, much like the one proposed in India. A 6% GST (among the lowest in the world) was introduced, with some essential goods exempted and some goods attracting a zero rate i.e they were not exempt and could be taxed later. India too has proposed a multi-tiered structure, which will be finalised by the GST Council whenever it is set up.

Two clear lessons emerge from the Malaysian experience. Under pressure to launch GST as soon as possible, the Indian government must resist temptations to truncate the implementation process, which will include the training of tax officers and business executives. A presentation by revenue secretary Hasmukh Adhia estimates that 60,000 tax officials in both central and state governments will need to be trained.[iii] GST is a tectonic shift in the indirect tax architecture: the point of taxation shifts from producers to consumers, requiring a significant reorientation in philosophy and perspective. This overhaul cannot be completed unless the technology backbone is in place and all the relevant economic agents are registered. That alone is a mammoth task. There should, therefore, be no compulsion to implement GST by April 2017 if either the system is not fully tested or all the pieces are not firmly in place.

A related issue almost tripped up Malaysia’s GST experiment: the timely payment of input tax credit refunds.[iv] Unless the necessary technology infrastructure is installed, it can take months to refund tax credits, thereby creating cash flow problems for all links in a supply chain. This can easily convert GST supporters into detractors. Delaying tax credit refunds leads to protracted litigation and provides perverse incentives for the supply chain to stay outside of the organised system.

A second set of lessons can be drawn from Singapore. The city-state introduced GST in 1994 but witnessed a sharp rise in inflation soon after its introduction, mirroring the experience of many other countries.[v] Although inflation rates tend to moderate after a couple of years, the Indian government must be prepared for an initial surge because of India’s unique supply-side pressures, which tend to firmly embed inflationary expectations in households and businesses. India can consider what many countries did: initiate anti-profiteering measures at the retail level to protect consumers from price gouging.

Subsequently, the Singapore government faced other predicaments, like t the need to increase GST rates without stoking inflationary pressures. Eventually Singapore did increase GST rates (from 3% in 1994 to 7% currently), but simultaneously cut income tax rates (both at the individual and corporate levels) and accelerated the delivery of welfare benefits to lower income sections.[vi] While GST is efficient, it can also be regressive, especially for low income workers or pensioners. The Indian government therefore needs to be cognisant of this, and act cautiously.

The final set of lessons come from Canada, which introduced GST in 1991 amidst great internal conflict and disagreement. In fact, at the tax’s introduction, three provinces–Alberta, Ontario and British Columbia–even sued the federal government for violating constitutional agreements and limits. But over the years, Canada has pioneered a unique system that allows for three different models to co-exist.[vii] [viii]For example, Quebec is permitted to administer its own value-added tax alongside a federal GST. Quebec is responsible for all tax administration in the state, independently determining its tax base, independently fixing the state VAT rate, and even remitting federal GST collected in the state to the central government for a fee.

Compared to Canada, India has been able to forge a broad consensus among most states through a process of negotiation and compromises. The only point of disagreement remains the GST rate, which has been entrusted to the GST Council. This may lead to intense political manoeuvring with demands for special status or special rates. Tamil Nadu has already expressed its dissatisfaction with GST.

These examples clearly illustrate that the GST battle has barely begun: there are many mountains to climb, and multiple fires to extinguish along the way. The process of bipartisan consultation and consensus-building with states and various stakeholders must continue to make GST a cornerstone of successful and sustainable fiscal federalism.

This feature was exclusively written for Gateway House: Indian Council on Global Relations. You can also read it here.

References

[i] Pachisia, Vivek; Lessons from countries that have implemented goods and services tax; Financial Express; July 28, 2016;http://www.financialexpress.com/economy/gst-lessons-from-countries-that-have-implemented-the-goods-and-services-tax/331289/

[ii] Dey, Sudipto; Some Lessons From Malaysia That India Can Use; Business Standard; New Delhi; June 13, 2015; http://www.business-standard.com/article/economy-policy/gst-some-lessons-from-malaysia-that-india-can-use-115061300748_1.html

[iii] Adhia, Hasmukh; Goods and Services Tax: Next Steps; Department of Revenue, Ministry of Finance, Government of India; New Delhi; August 4, 2016;http://finmin.nic.in/press_room/2016/GST_nextstep_04082016.pdf

[iv] Beh, Yvonne & Tan Yi Lin; GST In Malaysia: One Year On; Wong and Partners; April 2016;http://www.wongpartners.com/files/Uploads/Documents/Type%202/WP/al_kulalumpur_gstmalaysia_apr16.pdf

[v] Ilias, Suhaimi with Zamros Dzulkafli, Ramesh Lankanathan and William Poh; Malaysia: GST- Early Impact Assessment; Maybank KimEng; April 2015;http://info.maybank2u.com.sg/pdf/investment-insurance/misc/misc-15-04-15-3.pdf

[vi] Singapore Government; How Is the Government Helping to Mitigate Inflation in Singapore; December 14, 2012; https://www.gov.sg/factually/content/how-is-the-government-helping-to-mitigate-inflation-in-singapore

[vii] Kumar, Sanjay with ML Sukhpal, Sandeep Rawal, Ashok Kr Pandey, Samar Nanda; Policy Paper on Role of Central Board of Excise and Customs in GST; National Academy of Customs, Excise and Narcotics;http://nacen.gov.in/inspire/uploads/downloads/569887ea212d1.pdf

[viii] Sharma, Radheshyam with JK Simte, MK Sarangi, KGVN Surya Teja, Sydney D’Silva and Manish Thapliyal; How to achieve administrative harmony between centre and states in the GST regime; National Academy of Customs, Excise and Narcotics; January 6, 2016;http://nacen.gov.in/inspire/uploads/downloads/56989a961d524.pdf

GST: Adding Edge to Exports

The GST will not only advance domestic market efficiencies but also add teeth to India’s economic diplomacy by improving the ease of doing business and enhancing competitiveness for exports.

The passage of the Constitution (122nd amendment) Bill, 2014, on Wednesday allows for the launch of the Goods and Services Tax (GST), a unified and pan-national tax structure. GST will create a common domestic market, remove distortions arising out of a multiplicity of levies and rates, and foster efficiency by minimizing the cascading effect of taxes in the manufacturing chain. GST will also have a beneficial impact on India’s economic diplomacy, including foreign trade.

The GST fits nicely into the Modi government’s drive to improve ease-of-doing business in the ‘Make In India’ campaign. Manifold taxes, with differential rates in different states, created hurdles for the smooth conduct of business and added costs at every stage, frustrating foreign investors. Foreign Investment decisions and the expected rate of return from projects often suffered due to these distortions, occasionally even deterring fresh investment plans. Most global value chains, with the exception of Foxconn, have avoided investing in India because of regulatory and bureaucratic tangles, especially those related to the multi-layered tax regime.

The successful implementation of GST will reverse this, helping to attract new investments especially from global value chains which often aggregate inputs from different constituencies.

The other immediate beneficiary will be Indian exports which have long suffered from lack of international competitiveness due to differential taxes and the energies expended on complying with the complex tax labyrinth. A 2010 report from National Council of Applied Economic Research had found that eliminating cascading taxes on exports could increase GDP growth by 0.9-1.7 per cent.[1]

For instance, a garments manufacturer and exporter has to depend on multiple suppliers of inputs – finished cloth (processed and dyed), threads, buttons, zips, sewing machines, ironing products, packaging, labels – for producing his finished good. These suppliers in turn, source raw materials from multiple sources, located in multiple locations, each party paying multiple taxes in different tax jurisdictions. At each stage, goods get delayed in transit for assessment and payment of varied levies – sales tax, octroi, excise, service tax. This fosters inefficiency and adds costs to each additional layer for the exporter. In addition, with each state legislating separate laws, meant that exporters couldn’t claim full set-off on the free-on-board price, rendering exports uncompetitive.

GST will alleviate this. The Foreign Trade Policy (FTP) for 2015-20 says: “The simplification and harmonization of the indirect tax regime of the country will reduce the cost of production and lead to a seamless, integrated Indian market, thereby making Indian trade and industry more competitive.”[2]

The benefit to services exports will become clearer in the next few weeks, but right away, the travel, tourism and hospitality sector is a clear winner because of its dependence on a wide spectrum of vendors and suppliers.

As the implications and impact of this simplifiying legislation starts to make itself apparent and the GST’s advantages for incoming foreign investment and out-going exports gain momentum, it will add veracity to Prime Minister Modi’s on-going economic diplomacy efforts.

This feature was exclusively written for Gateway House: Indian Council on Global Relations. It can also be read here.

References
[1] National Council for Applied Economic Research, Moving to Goods and services Tax in India: Impact on India’s Growth and International Trade, December 2009,<http://fincomindia.nic.in/writereaddata/html_en_files/oldcommission_html/fincom13/discussion/report28.pdf>

[2] Department of Commerce, Ministry of Commerce & Industry, Government of India, Foreign Trade Policy Statement, <http://dgft.gov.in/exim/2000/FTPstatement2015.pdf>

Public Procurement: Policy Must Precede Law

Pressure for a unified public procurement framework is mounting on India from both within the country and internationally. While an integrated procurement structure is necessary, a broad policy architecture must precede the framing of any legislation

As India prepares to convert some of its free trade agreements into larger comprehensive agreements, it will have to re-examine some existing domestic rules and convert other rules into legislations. And in some cases, such as procurement by the government, it will have to first frame guiding principles that are aligned with global norms.

Comprehensive agreements usually include, apart from export and import rules, treaties on investment, intellectual property rights, and public procurement. All comprehensive agreements, and some bilateral investment treaties, demand that public procurement treat all vendors—foreign or domestic—equally. In keeping with these norms, India too will have to design a globally-aligned public procurement framework that is fair and equitable.

The Indian government’s annual procurement bill is enormous. If purchases by the Centre, states, local bodies, public sector organisations, and the armed forces are consolidated, various estimates put the total bill anywhere between 25% and 30% of the country’s GDP, amounting to over $600 billion. [1]

Despite this colossal bill, India does not have an over-arching policy to guide public procurement.

In theory, all public procurement is guided by General Financial Rules (1963) and Delegation of Financial Powers Rules of 1978, both framed (and occasionally updated) by the Ministry of Finance. [2, 3] The ministry has also published a manual called “Policies and Procedures for Purchase of Goods”. [4] On top of that, the centralised purchase department of the central government—the Directorate General of Supplies and Disposals—issues its own guidelines. Many ministries often tweak these rules, with government agencies developing their own rules, and framing model tender documents.

Defence procurement, on the other hand, is covered by a unique set of policies and procedures formulated by the National Security System, and the decisions are made by the Defence Acquisition Council. In addition, many states have legislated their own procurement Bills—for example, the Tamil Nadu Public Procurement Act, the Karnataka Public Procurement Act, and the Rajasthan Transparency in Public Procurement Act.

Given this wide variation in procurement rules within the government, regulation and supervision are casualties. While the Central Vigilance Commission provides supplementary regulations and oversight, with additional supervision by the Comptroller and Auditor General, there is no central authority that monitors public procurement to ensure compliance with existing rules.

A series of scandals—coupled with mounting pressure from international allies, trade partners, and multilateral organisations—forced the UPA-II government to draft a Public Procurement Bill in 2012. But that didn’t go anywhere, and the new government is now trying to resuscitate the Bill. The finance ministry has invited comments on the draft of the existing Bill. [5]

However, there is a problem with drafting legislation before articulating guiding principles, or a strategy architecture, or even a white paper. Such a model document can provide directional guidance to the Bill, and not vice-versa. Also, guiding principles enjoy greater longevity, which when incorporated into legislation, saves it from frequent, time-consuming amendments.

Tactically, such a document will help resolve numerous pending or unresolved policy-related issues in public procurement that a Bill cannot incorporate.

For starters, the proposed Bill applies to only procurement by the central government and its various organisations. Given the growing procurement costs of states and local bodies (such as municipal corporations or panchayats), this Bill then serves only a limited purpose. Any regulatory oversight over purchases by states and local bodies would need to be balanced with the tenets of federalism.

This can be debated in the guiding principles and an alternative solutions framework can be constructed. For instance, it might be instructive to integrate all public procurement—at whatever level—with the proposed technology backbone for the Goods and Services Tax (GST) regime. Aligning procurements with the GST backbone will also allow for fair comparisons between the pricing of similar goods and services procured elsewhere by private or public entities, thereby imparting transparency and accountability. This will then reduce divergence without the need to legislate a central bill.

Second, governments worldwide use public procurement strategically to drive their socio-economic agendas. In India, there is a 20% mandatory carve-out for the micro, small medium enterprises (MSME) segment. [6] This will raise questions about other exemptions, such as a legitimate gender-based quota—should it be part of the 20% or does it deserves separate reservation? With gender budgeting now well established, gender-based public procurement has the opportunity to improve female entrepreneurship, employment, and incomes. [7]

A reservation—known as offsets—has also been included in defence FDI to supplement the ‘Make in India’ programme, under which foreign companies manufacturing in India must source 30% of goods and services from local companies. Even the FDI policy on single brand retail mandates such a requirement. These exceptions might face opposition in comprehensive agreement negotiations. This reinforces the need for a national policy debate, and a broad strategy, which re-examines the extent of exemptions that can be allowed.

Any strategy’s most significant thrust will be in the geoeconomic sphere. For instance, India will probably want to exempt government’s procurement of foodgrains from Indian farmers from any comprehensive negotiations, at least till the Doha Round of discussions under the World Trade Organisation are concluded, or till the outdated WTO formula on agriculture support is overhauled.

Importantly, India also needs a strategy to gain greater market access for services in overseas markets, in exchange for a liberal, domestic public procurement policy in manufactured goods. Public procurement of services in most countries is restricted to citizens of a country, or a particular bloc (like Europe). India should leverage the growing clamour for access to its procurement market by seeking reciprocal access for its services.

This is a plan of action that cannot be included in a Bill, but needs to be outlined in a strategy document.

References

[1] United Nations Office on Drugs and Crime, India: Probity in Public Procurement,

<http://www.unodc.org/documents/southasia/publications/research-studies/India-PPPs.pdf>

[2] Ministry of Finance, Government of India, General Financial Rules, <http://finmin.nic.in/the_ministry/dept_expenditure/GFRS/index.asp>

[3] Ministry of Finance, Government of India, Delegation of Financial Power Rules, <http://finmin.nic.in/the_ministry/dept_expenditure/notification/dfpower/Purchase%20I.pdf>

[4] Department of Expenditure, Ministry of Finance, Government of India, Policies and Procedures for Purchase of Goods, <http://finmin.nic.in/the_ministry/dept_expenditure/acts_codes/MPProc4ProGod.pdf>

[5] Department of Expenditure, Ministry of Finance, Government of India, Notice: Public Procurement Bill, 6 April 2015, <http://finmin.nic.in/the_ministry/dept_expenditure/ppcell/PPDNotice180315.pdf>

[6] Ministry of Micro, Small and Medium Enterprises, Government of India, Public Procurement Policy Notification, <http://dcmsme.gov.in/notification.pdf>

[7] Kirton, Raymond Mark, Gender, Trade and Public Procurement Policy: Kenya, India, Australia, Jamaica. The Commonwealth, 2012, <http://assets.thecommonwealth.org/assetbank-commonwealth/action/viewAsset?id=22979&index=0&total=36&view=viewSearchItem#imageModal>