Several decades ago, when this columnist still had a hazy recollection of university-level economics, and finance minister Manmohan Singh devalued the rupee sharply, he was sent to interview him. You do realise, a prissy question was put to the FM, you've worsened the current account since imports-of mostly essentials like oil-will rise immediately while exports will take 2-3 years to respond. Given his background-chief economic advisor, economic affairs secretary, RBI Governor, Deputy Chairman Planning Commission-Singh could have dismissed this by saying he'd forgotten more economics than this columnist had learned; instead he said, you're right, and we've taken an IMF loan to bridge this gap, but in the long run, we felt it is more important that the rupee is priced correctly.
Much the same can be said about finance minister Nirmala Sitharaman's mini-budget on Friday; after dismantling part of the budget's proposals like the FPI tax some weeks ago, she has now slashed corporate taxes by around 10ppt, making them on a par with, or even lower than, those in competing nations in south-east Asia. The plan is to stimulate investment, especially that from overseas in the context of firms wanting to quit China, following its trade war with the US.
Whether this will happen, like Singh's exports, remains to be seen since several things can go wrong. For one, if deficits rise too much-the tax targets were always aggressive, and Friday's giveaways add up to 0.7% of GDP-interest rates can start trending up again; certainly, the hope of a continued fall in rates looks iffy now. And, in an environment where growth is slowing, especially in consumer demand, not many will rush to invest; in any case, most promoters are financially stretched. And, with nice discounted deals available in the insolvency courts (IBC), several buyers will prefer to channelise investments there; in the initial period, investments in IBC firms will be relatively lower than in setting up greenfield projects. But, as Singh said in 1991, it was important to get the rates right, and that is what the FM has done for corporate taxes.
When India's tax rates were 50-100% higher than those in competing nations, any investment in India meant the project had to clear a higher hurdle rate; this was all the more true for production meant for the exports market. Firms, such as Apple or Samsung, that are looking at de-risking their China operations could now find India more attractive, at least from the tax point of view. Indeed, lowering tax rates to 25% was something the late Arun Jaitley had also promised several years ago, but wasn't able to deliver on in its entirety.
It was always odd that Sitharaman didn't lower tax rates since, the day before her maiden budget, the Economic Survey was at pains to explain how India's tax and other policies were creating 'dwarves', or firms that never grew since labour laws, government purchase-preferences, reserving a certain share of bank credit, and even tax rates were all biased towards smaller firms. So, while not cutting rates for larger firms, the FM said the 25% tax rate was applicable to "99.3% of the companies"; clearly, she didn't care as much for the 0.7% that were investing a lot more than their share, creating more jobs, generating more exports, etc. Today, with the top rate coming down to 22%, the FM has clearly changed her mind completely.
Why a 15% rate has been fixed for new firms is unclear. While the plan is to attract global biggies, it creates an odd situation, where older firms pay one rate and new ones another; apart from lowering rates, the idea has to be to reduce arbitrage, not raise it. The fear of existing players trying to avoid taxes by shifting businesses to 'new units' is a real one; even though this will attract anti-avoidance rules, why have a tax system that necessitates such policing?
While an increase in investment levels-they have been plummeting for years (see graphic)-will require a few years at least, prime minister Modi needs to take a few other steps as well if investment levels are to grow. Top on the list, is resolving the deep problems in major investment sectors (bit.ly/2mni9g0) like telecom, oil and gas, mining, real estate, etc. In both oil and other mining, as this newspaper has pointed out before, India's non-tax levies are much higher than global ones, and the overall policy environment is also quite unfriendly. Both offer large investment and employment potential, so the PM just has to fix this. Telecom is another key investment area that was killed by rapacious policy; it didn't help that the policy also favoured RJio, but if the government was to fix even just the problem of high levies, this will go a long way in promoting investments, especially now that the tax piece has been fixed. Too many policy U-turns, like the one on e-commerce, or the hounding of Monsanto or price caps on pharma-including medical devices-have hit investor-faith. And it is difficult to woo either an Apple or a Samsung till the current policy of high import duties on mobile-phone manufacturing is junked; Niti Aayog is working on an alternative plan, and the sooner that is accepted, the better.
That the move isn't a sure-shot fix is, of course, best illustrated by the fact that global rating agencies Moody's and S&P have diametrically opposite views on whether the move is credit-positive (Moody's) or negative (S&P). The good news, on which there is unlikely to be two views, though, is that after seeming to ignore India's economic challenges, the government is now trying to address the major ones. The budget tried to address the NBFC solvency/liquidity issue, and after that, there were moves on real estate and bank recapitalisation. Some, like the real estate package, were not ambitious enough, and the main issue of bank competitiveness is far from being addressed. But, it does appear that, as in 1991, the economic crunch has focused the government's mind.