India should desist from cutting personal income tax rates for the middle-class for now and should use its scarce fiscal resources to support the rural poor through schemes such as the MGNREGA, former Reserve Bank of India governor Raghuram Rajan said.
In a detailed commentary on the Indian economy published in the latest issue of India Today, Rajan said there are signs of deep malaise in the Indian economy with significant slowdown in growth and little fiscal space to the government to spend more.
The repeated government allusions to a $5-trillion-economy by 2024, which would necessitate steady real growth of at least 8-9 per cent per year starting now, seem increasingly unrealistic, Rajan added.
“Given the scarce resources, India should not jump immediately to a permanent tax cut for the urban middle-class to boost consumer demand. Instead, while growth-boosting reforms are being put in place, scarce fiscal resources are perhaps best targeted toward supporting the rural poor — for instance, by bolstering the NREGA programme and by funding rural road construction,” he said.
India’s economic growth slowed to a 6-year low of 4.5 per cent in the July-September quarter. With inflation rising, fears of stagflation — a fall in aggregate demand accompanied by rising inflation — have resurfaced.
Rajan said the starting point to address the economic slowdown will be for the Modi government to acknowledge the problem.
“The starting point has to be to recognise the magnitude of the problem, to not brand every internal or external critic as politically-motivated, and to stop believing that the problem is temporary and that suppressing bad news and inconvenient surveys will make it go away,” said Rajan.
“Furthermore, even if some of the problems are legacies, the government, after five-and-a-half years in power, needs to resolve them. A massive new reform thrust is needed, accompanied by a change in how the administration governs.”
Also read: Is RBI right in not cutting interest rate even as it downgrades growth forecast to 5%?
‘Decentralisation must for economic growth’
The former RBI governor pointed out that decentralisation is critical for economic growth. He said that the Modi government should empower its own ministers and regain the trust of states by amending the terms of reference of the 15th finance commission that seems to push for a lower devolution to the states.
Many Indian states have opposed the terms of reference of the commission, pointing out that the central government is looking to bring down the share of state governments in central taxes from the existing 42%.
The Modi government’s decision to expand the commission’s terms of reference to find resources for defence spending has also left the states worried. They feel that this will bring down the total divisible pool of taxes.
Rajan said the Modi government has shown “surprising timidity” when it comes to unfinished reforms on the business environment, land acquisition, labour and the role of the public sector.
“Initially, it appeared to entertain the idea of reforms in these areas. However, these reforms were largely put on the backburner as soon as the Opposition alleged the government was in the pockets of business,” he said.
He termed the NDA government under Prime Minister Atal Behari Vajpayee as the last steady reformer. He pointed out how the first term of the UPA government did not have the internal consensus to pass growth-enhancing reforms and the second term was paralysed by scams and opposition non-cooperation.
What Rajan suggests
The former chief economic adviser in the union finance ministry also favoured a more transparent accounting of the government’s liabilities.
“The government cannot endlessly take on contingent liabilities without recognising they will have to be paid for — recent proposals to boost bank deposit insurance to Rs 5 lakh per individual, while popular, will mean an enormous liability. The costs will be seen when weak cooperative banks, that will gain more deposits as insurance limits are boosted, fail,” he said.
“Instead, deposit insurance should be raised only in parallel with improvements in the governance and regulation of the cooperative sector. The broader point is that India needs a full accounting of its contingent liabilities, including on entitlements like food security and Ayushman Bharat, if it is to give a convincing picture of its fiscal health.”
Rajan stressed the need for cleaning up sectors, including non-banking finance companies and big distressed developers. Reviving stalled infrastructure projects, addressing the power sector woes and preserving the competitiveness of the telecom sector should be the priorities of the government.
He also stressed the need for land, labour and agricultural reforms and a predictable tax and regulatory regime.
“India has a powerful government today, with a charismatic popular prime minister. It can hope that growth will revive in due course and it almost surely will. But it will be far less growth than what India owes its youth. Hopefully, the government will read the writing on the economic wall.”
via Modi govt shouldn’t cut income tax rates for middle class to boost growth: Raghuram Rajan
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