What the next four years hold for Modi
By now everyone has read how good, bad or indifferent a Prime Minister Narendra Modi has been in his first 365 days on the job. So, as year two of his prime ministership begins on Wednesday, May 27, it’s time to look ahead.
At an event at the Mumbai Press Club last Friday, I was debating Modi’s first year with Rajdeep Sardesai. We were asked by a member of the audience: “After a year of Modi’s prime ministership, is the glass half empty or half full?”
I replied that it was neither. The United Progressive Alliance (UPA) government had left behind a broken glass and all the water had spilled out. PM Modi had to first fix the glass before filling it up.
It’s easy to miss the fact that when a government inherits an economy in reverse gear, turning it around takes time. Once that’s done, though, progress is rapid – geometric, not linear. In other words, like a rolling stone that gathers speed down a hill, new governments pick up speed geometrically (1,2,4,8,16…) rather than linearly (1,2,3,4,5…)
That doesn’t mean the Modi government has done very well in its first year in office. It hasn’t. As I wrote in my article in Business World’s special issue (May 18-June 1, 2015) marking Modi’s first anniversary as prime minister: “Narendra Modi took office on May 26, 2014. Hope soared. The euphoria cut across demographies: The poor, middle class professionals, young entrepreneurs, business leaders. Has that hope been belied? Not entirely. But warning signals are aplenty. With a majority of 282 MPs in the Lok Sabha, Modi has a unique opportunity to steer India in a new direction. Does he have the political will to do it? I believe he does. But to achieve the objectives the prime minister has set for himself, several key initiatives need to be taken. Time is running out; so is people’s patience. The window of opportunity is closing fast.”
No retrospective taxation
What then should be the agenda for Modi’s next four years? First, it is imperative that the retrospective tax law is repealed. Finance minister Arun Jaitley said in his Budget speech that this egregious tax is a “legacy issue”. Repealing it would leave Indian “sovereignty” in a legislative vacuum. In other words, unless the retro tax law remains on the statute books, India will be shorn of a legislative lever to impose in future such a tax in extreme cases.
But India lived without a retrospective tax law for over 60 years. Pranab Mukherjee, then finance minister, introduced the legislation only in the 2011-12 Budget. If it is ever required – and if it wasn’t for 60 years it’s unlikely to ever be – the law can be re-legislated. But allowing it to remain on the statute books while, as the finance minister put it, “the judicial process unwinds itself”, benefits only highly-paid lawyers who will delay that judicial process for as long as they possibly can. Meanwhile, foreign investors will be wary of investing in India. If a country can legislate retrospective taxes that allow liabilities going back to 1960, trust is the collateral victim. Without trust, investment will dry up.
Investors, foreign and domestic, want certainty, clarity and predictability of laws. Retrospective legislation violates all three principles. It is a testament to India’s attractiveness as a market that, despite such a law, foreign investment continues to pour in. Fix the law and watch it become a flood. In 2013-14, UPA-2’s last year in office, India attracted Rs 1,26,000 crore in foreign direct investment (FDI). In 2014-15, the first year of the Modi government, FDI rose 39 per cent to 1,76,000 crore. If the retrospective tax law is repealed, that could double in 2015-16.
Instead of reversing a legislation that is one of the UPA-2 regime’s worst legacies, the income tax department, which reports to the ministry of finance, has rubbed salt into a festering wound by imposing minimum alternative tax (MAT) on FIIs.
As Parathasarthi Shome, one of India’s foremost finance and tax policy experts, wrote: “The government has given clear and rational signals by avoiding taking aggressive litigatory positions and attempting to stay or resolve contentious matters with respect to selected international taxation issues. A case in point was the decision not to appeal against the judgment of Bombay High Court in the Vodafone transfer pricing case that related to a dispute between the income tax department and the multinational corporation over Rs 3,200-crore tax liability arising out of differences in share valuation. It is, therefore, surprising why the matter of imposition of minimum alternative tax (MAT) on foreign institutional investors (FIIs) was allowed to re-emerge. The matter was at the cusp of resolution a year back. In a few cases, such unanticipated income-tax action seems to be followed by a retreat by policymakers. Such actions tend to blemish the friendly assurances of the top leadership.”
Unnerved by the universal opposition to MAT on FIIs, the finance ministry last week appointed a three-member panel, headed by Justice AP Shah, to examine the issue and deliver a conclusion. “expeditiously”.
Once the retro tax is repealed and the Justice Shah panel recommends withdrawal of MAT on FIIs, which it very likely will, the investment climate in India will undergo a sea change. As a British colony, we allowed Indian resources (money and labour) to be used for Western benefit. Now is the time to redress the historical balance and use Western resources (money and technology) for India’s benefit. It would be thoughtless not to do so. The retrospective tax is an unnecessary impediment.
Pass GST and Land Bills
The second urgent reform on the prime minister’s agenda is to ensure that the goods and services tax (GST) and land acquisition Bills are passed in parliament’s monsoon session. GST has been accepted in principle by most states and opposition parties. Only the Congress is dragging its feet, vowing to oppose the bill in the Rajya Sabha. It will, though, eventually fall in line.
The key issue in GST is the final tax rate which hasn’t yet been revealed. Initially, it was pegged at 16 percent. The states disagreed, asking for higher rate to compensate for loss of revenue from sales tax, value added tax (VAT) and octroi. It is speculated that the GST rate will be finalised at between 20 per cent and 23 per cent. Anything over 19 per cent, however, could be inflationary and deeply unpopular.
Even trickier is the Land Bill. As this week’s India Today-Cicero snap opinion poll suggests, not addressing “farmers’ problems” is seen by 30 per cent of respondents as the biggest failure of the Modi government. The Land Bill is now with a joint parliamentary committee. The key is to make farmers partners in the “acquisition” process by introducing a leasehold option. This will allow farmers who choose this option to retain a sense of ownership in their land along with the other clauses of an assured job to one family member, an annuity and a one-time payment of between two and four times the market value of the acquired land.
For farmers, land is not just about money but about a generations-old lifestyle. While their children want to move away from unremunerative farming to cities, and while India needs modern infrastructure in rural areas, the lease option (a 49-year or 99-year lease with renewable clauses) will be a win-win for industry and farmers. It will also be an electoral game-changer ahead of crucial assembly polls in Bihar, West Bengal and Uttar Pradesh.
Create new jobs
The third priority at the centre of Modi’s agenda in year two of his tenure is creating new jobs. Investment remains niggardly. Company balance sheets are stressed. Banks are groaning under bad loans and are in no mood to lend more. The central government too is short of funds. Where will investment that can kickstart the economic cycle of growth, jobs and consumption come from? FDI is one source. The excellent gold monetisation scheme is another: it will bring unproductive assets into the real economy. Increasing tax receipts from GST and a government stimulus through borrowings are lateral measures the government must take. India needs to create at least ten million new jobs every year. Without new investment, especially private investment, that will not be feasible.
The Modi government has taken a year to fix the broken glass it inherited. Now it must fill it up – fast. Once the perception hardens that this government hasn’t delivered the change it promised, it will be difficult to sway public opinion even if performance does improve in succeeding years.
Make the glass full before it freezes up. Once that happens, it won’t thaw before 2019.