Another Big Economic Blunder
Abstract
The Indian government is flailing around trying to solve the problem of the economic slowdown that was caused by its own previous wrong economic policies, especially demonetization and a badly-thought-out GST. The latest move of the Finance Minister in lowering corporate taxes by 10% is not only going to be ineffective in solving the root cause of the slowdown, but has the potential to make things worse by reducing India’s financial cushion in the face of further global economic shocks.
The statements of the Finance Minister, Ms. Nirmala Sitharaman, yesterday, lowering the corporate tax rate by about 10% have led to euphoria in the stock markets. Industry leaders are ecstatic about the “pro-business” attitude of the country. Supporters of Mr. Modi are also thrilled and have begun to hope that the long-promised “acche din” will finally come after 5 long years.
However, while it is true that this is a business-friendly policy change, it is unlikely to change the current economic situation on the ground. Industry leaders are understandably happy — who would not be if they had to pay less tax? And shareholders of companies are also understandably happy — the companies their money is invested in are making lower losses.
But what are they going to do with the money they are thus saving? Are they going to set up new factories and increase employment? Are they going to re-hire the staff that they fired in the last few months? Are they going to increase the capacity utilization of their existing factories?
NO.
I repeat, NO. The problem with this government is that it has fundamentally failed to diagnose the problem — partly because the correct diagnosis would reflect poorly on its own past performance.
The correct diagnosis is that demonetization devastated the informal and the rural economy, and a badly-formulated GST destroyed whatever was left. Because of this, people have no buying power, no money, and no jobs. Small-scale industries and the rural economy have been destroyed in the past 3 years because of these misbegotten economic policies of PM Narendra Modi, leading to widespread unemployment and shattered businesses. So nobody has money to buy anything.
The root of the current slowdown in India is that there is no demand. People are not buying underwear and even Parle-G and Britannia products, such as biscuits. And when that is the case, it is quite clear that they will not buy cars and motorcycles, let alone homes.
The solution to the current malaise is putting money in ordinary people’s pockets by generating jobs on a massive scale. This can only be done by large public works, such as irrigation works and replenishment of water bodies (on a permanent basis). Water works are important also because India faces a looming water crisis. A large government program to shore up water resources would therefore achieve two objectives simultaneously – eliminate unemployment and ensure the country’s water future, which in turn will kickstart development in the future. Building highways is not the solution because these days, it is a largely mechanized operation. In addition, is unlikely to yield immediate returns, because we are not being constrained by transport bottlenecks. Trucks are not being sold today because there is reduced merchandise to ship because of the slowdown. Trucks are sitting idle in the depots of transport operators because they have no goods to transport. So what will more highways achieve?
Instead, the government has been barking up the wrong tree, by emphasizing supply-side economics. They put more cash into banks by making the RBI part with a huge dividend. They lowered interest rates. And now they are reducing taxes on corporates.
But why would corporates hire any more workers or build any more factories when people are not buying their existing stock of goods? Auto companies like Ashok Leyland (a truck manufacturer, notably, not a car manufacturer – which tells you the problem is more widespread than “millenials not buying cars” - as the FM opined recently) are shutting down factories for half of September because they already have excess inventory.
So, even if you did not tax companies at all, and even if you made interest rates close to zero, companies will not, in today’s business climate, either create new factories or increase production at existing factories, because there is no demand for their products. They will just sit on that pile of cash. If anything, they will invest abroad with that money, as Anand Mahindra is doing – Mahindra recently announced that they are doubling their infrastructure and job creation in the US. That’s a sensible business decision for Mahindra, because Modi and his government have brought India down to such a low level that the US is now looking like a more attractive destination for investment than India.
On the other hand, the amount that the government is forgoing because of this corporate tax cut is around Rs. 1.45 lakh crores. Just recently, the government forced the RBI to part with its biggest dividend ever to the government – of Rs. 1.76 lakh crores. Clearly, most of that amount is going into this tax rebate for corporates. And it is not going to result in any increased consumption of goods or greater employment of people. It will not change the slowdown.
So who will benefit from this largesse? India, Inc., will, and so will those who depend on it. Those who will reap the biggest dividends of this largesse will be those with the most shares in the companies — namely, the promoters. Individual shareholders, either directly or through mutual funds, will benefit to the extent of their shareholding; but clearly, the lion's share of this reduction in taxes will go to the promoters of companies — the Ambanis, Adanis, Birlas, Tatas, Mazumdar-Shaws, and the like. Nothing wrong with that if part of that goes back into the ecosystem by creating more jobs. But as we have already seen, the business climate today is not conducive to the creation of more jobs, because the problem is not supply-driven but demand-driven.
So the government, after blundering monumentally by Mr. Modi’s disastrous policy of demonetization in November 2016 and a badly-thought-out GST policy, and many other mistakes, such as its surcharge on FPIs (which it has belatedly backtracked now), has committed another major blunder which will not only not have any immediate effect, but will further deplete the already depleted treasury of the government, making it vulnerable to any external shocks such as a steep rise in oil prices, which has already started due to the drone attacks on the Saudi oilfields that has taken out half of the Saudi crude supply out of the market. Thanks to the RBI transferring vast quantities of its reserves to the government, which the government has been profligate with, India has very little financial cushion for any more global surprises. If there were a war in the Persian Gulf or a war with our western neighbor, that would be the last nail in the coffin of the Indian economy.
This is not to say that a reduction in corporate tax rates is undesirable or a bad policy per se. It would have been a great boost to business in a good economy where we have robust demand and where growth is constrained by supply-side policies, such as interest rates or high taxation. But when there is a growth slowdown because of lack of demand, this is not the prescription the doctor ordered. It will fail to solve the country’s economic problem, and in fact will make things worse. The only people who will benefit are the promoters and shareholders of companies, because this cash saving will mitigate their current losses, and that is why Dalal Street is cheering.
But there is nothing for the common man to cheer about. This move is a big blunder, because this money that was received from the RBI could have been used to really kickstart the economy, but the government has chosen to use it on a measure that will have no tangible benefits. Now the government has no more money left for any more major interventions. This was their last chance, and they have blown it. In addition, this will lead to an increase in the fiscal deficit, with all the accompanying evils of that development.
It is in times like this that we understand why Harvard is more important than hard work.
