Should the MSP regime be dumped? Business Line 19th Jan 2020

As it doesn’t cover all crops, it hasn’t been effective. A well-developed derivatives market will serve farmers better

Indian agriculture has some stylised facts that need to be put in perspective. Most crops are grown once a year and post-harvest they are stored and made available throughout the year. Different States have variations in the months of harvest which hence makes the season longer. Next, prices tend to come down sharply when the harvest comes in and rises subsequently. Intermediaries add value by holding the stock for the entire year and bear the cost of carry — such as transportation, storage, interest and risk of damage.

Given this broad structure under which agriculture operates, the government has been pursuing the MSP programme where minimum support prices are offered for all crops just before the sowing time for both the kharif and rabi seasons. The idea is that farmers are aware of what price they could possibly get from the government in the worst-case scenario of prices coming down sharply at the time of harvest. Theoretically, this is a sound policy as it gives assurance to farmers of a fair price. As it based on a scientific formula that covers all costs plus a return on capital, it is fairly remunerative.

However, the major problem with this MSP is that it does not work for all crops. It works where the government has machinery for procurement and that too in specific States. The PDS system has ensured that there is active procurement by FCI for wheat and rice, which is stored according to the buffer stock norms and also used for distribution.

As it is an open-ended scheme, there are no limits to procurement, which creates a different set of problems for the government. However, for the other crops there is no systematic procurement, which means that while MSPs are announced, they are not credible if government agencies are not there to procure the crop and the farmer has to sell at the market prices.

The Table shows that the average mandi price tended to be lower than the MSP in most months, which means that if farmers sold their produce in the wholesale market they were unlikely to get the MSP and the demand-supply conditions would determine the returns. September would generally be the pre-harvest price while the bulk of the harvest would flow in October when the prices tend to come down due to excess supplies.

Time to revisit

The main takeaway is that the MSP system needs to be revisited. To begin with it should be announced only when there is back-end procurement so that it is relevant. Also, it should be across all States and not confined to those where the FCI has the requisite machinery. Access is of importance and FCI should be working with State agencies to ensure that even for paddy the market price should never go below the MSP because whenever it does it stands to reason that the farmers do not have access to the FCI.

Now while cooperatives like NAFED do get involved with procurement at times, it is not universal. If there is no or limited procurement, then the MSP actually sends incorrect signals to the farmers. As these announcements are made before the seeds are sown, farmers take sowing decisions based on these prices.

When the price looks attractive, there would be a tendency for group-think to take over and the acreage increases. This leads to higher supplies, and in the absence of a credible procurement system leads to prices coming down thus impacting the income of farmers which can snowball into indebtedness at times and other associated issues like loan waivers.

Therefore, MSP can be of disservice when an end-to-end solution is not provided.

Is there an option to MSP? A well-developed derivatives market can offer a viable alternative to the farmers and the government where a market solution is used for a pervasive problem of sale of product. As there are at least three running contracts for most agricultural products, we can have the prices displayed for the farmers who take a decision on which crop to sow and simultaneously take futures call in the market so that they are assured of the price.

The month can be chosen based on the time when the harvest would take place. The advantage is that the physical delivery need not take place and while locking into the price, the return is guaranteed. The actual sale would take place in the local market at the lower price, but the reversal of futures contract would make up for the possible lower price in the spot market.

Futures market

The way forward is to develop the futures market across all crops and ensure that multiple contracts are in force all the time, especially during the harvest time. This will help in making better sowing decisions on the crop as well as quantum that is sown. Ideally, options would be better, though they are not easy to understand. They would provide advantage of the upside and cover for the downside at the cost of the option premium. This is similar to the MSP but delivered through the market which is more efficient and can cover all crops.

This is probably the right time to review how this system has worked and since the story played over appears to be the same every year, where prices rule at less than the MSP, it may make sense to dismantle the same. As the eNAM evolves, it can also be integrated with the futures market over the next five years or so. But for sure, announcing prices that are not deliverable does not serve the larger good.

Indian economy on weak ground with 5%...: Interview with ET-CFO: 8th January 2020

The government’s advanced estimates forecast a 5% growth in the gross domestic product (GDP) for the year 2019-20. While these estimates are on the lower side, the question is if rising oil prices and depreciating rupee will pull down the estimates further, and how long will it take for the economy to revive?

In an interview with ETCFO, Madan Sabnavis, chief economist of CARE Ratings, a credit rating agency, explains and discusses the economic outlook.

“The year 2020 will be a critical year where hopefully things will fall in place and the economy should be able to inch upwards and grow by 6-6.5% (GDP growth), with a good monsoon season,” said Sabnavis.

He added that the corporates could hope for revival in the second half. Edited Excerpts:

Q: What are your views on the advanced estimates forecast. Also, with volatility in oil prices (with US-Iran tensions), weakening rupee, where do you see the Indian economy heading?
Madan Sabnavis: The Indian economy is presently on weak ground with GDP growth in the region of 5% which is a far cry from the 7% plus number expected at the beginning of the year.

Change for the better will happen gradually with support from accommodative policies of RBI and limited fiscal stimulus of the government.

However, the path upwards will be gradual and more likely to pick up in the second half of the year which will be monsoon dependent again.

The government has to keep pushing with its capex and private sector investment will come in subsequently.

Iran may not have a major impact if the matter gets resolved in the next two weeks. It would become an issue if it lasts for a long period or escalates, impacting the oil economy. The rupee, although depreciating presently, should stabilise as the fundamentals are strong going by the balance of payments (BOP).

Q: What is your sentiment of the health of the economy in 2020? What should India Inc be prepared for?
Madan Sabnavis: The year 2020 will be a critical year where hopefully things will fall in place and the economy should be able to inch upwards and grow by 6-6.5% GDP growth, with a good monsoon season.

Corporates can hope for revival in the second half, albeit a modest one. I believe that unless jobs are created and people have spending power only then can the economy grow rapidly. This has stopped in the last three years and needs to hasten. Companies need to hire more people which will be done only if there is growth. Such circular rationale means that things will happen only slowly.

Q: What should be the main focus areas of the government in 2020?

Madan Sabnavis: The government should first focus on meeting capex targets.

Secondly, it has to ensure along with RBI that the financial system is back on its feet and is able to lend backed by capital and a good asset portfolio.

Thirdly, the disinvestment plan should be completed as per calendar and one should be clear of the process.

Fourthly, farmer support through MSP or some direct procurement through state agencies should be on the agenda as farmers are not receiving the right price in the market.

There should be clarity on the GST structure for corporates as presently there is ambiguity about what the council may do. We do need a clear policy framework for business to operate.

And lastly, there should quick resolution of sector-specific shocks like the one in telecom as regulatory shocks can impact industry prospects quite sharply.

RBI’s Financial Stability Report: Be watchful, follow developments in next few quarters: Financial Express 2nd Jan 2020

Although RBI’s latest Financial Stability Report says that things have stabilised, one would have to be watchful and follow developments in the next 2-3 quarters, as external economic conditions will not be too ebullient, and banks, NBFCs and cooperative banks have to pay more attention to risk to strengthen their balance sheets and make them more resilient to shocks

The Reserve Bank of India’s Financial Stability Report (FSR) is a cogent and comprehensive representation of the state of the financial sector which is brought out twice a year. It presents facts with explanations that are then iced with forecasts which point to how the regulator sees things going in the course of the year. The tone is firm without being judgemental, and it is left for the players to take necessary action to correct processes and ensure that the system is stable.

The latest FSR does indicate that the financial system has sort of stabilised, given the myriad challenges faced in the last couple of years, starting with the asset quality review (AQR) that affected public sector banks (PSBs) first, and later brought in some disruptive changes in private banks too. The good part of the story is that the NPA levels have stabilised at 9.3% (in September 2019), and, more importantly, the slippage ratio which is defined as incremental NPAs during the period under review has been stable for industry, which is a big plus. It indicates that on an incremental basis NPA accretion is moderate, and the overall NPA ratio indicates that the AQR issue is tackled almost completely. The NPA ratio has been stable for industry at 17.3%, and had risen for agriculture and services in September compared with March. The stability in the ratio for industry is indicative of the NPAs being fully recognised. In fact, the slippage ratio for industry at 3.8% is lower than that in agriculture and services.

The fact that the CRAR (capital to risk weighted assets ratio) has improved to 15.1% is reflective of a great deal of resilience built in the system, with substantial support coming from the government in the form of recapitalisation of PSBs. Only one bank had a ratio of less than 9%. Also, the provisions coverage ratio at 61.5% shows that the banking system has largely gotten out of the rather nasty phase that lasted for around three years. And most assuring, the FSR also says the network analysis shows that there was a marginal decline in the bilateral exposures between entities, which means that the interconnected risks across sectors have stabilised. Therefore, the big plus of the system in the last six months is that, notwithstanding the NBFC crisis and the Punjab & Maharashtra Co-operative Bank (PMC) controversy, the financial system is back on its feet.

RBI is, however, cautious in the future outlook, where it has projected an increase in the gross NPA ratio to 9.9% in September 2020. This does not really cause alarm, but raises the flag that the system may not yet be out of the woods. It is indicative of the fact that overall GDP growth till Q2 of FY21 may still be uneasy, and the acceleration that may have been expected next year would not be witnessed during the first half of the year. The current economic slowdown, which is flagged by RBI, is hence expected to increase the numerator and result in incremental NPAs. One must remember that even the retail segment is witnessing a slight uptick in the NPA rate, as the slowdown also affects the ability of individuals to service their debt. Also, while the SME NPAs are not going to be recorded as being impaired as of March 2020, the same would be recognised subsequently unless there is a new dispensation that defers such assets. Hence, this will be something to look out for as it can get problematic if the volume increases.

The second factor flagged is that the denominator will increase at a slower rate as credit is likely to be sluggish. This is an important and critical judgement as banks today have surplus liquidity that is not being deployed due to both lower demand and relatively some extra caution being exercised while lending. In a way, it is also reflective of the implicit view on future GDP growth that may not be significantly higher than the 5% expected in FY20, in FY21. The finance minister has subsequently assured bankers that there should be no fear in lending as it would be within the domain of banks to escalate cases to the investigative agencies in case of suspicion of wrong doing. It needs to be seen if bankers feel assured on this count.

An interesting outcome of the stable picture presented is the capital adequacy ratio of 15%. While it was necessary for banks to be well-capitalised to fund future growth, the CRAR is a delicately balanced concept. A low CRAR restricts lending, while a very high ratio means that banks are not making good use of their capital. This has happened as their balance sheets have not expanded through credit but investments in G-Secs, given the share of PCA banks—those under RBI’s prompt corrective action—in the story. The focus must be on expanding credit in a judicious manner, or else it will not be an efficient use of capital. Quite clearly, banks must use their capital in lending, or else the purpose of dis-intermediation would be dented.

The other area of concern has been the non-banking financial companies (NBFCs), and here RBI is more cautious. The fact that funding to these institutions has been a challenge from markets as well as banks is well known. The asset-liability mismatch that engendered the crisis is being addressed gradually by NBFCs, which will help in stabilising the system. However, given that this would take time to work out, one may expect the situation to linger for a couple of quarters, and it is here that RBI has waved the flag again on the possibility of their NPAs increasing.
In this context, the FSR has also analysed the real estate sector and the exposures of financial institutions.

Interestingly, it shows that PSBs have lowered their exposures to this sector, while that of private banks and housing finance companies (HFCs) have increased. But in terms of impaired assets being carried on their books of this sector, PSBs have the highest ratio of 19%! Quite clearly, the credit standards are different for various imitations when lending to the real estate sector.

Hence, on the whole, the FSR does say that things have stabilised, though one would have to be watchful and follow developments in the next 2-3 quarters, as external economic conditions will not be too ebullient and banks, NBFCs, cooperative banks have to pay more attention to risk to strengthen their balance sheets and make them more resilient to shocks. The financial system is definitely on the right path, but should tread cautiously as the economic cycle turns around.

Review 2019: The economist’s year in a lighter vein: Financial Express 28th December 2019

Economic discussions and debates are now a habit. With so much media time and space to be filled, it is just great to talk about such subjects. The official view-point mouthed by economists in the establishment play the familiar aria while those in the corporate world tend to discreetly appreciate the same, even if they disagree. Those in the academic field could differ sharply, but, in any case, there is no skin in the game for the profession! This was an exciting year from an economist’s point of view, and following are its top-ten highlights.

First, were the global phenomena—Brexit and the trade wars—which entered all discussions. Every policy document spoke of the fear or uncertainty of these two factors, which had replaced oil as the chief concern. This is notwithstanding the general consensus that these won’t have much impact on a domestic-oriented economy, except that there will be less discussion once they are resolved. Until then, they serve as a very good excuse for doing or not doing anything. The non-resolution of these issues means that we will hear more of them despite Boris Johnson’s promise that January 2020 will see something more firm.

Second, a feeling of déjà vu pervaded through 2019 when it came to NSS data. Recall that last year, GDP and the back series dominated media time, with the CSO, Niti Aayog, and PMEAC debating this with economists, analysts and ex-government officials. This year had its moment when the data brought out on consumption—this was not released, but rejected—showed unfavourable trends. This episode of data management gave one the sense that if the results are not to one’s liking, one debunks the approach and commissions another study on grounds of the methodology being incorrect.

Third, as a nation, we improved our position in World Banks’ Doing Business rankings. While naysayers still complain that we addressed only the elements which go into the formula, a better rank is a better rank. There is no gainsaying this achievement. But, were this ease of doing business to be juxtaposed with the cancellation of contracts in Andhra Pradesh that followed the change of guard, investors would be left dangling in ambivalence. State risk is even more devastating than regulatory risk (ask the telecom companies!).

Fourth, as the year started with the accepted GDP growth numbers, the tagline that went along was that India is the fastest growing economy in the world. When questions were raised on a slowdown, we were reminded that we are the fastest growing country in the world—a fact which could be seen on the IMF and World Bank sites. Therefore, the fall of the growth rate from 7% to 6% to 5% was not really a concern. But, the alacrity with which policies were introduced raised suspicion—the multiple measures wouldn’t be required if the economy was really doing very well!

Fifth, economists had a blast with words and the common thought was that we did not have to worry even if growth came down to 5% or lower because things were not ‘structural’, but ‘cyclical’. Simple words have complex undertones, and a layman may not understand these when there is unemployed, there are less jobs, and the price of onions is Rs 150/kg. What this means is any one’s guess as consumption, investment, overall growth, and exports have all slowed down, with no light at the end of the proverbial tunnel. But, the feeble explanation of things not being structural has dominated thousands of hours of conferences, economic discussions, and articles. It is no wonder that the credibility of economists has—having no skin in the game, they can say anything anytime!

Sixth, if the structural versus cyclical debate dominated discussion time, it was overtaken by the $5-tn-dollar aspiration. Now, frankly speaking, the number will be achieved at some point of time with sheer gravity. Besides, a $5-tn-economy with few jobs, little income, and poor living conditions means nothing. Yet, almost everyone has a view on the $5 tn number, including the IMF, which one would have expected not to get swayed. Truly, the quality of discourse came down to discussing whether it would take five or six or seven years to reach this number. Does it really matter, considering that no one has a solution for reviving the economy today?

Seventh, another subject that should not have merited any discussion was fiscal management. Will the 3.3% target be achieved or not? How much will the slippage be? Will it affect market borrowings? Will disinvestment target be achieved? Recent fiscal history proves that anything can happen, and everything can be managed.

Expenditures can be deferred, discretionary expenditure cut, and disinvestment accomplished through inter-company holdings. Once we fix what level of fiscal deficit is tolerable, the rest can fall in place with relative ease. This is akin to the magician who can pull out just about anything from their hat by waving a wand.Inflation came down, and then went up. But, all analysts know one thing for sure—whichever way the number goes, interest rates should be lowered, and the argument can be forcefully articulated. When inflation was below 4%, but core inflation was at 6% and food inflation at less than 1% or negative, we looked at headline inflation and argued for rate cuts. We did not say that food inflation, which is impervious to monetary policy, was responsible for this. When inflation is above 5% due to food inflation, the argument is that we should not look at the headline number, which is influenced by food prices, but only core inflation. English is a wonderful language, and the art of polemics is amazing.

Nine, bankers were a nervous lot. They appreciated everything done on recapitalisation (but are not lending). They said the NPA problems were over as a matter of being politically right (but RBI keeps finding understatement of such numbers). They assured the government that they would reduce interest rates (which they haven’t done to the extent expected). They applauded when they were told to lend more to SMEs and not recognise the NPAs, like had happened during demonetisation (the future offers trepidation). The ‘Yes People’ have said their lines, just as the playwright had dictated.

Last, the spoken word does not end at the door of Shashi Tharoor and his pompous Stephanian English, which often sends the reader running for the dictionary. This is now passé. This was upstaged by a member of the MPC when the monetary policy minutes revealed the word ‘floccinaucinihilipilification’. Policy minutes will surely get harder to read and understand if such terms are going to be used. But, there can be variety in expression given that the script is the same every time with new numbers.

A decade marked by economic turbulence: Business Line 25th December 2019

etween scams, policy paralysis and the ill-effects of demonetisation, GST and NPAs, India lost the tag of ‘fastest growing economy’

The end of 2019 also marks the culmination of a particularly turbulent decade. This is contrary to the earlier decade, when we took credit in being decoupled from the experiences of developed countries following the Lehman crisis. It is time to go back and assess if there are lessons to be learnt.

The first shock evolved over a period of time, characterised by the irregularities in allocation of natural resources — which came to be known as ‘scams’ — in coal, telecom and iron ore. This led to a policy paralysis, which meant several projects got stalled as coal or iron ore were not available.

The country is still to recover from this blow, as gross fixed capital formation slipped from a high of 34-35 per cent to a low of 26-27 per cent and is now in the range of 28-29 per cent. As these projects were in heavy industry and infrastructure, the struggle continues.

Economic tinkering

Second, linked to these capacities that were created and then abandoned, was the financial system. Projects failed because of these institutional failures, but the government and the RBI in their wisdom told banks that these loans were not really the typical NPAs and should be called ‘restructured assets’, with the corporate debt restructuring cell being set up.

As bankers constituted this cell, there was a perverse incentive to shift assets to this category, and so started the evergreening. This camouflage came apart when the RBI ordered an Asset Quality Review which led to banks gradually revealing their true NPAs, which crossed 20 per cent at times and averaged 9-10 per cent as against 3-4 per cent earlier.

Third, just while the economy in 2016 looked like springing back to life post two successive sub-normal monsoon conditions, the government went in for demonetisation, which was probably an egregious blunder as employment, output, enterprise, the financial system, etc, were affected for three successive years with consumer demand slowing down, leading to this impasse.

Fourth, the government took a bold decision in 2017 by bringing in the GST — the biggest tax reform in the country. The timing was critical and political expediency was compelling, given that the general elections were in 2019.

Two problems had surfaced from this. First, the SMEs were at the receiving end of a double whammy and, second, the collections expected from the GST missed the target as the economy slowed down. For such a tax system to work with lower rationalised rates, growth is essential.

For two years, there have been only slippages, which debunk the overoptimistic visions painted by economists who said the GST may lead to higher collections, GDP growth and lower inflation.

As the banking system faced turmoil and went on the back-foot post demonetisation, NBFCs boomed by providing finance for real estate, SMEs and infrastructure. All went well until IL&FS collapsed in 2018, which had a domino effect.

This led to panic, as mutual funds moved out of the CP market and banks were reluctant to lend to NBFCs. The government and the RBI have stepped in to save the situation; but, even today banks are unsure of lending to both corporates as well as NBFCs as the mess is deep-rooted. It has become a kind of Lehman moment for us.

Managing the numbers

Fifth, this has been the decade of change in base years by the CSO, and data have become controversial and politicised. Even though governments have limited control over the GDP and other growth numbers, they have gotten personalised, which has meant that various series of data have given different results.

With the last CEA ironically coming up with another calculation, a good-intentioned methodology followed by the CSO has now gotten dented in terms of credibility — the demonetisation year, which saw all economic activity coming to a standstill for five months, registered the highest growth rate of 8.2 per cent.

Sixth, the fiscal management process has generated another controversy. While hours of debates conjecture whether the 3 per cent mark or whatever is targeted will be achieved, the quality of these numbers leaves a lot to be desired. First, there are rollovers where payments are made in the next year. Second, capex is cut to meet targets. Third, to make disinvestment successful, one public sector unit buys into another, which should not be the case. Fiscal management to make the exercise more meaningful will be the next challenge in the coming years.

Transfer of reserves

Seventh, the RBI had been in the centre of the storm with the controversy of transfer of reserves to the government. The picture became quite ugly because the issue was raised when the Budget exercise floundered. While the rules of engagement permit such a transfer, the fact that it was never done before was compounded by the apparent reluctance of the then RBI Governor to accede to the request. The resignation of the Governor added to the discomfort.

Eighth, in a historic move, monetary policy was transferred to an MPC (Monetary Policy Committee) with inflation targeting being the norm. This was after migrating from two to eight to six policies a year. Having independent members formulate policy added transparency. But towards the last couple of years, the efficacy of policy can be questioned as the effectiveness of interest rates has been tested. There may be need to revisit the framework.

Ninth, as the decade ends, the slowdown in growth has left everyone confused. The tag of being the fastest growing economy has gotten diluted, with little impact on growth numbers despite several policies put in place. Will we have to wait for another 5-10 years to recover, like the US or the Eurpoean region?

Last, the country has made tremendous progress in terms of ‘ease of doing business’ and the competitiveness index, which are tracked by the World Bank and the WEF. The FDI and FPI reveal that India is a preferred destination. Yet, the conundrum remains as to why the global rating agencies still rate us as being just about investment-grade. This should on our agenda in the 2020s, as it affects brand “India”.

A costly experiment that failed to deliver: Mint 25th December 2019

Demonetization was probably the biggest disruption brought about in the last decade which was based on erroneous assumptions and implemented in a rather unstructured manner, leading to the economy coming to a virtual standstill with the small and medium-sized enterprises (SME) segment and farming community being affected the most. Yet looking back now, everyone seems to be a winner. Systems have been streamlined to leave audit trails. People have become savvy and have turned digital. Currency in circulation continues to rule and cash is as important as ever. However, the collateral damage has been in the SME sector which is still struggling and employment has taken a big hit. And the Reserve Bank of India (RBI) surplus came down by over 50% meaning thereby less transfers to the government.

The assumption of cash being used to hoard black money has not been proved. Terror financing could have been an issue but the reduction in such incidents is more due to the credit of our security agencies which have controlled the same. Counterfeit currency has never been proved by RBI data. So clearly the initial thoughts were not right. Along the way the emphasis was put on digitization, though it is illogical for one to go in for demonetization to force people to digitize. Normally incentives are provided to move transactions into the digital world.

The implementation of the move was not neat as the banks did not have regular supplies of currency, nor was it known that the ATMs were not compatible with the new notes. The quantum of circulars that were issued by RBI in the period of two months or so was just too high and gave the impression that there was no concrete plan in place to implement the same as rules were fine-tuned depending on the responses of the public. Quite clearly the banking system was not prepared for this process and while the surprise element was required to catch the wrong doers (terror, black money, counterfeit) the inconvenience caused to over a billion people was unnecessary. The incongruity of the exercise was that while it was argued that black money resided in high-value currency of ₹500 and ₹1,000, they were replaced with ₹500 and ₹2,000 notes! It should have been in only lower denomination notes in case the argument had any serious merit.

The post Diwali phase of 2016 was important because it was a year with normal monsoon after successive years of sub-normal rainfall and it was widely expected that the festival-cum-harvest season would reignite demand. Not only did this not happen but also with employment in the SME sector being affected and payments to these units being impacted, the economy has gone through a serious downturn which is still in progress.

The subsequent measures that have been announced for the SMEs are good, but the damage done was deeper and it would take time before they are able to recoup and restore normalcy in operations. In fact, banks are reluctant to lend to them given the higher probability of delinquency in their loans.

Therefore, the question to be asked is whether or not such a measure should ever be attempted again. The answer is a definite no. It has been a costly experiment that has disrupted economic activity. The reverberations can still be heard and do not sound good.

Collections hit by slow consumption growth: Free Press Journal 20th Dec 2019

It may be recollected that when the GST was introduced, it was widely argued that it would lead to a decline in prices, increase collections and enhance GDP growth. Those more audacious came up with numbers of 1.5-3% increase in GDP. It was largely a theoretical exercise as the subject is complex and effect quite nebulous as these rates had to work their way through. With around two years of the new tax regime being in force, the question asked is whether or not it has worked. The issue being raised today is whether rates should be increased as there is a fear that revenue collections have been affected due to lower rates.

When the GST was introduced it was mentioned that the government was open to changes both in terms of rates and structures. Therefore, there has been fine tuning of rates in the downward direction over the last two years depending on the feedback received from industry. Systems have been made easier for SMEs so that payments became easier, as did refunds. Therefore the focus has been more on ensuring that the GST system was streamlined with the practical side. This was a pragmatic approach taken by the government as prima facie it was not possible to conjecture the way things would actually go.

The present slabs are 0, 5, 12, 18 and 28%. As a measure to move closer to a system with fewer slabs, this may be reduced to two or three to begin with. The 5% and 12% slabs can be integrated into either 10 or 12%. In case of the higher range the 18 and 28% could move to 28%. This seems to be a possibility now given that it looks like that the present momentum in the economy and the rationalised structure will not yield the kind of revenue required for maintaining the revenue targets.

The other contentious issue is in compensation for the states as it was to be in force for five years. Presently the delays have impacted the functioning of states with discretionary expenditure bearing the brunt as states have tended to defer or cut back on such expenditures with revenue flows not being buoyant. Therefore, clarity on these flows is required for sure.

The major problem for the government has been the tax collections on this score. The rule of thumb was that Rs 1 lakh crore per month had to be the collections from GST including all the three components. The states were also to be compensated for any loss of revenue which was reckoned at 14% per annum based on 2015-16 numbers. Intuitively it can be seen that for this model to work the taxable base had to increase which is that GDP growth has to be of a high magnitude in nominal terms. But the problem today has been that consumption growth (GST is a consumption based tax as against excise being on production) has slowed down leading to lower collections. This is the major challenge when tax rates are fixed with commitments to the states in the form of compensation. A double whammy is served to the centre when intrinsic growth is of a lower order. The fact that GDP growth in real terms for this year has been scaled down from above 7% to now just about 5% means that revenue collections are bound to get affected.

States are in a better position, which means that their compensation is a given quantum and the onus falls on the centre which will have a challenge to meet its fiscal targets. The expectation is that the GST council may selectively increase the rates. There are two problems here. The first is that when the rates were lowered, the benefit had to be passed to the consumer which has not always happened resulting in several companies being hauled up for profiteering. Second, if rates are increased and is passed on to the consumer, which will definitely be the case, it can actually lead to even lower growth in consumption which can come in the way of future GDP growth.

An accompanying problem is inflation. Presently, inflation is more due to supply issues on the food side and hence the so called core inflation is low. In fact manufactured goods inflation is negative going by the WPI which has helped to keep headline number low. An increase in GST rates will lead to higher growth in prices that can be a worry if the CPI number is higher wrung around 5%. This is a factor that the GST Council has to keep in mind.

The GST in India has not quite had the desired effect with the tendency being fairly volatile revenue and states not getting their compensation on time. As economic conditions have been downbeat overall consumption is also quite stagnant. Change of rates is required but has to be done in a measured way or else there would be more volatility in the markets. This was always going to be a challenge for us given the plethora of rates across the country. Integrating production and consumption taxes under an umbrella was always going to require a lot of dexterity as the interlinkages vary across commodity groups. We may still have a long way to go for the exact impact to be assessed more meaningfully.