Time to overhaul or replace GST
the States rose sharply, resulting in an average monthly deficit of close to Rs.5,800 crore in cess collections relative to compensation requirement. That more than wiped out the surplus available in the compensation fund, necessitating transfer of Rs.33,412 crore from the Consolidated Fund of India to the compensation fund to meet the States’ dues. The Centre’s belief that the compensation cess would serve its purpose over the five years when its contribution was needed had proved wrong.
The message was clear. So long as growth was reasonable, the GST regime seemed to be on a trajectory where it can be put on a firm footing. But if growth slowed, the system needed life support. The compensation fund could prove inadequate even as a temporary five-year crutch until the system’s design was altered. Moreover, with signs that slow growth would be the new normal in the foreseeable future, this would also imply that the States would be substantially short of the promised revenue growth once the five-year period for which the compensation was to be paid came to an end. It appeared that the Centre would have to make transfers from its own kitty to fully compensate the States for the next two years. In addition, it was likely to come under pressure from revenue-short States, through the GST Council, to continue with the compensation arrangement after its five-year term.
RENEGING ON COMMITMENTS TO STATES
That was before the pandemic led to a sudden stop in economic activity and the subsequent developments that have resulted in the economic contraction (rather than slowing of growth) which is expected to happen not only this year but possibly in the next as well. That would affect State revenues even more severely, increasing the shortfall relative to target. GST collections through April to July 2020 were, at around Rs.2.7 lakh crore, more than a third lower than that during the corresponding period of the previous year. It was true that collections were particularly low during the lockdown in April and May 2020, and as restrictions were lifted economic activity and collections were slowly recovering. But collections in July were lower than those in June, suggesting that, overall, 2020-21 would be a particularly bad year for collections and that the revenue shortfall of the States relative to the level warranted by a 14 per cent growth rate would be huge.
This is why the Centre has decided to renege on its commitment to the States, claiming that its responsibility ends with transferring sums generated from the compensation cess to the compensation fund. After the Finance Secretary’s statement on the matter came the news that the Centre had referred the issue of finding an alternative to compensation payment to the Attorney General. The Attorney General has reportedly held that the Central government was under no obligation to compensate States for any shortfall in GST collections, and that it was up to the GST Council to find a solution.
But the Centre must have a position, since it has a strong presence in terms of votes in the Council. A majority in the Council may still decide that the Centre has the responsibility to cover shortfalls in State revenues. If transfers from the Centre to the compensation fund were not made, financing the compensation would require the GST Council to either agree to raise rates to enhance revenues and cover the shortfall or for the GST Council to recommend borrowing to finance the shortfall. Raising rates when economic activity is shrinking is clearly not a feasible op
tion as it will only aggravate the demand compression that needs to be counteracted. More so, the magnitude of the duty hike required to generate the revenue needed would possibly be large.
One suggestion from the Centre is that the GST Council itself can borrow to enhance the compensation fund, and the period over which the compensation cess is levied can be extended beyond the five-yearcompensation period to mobilise the funds needed to service that debt. Besides the fact that this absolves the Centre of the responsibility of compensating the States, it also amounts to getting the States to accept that a chunk of additional resource mobilisation in the future would be reserved for servicing debt that finances shortfalls in the present. That would undermine the ability of the States to find ways of covering revenue shortfalls in the years when the compensation principle no longer holds. A third option is to provide States the leeway to borrow to cover their own shortfalls. But that would mean that the States will have to fend for themselves when servicing the cost of that debt in future when there is no compensation fund available to cover revenue shortfalls.
STATES’ PROTEST
Not surprisingly, the States are protesting against the Centre’s decision in the midst of a crisis to renege on a commitment it had made. In the drive to persuade States to endorse the plan to migrate to a GST regime, the previous National Democratic Alliance government and its Finance Minister Arun Jaitley had made all kinds of claims about the way the GST would change the fiscal game. The States did need persuasion because the transition implied that they would be giving up the power they had to decide on the indirect taxes that they could set and levy. If each commodity was to be taxed at the same rate across the country, rates would be decided through compromise at the GST Council, and any change would have to be agreed upon there.
To convince the States that this was in their own interest, a projection made by Central advocates of the GST was that the revenues from the new taxes would, at the minimum, grow by 14 per cent a year. To show that the Centre was confident that this prediction would prove right, it said that for the first five years the Centre would compensate the States for any shortfall in revenue growth relative to this minimal projection. There was the proverbial catch, however. The Centre extracted from the GST Council a decision that a special cess would be imposed to mobilise resources that would help finance this compensation, if needed. That obviously meant that there was no guarantee that in the first five years at least the projected revenue growth would be realised. If it did not, the States would lose out after those first five years unless GST rates were tweaked and raised to ensure the promised growth rate in the post-compensation period. Moreover, there was no guarantee that the cess chosen to be levied would garner enough to finance the compensation. The States clearly saw this as the Centre’s problem, at least for five years. It is now clear that the Centre thinks it is merely a manager of the cess fund, with the adequacy of the tax a problem to be addressed by the GST Council.
The recent controversy makes it clear that the States had been misled. Punjab Finance Minister Manpreet Singh Badal has in a letter reminded Union Finance Minister Nirmala Sitharaman that when pushing for the GST the Centre had provided “innumerable assurances” of “assured and unhindered compensation”. The Centre has clearly chosen to renege on those assurances by hiding behind the argument that there is no constitutional requirement that the Centre should ensure compensation of State revenue shortfalls.
STAGNATION IN GST REVENUE
This controversy is a diversion from two trends that both the Centre and the State governments must address. The first is the evidence that the crisis faced by the GST regime predates the COVID-19 pandemic, the effects of which on the economy were felt only from April, or in the current financial year (2020-21). Even by March 2020, or at the end of three financial years since inception (in July 2017), the GST regime was not delivering anywhere near the revenues it was expected to generate.
Total monthly collections from State (SGST), Central (CGST), and integrated (IGST) goods and services taxes and the compensation cess first crossed Rs.1 lakh crore in April 2018. Yet there have been only nine out of the 33 months until March 2020 in which that mark was exceeded in nominal terms. Further, there have been only four months in which the figure topped Rs.1.05 crore. In sum, the picture is one of near stagnation in GST revenue growth, as opposed to the expected 14 per cent growth. GST collections rose from 5.8 per cent of GDP in July 2017-18 to 6.2 per cent in 2018-19 and then fell to 6 per cent in 2019-20, even though GDP growth slowed in the last of these years.
The second is that, since three years is time enough for a policy regime to stabilise, this inability to generate the expected increase in revenues from GST by the end of financial year 2019-20 points to the failure of the regime. So even if the COVID-19 induced crisis had not struck, the Central and State governments needed to find ways to address that failure. The only possible solution seems to be a significant increase in tax rates across GST slabs. There is no guarantee that this intervention would work. But even assuming it would, that solution involves imposing heavy burdens on all sections of the population that pay some set of indirect taxes, and therefore is intrinsically regressive. Even if not a failure in a purely fiscal sense, the GST would definitely be a failure from a welfare perspective.
In all probability, the GST regime would be a failure in both senses. Rather than tweaking the regime, it possibly is time to find ways of overhauling or replacing it. m
ALTHOUGH PRIME MINISTER NARENDRA Modi did not mention the unresolved standoff with China along the Line of Actual Control (LAC) in his monthly “Man ki Baat” broadcast to the nation, Defence Minister Rajnath Singh more than made up for it when he welcomed the arrival of the first batch of five Rafale fighter jets from France at the Air Force base in Ambala. Tweeting on the occasion, he said that the addition of the jets would give the Indian Air Force’s (IAF) combat capacity a “timely boost” and make it “much stronger to deter any threat”. To make it clear that he was referring to China, Rajnath Singh added that if anyone “should be worried or critical about this new capability of the Indian Air Force, it should be those who threaten our territorial integrity”.
The French-made jets are capable of carrying out a variety of missions, including reconnaissance and nuclear strike deterrence. The planes had landed under strict security measures to prevent the leakage of sensitive information. Senior retired IAF officers and aviation experts in the country have claimed that the jets will prove to be game changers in the event of a military conflict, although they also concede that the IAF needs at least 42 fighter squadrons to be fighting fit. It currently has only 31 squadrons, comprising mainly Russian-made fighters, including some of Soviet vintage. All the 35 Rafale jets that India had ordered will be delivered only by the end of 2021. It will take some time to make the first batch of five fully operational.
The IAF has moved air defence systems, as well as a sizeable number of its front-line combat jets and attack helicopters, to bases near the northern border. Chinese military analysts claim that the Rafales are only slightly superior to the Sukhoi Su-30 fighter jets that the IAF
already has, and are a generation below the PLA’S J-20 stealth fighter jets. The only other countries that have ordered Rafale jets so far are Egypt and Qatar.
The arrival of the Rafale jets coincided with a noticeable stiffening of the Indian government’s attitude vis-avis China, after the successive rounds of military and diplomatic talks in the last two months failed to result in withdrawal of the People’s Liberation Army (PLA) from the disputed areas in the Pangong Tso. The Chinese Foreign Ministry spokesperson had claimed in the last week of July that Chinese and Indian troops had “disengaged” in most of the locations in eastern Ladakh. The Chinese Ambassador to India, Sun Weidong, reiterated this claim a few days later: “With the joint efforts of both sides, the border troops have disengaged in most localities. The situation on the ground is de-escalating and the temperature is coming down.”
The Indian side, however, painted a more pessimistic scenario. The Ministry of External Affairs spokesperson, Anurag Srivastava, while conceding that progress had been made, stressed that “the disengagement process has as yet not been completed”. He emphasised that the maintenance of “peace and tranquillity in the border areas is the basis of our bilateral relationship”, while expressing the hope that the Chinese side would “sincerely work with us for complete disengagement and de-escalation and full restoration of peace and tranquillity in the border areas as agreed by the special representatives”.
The senior commanders of both Armies last met on August 2 as part of the ongoing efforts to complete the disengagement process. It was the fifth round of commander-level talks in the last two months between the two sides. After the previous talks held on July 14, the Indian Army had said that both sides are “committed to the complete disengagement of troops” but had cautioned that the process was “intricate” and that it needed “constant verification”.
The spokesperson for the PLA, Senior Colonel Ren Guoqiang, however, stuck to the narrative that the disengagement process was being “gradually carried forward” and that there was “effective communication and coordination” between the two sides, both on the diplomatic as well as on the military front. Meanwhile, the Indian Army has let it be known that it is taking no chances and has indicated that it will have to keep a larger permanent force deployed along the disputed border until there was a verifiable disengagement by the PLA from the friction points. According to the Indian Army, Chinese soldiers remain deployed east of Finger 4 at Pangong Tso and are preventing Indian troops from resuming patrolling in the five patrol points in the Depsang Plains. The PLA has, however, pulled back from the Galwan Valley and most of the other friction points.
The Indian Army has said that it has already deployed an additional 35,000 troops along the border. From its point of view, the restoration of status quo ante would mean reduction of the additional troops deployed by both the sides on the LAC, removal of the new infrastructure installed in areas claimed by India and restoration of patrolling rights as they had existed until May. The Indian Army also wants the delineation of the border to avoid a repeat of what happened in May and June.
Sun Weidong has said that the Indian insistence on the clarification of a disputed boundary would only lead to more confusion and disagreements between the two sides. He said that China has “not strayed beyond its customary boundary lines” on the northern side of the Pangong Tso. “China’s traditional customary boundary line is in accordance with the LAC,” he said. The Chinese envoy also made it a point to emphasise that his country never claimed land outside its territory: “The label of ‘expansionist’ cannot be pinned on China.”
UNITED STATES’ ENCOURAGEMENT
New Delhi is being openly encouraged to take a tough stand on the border issue by the Donald Trump administration. The United States Secretary of State, Mike Pompeo, who wants to claim the mantle of John Foster Dulles and launch a new Cold War, told the U.S. Congress that the recent border skirmishes on the Indian border and China’s “real-estate claim” on Bhutanese territory were part of China’s expansionist policies. Pompeo even
claimed that Beijing’s goal was to spread “socialism with Chinese characteristics” to the rest of the world. He then went on to claim that the Trump administration’s policies had led to the growing international ostracism of China. Pompeo said that China’s recent actions had “reinvigorated” the Quad [Quadrilateral Security Dialogue], the antichina military coalition consisting of the U.S., Japan, India and Australia.
The Quad first began during the United Progressive Alliance government in 2007. Beijing had strongly protested to New Delhi about the blatant anti-china character of the putative military alliance at the time, following which the Indian government had put the Quad on the back burner. China had particularly objected to Australia being invited to participate in the annual Malabar military exercises held by the navies of India, the U.S. and Japan. The Narendra Modi government resurrected the Quad in 2017, and Australia is being sent an invitation to participate in this year’s Malabar exercises. Since 2017, the group has met seven times.
Derek Grossman, a former adviser to the U.S. Defence Department and currently a senior defence analyst at the RAND Corporation, specifically mentions the key role of the External Affairs Minister S. Jaishankar in resurrecting the Quad. He credits the former Foreign Secretary with convincing Prime Minister Modi to accede to Japanese Prime Minister Shinzo Abe’s request that all four leaders of the Quad sit together across the table from President Xi Jinping at the 2019 G20 summit. It was a signal that did not go down well with Beijing. The Modi government’s rush to re-embrace the Quad, according to most strategic observers, was triggered by the 2017 military standoff with China at the Doklam trijunction.
With the Trump administration declaring an open “Cold War” against China, the U.S. has adopted the Quad as the preferred mechanism to maintain “a free and open” Indo-pacific region. Washington has also taken the lead in criticising China on a host of issues, including Beijing’s handling of its internal affairs in Hong Kong, Tibet and Xinjiang. The U.S. is the only government that has officially labelled China as an “adversary” in its latest National Security Strategy, National Defence Strategy and Indo-pacific Strategy Reports. There has also been an attempt by the Trump administration to water down the country’s “one China” policy, in force since 1979. Washington’s allies in the Quad seem eager to follow suit.
UPGRADING TIES WITH TAIWAN
For the first time, the Indian government has appointed a senior diplomat of Joint Secretary rank, Gaurangalal Das, to Taiwan as Ambassador. The Indian diplomatic mission there is called the India-taipei Association, and the new appointment signals an upgradation of ties between India and a country that is not recognised by the international community of nations. Modi had invited Taipei’s chief representative in India along with the representatives of the Tibetan government in exile in Delhi for his first oath-taking ceremony as Prime Minister in 2014.
In the first week of August, the Indian government used the occasion of the death of Taiwan’s pro-independence former President, Lee Teng-hui, to send a strong message of solidarity with the breakaway republic. Its statement described the late President as “Mr Democracy”, and said his vision and leadership “helped deepen democracy and economic prosperity” in Taiwan. President Lee spearheaded Taiwan’s efforts to be recognised as an independent country, which is anathema to Beijing’s “one China” policy.
Participating in a webinar in the last week of July, Ambassador Sun Weidong had emphasised that issues relating to Hong Kong, Taiwan, Tibet and Xinjiang were “totally China’s internal affairs and bear on China’s sovereignty and security”. He pointed out that China does not interfere in the internal affairs of other countries and at the same time “it allows no external interference and never compromises on its core interests either”.
Sun Weidong also took the opportunity to comment on the Indian government’s moves to accelerate the decoupling of the economies of the two countries. In the last week of July, the Indian government issued orders for the banning of 47 more Chinese apps. It has delayed imports of machinery and other goods from China, and restricted Chinese companies from bidding for contracts in infrastructure projects. Sun Weidong pointed out that in the age of globalisation, the two economies are interconnected and that the “forced decoupling” would adversely impact the economies of both countries: “Whether we want it or not, the trend is difficult to reverse”. He gave the example of German automakers in India complaining of delays because of the lack of spare parts coming from China.
China had lodged a strong protest on June 29 after the first round of banning by the Indian government, saying that the move “severely damaged the legitimate rights and interests of Chinese companies”. But the Indian government seems determined to teach a lesson to the Chinese government, even if it means shooting itself in the foot.
China accounts for 14 per cent of Indian imports and is the source for even rudimentary products such as nails and toothpicks. While alternative sources can easily be found for such products, the fact remains that the electronic and pharmaceutical industries in India are substantially dependent at this point of time on imports and expertise from China. A significant amount of imports are also sourced from Hong Kong. Indian corporates have warned that hasty decoupling will add to the woes of an already beleaguered economy. m