Mini Tradeoff + Grand Bargain 2.0 May Bridge GST Deficit, Says Ajit Ranade

Ajit Ranade cites several reasons for why the centre should borrow to compensate states for the shortfall in GST revenue. To begin with, that’s the promise the centre made to states when implementing the goods and services tax in 2017—that it would compensate states’ revenue shortfall for five years, at a 14% increase every year. Also, the centre has many more fundraising options than states, such as dividends from the Reserve Bank of India or borrowing via special Covid, NRI or dollar bonds, pledging public sector entity shares to raise money.“...the centre is eminently more capable of raising funds and it's really seems unfair and also I think wrong I would say because it still is a written contract. So, leaving the states in the lurch or leaving them for their own devices is simply not right—both in letter and spirit,” the economist said in an interview to BloombergQuint. Ranade serves as chief economist of the Aditya Birla Group but was speaking in his personal capacity.If they were to opt for one of the two proposals put forth by the centre, states may end up borrowing at differential rates, based on their individual fiscal situations. Such discrimination was not envisaged in the GST design, Ranade said. “Because the compensation principle did not make any distinction about the rating or about the fiscal deficit or the debt-to-state-GDP ratio of different states. It was an unconditional thing to make up for the shortfall.”The centre has argued that additional borrowing to compensate states, at a time when its own funding needs have soared on account of a contracting GDP, could breach borrowing limits, hurt sovereign rating and push up benchmark rates across the economy. Ranade remains unconvinced. He believes a cash-strapped centre has to consider fiscal expansion even if that may mean a temporary suspension of limits laid out in law..All said and done, fiscal expansion makes sense especially in a downturn. If you’re not going to use that extra fiscal expansion or even temporarily suspend fiscal limits in a severe downturn like this, where else would you be using this flexibility?Ajit Ranade, Chief Economist, Aditya Birla Group.GST Compensation: Defer Centre’s Outgo, Don’t Deny States Their Due - Drabu.Time For A Grand Bargain 2.0.Time is ripe to reform GST, Ranade argues, to bring it “closer to the original design and objectives”.GST is a destinated-based consumption tax but currently doesn’t cover more than 33% of GDP even though consumption constitutes 60-65% of GDP, he points out. Elimination of all but just a few exemptions such that at least 50% of GDP is covered will allow for the standard rate to fall to 12%. In Ranade’s estimates, 12% of half of GDP would easily collect Rs 12 lakh crore, more than current collections.“So, if you do this, incidentally in the middle of a pandemic, we really need a massive fiscal stimulus as we’ve been talking about, an across-the-board reduction in GST rate to 12% is as simple and as big a fiscal booster boost that you can you can get.”Besides, the GST Council should also consider elimination of all classification disputes, simplify the tax design, zero rate exports and remove the anti-profiteering design among other measures to make the tax more efficient, effective and one with higher compliance.He terms this as the Grand Bargain 2.0.But what would constitute an effective short-term solution to the current centre-state stalemate over revenue shortfall?.The states can make an offer that perhaps for the next year we don’t need to insist on 14%, let’s go and rework into a lower number but at least for this year let’s stick to 14%. I think that’d be a face-saver for everybody.Ajit Ranade, Chief Economist, Aditya Birla Group.Most BJP-Ruled States Opt For Rs 97,000-Crore Borrowing Plan To Meet GST Shortfall.Watch the full interview with Ajit Ranade here or read edited excerpts below..What do you make of these two options because one might say in fact there is no option that's been offered to the states. They’ve just been asked to borrow.Ajit Ranade: The statements, also from the finance minister and more recent statements seem to imply that the centre is actually going to redeem the promise and keep the promise. What I mean by that is, that there were two or three concerns.Number one is that the centre seems to be making a difference between the loss of revenue due to GST implementation problems and the loss of revenue due to the severe downturn in the context of the current pandemic. But the 2017 Act and indeed the “written contract”, if I may say so, does not make such a distinction. So it seems unfair to now bring that up.Secondly, they also seem to be offering two different schemes to the states thereby creating kind of a two tier - a differential treatment for the states that also doesn't really go with the spirit of the original guarantee. More importantly, in this context I feel that the centre is eminently in a better position to raise the requisite funding. For example, it has access to RBI dividends; it has access to potentially floating a special bond Covid bond or even NRI bonds or dollar bonds which of course should be carefully evaluated. For example, we had written about a proposal to pledge PSU shares, which are currently valued at around Rs 13 or 14 lakh crore, in a bilateral repo arrangement between the RBI and the centre, which is like a loan against shares. Usually you pledge the shares but they returnable after five years and you can have a loan to value ratio of 100%. Those kinds of arrangements are simply not available to the state governments. If I may draw a parallel, remember organisations like the Indian Railway Finance Corporation or the Power Finance Corporation - these are finance raising organisations which raise money for let's say the railways or the power sector or central government-owned utilities which are by the way inherently loss making. Many of them are loss making, railways certainly maybe just about break even but despite the loss making status of the entities for which they are raising money- the IRFC and PFC and organisations like that enjoy AAA rating in the bond markets which means that they have a special advantage in raising funds at very fine rates because of their sovereign nature. So for all these reasons the centre is eminently more capable of raising funds and it's really seems unfair and also I think wrong I would say because it still is a written contract. So, leaving the states in the lurch or leaving them for their own devices is simply not right - both in letter and spirit. I hope, I believe the Finance Minister’s statements indicate that they will find a way to give the compensation.What this of course leaves out is perhaps if we have time we can discuss that, that 14% guarantee itself was too generous. In fact we said it's generous to a fault but we can't go back to that, but there is some room to renegotiate that but it should be done only after this current year's guarantee is fulfilled, I believe.The centre hasn't even offered to borrow and give states the 97,000 crore rupees that they have ingenuously computed to be on account of GST implementation. The centre argues if it borrows that will impact benchmark rates across the economy whereas states still have headroom to borrow. Do you buy into that?Ajit Ranade: If they are saying that the rate that the states will pay will be exactly the same net of the compensation what they would have paid if the centre had borrowed then perhaps this is feasible but we'll have to look into the fine print..Otherwise it opens up issues like; are you going to reward different states differentially because different states will presumably not command the same rate. So what if there’s a 10, 20 or 30 basis point difference? How would this ‘penalising’ happen?.Because the compensation principle did not make any distinction about the rating or about the fiscal deficit or the debt to state GDP ratio of different states. It was an unconditional thing to make up for the shortfall. What will happen is that if the state governments go to the bond markets, it's quite possible that they will get differential rates and then the compensation back from the centre will depend on the shortfall from state to state. Also, it looks like slowly-slowly; this is getting into the domain of a Finance Commission kind of gap-filling exercise. So that is a statutory exercise which the Finance Commission recommends - that different states are given differentially a share of the divisible pool of taxes.I must say also that at a time when all over the world, people are going full steam on fiscal policy on temporarily suspending the self-imposed limits, on say, the debt to GDP ratio or fiscal deficit ratios, it perhaps is not inappropriate for India also to think the same way including the state governments. So, if they (centre) think that the headroom for borrowing is less, it may be in reference to the limits as imposed by the FRBM law such as it is on paper but even that is being relooked at. So I think the statement that there's not enough headroom itself may not hold water because we have to relook at it..All said and done, fiscal expansion makes sense especially in a downturn. If you’re not going to use that extra fiscal expansion or even temporarily suspend fiscal limits in a severe downturn like this, where else would you be using this flexibility? .So on various counts I think this differential treatment to the states- it goes into the domain of Finance Commission or who is going to be sitting as arbiter to decide that this is fair and unfair. It is simpler for the centre to raise the funds by borrowing, even if that means going above the FRBM limits such as they stand, it is easier because then it will be just sticking to the promise which is a written promise as far as the 2017 Act is concerned.Earlier the Finance Ministry indicated the states would borrow from a special RBI window. We now have clarification from the xpenditure secretary what they actually meant was that the centre would help facilitate the states to be able to issue these bonds in the market; and these bonds would be backstopped by the compensation cess revenue from 2022 onwards. What do you make of this mechanism? Is it really going to help states achieve reasonable rates?Ajit Ranade: If this mechanism is basically to ensure that the states post facto- all of them will get the same rate, then, I think it's okay because what the state or centre may be saying that we can't really violate the pact made back in 1998- which is basically automatic monetisation. So maybe since you don't want to violate that pact or that agreement between the RBI and the centre, that's why you can't directly go and access the RBI window. That's my understanding but I may be wrong and even in that pact, I believe that there were some escape clauses in case of an exceptional situation can actually deviate from even from that fact. So if this is just mechanics but eventually to ensure that the state governments will end up paying for these equally, then perhaps it's worth looking at. But I still feel that the letter and spirit of the promise made; the centre should make extra effort to make sure that it sticks to the letter and spirit of their promise.As I said, let's wait for this year then let's convene a discussion and discuss the original sin- what I call the 14% sin but that's a separate topic. In any case it's even if it was 12% or 10%, even then we would have been in trouble because the shortfall is almost 33%. So, even then we would have had to discuss this topic.One might argue from the centre’s point of view that 14% was always aggressive. Okay yes we made a commitment but technically we can only pay this money from the compensation fund- and the fund hasn't collected enough revenue. Do note last year as well there was a shortfall but the centre used surpluses from the previous two years to make up for that. This year there's just no way to do it. We (centre) are cash strapped, you (states) still have borrowing headroom and why should the onus always be on us? Why do we have to move fast on disinvestment? Why can’t states consider the same for many loss-making state PSUs or cut back on other non-urgent expenditure?Ajit Ranade: That is a very good argument and that was the spirit of the discussion when we did the harmonisation of the VAT rates- the value added tax rates back in 2005. So this was a similar situation - that different states were charging different VATs and it was a mess. So the centre took the initiative to harmonise VAT rates all over India so that there would be no distortions caused by the differential VAT and the states had to be brought on board because they had the same apprehension - that in case your neighbouring state brought its VAT rate down to be in harmony with the neighbouring states, it would lose revenue..So the centre took the initiative and said no, we will compensate you for your loss of VAT revenue but that compensation formula was actually very clever. In the sense that, in the first year you would get 100% reimbursement of the shortfall and the shortfall was decided to be maybe 12% , but more importantly, the second year the shortfall that would be compensated would be 75% and third year would be 50% So, it was like a sliding scale tapering down, which means that there kind of a skin in the game..The states had to put in more tax effort to ensure that they also had a responsibility in collecting taxes or cutting costs. So in the current 14% problem, which is the GST compensation- no such arrangement was done. In the design of this compensation they should have put in first year 100%, in the second year at 75% or 50%, going down so that states incrementally have more incentive to put towards tax effort, tax collection, cost reduction, fiscal deficit management and all that and we don't even have to borrow this idea from other countries. Our own successful VAT design was just 10 years ago. I think we've missed that.I feel that maybe the desire to have this consensus on GST and perhaps to meet a deadline or there was some other political consideration but in the process we lost out on the opportunity to design it in this way but I think given that the pandemic has created such an unprecedented situation, this topic can be reopened at the GST Council I feel because it's only fair ultimately. I've been saying that the centre must honour this promise but I also understand it's only fair that all states in the union together need to bear some of the pain of the downturn.What is the solution now - both short term and long term? In the short term if states borrow what will happen next year because chances are high that the economy is going to take more than 6 to 8 months or 12 months to recover from this pandemic shock and we're going to face a shortfall in the next fiscal as well. How long will the cess be extended for? This solution of borrowing from the market for the states- is that going to work for two years in a row?Ajit Ranade: First of all, let us give ourselves a pat on the back. I mean let us celebrate the fact that India is not finding itself in a dire situation like the EU. The European Union is a monetary union but not a fiscal union and because of the pandemic, there's so much stress and requirement for funds that for the first time in its 70 year history, the European Commission is now floating bonds at the commission level, at EU level and creating a recovery fund. It's small, it's about €750 billion, which turns out to be about just 5% of their collective GDP but they had to resort to this very unusual thing because their fiscal union was not in place. We don't have that problem. We have a very sound system of fiscal union..So I think, to answer your questions, in FY22 perhaps too, we need to also be equally generous I would like to say. If the GST council agrees to a slightly lower than 14% then it’s okay but otherwise we need to find ways to compensate the 14% for the next year as well. .But remember this problem is much longer. It's not as if we are somehow able to solve the FY22 problem, we are in this for longer. This needs a longer structural solution. That's why when you ask me what is the longer term solution? In the longer term solution and we should use this pandemic and this downturn to actually do this radical overhaul of the GST design itself. Thankfully it doesn't need to go back to the Parliament, it can be done at the GST Council level but basically it needs some three or four key reforms to get this GST closer to the original design and objectives.The two-third one third issue and the need for another Grand Bargain as you’ve written about. Why don't you talk us through what you think might be the solution and then I’ll come to you about the timing of it?Ajit Ranade: When I said two-third, one-third problem - the current system is such that two thirds of the revenues are collected by the centre and one third by the states; whereas two thirds of the expenditure obligations of government- the basic services that governments need to provide are at the state and local government levels- cities, municipalities and villages. So, there is an inherent asymmetry in the way the revenue and expenditures are done.Therefore we have elaborate arrangements like the Finance Commission and the GST Council and so on. So we need to recognise this and we need to recognise that the GST, while it's a great reform, the original intent was the following.Number one, it's a destination-based consumption tax..Consumption as a proportion of India’s GDP is about 60% or 65%. So, we need to cover the entire consumption per share of GDP. If not the entire at least-- my guess is even if we reach 50% it will be a big achievement. Currently we’re not even reaching 33% I think. .So if we make it very comprehensive, in short, we just eliminate all exemptions as far as possible so that if 50% of GDP is covered, then we can go down to a standard rate of 12%. 12% of say roughly half of GDP would easily collect 12 trillion rupees or 12 lakh crore which is more than what we are collecting now. Incidentally, the Reserve Bank of India has calculated the weighted average rate as it is implemented today; it turns out to be 11.5%. So it will go above that.Secondly, we need to eliminate all the classification disputes, the discretion, this should be in that category etc, it is too much. It will bring down the rates automatically. The incentive for classification is arbitrary - the kind of disputes or discretion, litigation all that will substantially go down. I believe even compliance will improve. So, that's the second thing.The third thing is that, we need to sort of simplify the system. Currently, we are actually a hybrid because there was a state level GST, we have the centre GST and then we have the inter state GST. So, I don't want to go into the details but there is a research paper from the Pune International Centre which spells it out. It’s on basic principles, it is not are very complicated but when we designed it we just made it too complicated. So, there's a design simplification.Of course we need to zero rate exports. Taxes cannot be exported out of the country if you want to remain competitive. The current system is that the exporter has to pay sometimes as high as 28% GST and then collect a refund. The refund takes six months, nine months and when your profit margins are barely 2% or 3%, it basically wipes you out. So we need zero rate exports.We need to remove this anti-profiteering body. Again, it's just an invitation to more intrusion and all that.So, if you do this, incidentally in the middle of a pandemic, we really need a massive fiscal stimulus as we’ve been talking about, an across-the-board reduction in GST rate to 12% is as simple and as big a fiscal booster boost that you can you can get.Why do you think this is a good time for anyone in the centre or the states at the GST Council - especially given the distrust that is now built up - for them to agree to any of these reforms?Ajit Ranade: An important design element I forgot to mention is that we also need to earmark 2% to the third tier of government- to the local governments, local bodies; state and urban and rural bodies.Actually you say about the trust deficit. So, it's actually an opportunity for the centre to take the lead and sell this idea. I mean everybody's talking about the need for fiscal stimulus. On that, I don't think there is any debate.Everybody, except for the centre. They keep saying we're waiting to see how the economy recovers before we actually put any more money on the table.Ajit Ranade: But now we have evidence now we have -24%, the contraction in this first quarter. Second quarter is likely to be again -12% or -15%, god forbid. So, I don't think we need any more evidence.Earlier argument was that if you're in a strict lockdown, even if you give a fiscal stimulus or try to stimulate demand since people are not out there yet to work (it wouldn’t work), that is fair. But I'm saying, the debate always seems to be where will the centre find the funds for? So, that's a separate discussion. I think everybody is asking and convinced that we need a much larger fiscal stimulus than what has been provided so far. As you know the Rs 20 lakh crore package was 90% all liquidity support. There's not much coming out of the central government's treasury. What we want is stuff coming out of the treasury of the central government.So, reducing GST rates is kind of going to be a hell of a big fiscal stimulus for sure and the shortfall that it will lead to, we'll need to work it out and we'll need to constantly monitor that but I believe that once we start and I also believe that once we have some news on the vaccine or something, there's a good chance that we'll have a V-shaped recovery. It'll still take us time to recover to pre-Covid levels or go back to a somewhat a higher, sustainable growth trajectory but once we have that, perhaps even GST collections will reflect that. So the lower rate and the V-shaped recovery could actually bring us back to GST collections which are very different from now but at least it will be much more comprehensive than what it is today.For example, the exclusion of petrol, diesel and electricity, the goods transported by the road services, all these are just glaring exclusions. They don't need to be excluded.To question these a bite further. For instance, the fact that petrol is not included, it still gives states some leeway of being able to impose their own taxes on this which been one source of revenue in the last several months. That's one issue. Secondly, even if the rates were brought down, there would be a lag for compliance to catch up and therefore this GST shortfall would only widen over the course of next couple of years.Ajit Ranade: When I said that we are in the middle of a very severe recession and this is the opportunity to do this radical reform, I didn't mean to say that GST is the only reform we should look at. There are a lot of other structural reforms that can go together. There are many other supply side reforms- most notably in large areas like agriculture or land markets or labour markets and most importantly, judicial reform. So, there is a very big agenda for reform. So I think GST reforms should be seen in the context of all those things, let me just call them supply side reforms. So there's a demand stimulus but there's also supply side reforms that needs to be ushered in because I think this is what it is..Earlier we thought that we need some fiscal stimulus to come out of this. Now it is becoming somewhat more evident that we’re in a deeper kind of downturn and it has elements of structural features. So, we need structural long term reforms and if that means in the short run, there will be some pain, I think that’s part of the reform. .Remember when the GST was passed in 2017, there was this discussion of the revenue neutral rate. RNR is that you compare the collection for last year or two years ago and ensure that your collection is just going to stay constant. Now that kind of thinking is short term thinking. We just think of two-three years at a time but when you're doing a structural reform, you need to abandon that. That reference doesn't make any sense. In the long run, 5 to 10 years from now, the consumption basket is going to change so much. The digital economy is just growing leaps and bounds. That's going to be captured by GDP. Right now the GST is not capturing that.Incidentally, you mentioned petrol and diesel. The new GST design does not preclude states from imposing additional cess on petrol and diesel; so they will have that flexibility. But you just need to make petrol and diesel as part of the GST so you get input tax credit. It actually improves competitiveness of businesses too.How will these reforms be funded? You said pledging PSU shares etc. but those seem like things that would take at least several months as mechanisms to put in place. You think that debt or deficit monetisation is inevitable?Ajit Ranade: I don't think there's going to be one big idea which goes the entire shortfall. It's all piecemeal. So, we need to evaluate each of these options and perhaps add or contribute in some way. Pledging PSU shares is one idea. As I said, a special Covid long term bond or perhaps even an NRI bond, floating a bond and a little more aggression on disinvestment- that's an idea. Each one of them will contribute. I'm not saying that one of these is the silver bullet, if it goes some ways, it will help.I'm sure there is room to cut spending. When we talk about deficit, we always think about how to raise revenue. But remember, deficit has two sides its X-Y. Also look at where is the scope for reducing costs or removing duplications in various central or state government schemes. There's been talk of monetising land assets.I don't hear you say anything about deficit monetisation.Ajit Ranade: Are you saying automatic monetisation led by the RBI? Then yes. I think that we'll also have to kind of do that.Let's say if you're trying to raise 100, maybe 10 to 20% can be debt monetisation. We’ll have to do that. As I said, the original 1997/1998 pact did have an escape clause. There's a clause which says under the exceptional situations, the monetisation can be invoked. This whole idea of prohibition of monetisation was to discontinue the practices earlier. We used for this ad hoc issue of short term bills. So, to remove that, that's why it was decided that the RBI will never directly buy bonds from the central government but there was an escape clause. Maybe we can invoke that escape clause.What I have not used so far are these words called modern monetary theory. So, let's not go there. The world over, even conventional sort of hawks like Larry Summers the former Secretary of Treasury, even they started talking about resorting to MMT but before MMT, we can surely think of a partial monetisation with it.If you were advising the states on this GST shortfall issue what would you tell them? To pick option one option two or dispute resolution/litigate?Ajit Ranade: I think I will try very hard to come to a consensus. I mean there should be some back channel discussion. We need to understand what the compulsions of the central government are that it's abandoning this promise. I would say it's like abandoning both the spirit and letter. So, we need to have some fractional discussion as to why this is so and find a way to come back to the original agreement..The states can make an offer that perhaps for the next year we don’t need to insist on 14%, let’s go and rework into a lower number but at least for this year let’s stick to 14%. I think that’d be a face saver for everybody..States Need An ‘Act Of Comfort’ On GST, Not A Letter Of Comfort

Mini Tradeoff + Grand Bargain 2.0 May Bridge GST Deficit, Says Ajit Ranade

Economist Ajit Ranade has a face saver-option for the centre and states to end the the GST compensation stalemate.

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