Strain over growth, federalism, reform

Whether or not the economy can handle the tensions between maintaining growth, fiscal federalism and reforms — both those already rolled out and the ones being contemplated — will be the most important economic question of 2020.
As the Indian economy heads into 2020, the biggest question it faces is still about 2019.(ILLUSTRATION: MOHIT SUneja)
As the Indian economy heads into 2020, the biggest question it faces is still about 2019.(ILLUSTRATION: MOHIT SUneja)
Updated on Jan 01, 2020 03:03 AM IST
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Hindustan Times | By

As the Indian economy heads into 2020, the biggest question it faces is still about 2019. After GDP growth plummeted to 4.5% in the quarter ending September 2019, the lowest since March 2013, it remains to be seen whether there is a recovery in the December quarter. India is already facing the longest economic deceleration since December 1999, the earliest period for which we have quarterly GDP growth data. Because this low growth phase has been accompanied by a period of low inflation, which has dragged down nominal growth rates, challenges on the revenue collection side have grown disproportionately. All this comes at a critical juncture. The Indian economy has undergone significant policy reforms, including in taxation, in the past few years. It has been formalised to some extent, albeit forcefully, some believe. Finally, all of this comes even as the government has also delayed finalising of one of the most important arrangements which define fiscal federalism, namely the recommendations of the Fifteenth Finance Commission (FFC).


It is in this backdrop that the economy is entering 2020. Whether or not the economy can handle the tensions between maintaining growth, fiscal federalism and reforms (both those already rolled out and the ones being contemplated) will be the most important economic question of 2020 .

The Indian economy has worked to a fiscal consolidation framework for the past decade. This requires both the centre and the states to keep their fiscal deficits under check, thereby putting curbs on the autonomy of fiscal spending as a policy instrument. In 2016, the government also adopted a monetary policy benchmark by institutionalising an inflation targeting framework. The new arrangement mandates that the Reserve Bank of India use policy rates to balance growth and inflation. Within three years of adopting this reform, the economy is in a situation where repeated rate cuts have not been able to revive economic growth. As a result there is growing pressure on the centre to let go of its fiscal targets to pump-prime the economy. Whether or not the government decides to ignore its fiscal targets by a significant extent to boost growth will be one of the most important policy choices of the coming year.

The roll out of the Goods and Services Tax (GST), one of the biggest tax-reforms ever undertaken in independent India has emerged as a major fault line vis-à-vis both fiscal consolidation and centre-state fiscal relations. The centre missed its GST target for 2018-19 by 1 lakh crore. Missing GST targets is a bigger headache for the centre as it has committed 14% annual growth in tax revenue collected in 2015-16 to states until 2022. State governments have already been voicing their concern about delayed GST compensation from the centre. Even as the centre paid 35,000 crore in compensation to the states ahead of the GST Council meeting earlier this month, these concerns have been growing.

Weak growth has not been the only impediment to revenue growth in the recent period. Low inflation has generated headwinds for achieving revenue targets. At a time when the economic and political establishment has been celebrating the fact that India has managed inflationary pressures in a much better way compared to the first half of the current decade, this has become a big drag on revenue collections because of a collapse in nominal GDP growth, which is the base of tax collections. Nominal GDP growth in the June and September quarters was been much less than the 12% level, which is what the budget assumed. If this continues to be the case, the next year will see a compounding of the fiscal challenge.

To be sure, the problems discussed above will ease significantly with a sustained recovery in economic activity. However, 2020 could see another flashpoint vis-à-vis India’s fiscal federalism. The FFC will be using 2011 population figures for the first time to decide on horizontal allocation of central revenues among the states, and therefore there is a fear that states which have done well on population control; most of them in southern India, could end up being penalised. These economic fears could be exacerbated if they are followed by a political realignment – delimitation of parliament seats – in favour of the high population states later in the coming decade. Such developments cold reopen federal fissures in India’s political-economy framework.

These challenges will have to be addressed along with the existing contradictions between exploiting external tailwinds to growth without increasing domestic vulnerabilities and pushing domestic reforms without creating a popular backlash. India’s decision to stay out of the Regional Comprehensive Partnership Agreement (RCEP) – a mega regional trade agreement including China and ASEAN countries – was an example of the former contradiction driving a policy choice. Ambitious policy reforms such as disinvestment of public sector companies, pushing governance and organisational reforms in government owned banks and railways etc. will also test the government’s political willingness to pursue pro-market reforms amidst political opposition, including from trade unions affiliated to the BJP’s ideological parent Rashtriya Swayamsevak Sangh. A confrontationist approach on these issues might add to the economy’s problems in the next year.

With its dominance in Parliament -- the legislative business conducted in the first two sessions of this Lok Sabha bears testimony to this -- this government can pretty much do what it wants to. The direction the economy will take in 2020 then, will be a function of the government’s political choices and its ability to take all stakeholders into confidence.


    Roshan Kishore is a journalist with Hindustan Times in New Delhi. He focuses on political economy issues with a data-driven approach.

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