Recent policy changes present an opportunity to reset the economy: Sachidanand Shukla

Sachidanand Shukla, Chief Economist, Mahindra & Mahindra is of the view that global central banks have limited ammunition left. India is dealing with unprecedented economic paradoxes, and is effectively accommodating them in an ‘age of discontinutity’, he says.

In an interview with BusinessLine , Shukla explains how the recent tax cuts and challenges to business model may fuel the engine of growth.

How does recent tax cut impact India’s global position as a business destination and government finances?

The recent corporate tax cuts definitely place India at par with nations having the lowest corporate tax in the region, as well as, the world. However, we must note that corporate tax rate is just one of the variables that induces businesses and investments. There are other factors such as future prospects, policy certainty, ‘ease of doing business’ and rule of law etc., which have a major bearing on the final investment decision.

Prima facie the mixed reaction of capital markets gives us important cues. While equities rejoiced, bonds sulked, given the impact of these tax cuts on the government’s borrowing programme.

As for fiscal deficit itself, the impact is not ‘simply proportional’. Let me explain: the near-term impact of lower tax rate will be smaller than is being assumed. As Prof. Ajay Shah explained recently, when tax rate is cut the distortion in the economy comes down, spurring growth. Concomitantly, efforts made by people to evade taxes also goes down.

By the same token, when tax rate is raised, tax revenues in the near-term rarely meet expectations.

Thus, to summarise, while the jury is out, if the tax cuts manage to “buy” investment growth overtime, the fiscal impact will be mitigated.

Will a reduction of tax on individuals spur demand?

Let us be clear that this tax rate is aimed at incentivising investments over consumption, as it leaves more money behind in corporate pockets. In the current scenario, there is also a clear lack of demand, which this move doesn’t address directly.

In the recent past, we have seen two distinct phases in the economy. First, money was transferred into farmer pockets through loan waivers by states and through direct cash transfers schemes by both states and the Centre through PM Kisan.

Next, we have now seen money being left behind for corporates through tax cuts. Given the state of demand deficiency and the fact that nominal incomes have either stagnated or have been rising anaemically, it is about time the government looks at money being transferred to the tax payer through lower, flat income tax rates, sans any exemptions.

The new Direct Tax Code will most probably give that recommendation. However, note the finances of the government can’t absorb such a transfer currently, and hence may be next fiscal year when government revenues and GDP growth stabilise, we will see this move from the government, which could alleviate the demand side challenges.

How have the recent reforms affected the economy?

India, certainly, has seen a policy reset with big economic policy disruptions of late, and that too in quick succession, and a short period of time. Demonitisation, GST, RERA, IBC, MPC, accounting standard changes, Direct Cash Transfers — each one of these are hugely disruptive. One of the key challenges of our times is to accommodate paradoxes. For ages we have been housed simple problems that entailed simple solutions. But not any more. To quote Peter Drucker: “We are in the Age of Discontinuity”.

While these policies have disrupted the economy and cost us growth and jobs in the short term, they also present an opportunity to reset the economy at a different yet higher plane. This will require changes to business models, policy tweaks etc., but it will help us reach a higher sustainable growth path.

For example, IBC has taught India to “fight fire with fire”. It will free up entrepreneurial energy and capital, which will seed the next investment wave. GST, once it stabilises and teething issues are ironed out, will help raise tax/GDP for the government, volumes for companies and lower tax incidence for consumers.

Global banks are yet again moving towards QE. Your view on inflation and bull run in gold?

The key challenge for the developed world has been lack of inflation. This is despite a stimulative decade post the Lehman crisis, with almost $15 trillion worth of cumulative QE.

Yet, barring US, where growth and employment moved up over the last few years, there is hardly any solace elsewhere. We haven't seen GDP growth, exports, consumption or investment/GDP ratio moving ahead of the past decade averages.

Globally, there still exists huge overcapacity across sectors in terms of manufacturing and services. China is the mother of this overcapacity built-up, especially in manufacturing (and hoarding of commodities). Hence, the fresh wave of quantitative easing (boosting liquidity into financial system) should be inflationary.

But a point also to be noted is, now global central banks have limited ammunition (tools of monetary policy) compared to in the past, and on the demand side, the appetite will still be lower than what we saw during the last cycle of easing.

Therefore, while inflation will go up initially and so will the price of gold as a hedge, but the upside for both is likely to be limited due to the above factors.

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