By Sameer Punyani
The announcement that India’s GDP growth slowed to 5.3% last quarter, a 9-year low, was just the latest in a slew of bad news for the Indian economy. The low GDP numbers came after Standard and Poor’s lowered its outlook for the Indian economy in April, the Indian rupee slid to an all-time low in May vis-à-vis the dollar, and trade and fiscal deficits that have only been worsening since the start of the year.
As a recent New York Times front page article aptly pointed out, India’s economic slowdown has “global implications,” and is of particular importance for the U.S.-India relationship. Just as Indian Foreign Secretary Ranjan Mathai implored the U.S. and India to strengthen their economic partnership earlier this year, upon arrival at her new post in India Ambassador Nancy Powell also reiterated the significance of the economic component of the U.S.-India relationship. With this recent data, the sluggish Indian economy is sure to be on the agenda of the upcoming U.S.-India Strategic Dialogue. Yet despite recent struggles, there is a general consensus amongst analysts and economists that India’s economic and fiscal problems are not insurmountable. But where to start? Why not with these three: Foreign Direct Investment, Goods & Services Tax, and General Anti-Avoidance Rules. All are already on the table.
Of late, the Indian government has considered several economic and tax reforms that have either been held up or were reversed due to political pressure.
To begin with, last fall the government decision to allow Foreign Direct Investment into the multi-brand retail sector (supermarkets and “big box” stores) was quickly rescinded after strong and vocal political opposition. This certainly would have adverse effects on India’s mostly mom-and-pop retail shops, yet the overall benefits to the economy from increased investment such as improvements in supply chain management and higher tax revenue would far outweigh the disadvantages.
Second, the current government has made little progress on enacting the Goods and Services Tax (GST), a value-added tax that has been languishing in the central and state parliaments for years. The GST would simplify a tax code riddled with exemptions and broaden the tax base, both necessary steps for India to address its burgeoning debt and deficit.
Third, in May the government delayed the implementation of the General Anti-Avoidance Rules (GAAR), new tax regulations aimed at reducing tax evasion, because its ambiguities troubled investors. Once the objectionable sections are removed, going forward with the GAAR could deter some investors but it would considerably improve tax collection. Allowing multi-brand FDI and implementing the GST and the GAAR would be bold steps towards getting India’s fiscal and economic house in order, but at the moment these reforms remain merely strong proposals and not effective policies.
India’s lack of political will is not only slowing down its reform process, its seemingly erratic economic behavior is also scaring off investors. The situation is so bad that major Indian companies like Tata and pharmaceutical and healthcare giant Piramal are increasingly investing abroad rather than in India, and they are not the only ones. In 2008, FDI into India stood at US $33 billion -twice the amount of Indian investment abroad. But by 2010, that trend had reversed as inward FDI fell to nearly US $20 billion and Indian investment abroad topped US $40 billion, a pattern which continued in 2011. Investor confidence also took a big hit several months ago when the Indian government suddenly implemented a retroactive tax on international transactions creating an uproar in the international business community. India’s vicissitudes have created an unpredictable business environment contributing to slowing growth in foreign investment, a critical component of India’s economic growth and tax revenue.
Economic reforms will be difficult, particularly in a time of economic upheaval in India and around the globe. But Indian Finance Minister Pranab Mukherjee referred to the S&P downgrade as a “timely warning,” instead New Delhi should view the recent economic data as a “call for action.” Implementing the FDI proposals, the GAAR, and the GST will be unwelcome by some segments of the population, but they are necessary to increase government revenues, decrease the deficit, and signal to investors and the market that the government is serious about reform and promoting sustained growth. Despite the recent weariness, foreign investors remain bullish on the prospects for the Indian economy in the long-run. Given current U.S. economic woes, perhaps the upcoming U.S.-India Strategic Dialogue can spur a discussion on how leaders in both countries can advance their respective economic and tax reform agendas in a contentious political environment.
Mr. Sameer Punyani is a research intern with the Wadhwani Chair in U.S.-India Policy Studies at CSIS.