RBI to Print Rs 1 Lakh Crore to Keep Government Happy

After Lehman Brothers, the fourth largest investment bank on Wall Street went bust in September 2008, the Federal Reserve of the United States, the American central bank, came up with three rounds of large-scale asset purchases (LSAP). The LSAP was popularly referred to as quantitative easing or QE.

Yesterday, Shaktikanta Das, the governor of the Reserve Bank of India (RBI) announced a similar sounding GSAP or G-sec acquisition programme, where G-sec stands for government securities. India now has its own planned QE. (At the risk of deviation, it’s not just the Indian film industry which copies the Americans, our central bank also does.)

The government of India issues financial securities known as government securities or government bonds, in order to finance its fiscal deficit or the difference between what it earns and what it spends. Banks, insurance companies, non-banking finance companies, mutual funds and other financial institutions, buy these securities. Some are mandated to do so, others do it out of their own free will. 

What does GSAP entail? Like was the case with the Federal Reserve and the LSAP, the RBI will print money and buy government securities. For the first quarter of 2021-22 (April to June), the RBI has committed to buying government securities worth Rs 1 lakh crore. The first purchase under GSAP of Rs 25,000 crore will happen on April 15, later this month.

Why is this being done? Among other things, the RBI is also the debt manager for the central government. It manages government’s borrowing programme. After borrowing Rs 12.8 lakh crore in 2020-21, the government is expected to borrow another Rs 12.05 lakh crore in 2021-22. Due to the covid-pandemic and a general slowdown in tax revenues over the years, the government has had to borrow more in order to finance its expenditure and the fiscal deficit.

This information of the government having to borrow more than Rs 12 lakh crore again in 2021-22, came to light when the annual budget of the central government was presented on February 1. Due to this higher borrowing, the bond market immediately wanted a higher return from government securities.

The return (or yield to maturity as it is more popularly know) on 10-year government securities as of January 29, had stood at 5.95%. By February 22, the return had jumped to 6.2% or gone up by 25 basis points, in a matter of a few weeks. One basis point is one hundredth of a percentage. 

The yield to maturity on a security is the annual return an investor can expect when he buys a security at a particular price, on a particular day and holds on to it till its maturity.

As the latest monetary policy report of the RBI released yesterday points out: “Yields spiked following the announcement of government borrowings of  Rs12.05 lakh crore for 2021-22 and additional borrowing of Rs 80,000 crore for 2020-21.”

In May 2020, the government had announced that it would borrow a total of Rs 12 lakh crore in 2020-21. When the budget was presented, the government said that it would end up borrowing Rs 12.8 lakh crore or Rs 80,000 crore more. 

At any given point of time, the financial system can only lend a given amount of money. When the demand for money goes up, it is but natural that the return expected by the lenders will also go up. This led to the bond market demanding a higher rate of return on government securities, pushing up the yields or returns on government securities.

How did this become a bother for the government? When the returns on existing government securities go up, the RBI has to offer higher rates of interest on the fresh financial securities that it plans to issue on behalf of the government to fund the fiscal deficit. This pushes up the interest bill of the government, which the government is trying to minimise. 

Government securities are deemed to be the safest form of lending. Once returns on these securities go up, the interest rates in general across the economy tend to go up, which is not something that the RBI wants at this point of time. The hope is that lower interest rates will help the economy revive faster.

As the debt manager of the government, it’s the RBI’s job to offer the best possible deal to its main client. Hence, post the budget, the RBI got into the job quickly and to drive down returns on government securities launched an open market operation (OMO). As the monetary policy report points out: “Yields subsequently eased somewhat on the back of… the OMO purchases for an enhanced amount of Rs 20,000 crore on February 10, 2021.”

In an OMO, the RBI prints money and buys government securities from those institutions who are willing to sell them. The idea here is to pump more money into the financial system and in the process ensure that yields or returns on government securities go down.

With the GSAP, the RBI has just taken this idea forward. While the GSAP is not very different from the OMOs that the RBI carries out, it is more of an upfront commitment and clear communication from the RBI that it will do whatever it takes to ensure that yields on government securities don’t go up. Like between April and June, the RBI plans to print and pump Rs 1 lakh crore into the financial system. 

Let me make a slight deviation here. In this case, the RBI is also indirectly financing the government’s fiscal deficit. As the debt manager for the government, the RBI sells fresh securities to raise money in order to help the government finance its fiscal deficit.

These securities are bought by various financial institutions. When they do this, they have handed over money to the RBI, which credits the government’s account with it. In the process, the financial institutions as a whole have that much lesser money to lend for the long-term.

By printing money and pumping it into the financial system, the RBI ensures that the money that financial institutions have available for lending for the long-term, doesn’t really go down or doesn’t go down as much,

Hence, in that sense, the RBI is actually indirectly financing the government borrowing. (It’s just buying older bonds and not newer ones directly). A reading of business press tells me that the bond market expects more money printing by the RBI during the course of the year. One particular estimate going around is that of more than Rs 3 lakh crore. In that sense, even if the RBI prints Rs 3 lakh crore, it will indirectly finance around a fourth of the government borrowing given that it is scheduled to borrow Rs 12.05 lakh crore in 2021-22. 

Now getting back to the topic. Like in any OMO, while carrying out a GSAP operation, the RBI will print money and buy government securities. In the process, it will put money into the financial system. This will ensure that returns on government securities don’t go up. In the process, the government will end up borrowing at lower rates.

This is how the RBI plans to keeps its main customer happy. It needs to be mentioned here that with the second wave of covid spreading across the country, chances are economic recovery will take a backseat and the government will have trouble raising tax revenues like it did in 2020-21, the last financial year.

This might lead to increased borrowing on the government front. Increased borrowing without the RBI interfering will definitely lead to the bond market demanding higher returns from government securities. With the GSAP, the hope is that yields or returns on government securities will continue to remain low.

It is worth remembering that Shaktikanta Das’ three year term as the RBI Governor comes to an end later this year. Hence, at least until then, it makes sense for Das to keep Delhi happy.

Of course, the money printing leading to lower return on government securities, will also ensure that the interest you, dear reader, earn on your fixed deposits, will continue to remain low, and the real rate of interest after adjusting for the prevailing inflation, will largely be in negative territory. 

As mentioned earlier, lending to the government is deemed to be the safest form of lending. And if that lending can be carried out at low rates, the other rates will also remain low. This is the cost of the RBI trying to help the government, the corporates and the individual borrowers. It comes at the cost of savers. This is interest that the savers would have otherwise earned.

It is as if the RBI is telling the savers, don’t have your money lying around in deposits. Chase a higher return. Buy stocks. Buy bitcoin. 

If the RBI had let the interest rates find their own level, with the government borrowing more, the interest rates would have gone up and helped the savers earn a higher return on their deposits. This would have also encouraged consumption, especially among those individuals whose expenditure depends on interest income. The argument offered by economists over and over again is that lower interest rates lead to higher borrowing and faster economic recovery.

Let’s take a look at this in the case of bank lending to industry. As of February 2021, the total bank lending to industry stood Rs 27.86 lakh crore. As of February 2016, five years back, the total bank lending to industry had stood at Rs 27.45 lakh crore.

Over a period of five years, the net bank lending to industry has gone up by a minuscule Rs 40,731 crore or just 1.5%. Meanwhile, the interest rate on fresh rupee loans given by banks during the same period has fallen from 10.54% to 8.19%, a fall of 235 basis points.

So much for corporates borrowing more at lower interest rates. This is their revealed preference; the actions that they are taking and not the bullshit that they keep mouthing on TV and in the business media. Currently, the Indian corporate simply isn’t confident enough about the country’s economic future and that’s the reason for not borrowing and expanding, irrespective of the public posturing. 

Anyway, the point is not that higher interest rates are required. But the point is that if the RBI did not intervene like it has been doing, by printing money and buying bonds, slightly higher interest rates which would put the real interest rate in positive territory, would have been the order of the day. And that would have been better than the prevailing situation. A little better for the savers about whom neither the RBI nor the government seems to be bothered about.

But then as I said earlier, the government is the RBI’s main customer these days. And that’s the long and the short of it.

Only 1.7% of Central Govt Petrol Taxes Shared with States – Where Has Cooperative Federalism Gone?

Note: Detailed analysis takes time. Like this piece took three weeks to write. Hence, please continue supporting this effort. Every rupee helps. 

Chintan Patel and Vivek Kaul

The devil, as they say, is always in the detail.

Nevertheless, in an era of instant digital journalism, where you, dear reader, are constantly bombarded with information, the real story, or should we say stories, often get buried under numerous headlines, lazy journalism, government press releases and the false news that is the flavour of the day.

But if one is willing to do some basic number-crunching, like we are, some interesting details and narratives can emerge.

This is one such story of the central government taking both the states and the common man, for a ride and that too in broad day light. At the risk of stretching the metaphor a bit too far, the scene of the crime is the petrol pump and the motive, the dire state of the economy.

But to do this story full justice, we need to set up the background with some dry, academic points as well as digress into some adjacent details.

So, kindly bear with us. While sensational things might get you excited and help us get a few more clicks, but as we said at the beginning, the devil is in the detail.

And here’s presenting the detail.

What’s the point?

Over the years, the central government has been sharing less and less of the overall taxes that it collects, with the state governments. This is the main point we make in this piece. 

The annual budget of the central government is presented in February ever year. The budget is analysed by the media in minute detail.

However, amidst all the analyses, one subject that is often ignored is the financial relationship between the central government and the state governments. After all, much of the services that the government provides are in fact delivered by local and state governments.

It is worth remembering that while the central government collects the bulk of the taxes in the country, it’s the states that the taxes ultimately come from. And given that, this money in one way or another needs to go back to the states.

But does it? The short answer is no. And there is a longer answer which explains the reasons, has some nuance and which forms the heart of this piece.

This piece is divided into three sections. The first section provides a background on how tax revenue is transferred from the central government to the state governments and the role of the Finance Commission.

The second section focuses on a special tax category – cess and surcharge, their increased prominence in recent times, and how that raises prices of petrol and diesel.

The third and final section examines the trend of total transfer of funds from the central government to the state governments.

This is an opportune time for such an analysis, since this year’s Union budget was accompanied by the unveiling of the 15th Finance Commission’s report for the period 2021-22 to 2025-26.

So, read on, to find out.  

Who Gets How Much?

The Constitution stipulates how taxes are collected and split between the central government and the state governments. It empowers the central government as well as the state governments to raise revenues from different sources of taxation.

The central government gets to collect more taxes while the state governments end up with the bigger portion of the expenditure, leading to a mismatch. This mismatch of money that is earned through taxes and other routes and money that needs to be spent, is referred to as a “vertical imbalance”.

Take a look at Figure 1. In 2018-19, the Union Government raised 62.7 per cent of the aggregate resources raised by both the Union and states, whereas the states spent 62.4 per cent of the combined aggregate expenditure. While Figure 1 shares data for just one financial year, what’s true for 2018-19 has also been true for other financial years.


Figure 1: Vertical imbalance (2018-19)

           Source: 15th Finance Commission Report. 

To offset this imbalance, the Constitution provides mechanisms for intergovernmental transfers – the transfer of funds from the central government to the state governments. A key player of this setup is the Finance Commission.

The Finance Commission (FC) is an advisory body that is appointed by the President every five years and which evaluates the state of finances of the central as well as the state governments, and determines how taxes collected by the central government are to be distributed between the central government and the state governments, and among the state governments.

Over and above this, the FC also recommends grants to states based on revenue needs, grants for local governments and grants for specific purposes e.g. health sector grants etc. Thus, there are two broad channels of transfer of funds under the FC umbrella – i) devolution of taxes, and ii) grants. 

At the heart of the idea of intergovernmental transfers and tax devolution is the concept of ‘divisible pool’. The divisible pool is the portion of the taxes (technically referred to as the gross tax revenue) collected by the central government, which is distributed between it and the state governments. What this means is that all the taxes collected by the central government aren’t shareable with the state governments.

Till the tenth FC which tabled its report in 1995, only union excise duties and personal income taxes made up the divisible pool. Under this arrangement, 85% of the personal income taxes and 40-45% of excise duties were shared with the state governments.

In 2000, the tenth FC recommended a constitutional amendment to expand the divisible pool to all central taxes. The central government accepted this recommendation and the 80th Amendment was passed making a certain portion of  central government taxes shareable with the state governments, effective retrospectively from April 1, 1996.

Further, the portion of the divisible pool that is shared with the states is referred to as the devolution of taxes and is determined by the FC. Before the14th FC which came into effect from April 2015, 32% of the divisible pool was shared with the states.

The 14th FC increased the share of the state governments in the divisible pool to 42%. At the same time, the sector-specific grants were eliminated. This decision was primarily in response to grievances expressed by the state governments. State governments prefer funding through devolution since such transfers are unconditional.

Other transfers of money, whether they are through FC grants, or through channels outside the FC (like schemes from central government ministries) impose policy priorities set by the central government over the state governments, compromising the latter’s fiscal flexibility or the ability to spend money as the state government deems fit.

To give an example, a FC health-sector grant can only be used for health spending by the states, or funds transferred to the states under Pradhan Mantri Gram Sadak Yojana can only be used to make roads.

When state governments have more flexibility in allocating funds for various initiatives, they can craft policy that is more responsive to the needs on the ground than having to blindly follow policy that is framed in New Delhi.

The 14th FC recognised this and increased the state share of the divisible pool from 32% to 42%. The intent behind this increase was not to increase the amount of transfers but rather change the composition of the transfers – from diverting conditional funds to diverting unconditional funds, to state governments.

The 15th FC tabled in 2021 lowered the divisible pool marginally to 41%, from the earlier 42%. The is because Jammu and Kashmir is no longer a state and the money allocated to it has not been counted as transfer to a state government. Given this, the 15th FC has kept the divisible pool distribution unchanged.  

And now we come to the most important point of this write up. A key detail in this entire discussion is that the only tax revenue that is excluded from the shared divisible pool are different kinds of surcharges and cess.

As we shall see next, this exclusion has proved to be the back door that the central government has been using to divert funds from the states governments’ kitty to its own.

A Tale of Two Taxes

Before we get into the details, let’s first try and understand what surcharge and cess actually are.

A cess is tax on a tax imposed by the central government attached to a specific purpose. For example, an education cess collected should be utilised only for financing education and not for any other purpose. It is worth remembering here that the education cess is imposed on the total income tax and not on the total taxable income.

Hence, as explained earlier, it is a tax on a tax. Examples include infrastructure cess on petrol and diesel, krishi kalyan cess, health and education cess on Income Tax, etc.

In theory, money collected under a cess is to be spent on the specific purpose for which it is collected but that’s not always the case.

A Comptroller and Auditor General (CAG) report for 2018-19 indicates that only Rs 1.64 lakh crore of the Rs 2.74 lakh crore or around 60% of the amount collected from cess and surcharge during 2018-19 had been transferred to their respective funds. Around 40% was still retained in the Consolidated Fund of India, which is the general-purpose fund of the Indian government.

The provision of levying a cess was intended to be used for shorter specific purposes. So, the procedure for introducing a cess is comparatively simpler than introducing new taxes, which usually require change in the law.

Coming to surcharges, a surcharge is also a tax on a tax, but is not tied to a specific purpose like a cess is. Let’s take the example of the surcharge on income tax. It is an added tax on the taxpayers having a higher taxable income during a particular financial year. So, an individual having a taxable income  between Rs 50 Lakhs and Rs 1 crore pays an income tax surcharge of 10%.

Further, an individual with a taxable income between Rs 1 crore and Rs 2 crore, pays an income tax surcharge of 15%, and so on.

Note that this surcharge is only on the base income tax, not on the income itself. So, if an individual earning Rs 1 crore in a year needs to pay an income tax of Rs 20 lakhs, the applicable surcharge would be Rs 2 lakhs (10% of 20 lakhs).

A surcharge can be utilised for any purpose of the government, without having to bend the rules, like they do sometimes for cess collections.

In the last few years, these surcharges and cess, which do not need to be shared with the state governments, have become the central government’s go-to tools to address the tax revenue shortfall.

Take a look at Figure 2a, which basically plots the total amount of surcharges and cess collected by the central government over the years, along with the surcharge and cess it hopes to collect during 2021-22, the current financial year.

Figure 2a: Total cess and surcharge revenue (in Rs crore).

Source: Union budget documents.  

Figure 2a clearly shows that the general trend is upwards, with small blips in 2017-18 and 2018-19. The government expects to collect total surcharges and cess of Rs 4,45,822 crore (revised estimate) in 2020-21.

This is surprising given that overall tax collection during the year is expected to come down. In comparison to the years before 2020-21, the collections for 2021-22 are also expected to be at a very high Rs 4,48,821 crore.

The collections of cess and surcharge surged from Rs 2,53,540 crore in 2019-20 to Rs 4,48,822 crore (RE) in 2020-21, an increase of a whopping 77%. This huge increase is almost entirely due to increased cess and surcharge on petrol and diesel – in particular, the road and infrastructure cess and the additional duty of excise on motor spirit (which is a surcharge), which increased by Rs 1,92,792 crore. Motor spirit is the technical term for petrol.

The increased reliance on cess and surcharge is also seen in Figure 2b below, which plots the total cess and surcharge earned by the central government as a proportion of the Indian gross domestic product (GDP). This is done in order to take the size of the Indian economy into account as well.

Figure 2b: Cess and surcharge revenue expressed
as a proportion of the GDP (in %).

Source: Union budget documents.

The above figure makes for very interesting reading. The total amount of cess and surcharges earned by the central government went up from 1.25% of the GDP in 2019-20 to 2.29% of the GDP in 2020-21, a massive jump of 104 basis points. Some of this jump was obviously because the size of the economy or the GDP is expected to contract in 2020-21. Nevertheless, the fact that cess and surcharges collected by the government went up in a year when the economy contracted, does come as a surprise.

In Figure 3, let us look at the breakdown between cess and surcharges earned by the central government over the years. Looking at the below figure it is evident that cess collections form the bulk of the total revenue.

Figure 3: Cess and surcharge breakdown (in Rs crore).

Source: Union budget documents.

Clearly, cess is bringing in more money for the central government, though the contribution of surcharges has also jumped up since 2019-20.

Now let’s try and understand, why has the central government increasingly become more dependent on earning money through cess and surcharges, and in the process it is sharing lesser proportion of taxes with the state governments.

This increased reliance on cess and surcharges in the last two years can be understood when one looks at what is happening with the total tax revenue. Figure 4 plots the total taxes earned by the central government or gross tax revenue as a proportion of the GDP.

Figure 4: Gross tax revenue as a proportion of GDP (in %).

Source: Union budget documents 

While the negative economic impact of the covid pandemic has been a telling blow, the downward trajectory in tax collections of the central government had started as far as back as 2018-19. The twin economic debacles of PM Modi’s first term – demonetisation and a shaky GST implementation – meant the economy was already tottering before the covid pandemic hit.

An obvious casualty of this slowdown has been a declining tax revenue as a proportion of the GDP. In the normal scheme of things, this would have meant that the central government would have ended up with lesser taxes for itself, after sharing with the state governments.

But this fall has been cushioned with the central government earning a higher amount of taxes through cess and surcharges (as can be seen from Figure 5).

Figure 5: Cess and surcharge as a proportion of total central government taxes. 

Source: Union budget Documents
RE = Revised Estimate
BE = Budget Estimate

 In 2019-20, the total taxes earned by the government or the gross tax revenue had stood at Rs 20.1 lakh crore. In 2020-21, it is expected to fall by 5.5% to Rs 19 lakh crore. The net tax revenue of the central government (what remains after sharing taxes with the state governments) in 2019-20 was at Rs 13.59 lakh core.

This is expected to fall to Rs 13.45 lakh crore in 2020-21, a fall of 0.9%, which is much lower than the 5.5% fall in gross tax revenue. While, the total gross tax revenue is expected to fall by Rs 1.1 lakh crore (Rs 20.1 lakh crore minus Rs 19 lakh crore), the net tax revenue is expected to fall by just Rs 14,000 crore (Rs 13.59 lakh crore minus Rs 13.45 lakh crore). 

In percentage terms, in 2019-20, the central government kept 67.6% of the taxes for itself in 2019-20. This shot up to 70.8% in 2020-21. 

Clearly, the state governments have been short-changed here, with their share of taxes falling from Rs 6.51 lakh crore in 2019-20 to Rs 5.5 lakh crore in 2020-21, a fall of a little over Rs 1 lakh crore or 15.5%, in such economically difficult times.

This is primarily because the share of cess and surcharge in total taxes collected by the central government has jumped from 12.67% in 2019-20 to 23.46% in 2020-21. Do remember that cess and surcharges are outside the divisible pool.

So, when the inflow of these taxes increases, the central government gets to keep all the revenue, as opposed to sharing 41% (15th FC guideline) with the state governments. So, it is far more efficient for the central government to increase cess and surcharge when it needs to increase tax collection. 

This overuse of cess and surcharges by the central government has not gone unnoticed. In fact, the chairman of the 15th FC, NK Singh has talked about introducing a constitutional amendment to include them in the divisible pool.

As he said

“I see no viable solution except a constitutional amendment. If that constitutional amendment is introduced, recognizing some proportion of cess and surcharge to the divisible pool, it will certainly allow greater flexibility to the successive Finance Commissions subsequently to be able to calibrate a framework.”

Ultimately, as we said at the very beginning, whatever might be the term used, a tax, or a cess or a surcharge for that matter, it is being paid by people. And hence, the money thus collected should be shared with the state governments.

How does all this affect you, dear reader?

If you have managed to make it thus far, many of you by now would be like how much gyan are these guys going to give. Why can’t they tell me straightaway how does all this impact me or the world at large or the aam aadmi?

Well, sometimes it is important to take a look at the bigger picture first and then arrive at how it impacts all of us.

The government’s increased reliance primarily on cess actually has had a direct impact on most citizens – in the form of increased prices at the petrol pump.

The biggest contributor to the spike in cess collection over the last two years has been cess collected on the sale of petroleum products. The figure below charts the total cess collected on petroleum products (crude oil, petrol and diesel) over the last five years. While the cess on petrol formed at least 50% of total cess each year, it was as high as 69% of the total cess revenue in financial years 2019-20 and 2020-21. 

Figure 6 clearly shows that the government has resorted to taxing petrol and diesel to make up for revenue shortfalls. This conclusion is hardly a revelation to anyone paying attention to prices at the pump, but the numbers help understand the government’s motivation.

Figure 6: Total cess on petroleum products (in Rs crore).

Source: Union budget documents

There is another way of looking at the cess on petrol and diesel. Table 1 below gives a breakdown of the union taxes on petrol and diesel for 2020-21 and 2021-22. Note that the table below only analyses central excise tax and excludes customs duty. There are technical complications in figuring out the per litre customs duty.  

Table 1: Central government tax breakdown on petrol and diesel.

Source: https://www.ppac.gov.in/content/149_1_PricesPetroleum.aspx

 

The total union excise duty on petrol and diesel, in 2021-22 are Rs 32.90 per litre and Rs 31.80 per litre, respectively, which are marginally lower than the previous year. All taxes other than basic excise duty, including special additional excise duty, which is a surcharge, are exempt from the divisible pool.  

1) For 2021-22, only ~5% of the excise taxes on petrol and diesel will go to the divisible pool. The rest (~95%) will be kept by the central government. In 2020-21, this portion was at around 91% for petrol and 85% for diesel. Clearly, the government is keeping a greater share of petrol and diesel taxes for itself.

2) The above point does not clearly bring out the gravity of the situation. Let’s do a simple calculation to show that. In 2021-22, the total excise duty on petrol stands at Rs 32.90 per litre. Of this, the basic excise duty of Rs 1.4 per litre is the only part which is a part of the divisible pool and hence, will be shared with the states. It is worth remembering only 41% of this or around 57 paisa per litre needs to be shared with the state governments.

What this means is that just 1.7% of the total excise duty earned by the central government per litre of petrol will be shared with the state governments. It was at 3.8% in 2020-21.

3) Now let’s carry out the same exercise for diesel. The total excise duty earned by the central government on the sale of one litre of diesel will be Rs 31.80 during 2021-22. Of this only Rs 1.8 per litre will be shareable with state governments. 41% of this amounts to around 74 paisa per litre.

This amounts to around 2.3% of the total excise duty of Rs 31.8 per litre earned by the central government per litre of diesel. It was at 6.4% in 2020-21.

4) In 2021-22, a new agriculture infra cess has been introduced. It amounts to Rs 2.5 per litre on petrol and Rs 4 per litre on diesel. This has led to the reduction of basic excise duty on petrol from Rs 2.98 per litre to Rs 1.4 per litre and that on diesel from Rs 4.83 per litre to Rs 1.8 litre. As mentioned earlier, only the basic excise duty needs to be shared with the state governments.

Hence, by introducing a new agriculture infra cess, the central government has ensured that state governments get an even lower share of taxes from petrol and diesel in 2021-22.

The general public is quite sensitive to price rise at the petrol pump since it is a highly visible and recurrent cost. That the government has still resorted to this strategy for increasing revenue, speaks to the lack of better options – a fact that is a direct consequence of the tepid economic scenario even before the pandemic began. Of course, the covid pandemic has only made things more difficult for the government on tax front.

Nonetheless, things are even more difficult for state governments, which don’t have many avenues to raise tax. Clearly, this amounts to the centre shortchanging the state governments during difficult economic times.

Oh wait, there is more – Total intergovernmental transfers

Other than the divisible pool of taxes, there are other channels of intergovernmental transfers between the central government and the state governments. So, to get the complete picture on the flow of money from the central government to the state governments, it is instructive to examine the total intergovernmental funds transferred in more detail.

Before diving into those details, a brief overview of intergovernmental transfers would be useful. Figure 7 below is a good graphical representation of all the ways in which the central government can transfer funds to the state governments.

Figure 7:  Vertical fiscal transfer channels. 

Source : Asian Development Bank

Broadly speaking there are two instruments of fund transfers.

1) Finance Commission funds: As discussed earlier, this includes the 41% of the divisible pool revenue, general-purpose grants for states with weak revenue raising capacity and specific purpose grants for funding local governments (panchayats and municipalities) and funding certain specific initiatives (eg. health-sector grants by the 15th FC). Most of the funds provided via the FC channel are not conditional and don’t require state government contributions.

2) Funds from central ministries: In addition to the FC funds, the central government also gives specific purpose grants through the respective ministries. These funds are transferred either through centrally sponsored schemes or central sector schemes. Central sector schemes are entirely funded by the central government. Some examples include the free LPG connections provided to poor households, crop insurance scheme etc.

The centrally sponsored schemes require a matching component from the state governments i.e. they have to fund a portion of the scheme. Examples of this include the Pradhan Mantri Gram Sadak Yojana, the Swachh Bharat Mission etc.

As Figure 7 shows, the mechanism of intergovernmental transfer underwent a major transformation in 2015. Two things led to this. Firstly, the 14th FC gave its recommendations for increasing the devolution share of state governments from 32% to 42% and eliminating a host of specific purpose grants. The underlying rationale was to change the composition of state transfers to increase the “no-strings-attached” outlays and reduce conditional grants to give state governments more financial headroom.

Secondly, the newly elected NDA government disbanded the Planning Commission and replaced it with the NITI Aayog. While the NITI Aayog has some shades of resemblance with the Planning Commission, the five-year plans, which was the responsibility of the Planning Commission, were scrapped.

The five-year plans would have their own grants for states in the annual budget of the central government. The establishment of the NITI Aayog and the approval of the 14th FC recommendations were two initiatives that formed the basis the oft-cited “cooperative federalism” mantra of the NDA government, especially in the early years.

The argument put forth to claim this catchphrase was that the Modi-led administration was reversing the centralising tendencies of earlier governments and ushering in an environment where states had greater fiscal autonomy.

Does the data corroborate these claims? Let us examine. Figure 8 below charts the tax devolution to states as a portion of the gross tax revenue.

Figure 8: Tax Devolution vs Gross Tax Revenue (in %).

Source: Union budget documents

  

Some interesting observations can be made from Figure 8.

1) The first few years after the 14th FC came to effect (April 2015) saw a significant increase in the portion of taxes devolved to the states.

2) This increasing trend of devolution peaked in 2018-19 when the devolution was 36.6%. The last three years have seen this number come down, with the 2020-21 figure (~29%) close to the pre-2015 levels. So, all the talk about cooperative federalism has gone for a toss, in the last few years.

3) Note that these numbers don’t reflect the 32% (pre-2015) or 42% (post-2015) devolution share prescribed by the FC since cess and surcharge revenue is not devolved. This also explains why the devolution percentage has dipped sharply in the last two years, a period when cess revenue has had a corresponding increase (as shown earlier in Figure 5).

While the 14th FC may have been the catalyst, the Modi government can rightfully claim credit for strengthening fiscal federalism, at least in its first term. However, most of these gains have been reversed in their second term. This justifies N.K Singh’s lament

“ It should not be a cat and mouse game that every finance commission raises the devolution number and it then neutralised simultaneously by an increase in cess and surcharge leaving the states where they were, nor the opposite way.”

Next, in Figure 9, let us look at the total transfers made to state governments in recent years, not just tax devolution. The total transfers to states includes tax devolution, finance commission grants, centrally sponsored schemes, central sector schemes and other miscellaneous items listed as state transfers in the union budget.

The figure below charts the total transfers made to states as a percent of the total expenditure of the Union government.

Figure 9: Portion of total expenditure of central government
transferred to state governments (in %).

Source: Union budget documents

 There are two caveats on the chart above.

1) Starting 2014-15 there was a change in how expenditure for central schemes was routed to the states. The figures for 2013-14 have been adjusted to make the comparisons with the subsequent years correctly.

2) We have excluded loans made to states from the total transfer amounts and only included grants and devolution, since loans do need to be repaid.

That said, these figures also lead to similar observations made from Figure 8. The period from 2015-16 to 2018-19 (roughly co-incident with NDA’s first term) had a significant increase in funding to the state governments.

While the increased devolution of taxes could be attributed to the recommendations of the 14th FC, the increase in total transfer of funds was certainly government policy. The last two years (and the projections for the next year) show a steep decline in the intergovernmental transfers.  
The huge spike in cess and surcharge collections which are not shared with states and declining tax revenues during this period contributed to this effect.

There are two other conjectures one can make based on the trends seen above. First, when Narendra Modi won in May 2014, he was a sitting chief minister and his perspective on governance was heavily biased towards the challenges of governing a state.

Hence, financial outlays were perhaps favourable to the states. In the second term, he was well-entrenched as a national leader and the instincts were now honed favouring centralisation.

Second, the Bhartiya Janata Party has adopted an increasingly overt approach favouring homogenisation of the country. Whether it is the abrogation of Article 370, the passage of national farm laws, or flirtations with one-nation-one-language, it is evident that impulse is towards uniformity and centralisation. In this context, the trend of holding back funds from states, seems a natural accompaniment. 

Vehicle Scrapping Policy is Half-Baked and More About Feeding a Constant Narrative

Late last week the central government announced the vehicle scrapping policy (VSP). As the Minister for Road Transport and Highways, Nitin Gadkari, put it in the Parliament, the aim of the VSP is to create “an eco-system for phasing out of unfit and polluting vehicles”.

So how will this be put into action? Using the public private partnership (PPP) model involving the state governments, private sector and the automobile companies, the central government plans to promote the setting up of automated fitness centres (AFCs). 

These AFCs will issue vehicle fitness certificates to private vehicles and commercial vehicles based on emission tests, braking, safety equipment among many other tests which are as per the Central Motor Vehicle Rules, 1989.”

A commercial vehicle which is 15 years old and fails the vehicle fitness test will be declared an end of life vehicle and scrapped. Similarly, a private vehicle which is 20 years old and fails the vehicle fitness test will be declared to be an end of life vehicle and scrapped. Further, if owners don’t renew the registration certificate, their vehicle may be declared as an end of life vehicle and scrapped.

In order to disincentivise commercial vehicle owners who own vehicles which are 15 years old, from continuing to use them, even if they clear the vehicle fitness test, the fee for the fitness certificate and the fitness test will be set on the higher side. For private vehicle owners with vehicles which are 15 years old, the re-registration fee will be set on the higher side.

The point being that if you have a private vehicle which is 20 years old or perhaps even older, the government wants you to stop using the vehicle and buy a new one, irrespective of what state it is in. For commercial vehicles, the same logic applies for vehicles which are at least 15 years old.

And the expectation is this will lead to lower pollution, newer cars, safer pedestrians, more spending, more investment and more jobs. QED.

The minister expects additional investments of Rs 10,000 crore and 35,000 job opportunities to be created because of this.

It will also lead to banks and non-banking finance companies (NBFCs) giving out more loans. Of course, given that the auto industry and the auto-ancillary industry use a lot of contract workers, one could possibly argue that this could lead to more work opportunities for them as well. 

The question is how will things really play out? Let’s try and understand that in some detail.

Economics is basically the study of incentives and second order effects. The trouble is that politicians and policy makers don’t keep this in mind while designing policy, particularly the second order effects of what they are proposing.

Let’s try and understand this pointwise.

1) There are a total of 1.02 crore vehicles, both commercial and private, which fall under the defined category of older vehicles. Even if a small proportion of these vehicles are scrapped they will generate a huge amount of non-biodegradable waste.

What plans do we have to handle all this waste coming our way? As the press release announcing the policy pointed out: “Efforts are also being made to set up Integrated Scrapping Facilities across India.” Even while taking into account that this policy will be implemented over the next few years, this sounds too much like work in progress than definitive economic policy. One needs a lot more clarity on this front. 

2) As a way to get the scheme going, the government first plans to scrap its older vehicles. As the press release announcing the plan puts it: “It is being proposed that all vehicles of the Central Government, State Government, Municipal Corporation, Panchayats, State Transport Undertakings, Public Sector Undertakings and autonomous bodies with the Union and State Governments may be de-registered and scrapped after 15 years from the date of registration.” This is supposed to be implemented from April 1, 2022 onwards, or little over a year from now.

Why have this blanket policy at a time when governments, in particular state governments, are already short of money? Why not look at the fitness of vehicles and then decide? If at all, vehicles of the central government and the public sector enterprises tend to be decently maintained.

3) Also, the assumption here is that only older vehicles cause pollution. The manufacturing of newer vehicles needs electricity. Most electricity in India is generated by burning coal, which causes pollution. Steel goes into the making of vehicles. The process of making of steel, releases carbon dioxide into the atmosphere. That causes pollution as well. The same is true of plastic and pretty much everything else which goes into the making of vehicles. Hence, every new vehicle that is produced has a carbon footprint. 

Of course, all this pollution doesn’t show up in cities where most private vehicles are driven and tends to be well distributed across the country. But shouldn’t a policy that has lower pollution as one of its key points, take this basic factor into account as well? Further, we need to consider the fact that many older private vehicles are not constantly in use. 

4) As I have explained earlier, the government wants private and commercial vehicle owners to buy new cars. Of course, as and when this happens, the automobile companies are supposed to benefit. This explains why companies have come out in favour of this policy (or even otherwise, when do Indian businessmen ever disagree with the government). But this doesn’t take a very basic factor into account.

Whatever we might like to say about the new India and such things, we are a poor country at the end of the day. And covid has only made things even more difficult by pushing many more people into poverty, as health bills have mounted, incomes have crashed and small businesses have gone bust.

Hence, assuming that people will go out and buy new vehicles if the older vehicles are scrapped or because re-registration is made more expensive, is just looking at first order effects of policy, in the same way that economists tend to believe that lower interest rates always push up consumption. 

Private vehicle owners who are not heavy users of their vehicles, might just prefer to use Uber or Ola or even the metro infrastructure coming up across India’s major cities. (This reminds me of a time when the government kept telling us that slower automobile sales were primarily because of Uber and Ola).

Further, owners might financially not be in a position to buy a new vehicle. Already, the trucking industry has spoken up against the idea.

Also, even if owners buy a new vehicle, they might cut consumption on something else given that there is only so much money going around. Hence, net-net, the impact on the overall economy may not be much.

The trouble is that the costs of second order effects are not so obvious and straightforward, whereas the supposed benefits are easy to convey in a simplistic way. And politicians love stuff which they can convey in a simplistic way.

5) Kitna deti hai (how much does it give?), goes a Maruti advertisement, telling us that Indians are price conscious value for money consumers. And there is nothing wrong with this, given that an automobile is probably the second most expensive thing we buy during our lifetime. So, while the idea that old polluting vehicles need to be discarded is a noble one, what is in it for the consumer?

This is what the government is planning. a) The owner will be paid 4-6% of the showroom price of a new vehicle, when his old vehicle is scrapped. b) The state governments may be advised to offer a road- tax rebate of up to 25% for personal vehicles and up to 15% for commercial vehicles. c) The vehicle manufacturers are also advised to provide a discount of 5% on purchase of new vehicle against the scrapping certificate. d) The road transport minister has requested the finance minister and states to give a concession in goods and services tax (GST) on purchase of new vehicles.

There are too many ifs and buts in the above paragraph. As usual, the government seems to be in a hurry to announce and implement a policy. As I have said in the past a massive cut in GST on automobiles will encourage buying. What the government will lose out on per unit of sales, it is more than likely to make up for through volumes. 

One understands that the road transport minister cannot ensure all of this on his own, which is why it is important that the government spends some time in discussing and figuring out how to design and implement policy. Also, it is important to carry out small experiments in union territories, before announcing policies which need to be implemented across the length and the breadth of the country.

As Vijay Kelkar and Ajay Shah write In Service of the Republic

“The safe strategy in public policy is to incrementally evolve—making small moves, obtaining feedback from the empirical evidence, and refining policy work in response to evidence.”

But the trouble is that small moves involve a lot of time, effort and thinking, which is very difficult for a government which believes in constant action and constantly creating new narratives to keep people busy and happy. The narrative also feeds into the idea that the government is trying to do new things. 

6) Take a look at what happened to two-wheeler sales in 2019-20 (This is before covid struck). Sales fell by nearly 18% year on year to 17.42 million units, as the price went up due to various reasons. Hence, India is a very price sensitive market and the point is that there has to be a huge benefit involved in buying a new vehicle in a tough economic environment.

While the notion of pollution control is a noble one, it is not something which is going to get people to go out and buy new vehicles, unless it is very clear what is in it for them. Ultimately, if you want people at large to behave in a certain way, the right incentive should be on offer, something this half-baked policy, like the policy to encourage electric vehicles before it, lacks.

To conclude, one does wonder, what were they doing all these years, given that the policy has been on the anvil for a while now. 

Women Are Bearing the Brunt of India’s Unemployment Problem

This piece is an extension of a piece on unemployment I wrote sometime back. Nevertheless, you don’t have to read that piece in order to make sense of this.

Honestly, this is probably the most disturbing data driven piece that I have ever written, despite the fact that I started writing on the issue of unemployment more than half a decade back, when it wasn’t very fashionable to do so.

The brunt of India’s unemployment problem is being borne by women. This is not to say that the men are having an easy time. They aren’t, given that many more men enter the labour force than women.

Nevertheless, the proportion of women who are employed and get paid was low to start with, and it has become even lower over the years. This, at a time, when more and more women are going to school and college.

As the All India Survey of Higher Education for 2018-19 points out: “Total enrolment in higher education has been estimated to be 3.74 crore with 1.92 crore male and 1.82 crore female. Females constitute 48.6% of the total enrolment.” But all this education isn’t helping them find paid employment.

Let’s start with the unemployment rate for men and women. The following chart plots this data since January 2016.

Source: Centre for Monitoring Indian Economy.

The above chart tells us several interesting things.

1) The unemployment rate for women is significantly higher than that of men. In February 2021, the unemployment for women stood at 12.39% whereas for men it stood at 6.23%.

2) The unemployment rate for women in February 2021 is much lower than it was in January 2016, when Centre for Monitoring Indian Economy (CMIE) published the unemployment data for the first time. Have things improved? Keep reading to know the answer.

3) The peak unemployment rate for women during covid was 29.22% as of April 2020. The rate has fallen since to 12.39%, as of February 2021. Again, have things improved?

In order to answer the questions raised above, we need to understand how unemployment is defined. (For those who have read the earlier piece I wrote on unemployment, the next few paragraphs may seem like a repetition, which they are. I have repeated these paragraphs, simply because it is important for every piece to stand on its own, so that first time readers can also read and understand it easily).

A person is categorised as unemployed “because of a lack of job and where such a person is actively looking for a job”. The word to mark here is actively. Hence, a person can be categorised as unemployed only if he doesn’t have a job and is searching for one.

As the Centre for Monitoring Indian Economy (CMIE) puts it, a person categorised as unemployed, “should be unemployed on the date of the survey, should be actively looking for a job in the 100 hundred days (approximately three months) preceding the date of the survey and should be willing to take up the job if a job is found.”

They further point out: “A person is considered to be actively looking for a job if such a person has contacted potential employers for jobs, contacted employment agencies, placement agencies, appeared for job interviews, responded to job advertisements, online employment sites, made applications, submitted resumes to potential employers or reached out to family members, friends, teachers to look for jobs from them.”

To put it in short, waiting for a job offer to come, is not considered as actively looking for a job.

Let’s move on and plot the next two charts, the labour participation rate for men and women.

Source: Centre for Monitoring Indian Economy.

Source: Centre for Monitoring Indian Economy.

Before we interpret these charts, we first need to define what labour participation rate is. Labour participation rate is the ratio of the labour force to the population greater than 15 years of age. And what is the labour force? As per CMIE, labour force consists of persons who are of 15 years of age or more, and are employed, or are unemployed and are actively looking for a job.

Now we are in a position to interpret the above two charts. Let’s do that pointwise.

1) The labour participation rate for women is miniscule on the whole. In February 2021, it stood at 9.42%. What does this mean? It means that a very small proportion of women over the age of 15, are employed and get paid for it or are unemployed and are actively looking for. a job. And the tragic part is that this rate is falling. It was at 17.7% in May 2016. Since then it nearly halved.

2) The labour participation rate of men is considerably higher. It was 67.82% in February 2021, even though it has been falling. Hence, two in three men over the age of 15, are employed and are getting paid for it, or are unemployed and actively looking for a job. For women, this ratio is less than one in ten. That’s the difference between the two sexes and it’s huge. 

3) Urban women are in a much worse position on this front. The labour participation rate for urban women stood at 6.56% in February 2021. The rate had peaked at 16.58% in August 2016 and has been falling ever since. What does this mean? It means that it is more difficult for a woman to be employed and get paid, if she is in urban India than in comparison to rural India.

Also, the dramatic fall in the rate since August 2016, tells us that once a woman loses a job or a source of income, it is very difficult for her to get it back. And finally, very few women in urban India are stepping out of their homes to go to work and get paid for it. This has only increased post the spread of covid. The labour participation rate for women was 9.92% in January 2020. It’s not at 6.56%.

4) Now comes the worst part. Between January 2016 and February 2021, the number of women greater than 15 years of age has gone up by 5.41 crore to 49.49 crore. Hence, the number of women who have entered the working age population has gone up by 12.26% (5.41 crore expressed as a percentage of 49.49 crore). On the other hand, the female labour force, has shrunk by 2.75 crore to 4.66 crore. In January 2016, it was at 7.41 crore. This is a collapse of 37% (2.75 crore expressed as a percentage of 7.41 crore).

Let me just repeat this again. While the working age population for women over the last five years has gone up by 12.26%, the female labour force has collapsed by 37.11%. This also explains the fall in unemployment rate for women, given that much fewer women are actively looking for a job. Many women who haven’t been able to find jobs, have stopped actively looking and simply dropped out of the labour force.

Economists have struggled to come up with an explanation for this phenomenon. One possible explanation lies in the fact that the number of jobs available haven’t grown at the pace that could accommodate the new individuals, both men and women, entering the workforce. Hence, in a patriarchal society, men in deciding positions, have offered jobs to other men, forcing women who have searched and not found jobs to stop actively looking for a job and drop out of the labour force altogether.

5) Let’s take a look at the overall population. The working age population, between January 2016 and February 2021, has gone up from 93.85 crore to 105.8 crore, this implies an increase of 11.95 crore. Nevertheless, the number of people employed or unemployed and looking for a job, that is the total labour force, has fallen from 44.76 crore to 42.85 crore, or by 1.91 crore.

Sothe working age population has increased by 11.95 crore between May 2016 and February 2021, but the total labour force as such has fallen by 1.91 crore. What does this really mean?

While, the total labour force has shrunk by 1.91 crore, 2.75 crore women have dropped out of it. This basically means that the number of men in the labour force has gone up.

Hence, the brunt of India’s unemployment problem is being borne by women. Women who lose their jobs find it difficult to find a new one and over a period of time simply drop out of the labour force. Many women who enter the labour force and actively look for jobs, are unable to find one and eventually stop searching and drop out of the labour force.

Given that chances of men finding a job are higher, they continue to look for a job and the situation is not as bad as it is for women. Between January 2016 and February 2021, number of men who crossed the age of 15 and entered the working age population, increased by 6.54 crore to 56.30 crore.

During the same time, the number of men entering the labour force (that is either they were employed or were unemployed and actively looking for a job) increased by 83.62 lakh to 38.19 crore. Hence, in this case of men, the labour force at least hasn’t shrunk.

6) Given that more and more women are dropping out of the labour force, it makes it easier for the men who don’t drop out of the labour force to find a job, from the opportunities that come up. (I am using the word easier here and not easy. Kindly appreciate the difference between the two).

7) Urban women are likely to be more educated, but their labour participation rate is very low. Hence, what that means is that they are unable to utilise their education to work and earn money in the process.

8) Now let’s take a look at how things have been post-covid.  In January 2020, before covid had struck, the working age population had  stood at 103.13 crore. By February 2021, this had jumped to 105.8 crore, a jump of 2.67 crore. Meanwhile, the labour force as of January 2020 stood at 44.24 crore. It has since shrunk to 42.85 crore, by 1.39 crore. So, post-covid, the working age population has gone up by 2.67 crore, but the labour force has shrunk by 1.39 crore.

How have the women done on this front? The working age population post covid for women has gone up by 92.23 lakh whereas the labour force has shrunk by 78.03 lakh. Again, more women have dropped out of the labour force than men, given that the labour force has shrunk overall by 1.39 crore. Also, do keep in mind that the fact that a lower number and proportion of women enter the labour force in the first place.

To conclude, the world celebrated the international women’s day a few days back (on March 8). On that day, the corporates and the government institutions talked about the importance of the women who worked for them. The social media influencers talked about women. Many women talked about what it means for them to be a woman.

But almost none of them talked about one of the most important issues at hand, the fact that Indian women are bearing the brunt of India’s unemployment problem.

If you are reading this(man or woman) please share it with your friends and family. The first step towards solving any problem is knowing and acknowledging that it exists.

India, China and the Quest for Atmanirbharta

Atmanirbharta has been the hot political and economic buzzword in India for quite a while now. It means self-reliance in English. Or as the finance minister Nirmala Sitharaman put it in her budget speech:

“Atmanirbharta is not a new idea. Ancient India was largely self reliant, and equally, a business epicentre of the world. Atmanirbhar Bharat is an expression of 130 crores Indians who have full confidence in their capabilities and skills.”

In economic terms it essentially refers to import substitution, which India practiced for almost four decades, after independence, where the idea was to make everything in the country rather than import it.

In political terms, the narrative is directed towards China and our import dependence on the Middle Kingdom. In the recent past, our political tensions with our largest neighbour have escalated and we are trying to hurt it economically by producing more at home, and not importing as much from it as we had done in the past. Also, we have banned many Chinese apps.

The question is where are we going with atmanirbharta. Let’s take a look at the following chart, which plots the total amount of goods imported from China during the period April to January, over the years.

Source: Centre for Monitoring Indian Economy.

The goods imports from China during the current financial year have been the lowest between 2016-17 and 2020-21, at $51.92 billion. Nevertheless, a simple presentation of goods imports doesn’t take into account the fact that India’s goods imports during April 2020 to January 2021 have fallen by 23.1% to $340.9 billion. They stood at $443.22 during April 2019 to January 2020. This fall shows a lack of consumer demand, which has crashed during the course of the year, with the spread of the covid pandemic.

Let’s look at the next chart, which plots what proportion of India’s goods imports came from China, during the period April to January of a financial year, over the years.

Source: Author calculations on data from Centre for Monitoring Indian Economy.

During April 2020 to January 2021, the proportion of imports coming from China stood at 15.23%. This is the highest in the period considered. Hence, while economic and political narrative maybe moving towards atmanirbharta, the data clearly shows something else. Our dependence on China for goods imports continues, like it was in the past.

There is one more way we can look at data. While we don’t have the full year’s data for 2020-21, we do have that for the years gone by. Hence, we take a look at proportion of full-year imports coming from China, in the next chart.

Source: Centre for Monitoring Indian Economy.
*April 2020 to January 2021.

The above chart makes for a very interesting read. In 1991-92, India barely imported anything from China. Just 0.11% came from China. In the nearly three decades that have followed, the imports from China have exploded. This just shows the rise of Chinese productivity year on year, in comparison to that of India. The proportion of imports coming from China peaked at 16.4% in 2017-18, fell for the next two years, and have risen again this year.

What is the reason for this marginally increased dependence in 2020-21? Ananth Krishnan writing in his terrific book India’s China Challenge – A Journey Through China’s Rise and What It Means for India, quotes Amitendu Palit, an economist at the National University of Singapore, in this context.

As Palit says: “If you look at critical medical supplies, which India has been importing for frontline healthcare workers in the Covid-19 battle, most of these come from China, which is one of the top sources, but, on the other hand, there isn’t a very widely diversified source of countries from which India can actually import these either.”

The larger point here is that China has now become central to many global supply chains and hence, it won’t be easy for India to lower its dependence on China dramatically as far as imports of goods is concerned.

In fact, one area where India has managed to reduce its dependence on China in the last five years, is telecom instruments, as they are categorised in the imports data. Given that the use of landline phones has come down over the years, the category  primarily includes mobile handsets.

Take a look at the following chart. It plots the value of the telecom instruments (read mobile handsets) imported from China, over the years.

 Source: Centre for Monitoring Indian Economy.
*April 2020 to January 2021.

As can be seen, the value of the instruments imported from China has come down over the years, though the 2020-21 full year imports are likely to end up being higher than those in 2019-20. In 2017-18, import of telecom instruments formed a little over a fifth of our imports from China. This fell to 8.67% in 2019-20 and has increased to 10.48% in the current financial year.

To make companies manufacture mobile phones in India, the government has been imposing duties/tarrifs on various goods that go into making of a mobile phone. The idea is to make imports from China expensive and in the process, force companies to manufacture phones in India.

In fact, this strategy has been borrowed from China. As Matthew C Klein and Michael Pettis write in Trade Wars and Class Wars: “Import substitution has succeeded thanks in part to Chinese government policies that have systematically encouraged Chinese businesses to substitute foreign production for domestic production, even when this has raised costs for Chinese consumers.” Of course, unlike India, China does not need to impose duties/tariffs to “direct domestic demand towards domestic production”.

As Klein and Pettis point out: “Executives can simply be told to pick Chinese suppliers over foreign ones… The result is that, unlike many other countries, imports have become less and less important to the Chinese economy since the mid 2000s.”

Also, given that Indian productivity is worse than that of the Chinese, manufacturing in India, comes with a cost. While, mobile handset prices barely rose between 2015 and 2019, the same hasn’t been the case in 2020, when they rose by 7%. Clearly, the cost of atmanirbharta on the mobile handsets front is being borne by the Indian consumer. As I keep saying, there is no free lunch, someone has got to bear the cost.

The government has also come up with the production linked incentive (PLI) scheme in order to help manufacturing companies in India. As Sitharaman said in the budget speech:

“Our manufacturing companies need to become an integral part of global supply chains, possess core competence and cutting-edge technology. To achieve all of the above, PLI schemes to create manufacturing global champions for an Atmanirbhar Bharat have been announced for 13 sectors. For this, the government has committed nearly Rs 1.97 lakh crores, over 5 years starting FY 2021-22. This initiative will help bring scale and size in key sectors, create and nurture global champions and provide jobs to our youth.”

There are multiple problems with this approach. The first being that the government is trying to pick winners. This entire approach smells of how things used to happen before the economic reforms of 1991, with the bureaucrats deciding what businesses should be doing.

Also, this comes at a time when prime minister Narendra Modi has been critical of IAS officers. As he said in February: “Just because somebody is an IAS officer, he is running fertiliser and chemical factories to airlines.” The same babu is now expected to run an incentive scheme for big business.

India’s biggest success stories over the last three decades, software, pharma and automobiles, happened despite the government, and not because of it. So, the idea still should be to make things easier for smaller businesses to grow bigger, which is something that happened beautifully in the IT sector. (This is not to say that the government didn’t help. It did. But it largely didn’t meddle).

In fact, while we think of China as a country with big companies that wasn’t always the case. China’s initial growth in the 1980s and up until the mid 1990s was through the growth of millions of Township and Village Enterprises (TVEs). This is a fact that seems to have been forgotten.

Big companies growing bigger can create some jobs, but not the number of jobs that India requires. As data from the Centre for Monitoring Indian Economy shows, in the last five years India has added 11.77 crore individuals to the working age population.

This means that around 19.76 lakh individuals have crossed the age of 15 on an average every month, over the last five years. Of course, not all of them are looking for jobs but a good chunk are. Even if we assume that around 40% of them are looking for jobs, we end up with around one crore people looking for jobs every year.

Such a huge number of jobs can only be created by small businesses growing bigger and not by big businesses growing bigger, which can only possibly be the icing on the cake.

As an OECD (Organisation for Economic Co-operation and Development) research paper points out:

“SMEs (small- and medium-sized enterprises) account for 60 to 70 per cent of jobs in most OECD countries, with a particularly large share in Italy and Japan, and a relatively smaller share in the United States. Throughout, they also account for a disproportionately large share of new jobs, especially in those countries which have displayed a strong employment record, including the United States and the Netherlands. Some evidence points also to the importance of age, rather than size, in job creation: young firms generate more than their share of employment.”’

In fact, given the obsession the current government has had with scale and formalisation of the economy, small businesses have been hurt through a mind-numbing move like demonetisation and a half-baked goods and services tax.

Further, the globalisation game itself might be changing. While, we might want companies based out of India to become a part of global supply chains, it is worth remembering here that the strategy worked at a certain point of time.

As Krishnan writes:

“China was able to recognize and exploit the opportunities just as global production chains were forming through the opening of the early 1990s… The infrastructure it was able to create through the 1990s enabled ‘a unique and probably unrepeatable combination of low developing country labour costs and good, almost rich country infrastructure.'”

Also, the supply chains that are already in place are not going to shut down and move to India, just because India is now offering incentives. As Apple CEO Tim Cook said in 2017: “The popular conception is that companies come to China because of low labour cost… The reason is because of the skill, and the quantity of skill in one location and the type of skill it is.”

India clearly has a skills problem. A little more than a fifth of Indian graduates are unemployed, and at the same time when companies advertise for personnel, they can’t seem to find enough of them who meet the right criteria. Multiple surveys have found Indian graduates and engineers to be simply unemployable. This is not something that can be set right overnight.

The corporates, not surprisingly, have welcomed the scheme, given that the government is offering “a recurring cash subsidy computed as a fixed percentage of the manufactured sales turnover.” Hence, they clearly have an incentive to do so. In fact, lobbying has already started on this front.

Take the case of the PLI scheme in the electronics and mobile manufacturing, which has been touted as a success, after attracting investments of over Rs 11,000 crore in 2020. As an editorial in The Hindu Business Line points out, the beneficiaries are already asking for a rollover, “citing land acquisition delays, lack of skilled workforce and demand issues post Covid.”

Also, as has been seen in India in the past, once a subsidy is introduced into the government’s budget, it rarely goes away.

Finally, lest I be accused of looking at only negatives (honestly, please go to news.google.com and enter PLI scheme, you will only get positive stories to read), one positive thing could come out of the scheme.

As Palit told Krishnan in the context of China: “When we look at value chains today, let’s say in a post Covid-19 situation, the emphasis on the part of businesses is to make these chains shorter, more resilient, more durable, and locate them closer to demand markets… This is where we often overlook the importance of China. It continues to remain a major source of final demand.” And given this shifting supply chains out of China will be difficult.

This applies to India as well. Given India’s size, it will continue to have a huge source of consumer demand in the years to come. This should encourage companies looking for stable supply chains to have their manufacturing bases in India to cater to its domestic market. And this is where PLI can work its magic.

As Neeraj Bansal of KPMG put it in a recent writeup:

“From raw materials to critical components, the COVID-19 pandemic exposed the reliance of country’s key sectors on a few markets for fulfilling their manufacturing and sourcing requirements. To put things in perspective, India depends on a single market for 70 per cent of its API consumption needs, 85 per cent of smartphone components imports and 75 per cent of television components imports. As global supply chains were swiftly and effectively dismantled as one country after another went into lockdown in 2020, efforts toward bolstering domestic manufacturing gained momentum.”

Nevertheless, there is a corollary to this. As more and more people get vaccinated and the world moves on and goes back to doing things that it always has, this narrative of having manufacturing facilities closer to the demand markets, will keep getting weaker. Hence, India has a couple of years to cash in on it.

Of course, whether India emerges as a country where the products are assembled or major value addition takes place, remains to be seen. Also, prices will go up. Make in India will come at a cost.