Time to Save the Economy

The Prime Minister’s vision of India becoming a $5 trillion economy by 2024 has inspired every citizen to contribute to this worthy cause. In his words, “If every one of the 130 crore Indians takes one step forward, the country too will go that many steps ahead”.

16 December, 2019 Opinion, Economy
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The Prime Minister’s vision of India becoming a $5 trillion economy by 2024 has inspired every citizen to contribute to this worthy cause. In his words, “If every one of the 130 crore Indians takes one step forward, the country too will go that many steps ahead”. The Economic Survey had extended its absolute commitment to this collective endeavour of fructifying the Prime Minister’s vision.Rather than viewing the national priorities of fostering economic growth, demand, exports and job creation as separate problems, the Survey postulates that these macroeconomic phenomena are complementary to each other. And that investments are the key driver that will catalyse the economy into a self-sustaining virtuous cycle supported by a favourable demographic phase.

TreDS: GST-based Bill Discounting

The Reserve Bank of India (RBI) and the Government have been sensitive to the liquidity issues micro, small and medium enterprises (MSMEs) are facing. A number of steps have been taken. Although policy innovation can help further.

In 2014, the RBI had introduced The Trade Receivable Discounting System (TreDS), an online bill discounting platform that allows MSMEs to raise funds by selling their trade receivables to corporates.

In 2017, the RBI issued licence to three players: Receivables Exchange of India Ltd (RXIL), a joint venture between Small Industries Development Bank of India (SIDBI) and National Stock Exchange of India Limited (NSE); Invoicemart, promoted by A Treds Ltd (a joint venture of Axis Bank and mjunction services); and, M1Xchange, promoted by Mynd Solutions Private Limited. By 2018-19, all three exchanges put together had done business of Rs. 7,000 crore.

The TReDS platform ensures regular flow of operational funds to MSMEs at attractive interest rates, easing the liquidity crunch that hurts them. It is supposed to ensure their working capital limits are not affected as these are ‘off balance sheet finance’ and see to it that corporates comply with the MSME Act, under which a buyer has to pay the MSME supplier within 45-days. Companies with turnover in excess of Rs. 500 crore have to be registered on the TReDS platform. The seller MSMEs of receivables are not required to give any collateral and have no recourse to them in case of defaults.

Government Dues Wallet

One of the measures the government has taken to ease the liquidity-related problems is to assure strict adherence to the rule that promises GST refunds to small companies within 30 days. The amount of refund pending as on 23 August 2019 was Rs 10,841 crore. Of this, about 97 per cent of the claims worth Rs. 10,490 crore have been disposed up to 24.10.2019.

To further help, an innovation can be worked out. Most of the time, even as tax refunds are due from the government, other taxes have to be paid. For instance, even as GST refunds are awaited, Income tax has to be paid. This is inefficient use of precious funds. Can an online digital tax wallet be created for paying and refunding government dues? Those with pending refunds can simply use credits for making payments of other taxes.

A New Model of the Public-Private Partnerships

Recently, India’s largest biopharmaceutical company has offered recombinant human insulin (rh-Insulin) at less than 10 cents per day (assuming an insulin dosage of 40 IU per day) in low and middle-income countries (LMICs) for vials sourced by governments directly from it. This is almost 70 percent cheaper than the existing prices.

What will happen if the Ayushman Bharat coverage could be extended to rh-Insulin, with the government bulk-procuring it from the biopharmaceutical company and disseminating it through the 18,059 and growing empanelled hospitals? This public-private partnership could also be operationalised through the Direct Benefit Transfers (DBT) payments.

The direct benefits in terms of the population’s improved health will outweigh the costs in terms of additional public spending required. Plus, there will be additional indirect benefits. The volumes will make it worthwhile for the manufacturer to expand its rh-Insulin capacity, creating new investments, scale and jobs. This can be a new model of the Public-Private Partnerships for reducing the India-Bharat divide and at the same time improving delivery of government services.

It has become fashionable for people to ask where would the final demand for the large capacity expansions by high investment come from? Well, unmet demand is right there. We are just not looking at the right place. More importantly, we are just not looking at the right price points. Think about it. If cars are not selling, how about mopeds? Can advertising strategies shift consumption aspirations away from cars to mopeds to tap the potential of vast volumes at the bottom of the pyramid? Can mopeds be positioned as a mobiliser of the young generation?

Volumes be Used to Create Competitive Products

The sky is the limit. As General Electric has shown with its now famous ultra-low cost ECG machine that there is a Western market for products born out of the constraints of the Indian healthcare market. If multinationals are thinking about how their existing investment intensive models of innovation can leverage the Indian volumes, certainly so can Indian companies.

Jan Dhan bank accounts have been linked with mobile numbers and subsequently Aadhaar, which has led to the creation of a JAM (Jan Dhan, Aadhaar, Mobile) trinity. The Government of India uses this channel to secure DBT to the intended beneficiaries. Presently 55 central ministries through 370 cash-based schemes are transferring benefits under the DBT mechanism. The JAM trinity has enabled cumulative transfers thus far of around Rs. 7.3 lakh crore. Total deposits of close to Rs. 1 lakh crore are held presently in more than 35 crore bank accounts opened under PMJDY – this represents the consumption spending potential from DBT.

The logical extension would, thus, be to fully integrate the BHIM mobile payment App, the UPI payment system and the RuPay card with the JAM to facilitate spending of the DBTs received.

As of March 2019, there were 142 banks live on UPI payment system with a monthly volume of 799.54 million transactions for a value of Rs. 1.3 trillion ($19 billion). By July 2018, more than 260 million transactions were taking place every month through RuPay cards.

Now what if India, as part of its negotiations for bilateral and plurilateral economic and trade agreements, insists that the operation of the UPI and RuPay should be a must in our trade partner countries, especially where there is a sizable diaspora of Indian expatriates?

If Indians are able to make all their account-to-account transactions, including when they travel overseas, on the UPI, a significant chunk of the Indian market to these payment platforms from where further scale-up by launch at the global level will be easier. Shift to RuPay cards will speed up further once its international acceptance increases.

Make for India

This model can be replicated by corporate India where they make specific products for India and then take them global. Why do we need to import AI and software? Why should Indian farmers have to depend on MNCs for weather forecasting? Can commercial collaboration between agricultural research institutions and Indian start-ups facilitated by government advances, development financing and contracts fill in the supply-side gap? The Indian corporate sector can step in to make offerings to make Indian agriculture more efficient – starting from GPS driven crop mapping, to agri-specialised automobiles, IT-based demand planning and sowing etc.

But to do this, we need to quickly fix some legacy issues. Chapter 3 in Volume 1 of the Survey recognises a startling fact. Dwarfs, or the small firms that never grow beyond their small size, dominate the Indian economy and hold back job creation and productivity.

Firms employing less than 100 workers and are older than ten years are categorised as dwarfs. Using firm-level data from the Annual Survey of Industries for the year 2016-17, we found that dwarfs account for half of all the firms in organised manufacturing by number. Yet, the contribution of dwarfs to employment is only 14 per cent and to productivity is a mere 8 per cent.

In contrast, large firms (more than 100 employees) account for three-quarters of employment and close to 90 per cent of productivity. This when they account for just about 15 per cent by number of the total manufacturing firms.

Clearly, firms that are able to grow over time to become large are the biggest contributors to employment and productivity in the economy. In contrast, dwarfs that remain small despite becoming older remain the lowest contributors to employment and productivity in the economy.

Small firms find it difficult to sustain the jobs they create. In contrast, large firms create permanent jobs in larger numbers. The young firms, that may have less than 100 employees but are also less than 10 years old, create more jobs at an increasing rate than the dwarfs.

Unless a proportion of firms is able to grow in size as they age, the macro strategy of Indian manufacturing and service providers producing for the large local volumes and then capitalising on that success to scale up to global level will not work. We need to remove the hurdles that prevent firms from growing in size.

By the time an average firm in the US celebrates its 40th year of inception, it has seven times as many workers as when it was less than five years old. At 40, an average firm in Mexico has twice the number of employees it employed when it was less than five years of age. In contrast, an average firm in India only employs 40 per cent more workers when it is forty years old than when it was less than five years old. Thus, firms in India do not grow enough to create the necessary jobs and productivity in the economy.

Why don’t so many Indian firms become large?

Several size-based incentives are at present provided irrespective of firm age. Further, the inflexible labour regulation prescribes size-based limitations. Policies that foster dwarfs, i.e., small firms that never grow, instead of infant firms that have the potential to grow and become giants rapidly, slows job creation.

Policy must encourage firms to grow large while becoming more productive and job-generative rather than provide perverse incentives to remain small. We need MSMEs that grow not only to create greater profits for their promoters but also contribute to job creation and productivity in the economy.

Deregulating labour law restrictions can create significantly more jobs, as seen by the recent changes in Rajasthan when compared to the rest of the states.

Next, systematic lowering of the risks faced by investors is important for the success of the investment-driven model for economic growth. Risk pertains to the possibilities of upside, when a project performs well and downside, when the project fails, which in India are crucial. Without an ecosystem that rewards innovation and entrepreneurship, growth cannot be fostered. Startups and innovative ventures face significantly greater uncertainty than traditional “brick-and-mortar” firms. If policy ambiguities create collateral damage for genuine risk-takers, investments can get affected by dampening the animal spirits in the economy.

Our Pound of Taxes

A major source of revenue leakage has been identified by the Organisation of Economic Co-operation and Development (OECD): digital companies that escape taxation because of the nature of their business that makes it easy to shift profits from one tax jurisdiction to another. The OECD has proposed an overhaul in the taxation system to make sure tech giants don’t get away without paying their fair share of taxes. It has recommended that international negotiations must be advanced to ensure the highly profitable multinational enterprises pay tax wherever they have significant consumer-facing activities and generate their profits, regardless of whether they are physically present in that country or not.

India is not yet a part of OECD but is one of the biggest digital markets. However, unlike countries like China, France and Germany India has not managed to design a system for taxing Internet giants. Should India not tax sales generated domestically by say social media giants or search engines, the online market places and the e-Commerce players?

A global social media giant has over 300 million users in India, while its messaging platform has over 200 million users in the country, making it the largest user base for both firms. According to statutory disclosures the company has made to the registrar of companies (RoC), this company’s Indian subsidiary reported revenues of Rs 892 crore for fiscal year ended 31 March 2019, up 71 per cent from the previous year. Its net profit rose 84 per cent to Rs. 105 crore from last fiscal.

A global search engine’s India profits rose 16 per cent to Rs 473 crore in the financial year ending 31 March helped by lower expenses, despite a sharp fall in revenue. India is a significant, although largely untapped, market for this company as it is essentially shut out of China. India is also a testing ground for these tech giants. For instance, the largest search engine in the world created its first-ever digital payments app as an offering for the millions of Indians rapidly shifting to digital payments.

No wonder that the company has remitted over $2 billion from the revenue it has earned here in India over the past five financial years to its parent, US-based search giant’s subsidiaries in Singapore and Ireland. The Indian tax authorities have raised tax demands relating to these transfers and the matter is pending in court. Therefore, having well-defined policies is the way forward.

Realising that tax revenue from digital firms billed overseas was being lost, the Modi government in June 2016 had introduced a 6 per cent tax in the form of an equalisation levy, popularly known as the Google tax, on the amount paid to Internet companies by advertisers.

Union Budget 2018-19 proposed to amend the Income Tax Act to tax the income emanating from India of all digital entities with a large user base or significant economic presence here.  Despite initial resistance from the tech giants, the equalisation levy raised over Rs 1,000 crore in the year of its inception itself. This is just the tip of the iceberg. No tax is being collected still on services such as annual or monthly subscriptions to streaming websites, or paid promotions done through social media platforms. Tax revenue is also lost when advertising or promotional deals are signed at the global level but also run in India. The potential for raising revenue efficiently and justly is tremendous.

The Central Board of Direct Taxes (CBDT) is in the process of formulating profit attribution rules for tech giants, which, together with the significant economic presence (SEP) amendment, could impact several digital companies operating in India. The SEP framework enables India to tax digital companies in India even if they don’t have a permanent establishment here.

Up till now, tax treaties would override any other domestic law but now, apart from the tax treaties, the tax department can also take note of the India employees, sales, consumer base and other factors into account to determine permanent establishment. In taxation, permanent establishment is a concept that determines the jurisdiction in which taxes will have to be paid.

The OECD consultation paper proposes a new nexus rule that would not depend on physical presence in the user/market jurisdiction but would mostly rely on sales. Going beyond the arm’s-length principle for allocation of profits, the paper proposes using formulae-based apportionment. India’s draft report on profit attribution gives weightage to sales and users.

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