How state drought tax negates Raghuram Rajan's rate-cut relief

Reserve Bank of India governor Raghuram Rajan singlehandedly stopped the stock market slide by lowering interest rates by 50 basis points (double than expected). Banks have followed the lead and reduced interest rates and the expectation is that there will be capital investment and growth. Prime Minister Modi too has done his bit and he has, without a doubt, in one year changed the way other countries view India. There are promises of substantial investments.

However, before we get glassy eyed and ready to jump over the moon, I would urge you to heed A M Naik's words. The 77-year old chairman of Larsen & Toubro stated , "In terms of economic revival, it is not happening on the ground." He went on to say that Modi's reform agenda had failed to boost business among its core engineering, construction and infrastructure customers. He is the first chief executive of a major industrial company to voice such a concern. Others have tended to be more circumspect and say "Achche Din" will be upon us shortly and that one cannot expect miracles in a year, though at the time the elections took place last year, the miracle was expected immediately.

Rajan too said very pragmatically that Modi's visits abroad must be "backed up with action on the ground" to reinforce the positive impression that has been created. Rajan's riposte to industry that the cutting of rates is not the "be all and end all of all issues being faced by the economy" is absolutely right.

I too have several concerns. Core sector growth has slowed down to 2.6% in August. WTO has lowered the global trade growth forecast for 2015 to 2.8% from 3.3%. GDP growth is now forecasted by the Asian Development Bank at 7.4%. Manufacturing activity fell to a seven-month low in September. Exports in 23 out of the 30 sectors monitored by the commerce ministry declined, and exports fells by 20.7% to $21.3 billion in August 2015, pushing the trade deficit to $12.47 billion. Real inflation is high. The rupee has fallen against the US dollar and other currencies which would make imports dearer. The monsoons have not been excellent. However, the manufacturing sector has improved on a year-on-year basis. The yearly SBI composite index, which is an indicator of manufacturing activity, rose to a four-month high of 53.9% (in the same period last year it was 53.4%).

It is in this scenario that the cash-strapped Maharashtra government on Wednesday introduced an out of turn increase in Value Added Tax on liquor, petrol, diesel and jewellery to provide drought relief to farmers in the state. In effect, the state government has taken away the relief the Reserve Bank has given by reducing interest rates. Although it was stated that this will be in existence for only five months, I do not think any intelligent person believes that. Once a tax is imposed (like service tax many years ago), it stays. And in this delightful scenario, we are told that the state is planning other taxes as it has a huge deficit.

I believe that the state, as opposed to taxing us more, should tighten their belts and cut down on wasteful expenditure. There is no need to purchase properties abroad to build museums or construct statues and monuments. Trips abroad should be limited. Nor should we be subsidising sections or agreeing to reserve jobs for some others.

The government's focus should not be on bans and wasteful expenditure that does not help anyone. The infrastructure must be developed, investment made easy and development encouraged. The emphasis must be on job creation by inviting capital to invest. That will give the exchequer the funds it needs.

The writer is MD, Cortlandt Rand, and an author