Modi's Fiscal Reconstruction

The Indian PM is planning the most audacious rethink of fiscal policy ever seen in India. Even if he is partially successful, Narendra Modi's reconstruction of the Indian fiscal policy will have far-reaching implications for the incipient economic recovery underway in India. In particular: (1) The PM's focus on reducing 'leakages' from the subsidy system looks likely to stymie the rural wealth effect that has been such a powerful driver of consumption over the past five years. (2) The big blast of government-funded capex that is likely to be announced in the Budget is likely to compensate for the private sector's reluctance to embark upon capex. (3) The PM's willingness to use fiscal incentives to push states towards land, labour and subsidy reforms creates the genuine possibility of structural reform in a country where the political class does not really want reform. What is the PM trying to do? Based on my meetings with policymakers in Delhi, I reckon Mr Modi is pursuing four distinct goals, as he and his team rethink and reconstruct the fiscal policy: Higher tax/GDP ratio: India's tax-to-GDP ratio has been between 8 and 12 per cent over the past two decades. This makes India similar to most sub-Saharan African economies as for most developed economies this ratio is upwards of 25 per cent. This unflattering comparison with more mature countries highlights the sheer scale of tax evasion in India. Using GST (the constitutional amendment for which has been tabled in the Parliament) and clever IT infrastructure, Modi seems determined to lift India's tax/GDP ratio. Lower leakages: The PM's advisors are convinced that by moving India's subsidy mechanism from subsidies in kind (for instance, cheap food, fuel and fertiliser) to subsidies in cash (through direct benefit transfers to recipients' bank acc

This article was originally published on March 27, 2015.