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India will be a great economic by 2025
November, 06th 2009

He is the man who works behind the scenes to fine tune the economic machine of our country to achieve its optimum limit.

As his designation goes, the Chief Economic Advisor to the Ministry of Finance, Dr Arvind Virmani is the go-to person when it comes to reforms or solutions to any issues that the nations economy faces.

Keen on economic reforms as was evident when he came up with the economic survey two days before the Union Budget in July this year the soft-spoken Virmani, in a freewheeling interview with Moneycontrol, talked about issues like GDP growth, fiscal deficit, tax and where he sees India in the 21st century.

Read the full interview below
Q: Do you see 10% growth being achieved say 10 years down the line? There is talk of achieving 10% growth by the end of this plan period though Dr Montek Singh Ahluwalia had said the average will be 9%. Going forward, in 2012 or 2013 that could happen?
A: I think there is no expectation that the average for the plan period would be 9%. Of course, there would be a mid-term appraisal but the preliminary expectations that the Deputy Chairman himself has given will be lower than that.

Q: I thought he downgraded it from 10% to 9%.
A: Average was 9% in the plan. When the plan was being formulated, I was in the PPD and DPD at that point in the planning commission, the same arguments apply: The key issue is to sustain growth at 9%. As we have seen in this plan period there will always be shocks. Of course, this particular shock was exceptional but there can be other shocks including the usual monsoon and other factors like that will come again. So, its okay to aim for 10% but, really, in my view if one takes the long-term picture, 5 years or in terms of decades, the objective is to sustain growth at 9% and focus on what is needed to achieve that. I think, as I have indicated in my recent book The Suduko that is very feasible but the key to doing that is when new challenges arise and new shocks arise which expose certain weakness in the economy, those weaknesses have to be addressed. Being an optimist, I am reasonably confident that they will be addressed in the next five years.

Q: Fiscal deficit, of course, is a concern over a short period. But do you see the government walking the talk, in other words, coming back to the fiscal potency?
A: The finance minister in the last budget and FRBM paper has said that hell bring it down to 5.5% next year, and 4% the year after. Of course, we have to see in the next budget what the current numbers are, but I personally dont see any difficulty in being able to do that.

Q: In India, we have a problem with populist subsidy - oil, fertilizer, food - they are still not being redressed for reform under reform levels. Beyond a point, this kind of populist expenditure will always be there. Would it bring up your fiscal deficit number?
A: This argument has been there for a long time. And, this argument was used to say that the FRBM targets were of no use and we will not be able to reduce the deficit. But, we have been able to do it. Of course, you can have pessimistic perspective and an optimistic one. The three main subsidies of the central government are fertilizer, petroleum and food. So, I see no reason why the fertilizer and petroleum subsidies cannot be contained to a point where it is manageable like any other expenditure. The food issue, of course, is now connected with the new Food Security Act and till that becomes clear it is difficult to say much more than that. By definition, food security means people who are not secured should get the food. Inherently, that is targeting to those people who need and if thats what happens there is no need for food subsidies to go out of hand. Of course, there have been many predictions and many of them have come wrong. I am not a soothsayer but ones hopeful that something will happen on the subsidy front.

Q: On the expenditure side, there is talk about revenues and cutting subsidies, but the Government has not done much. If you look at the last 5 years, in terms of cutting subsidies and even non-plan expenditure, there has been a failure on the part of the Government to appreciate the basic issues. Why is this so?
One more word on subsidies. One of the things, perhaps, we dont do is to think of new ways of achieving subsidy objectives. For example: the LPG and kerosene subsidy instead of looking at it as a subsidy on a particular item, you have to understand the purpose of that subsidy. And, the purpose is to make sure that poor and everybody have light and heat for cooking their food; If everybody focuses on that, perhaps, we can solve it much cheaper and much more permanently. For instance, as I have suggested in the Economic survey, by making sure that every individual/household of this country has a solar cooker and a solar light.

So, this is a failing in the Government and outside; we tend to get too involved in the mechanics rather than the objective. If we all focus on the objective and what is the best way to achieve it, and the best way can keep changing and thats why it is so important. Lets say the best way 20 years ago may have been to subsidise LPG or kerosene or whatever, it may not the best way right now. So, the objective is more important.

As far as the expenditure is concerned, let me state a simple point. Recent research shows that at the district level, the district collector or whoever is in charge of the district, has 93 different programmes to implement. Thats the real problem. Again, you are not achieving the objective. It is not a question of corruption or lack of application; you have to look at the objective of these programs. A better approach is to focus on 5 or 6 critical things which you do every 5 years. If you focus on achieving these 5 things in 5 years, the next 5 year period we can go on and achieve something else. Again, unfortunately, I would not blame the Government so much it is the objective setting by the academics, advisors and the general public. There is too much pressure on government to solve every problem and the Government is unable to do at this point because it does not have the human resources. Anybody proposing a new scheme should think, there are 93 schemes already at every district level does it make sense to put it in another one? Will anything be achieved? So, if one does that one can get a better handle on the expenditure.

The other point everyones talking about is the UID, which will play an important role eventually but that may take some years.

Q: In terms of revenue, what does the new direct tax code do to increase your tax rates? There is only so much you are doing with the existent tax revenues; you still cant tax agricultural incomes, there are still corporate exemptions even in this particular code. So, how are you increasing this tax rates through this code?
A: The objective of an income tax reform is to simplify the system, which means to reduce exemptions and deductions, and to lower the tax rate. At this stage, the proposed direct tax code is not perfect. Over the last couple of months, I have been personally involved in discussing it. One has identified certain weaknesses and hopefully some of them would be removed. The process is still going on; the parliament has to still discuss and theyll have their own suggestions. The finance minister has also indicated four areas which need a re-look. If key imperfections are removed, itll achieve the objective. I have absolutely no doubt about it. And tax reforms is important not for the immediate purpose, but to have a long- run and sustainable growth of revenues.

Q: Sir, the way corporate India is going, to cite an example, you have got different ways of financing today, and you have got different ways of acquisition. Do you think this kind of a code will run its course at least for the next 40 to 50 years? The last code was in 1950-51, its round about 50 years. Do you think this new code can run its course?
A: The critical thing for a good tax system, which is not easy, is neutrality. Neutrality is the loadstone for a good, simple tax system. Now, it turns out that corporate tax neutrality is more difficult than personal income tax neutrality because there are three basic sources of finance and there are different ways of investing. So, the design of the neutral tax corporate system is much more difficult. And some of the shortcomings, which one has pointed out, are really trying to remove them because if we dont do so, we will have the type of problem which you are saying. If the corporate tax is not neutral then youll get biases between foreign and domestic and different sources of financing, equity, between different ways of income from debt, capital gains, etc. That is exactly the trick. The challenge is to make sure that all these ways are neutral and the theoretical theory gives you two or three simple ways of doing it. Any practical system will only approximate a perfectly neutral system but even if you get an approximately theoretically-sound-system, that will have a big effect in achieving what we just discussed.

Q: India, perhaps, is the only country which is introducing two landmark types of reforms in the direct tax pays and the indirect tax pays. On the indirect tax side, GST is still being debated. In its current form, does this help the revenue and where does this help India, in terms of growth aspirations?
A: There are two critical elements in the GST one, is that the base rate should apply to as large a number of commodities as possible. I do not believe as some people have said that it needs to apply to 100%. I think it is possible to have, 5 or 10% of commodities which are taxed at a lower rate and a smaller number about 5-10 that can have a higher rate. The higher rates should be restricted by numbers and lower ones by percentage or revenues. And, the lower ones are basically very simple. It has to do with food, and health which are kind of fundamental perquisites for human welfare. On the other (higher) side, there are two ways to do it. One, is to change the GST or VAT tax rate itself.  The other way, in my view the better way is to have a separate tax on negative externalities. This separate tax applies on top of the standard VAT rate, so it doesnt mess up the system of providing refunds. Thats the reason for having a separate one because that part of it does not attract an offset or a VATing principle.

The second thing, people have objected to is the two-level VAT. Unfortunately or fortunately, we have a two-level government system. There is no getting away from it. The States demand a certain amount of flexibility and without it its not possible to have an integrated tax. So, the dual tax, in that sense, of having one rate set by the Centre and one by the State is inevitable. Again as long as there are some reasonable limits placed on the degree of flexibility its not one State goes of completely in one direction and another goes in other direction as long as there is a reasonable limit, it is certainly workable and effective tax.

Q: India has structural change going forward in the next 10/20 years in terms of contribution to the GDP?
Absolutely. I missed your question on agriculture. Incidentally, twenty years ago, I actually tried to estimate what kind of revenues youd get from an agriculture income tax and even at that time it was much lower than many people had anticipated. And, now with the share of agriculture in GDP down to about 16%, it is likely to keep going down. I dont think that issue is that important. Obviously, a system that captures everything is good but that issue is becoming increasingly irrelevant.

Service, yes. That is the whole point of the GST is that the earlier system which has changed over the last 5 years was missing certain sources of tax and yes these two things together the income tax and corporate tax reform, goods and service tax reform will have a tremendous impact on the Indian economy. Theres absolutely no doubt about it.

Q: Sir, you have been a keen advocate on reforms. That reflects on the last economic survey. In the next 5 years, how much of that do you see actually playing out on the policy and which ones do you think would get precedence?
A: I am hopeful that over the next 5 years period, counting from the formation of the new government, 80% or more of the specific reforms mentioned in the economic survey will get done. Which ones will happen first or last is not critical to success. Throughout the reforms, we have seen that the important thing is to have the goal right and keep moving in that direction. The actual pace is much less important than many critics think. The deviations are important, the back stepping can have negative impacts because it throws economic expectations into turmoil, thus increasing risk. As long as your goal is clear however and you are moving towards it, growth will not suffer, because economic agents can adjust more easily to the pace of reform as long the direction does not change completely.

Thirdly, in the time frame of the next budget which is in 4 months or so, the fiscal issue is clearly the most important issue; there are linked things which will go into it, like subsidy issue, etc. That is the immediate priority. But, I think it is important to complete the process of de-control. In India, I never use the word de-regulation because you need better regulation even where we have regulators in certain cases. So, the de-control process of the usual ones fertilizer, sugar, etc, - there is little reason why these should be exceptions. In the last 15 years, if you think of all the industry which has been de-regulated, there is nothing special about these two to argue that these should be controlled for the next 15-20 years. So, finishing the process of de-control is the next one.

The third one: is so important for infrastructure for example and financial sector reform is to have simple, effective regulations and good regulators. I think we have a long way to go in that. Even though, I dont want to go into specifics and discuss an individual regulator, I think there is still a great need for improving the regulatory process, regulated entities and the way we do regulations.

Q: How do you see the future of India in the Global economy?
A: In November 2004 and early 2005, I did two papers which talks about a tri-polar world.  This was the time when the concept of BRICS was introduced and was making headlines. I, actually, argued that the big new thing for this century is not the BRICs but the Tri-polar world, which is the rise of China and India to a level competitive with the US and that is going to happen over the next 20 years or so. We are already beginning to see China being recognised as almost as the second power, which was predicted in the 2004 paper. I argued that the world will first become bi-polar with the rise of China relative to the US. In the second paper (2005) I projected that by around 2030, India would  emerge as the third power. I expect India to become and be recognised as a great power by around 2025.

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