Address by Dr. Vijay Kelkar, Chairman, Finance Commission
at the FICCI National Executive Committee Meeting on
“Flawless” GST for promoting Growth and Employment
12th October, 2009
Introduction
1. It is indeed a privilege to address the FICCI National Executive Committee and share my thoughts on the issues relating to the design and implementation of Goods and Services Tax (GST).
2. Over the past twenty months, in my capacity as Chairman of the Finance Commission, I have had the privilege of visiting twenty eight States in our country and discussing with the respective State governments their views on our Terms of Reference and how the Commission should go about its work. One important item in our Terms of Reference relates to consideration of “the impact of the proposed implementation of the goods and service tax with effect from 1st April 2010 including its impact on the country’s foreign trade.” A number of State governments have expressed their views on the GST to us while voicing their own concerns. Independently, a number of economists, practitioners and financial journalists have raised issues and suggested options relating to the implementation of GST. I am aware that the GST debate has so far been dominated by the concerns of two of the three major players in this policy triangle – the Central government on the one hand and the different State governments on the other. The third group of stakeholders – trade and industry should proactively seek to influence this debate so that their concerns, needs and aspirations can be incorporated into the GST design as well as the implementation protocols. Policy is best influenced when it is still malleable and I urge not only FICCI but also all the other trade associations to closely study all possible ways in which the GST will impact their membership and put forward their views to the Union Government and the State Governments on the various issues as early as possible.
3. Much has been said on the merits of the GST. It will bring about a qualitative change in the tax system by redistributing the burden of taxation equitably between manufacturing and services. It will lower the tax rate by broadening the tax base and minimizing exemptions. It will reduce distortions by completely switching to the destination principle. It will foster a common market across the country and reduce compliance costs. It can provide a fiscal base for local bodies to enable them to fulfill their obligations. I cannot overemphasize the importance of this given the growing and urgent needs of urbanization. It will facilitate investment decisions being made on purely economic concerns independent of tax considerations. It will promote exports.
4. The Finance Commission had appointed a Task Force on GST as well as commissioned a study by NCAER to assess its impact on growth in GDP and exports. The preliminary results of the NCAER study indicate that the growth in GDP can be between 2-2.5 per cent with the implementation of a well designed GST. This pioneering study explores the impact of GST on growth through direct cost reduction as well as cost reduction of capital inputs. The increase in exports can be between 10-14 percent. If we use 3 per cent as a discount rate, and lower estimate of the GDP increase of 2 per cent accruing year after year, the net present value of the GST reform exceeds half a trillion dollars. You will agree that it is indeed a staggering impact and demands an energetic action to usher in a well designed GST system at an early date. FICCI and their members should be in the forefront in getting this done. Today, I attempt to address some critical questions relating to the design and effective implementation of the GST regime.
Concerns relating to GST
5. Most concerns expressed about the implementation of GST can broadly be divided into three categories -
a. Design issues
b. Operational issues.
c. Infrastructure issues.
I shall take these up one by one.
Design issues:
6. What should be the design of the GST ? The broad framework of GST is now clear. This is on the lines of the model approved by the Empowered Committee of the State Finance Ministers. The GST will be a dual tax with both central and State GST component levied on the same base. Thus, all goods and services barring a few exceptions will be brought into the GST base. Importantly, there will be no distinction between goods and services for the purpose of the tax with a common legislation applicable to both.
7. However a number of issues remain to be resolved. These are presently under the consideration of the Empowered Committee under the Chairmanship of Dr Asim Dasgupta, the distinguished Finance Minister of West Bengal. These issues include :
The rate structure and value
8. The primary concern of all State governments is protection as well as enhancement of existing revenue streams. There are three parameters which need to be balanced here – one is the range of taxes presently being levied which will be subsumed into the GST. This will determine the tax base of the GST. The other two parameters are the number of rates and the numerical value of these rates which will be applied to this base.
9. All indirect taxes on the supply of goods and services would need to be subsumed into the GST. The Empowered Committee in its road map of Dec 2008 has indicated which taxes which will qualify. For the purpose of computing the Revenue Neutral Rate the GST Task Force of the Finance Commission assumed that apart from VAT, stamp duty, vehicle tax, taxes on goods and passengers, taxes and duties on electricity, entertainment tax, entry tax, luxury tax, taxes on lotteries, betting and gambling, purchase tax as well as all State cesses and surcharges will be subsumed into the State GST. Central Sales tax will stand abolished. From the government of India side, Central excise, additional excise duties, service tax, Additional Customs duty (CVD), and all cesses and surcharges (other than educational cess) will be subsumed into the Central GST. This would achieve what I call a “flawless GST” giving maximum possible benefits to Indian economy and particularly to the manufacturing sector.
10. There appears to be agreement that the best option would be a bare minimum number of rates, at best two, preferably one. We assume that a single rate structure will find favour with a very limited set of exemptions available for basic foodgrains as well as basic education and health services. This single rate will ensure low compliance costs, obviate classification disputes, and ensure uniformity of approach amongst all players. But to be attractive, a single rate cannot be too high. At the same time, the rate must be high enough to address the concerns of States regarding revenue neutrality.
11. Using data from about 2 million business entities for the year 2007-08, the GST Task Force of the Finance Commission has generated very interesting data relating to the GST rate which will maintain the same level of income for the centre and States respectively in a minimal exemption regime. Their preliminary calculations suggest that Revenue Neutral Rate will be substantially below the present combined Central and State rates. The report of this Task Force will be published on the Finance Commission’s website shortly and I hope that this will contribute to better awareness and constructive policy dialogue.
Rules of Supply for goods and services
12. While CST will be abolished in the GST regime, the treatment of inter state sales will need to be carefully thought through. It would be necessary to guard against tax arbitrage where local sales which will be taxed could be shown as inter state sales which will not. The CST Act provided for documentation to attest the interstate nature of the sales. A number of models are being examined by the Empowered Committee which will serve as alternatives. Since the final model adopted would have a direct bearing on the ease of inter state trade transactions as well as the compliance cost, I would urge that all trade and industry associations involve themselves in this choice through voluntary submissions of their views to the Empowered Committee.
13. Putting in place the Rules of Supply for the inter state provision of services will be demanding. Services produced and consumed within the same State would not pose a problem as far as the appropriation of taxation proceeds is concerned. However, some services may be supplied from one State, consumed in another and paid for in a third State. A set of rules to determine the taxation jurisdiction and appropriation would need to be worked out. There is adequate international precedent for this but here again, trade and industry associations could take proactive steps to suggest possible options.
The framework for exemptions, thresholds and composition
14. The existing sales turnover thresholds for VAT taxation vary widely across States. Some small States have specified a threshold turnover of Rs 2 lakhs per annum. Larger States have stipulated Rs 40 lakhs per annum. The turnover range for composition eligibility is equally diverse. The list of exempted goods also differs across States. To allow for uniform treatment of inter state transactions nationally, it may be necessary that these variations be bridged so that tax cascading is eliminated. However, the concerns of smaller States need to be kept in mind. For this reason, perhaps such convergence could be targeted over a certain period of time rather than immediately.
Operational Issues
Common Approach
15. For GST to be successful, all States and the Centre should implement it in a similar fashion. Only this will bring about the national common market which is one of its goals. This will be possible when there will be a common law, common exemptions, a common assessment procedure and perhaps even a common return. The Empowered Committee can provide the required leadership to engender this uniformity of approach between all the States amongst themselves and also with the Union government.
Sharing of information
16. Recent experience relating to revenue collections from the Central Sales Tax have raised the issues relating to tax arbitrage. It appears that local sales under the VAT regime are being shown as lower taxed CST sales leading to revenue loss. Some States have expressed concerns and referred to tax evasion in developed countries which have a VAT in place. They have sought reassurance that revenue leakage would be effectively checked in the GST system. Apart from putting in place a comprehensive IT network, sharing of tax related information and coordination amongst all the States will be crucial for this. Perhaps the Empowered Committee could set up a coordination mechanism to address such concerns. Trade and industry bodies also have a strong role to play in curbing such malpractices.
Infrastructural Issues
IT infrastructure
17. A simple system for inter-state verification of dealers and transactions is essential to ensure tax compliance and check avoidance. It will also be essential for enforcing the rules of supply discussed earlier. Given the volume of such transactions, this system necessarily has to be IT based. The present system Tax Information Exchange System ( TINXSYS) does not appear to be fully operational across all States. There are asymmetric benefits to States in putting in place such infrastructure and this appears to be affecting their incentives to do so. We need to put in place a system which will uniformly incentivize all States to participate in and contribute to the verification system. Or alternatively, one central agency could be charged with maintaining this system. Both the alternatives available are challenging, but this needs to be done.
Checkposts
18. Most States have put in place a system of checkposts on its road borders. Apart from other verifications which may take place, these checkposts verify and document inter-state sales of goods carried by the vehicles which cross these borders. These details are then cross verified with the VAT returns of the importing dealers. The need for such an arrangement to continue in the GST regime has been emphasized, especially in view of the abolition of CST and the possibility of tax arbitrage. However, the fact remains that such checkposts by the very nature of their operations, generate enormous delays in road traffic, sometimes upto three hours per checkpost. A freight truck travelling by road between Delhi and Chennai will need to cross five State borders and ten checkposts. Delivery times for goods may be extended significantly because of delays at checkposts. The arrangement also encourages rent seeking behavior.
19. It may be difficult to eliminate checkposts given the valid concerns of State governments which may extend beyond collection of taxes and movement of goods to vehicle fitness examination, prevention of trafficking, collection of local cesses, etc. But what appears to be egregious is that the same vehicle has to pass through two checkposts while crossing one border – the exporting States checkpost and the importing States checkpost. Both these checkposts are often located within a couple of kilometers of each other and a vehicle driver has to spend considerable time in both. Perhaps, it may be possible for both the States to put up a combined checkpost. Officials of both States could sit together and conduct their verifications in one checkpost. Or one State could handle traffic on one direction and the other State in the other direction. But essentially there would be only one check per border for a goods vehicle. Such an arrangement will significantly reduce travel time. The Finance Commission is prepared to support creation of such checkposts if the respective State governments are willing to operate jointly.
Impact on Small Enterprises
20. The impact of GST on small enterprises is often cited a concern. On the State GST component, the position will be exactly the same as under the present VAT regime. There will be three categories of small enterprises in the GST regime. Those below the threshold need not register for the GST. Those between the threshold and composition turnovers will have the option to pay a turnover based tax or opt to join the GST regime. Given the possibilities of input tax credit, not all small enterprise may seek the turnover tax option. The third category of small enterprises above the turnover threshold will need to be within the GST framework. Possible downward changes in the threshold in some States consequent to the introduction of GST may result in obligations being created for some dealers. In such cases suitable provisions could be made to provide direct assistance to the affected small enterprises if considered desirable .
21. In respect of Central GST, the position is slightly more complex. Small scale units manufacturing specified goods are allowed exemption of excise upto a turnover of Rs 1.5 crores. These units, which may be required to register for payment of GST, may see this as an additional cost. In this regard, I would like to invite your attention to the suggestion made to the FRBM Task Force where it was suggested that for these units, the State Government will also collect the central GST on behalf of the central government. This will ensure that the small enterprises will have to only deal with one tax authority and thus ensuring that their transaction costs are not increased. There can be other suggestions. I am sure the authorities will welcome the suggestions from FICCI and how can this be achieved.
A “Flawless” GST
22. Ideally the GST would subsume all the major State Level taxes, use a single rate, allow for only essential exemptions and eliminate all barriers to trade. This flawless GST will feature the following characteristics:
Harmonisation
23. For GST to be effective, there should be identical GST laws across States as well as at the Centre. I propose that not only the law but also the methodology relating to levy, assessment, collection and appropriation of the GST should be similar across States and the centre. Such a unified approach will simplify procedures, eliminate bottlenecks and drastically reduce transaction costs for dealers, enabling them to leverage cost and time gains from the new taxation system. Necessarily, such an approach requires that tax rates for most goods and services be common across the country as should be the list of exemptions and thresholds. These considerations would need to be kept in mind while considering fiscal autonomy of States. Some States have proposed a mechanism which ensures that in future, changes in the essential elements of GST are made only with the concurrence of all States and the center. Such a mechanism will provide stability of the taxation regime and suggestions from trade and industry would be welcome on how to move forward on such a proposal.
Common Procedure- levy, assessment, collection, appropriation
24. For industry to reduce its transaction and compliance costs, it is necessary that apart from a common law, the implementation of the law be also similar across States. All stages of the taxation chain from the levy of the tax to its assessment collection and appropriation should be similar. This would involve similar rules across States dealing not only with assessments, audit, refunds but also more basic issues like registration, filing of returns, treatment of transportation of goods etc. A common dispute resolution mechanism as well as a mechanism for giving advance rulings would further facilitate trade and industry. Here too, associations can play a very useful role by providing advice and suggestions on the modalities to be followed.
Expanding the envelope
25. The broader the tax base, the lower will be the GST rate. I therefore return to an issue raised in the 2003 FRBM Task Force report – the taxation of real estate. The construction sector is a significant contributor to the national economy. Housing expenditure dominates personal consumption expenditure. Further, the present piece meal taxation of this sector encourages perverse incentives. Raw material is charged CENVAT, the works contract is charged VAT and stamp duty is levied on the sale. With no provision of input tax credit in place, there is little incentive to record such transactions either at the construction stage or at the sale stage at their correct value. This leads to substantial loss of tax revenue and fuels the parallel economy. I am aware that the present discussions on the GST configuration do not consider the inclusion of this sector. However, given the potential long term benefits to the economy and to a successful GST, I would urge that the construction and housing sectors be included in the GST tax base, either immediately or during a subsequent phase.
26. Another possible step to expand the GST tax base will be the inclusion of the rail sector. This will be necessary if a level playing field is to be provided to the road and air transportation sectors which will be subject to this tax. This inclusion will also ensure that all inter state transportation of goods can be tracked through the proposed IT network. The railways themselves will benefit from this by availing input tax credit on the significant purchases made by them .
Benefits to State Government
27. A few State governments have recently indicated their opposition to the implementation of GST at the present juncture. While their objections need to be carefully examined, it must also be recognized that while implementation of the GST is aimed at being revenue neutral to the States, it will be budget positive for the government. This is because governments are large purchasers in the market for their own consumption and their cost of procurement will come down significantly with the implementation of GST. Apart from these static benefits, dynamic benefits will be generated in the medium term through more economically efficient production, improved competition and more importantly greater employment.
Role of the Finance Commission
28. It is possible that some States may want assurances that existing revenues will be protected when they implement GST. The Commission is willing to consider providing for compensation in order to advance the implementation of a “flawless” GST.
Next Steps
29. I have shared with you my views on what should be some of the goals of the Goods and Services Tax. The two major players – the Empowered Committee and the Government of India are discussing these issues. As I mentioned earlier, the policy on GST is still malleable and industry and trade associations can play a valuable role in forging it. I would urge that FICCI and all similar promotional bodies study some of the issues highlighted above and present their suggestions to the Empowered Committee and the State governments. In particular, they could work on the appropriate treatment of inter state sales of goods and services; the thresholds, composition and exemption regime which should be adopted; the treatment of small industry; the assessment and audit regime to be adopted; the inclusion of real estate in the tax base and even a draft GST law.
Conclusion
30. During his recent interaction with State Finance Ministers, the Finance Minister has encouraged State Governments to implement GST from 1st April 2010 noting that this was a critical part of the government’s economic reforms program. This is a strong signal. The agenda is vast. All stakeholders need to and must contribute to the present debate. Once GST is introduced, outreach efforts by all agencies will be equally important.
31. The launching of GST will perhaps be the single-most important reform stimulus since the 1991-91 economic reforms launched by the then Prime Minister Narasimha Rao and Finance Minister Dr Manmohan Singh. Flawless GST and the New Direct Taxes Code will put India’s fiscal system at the cutting edge of the world’s market economies. I need not tell you how important this will be for promoting investment – whether domestic or international – and thus give a dynamic boost to our economy.
32. Flawless GST reforms will remove the historic tax-induced bias against the manufacturing sector and would dramatically increase growth in the manufacturing output, exports and blue collar employment. As you know, even a 2 per cent reduction in the costs increases profits by more than 20 per cent. This will attract investments in the manufacturing sector. What is perhaps most attractive is the very favourable impact of a “flawless” GST on the lagging regions of India. As “tax cascading” disappears, the industry will move to the lagging regions because of the likely lower costs and thus bringing the lagging regions into the growth dynamics. For all these reasons, a flawless GST is a must and FICCI should undertake all possible steps to ensure this happens at an early date.
Thank you.
Monday, October 12, 2009
Saturday, August 22, 2009
Inaugural Rajiv Gandhi Lecture
Rajiv Gandhi Lecture Series
Inaugural Lecture by Dr. Vijay Kelkar, Chairman, Finance Commission at
the Rajiv Gandhi Institute of Petroleum Technology
22nd August, 2009
1. I want to thank the Rajiv Gandhi Institute of Petroleum Technology for inviting me to deliver this inaugural lecture. I feel honored to be associated with this event which is in memory of Rajiv Gandhi who was one of our distinguished Prime Ministers. Although I did not work directly with him, I had the privilege of interacting with him as the Secretary to the Economic Advisory Council to the Prime Minister - which was then chaired by Prof. Sukhomoy Chakravarty - and also as Advisor to Ministry of Petroleum. Rajiv Gandhi was a statesman and a visionary who took a “long view” of our development options as well as development perspectives. He wanted India to occupy her rightful place in the comity of nations and envisaged that a dynamic India will greatly contribute to global welfare and world peace.
2. As I mentioned, at personal level, I got associated with Rajiv Gandhi in connection with two different areas and at both times, I saw his unique ability to think in long term. For instance, it was he who initiated India’s long term fiscal policy and many of the later years’ important fiscal reforms can be attributed to his vision. Similarly, he recognized the importance of natural gas for the coming decades. To recognize this and to impart a new focus, he was the one who changed the name of the Ministry of Petroleum to Ministry of Petroleum & Natural Gas.
3. In today’s lecture, this is the aspect of Rajiv Gandhi’s approach which I wish to emulate by focusing on one of the important long term issues and this issue relates to the natural gas sector. I have therefore titled my lecture “Towards a New Natural Gas Policy”. In preparing this lecture, I was mindful of the fact that there is currently a high octane dispute regarding the KG basin gas between two companies. This dispute has now gone to the Supreme Court. I have therefore made every effort to observe the “Lakshman Rekha”.
4. India, as I argued elsewhere, is on a “Growth Turnpike” . Barring the last 12 months of growth interruption thanks to the global financial crisis, India’s growth rate in recent years had accelerated to 9 per cent per annum while the manufacturing sector attained double digit growth rate. Now that the international crisis seems to be waning, I do think we should be able to go back to our earlier dynamism and resume the accelerated growth path. We can do it for the simple reason that there a number of growth drivers that are available to our economy.
5. Essentially, the growth of any economy depends on the growth in factor inputs and such as labour and capital, the growth in productivity and entrepreneurship which exploits market opportunities. In all these areas, India is indeed very favorably placed today. As far as human capital is concerned, in the coming decades, India will have world’s largest working population and given our emphasis on education, we will have increasingly better skilled human capital. People are calling this phenomenon as “demographic dividend”. As far as supply of capital is concerned, this is also getting more abundant thanks to the increasing savings rate in the economy and growing foreign equity and portfolio capital inflows. We are already investing annually 37 per cent of our GDP and with the present trend, this rate can certainly reach 40-45 per cent in the coming years. When we come to productivity growth, it is getting accelerated thanks to increased competition, network externalities and the technological progress. For instance, now there are new technologies in the areas of telecommunication, information technology, bio-technology, etc. These technologies use less inputs and give better and higher output. These technologies were not available earlier to developing countries. This is one of the few but very important advantages for the latecomers!! There are network externalities due to much larger fixed and mobile phone networking, power transmission network and National Highway network. Further, in recent years, we are seeing blossoming of entrepreneurship in India. All these developments suggest that India is going to be the “next growth miracle” of the global economy and I do see that in the next decade or so, with “better governance and appropriate policies”, India can in fact, become the fastest growing economies in the world. Yes my friends, you must have noticed that I slipped in the words “better governance and appropriate policies”. Inter alia, better governance means greater transparency, fairness and efficient justice system in terms of equitable access and speedy delivery.
6. Now, what are these appropriate policies? These relate to fiscal consolidation, inflation targeting, financial sector liberalisation, reforms of education and health sectors, selling of under-performing assets, vigorous implementation of competition policy covering both private and state enterprises, second generation land reforms to promote land markets, infrastructure reforms including reforms of the energy sector as well as policies to promote environment protection and strengthening of the national innovation system. Fortunately, both the Central and State governments are taking a number of important reform initiatives in many of these areas. Amongst all these policies, reforms of the energy sector will be decisive for accelerating growth as well as for promoting economic security. Within the energy sector, however, I would argue that it is the natural gas which will be of strategic importance to our country and hence the need for a New Natural Gas Policy.
7. In 2006, a High Powered Expert Committee under the chairmanship of Dr.Kirit Parikh, Member of the Planning Commission submitted a report on the Integrated Energy Policy for the country. This thoughtful report looked at country’s energy requirements upto the year 2030 in order to meet the challenge of achieving a growth rate between 8-9 percent as well as meeting the increasingly ambitious environmental standards. This study looks at all the energy sources in an integrated manner. In other words, it covers the respective roles of nuclear power, the non-renewable energy sources like solar and wind as well as traditional sources of energy such as coal and hydrocarbons. Given our resource endowment and the level of development, the Committee projected that to maintain a growth of 8-9 per cent over the next few decades, India’s energy requirement will increase three fold. According to the Committee, by 2030, the per annum total energy requirement will be 1.8 billion tonnes of oil equivalent with natural gas increasing its present share between 6 – 10 per cent which translates to a need of 295 to 430 mmscmd (million metric standard cubic meter per day).
8. As I just mentioned, the Committee projects that the share of natural gas would grow upto 10 per cent. In the advanced countries, the share is now almost 25 per cent. In other words, if the supply of gas is abundant, India’s demand can even grow more, probably exceeding 500 mmscmd. The report has detailed a number of policies for different sectors such as nuclear energy, renewable energy sources such as solar and conventional energy sources such as coal and hydrocarbons. However, when it comes to natural gas, it seems that the policy regime that it has envisaged is more following the present policies which I believe requires a paradigm shift.
9. Natural gas will be the key driver of the global economy for this century. What oil was for the 20th century, natural gas will be for the 21st century. This is due to several compelling reasons.
10. Worldwide reserves of natural gas at the current production rates are of the order of 60 plus years, about 20 years longer than Crude Oil. This does not take into account non-conventional sources of natural gas like shale gas, gas hydrates and potential as a result of technological developments to convert coal into natural gas. Once these become technically viable, reserves could increase exponentially. We must also keep in mind that as far back as early 80s, most oil companies would walk away from gas finds. Only when the world accepted that crude oil will peak in early part of this century, natural gas got its due importance. This would mean that new discoveries of hydrocarbon are more likely to be in the form of natural gas. Present discovery in the KG basin in India is a good example. Similar examples are available worldwide.
11. Compared to the petroleum products, natural gas burns cleanly and efficiently in any fuel application. This is amply borne out by the fact that when Metros started using compressed natural gas (CNG) in lieu of gasoline or diesel in transport vehicles, there was a significant reduction in pollution. In other words, natural gas is a “green” fuel compared to coal or oil.
12. As discussed, control of the CO2 emission to the environment is of utmost importance. As compared to liquid petroleum products, natural gas would emit 25 to 30% less carbon dioxide and roughly half when compared with coal per unit of heat generated. This in itself would be a compelling reason to substitute natural gas in place of petroleum products and or coal in any and every application possible.
13. International price of natural gas on heating value basis, including transportation costs, has always been significantly lower when compared with petroleum products. For the last decade, it has been nearly half. Almost in every application, natural gas can substitute petroleum products. However, success of natural gas substituting petroleum products in transport sector has been somewhat less effective. Some countries with abundance of natural gas like Russia has as much as 50% share of natural gas in commercial energy basket as compared to world average of about 25%.
14. Finally, the availability of natural gas is widespread geographically or less concentrated geographically than crude oil and thus enhancing energy security and market stability. This will become an issue of growing importance for our country.
15. The present policy approach for gas seems to be derived from a mindset that India is relatively “gas short” and this scarcity is attempted to be met through rationing or in other words, allocating available gas through quantitative allocation with its consequent under-pricing. Ironically, this approach only reinforces the shortage phenomenon as this discourages supply and enhances demand as prices are not allowed to play their full role. This policy which creates “rent” in the gas markets gets reinforced through the “political economy” factors as a number of important players share these rents. The other conceptual shortcoming of the present framework is that when people think about gas, it is thought of as something distinct from crude oil while in reality both being hydrocarbons, are close substitutes. The fact that they are close substitutes is vividly reflected by how closely they are tracked in terms of prices in the international markets. For instance, if you look at the international LNG prices or Henry Hub price for domestic gas in USA, both track very closely to the corresponding crude oil prices. Yet another shortcoming in the approach is forgetting Rajiv Gandhi’s insight that we have to think long term and that is of even greater relevance to natural gas. As buyers and sellers usually adopt long term contracts, our own policies need to be stable and the authorities should always honour explicit or implicit commitments as this reduces policy uncertainties and encourages buyers and sellers to enter into long term commitments. I cannot overemphasize the importance of this issue to the development of gas sector. In describing in this manner the present policy framework, I may be criticized for being less than fair to extant policies, but I would submit that I may be closer to the evolving state of affairs in this sector.
16. The current procedure for determination of gas pricing being somewhat non-transparent, there is an element of uncertainty and enormous variance in gas prices in the same markets in India. For instance, both in Gujarat and Andhra Pradesh, amongst consumers, the gas prices vary by almost 200 per cent. Such price variation and non-transparency in price determination ironically discourages anchor customers such as fertilizer and power sector creating further difficulties for making any large investments required for laying the pipeline infrastructure. In other words, the present pricing policy framework is not leading to more rapid development of natural gas sector in India – whether in terms of creating supply or demand. This is unfortunate as with better policies for the gas sector, one can foresee a reduction in total imports of hydrocarbons in our economy and enhancement of the country’s energy security.
17. How do we achieve this paradigm shift? Firstly and most importantly, the policy makers will have to change their perspectives or their mindset by recognizing three important factors. Firstly, both oil and gas being hydrocarbons are close substitutes and these markets move in tandem internationally where the infrastructure for gas is well developed; Secondly, although oil and gas are both hydrocarbons, one is liquid and the other gaseous and therefore requires different logistics in terms of supply infrastructure. Hence, these two energy infrastructures create different market structures which has some regulatory implication. I will come to this point a little later.
18. The third factor is that India is potentially a “gas abundant” country. I am using the word “abundant” compared to availability of oil and compared to the present projections of demand for gas in the next 20 years. Given right incentives for producers, it is possible to foresee India to achieve over a decade or so gas output level of more than 500 mmscmd from current supply level of 120 mmscmd. These supply projections may be somewhat speculative, but I would argue these are not without basis.
19. I have talked to a number of knowledgeable experts and I think it is possible to argue that from the current gas reserves of 30 tcf (trillion cubic feet), we can increase the reserves to more than 120 tcf within the next decade. This is based on likely reserves in the eastern deep waters which is estimated between 70-90 tcf and the CBM (coal bed methane) gas reserves which are estimated to be 10-15 tcf and the west coast gas reserves which are again 10-15 tcf. With these reserves, we can sustain production of even more than 500 mmscmd for 15 years or so. Mind you, I have not added to these reserves either the shale gas reserves or the gas supply possibilities from in situ gasification of the country’s deep coal reserves.
20. The new technology of horizontal drilling makes it possible to access shale gas. For instance, in USA, in a decade or so, the share of shale gas increased by 20 per cent. Our geologists in India also estimate the presence of shale gas in Gujarat and Assam. All these potentially large gas reserves can become a reality only if we allow incentives to the producers. This requires that our exploration contracts should have transparency and complete stability. In recent years, there have been instances of unilateral deviations from the stated policy and practices regarding the Production Sharing Contracts and this needs to be eschewed if we want to make any radical gains in finding new gas which is indeed there to tap. Exploration and production of hydrocarbons is inherently hugely risky and such policy instability makes it even riskier thus discouraging the oil companies. In addition to transparency in the contracts, we should give freedom to producers to market their gas provided the price determination is at arms-length and on a transparent basis which avoids transfer pricing or deliberate under pricing. This would mean, inter alia, long term prices to be linked to international crude oil prices providing transparency like in our LNG contracts. What I am arguing is for further liberalization of gas markets in India. This will require an improved regulatory regime. One possible regulatory model to strengthen gas markets in India is the recent Australian Natural Gas Act, 2008 which has very detailed provisions for pricing, production pipelines, operations including the tariffs and safety etc. We can also learn from the OFGAR (Office of Gas and Electricity Regulator of Australia) about enforcement of competition policies to curb potential abuse arising out of possible monopolistic power. With such incentives and regulatory approach, we will find that a number of oil companies will be forthcoming to invest in our gas sector along with new technologies and improved oil field practices. To achieve such an outcome, I should reemphasize the importance of having an upstream and gas regulatory agency which is fair, transparent and technically at par with the best oil companies of the world.
21. As I mentioned, natural gas is different than oil because of its transportation requirements. Large pipelines are required to transport gas and once such pipelines are created, the market structure can become locally monopolistic. To create competitive national gas market, we require national gas pipeline grid, what I call NATGAS grid. But working of this NATGAS grid will have to be supervised by a regulator for ensuring transparency, competition and safety. This inter-state network has to work as a common carrier and all inter-state pipelines would be built either through public sector or private sector companies where construction, sizing, routing and pricing will be done on open tender basis in consultation with the regulator.
22. One possible way of promoting gas markets could be that even where the cross-country or inter-state pipelines are under the private sector, 25-30 per cent of capacity of such pipelines can be “crown” capacity which can be either on “carried interest” or “participating interest” basis and such capacity will be available to any buyer or supplier of gas with the toll charges which are determined by the regulator. This will enable the development of gas market in India where third party suppliers and buyers can use the common carrier. Given the multiple sources of gas such as ONGC, Reliance, GSPC Cairn or other operators and multiple sources of import like Petronet LNG, Shell, GAIL, or the new ones, under a new policy approach, India’s gas market will become competitive like the one obtained in USA or Europe giving consumers choice as well as supply stability. This way, the gas prices all over India will converge barring inherent transportation costs, the tendency which is already observed in the US gas market which is fully liberalized. This will also vastly improve the bargaining power of our country in organizing large scale gas imports whether in the form of LNG or gas through pipelines.
23. The new gas policy can bring large benefits to our economy due to a number of positive outcomes. Firstly, it will increase energy security by enhancing sharply the supply of natural gas from the home or domestic sources. Secondly, it will reduce imports of crude oil and thus bring in considerable macroeconomic benefits. Thirdly, it will lead to investment in power and fertilizer sectors thus benefiting agriculture as well as Indian industry. Fourthly, by reducing cost of power and fertilizers, it will improve all-round competitiveness of Indian industry and agriculture. Also, gas being more environmental friendly fuel, it will enable us to meet our national goals of sustainable development by reducing pollution. It will also lead to better price discovery and greater choice for consumers. We will see that the long term contractual gas prices will be aligned to international crude oil prices in a transparent manner and one can foresee spot market prices such as our own “Kakinada hub” price emerging and providing transparency to gas prices nation-wide. Such augmented supply of domestic gas can be further supplemented with LNG imports as well as import of gas through international pipelines from Iran or Myanmar. This will increase the system stability as well as give impetus to the growth of the neighborhood region whether Gulf or East Asia. Finally, one of the most important benefits of this policy approach is it will help us to eliminate the humongous levels of subsidies the country is incurring on the nitrogenous fertilizers and LPG. Such an elimination of subsidies will provide fiscal space to the Union government to increase investments in areas such as environmental protection and for the reduction of public debt.
24. There is a final point and this relates to the possibility of the new gas policy increasing fiscal space to the State governments also. As our increased gas resources are going to come from off-shore, it is going to create literally tens of thousands of crores of “resource rent” in the form of profit gas and royalty. This resource rent from off-shore hydrocarbon resources while belonging to the Union of India could be shared with all the States of the Union. Already, the Union government shares the profit petroleum or profit gas and royalty from the on-shore fields under the NELP with a State where oil or gas is being produced. By sharing the off-shore profit gas and royalty, considerable amount of resources will become available to all the States of the Union for increasing the supplies of critically short public goods in the important fields such as health, education, water and urban infrastructure.
25. Friends, in conclusion, what I am saying is that with these second generation reforms of the hydrocarbon sector, we can change the energy base of our economy and this will give all-round benefits to the economy. Given our human capital, natural resources endowment and the new technologies, it is possible to achieve this with a new approach or with what I call “Towards A New Natural Gas Policy”. I am mindful that I have only outlined an approach and many improvements may be necessary for the implementation of these proposals. I leave that to you all who are experts and keen students of this fascinating field.
26. I thank you all for your kind attention.
Inaugural Lecture by Dr. Vijay Kelkar, Chairman, Finance Commission at
the Rajiv Gandhi Institute of Petroleum Technology
22nd August, 2009
1. I want to thank the Rajiv Gandhi Institute of Petroleum Technology for inviting me to deliver this inaugural lecture. I feel honored to be associated with this event which is in memory of Rajiv Gandhi who was one of our distinguished Prime Ministers. Although I did not work directly with him, I had the privilege of interacting with him as the Secretary to the Economic Advisory Council to the Prime Minister - which was then chaired by Prof. Sukhomoy Chakravarty - and also as Advisor to Ministry of Petroleum. Rajiv Gandhi was a statesman and a visionary who took a “long view” of our development options as well as development perspectives. He wanted India to occupy her rightful place in the comity of nations and envisaged that a dynamic India will greatly contribute to global welfare and world peace.
2. As I mentioned, at personal level, I got associated with Rajiv Gandhi in connection with two different areas and at both times, I saw his unique ability to think in long term. For instance, it was he who initiated India’s long term fiscal policy and many of the later years’ important fiscal reforms can be attributed to his vision. Similarly, he recognized the importance of natural gas for the coming decades. To recognize this and to impart a new focus, he was the one who changed the name of the Ministry of Petroleum to Ministry of Petroleum & Natural Gas.
3. In today’s lecture, this is the aspect of Rajiv Gandhi’s approach which I wish to emulate by focusing on one of the important long term issues and this issue relates to the natural gas sector. I have therefore titled my lecture “Towards a New Natural Gas Policy”. In preparing this lecture, I was mindful of the fact that there is currently a high octane dispute regarding the KG basin gas between two companies. This dispute has now gone to the Supreme Court. I have therefore made every effort to observe the “Lakshman Rekha”.
4. India, as I argued elsewhere, is on a “Growth Turnpike” . Barring the last 12 months of growth interruption thanks to the global financial crisis, India’s growth rate in recent years had accelerated to 9 per cent per annum while the manufacturing sector attained double digit growth rate. Now that the international crisis seems to be waning, I do think we should be able to go back to our earlier dynamism and resume the accelerated growth path. We can do it for the simple reason that there a number of growth drivers that are available to our economy.
5. Essentially, the growth of any economy depends on the growth in factor inputs and such as labour and capital, the growth in productivity and entrepreneurship which exploits market opportunities. In all these areas, India is indeed very favorably placed today. As far as human capital is concerned, in the coming decades, India will have world’s largest working population and given our emphasis on education, we will have increasingly better skilled human capital. People are calling this phenomenon as “demographic dividend”. As far as supply of capital is concerned, this is also getting more abundant thanks to the increasing savings rate in the economy and growing foreign equity and portfolio capital inflows. We are already investing annually 37 per cent of our GDP and with the present trend, this rate can certainly reach 40-45 per cent in the coming years. When we come to productivity growth, it is getting accelerated thanks to increased competition, network externalities and the technological progress. For instance, now there are new technologies in the areas of telecommunication, information technology, bio-technology, etc. These technologies use less inputs and give better and higher output. These technologies were not available earlier to developing countries. This is one of the few but very important advantages for the latecomers!! There are network externalities due to much larger fixed and mobile phone networking, power transmission network and National Highway network. Further, in recent years, we are seeing blossoming of entrepreneurship in India. All these developments suggest that India is going to be the “next growth miracle” of the global economy and I do see that in the next decade or so, with “better governance and appropriate policies”, India can in fact, become the fastest growing economies in the world. Yes my friends, you must have noticed that I slipped in the words “better governance and appropriate policies”. Inter alia, better governance means greater transparency, fairness and efficient justice system in terms of equitable access and speedy delivery.
6. Now, what are these appropriate policies? These relate to fiscal consolidation, inflation targeting, financial sector liberalisation, reforms of education and health sectors, selling of under-performing assets, vigorous implementation of competition policy covering both private and state enterprises, second generation land reforms to promote land markets, infrastructure reforms including reforms of the energy sector as well as policies to promote environment protection and strengthening of the national innovation system. Fortunately, both the Central and State governments are taking a number of important reform initiatives in many of these areas. Amongst all these policies, reforms of the energy sector will be decisive for accelerating growth as well as for promoting economic security. Within the energy sector, however, I would argue that it is the natural gas which will be of strategic importance to our country and hence the need for a New Natural Gas Policy.
7. In 2006, a High Powered Expert Committee under the chairmanship of Dr.Kirit Parikh, Member of the Planning Commission submitted a report on the Integrated Energy Policy for the country. This thoughtful report looked at country’s energy requirements upto the year 2030 in order to meet the challenge of achieving a growth rate between 8-9 percent as well as meeting the increasingly ambitious environmental standards. This study looks at all the energy sources in an integrated manner. In other words, it covers the respective roles of nuclear power, the non-renewable energy sources like solar and wind as well as traditional sources of energy such as coal and hydrocarbons. Given our resource endowment and the level of development, the Committee projected that to maintain a growth of 8-9 per cent over the next few decades, India’s energy requirement will increase three fold. According to the Committee, by 2030, the per annum total energy requirement will be 1.8 billion tonnes of oil equivalent with natural gas increasing its present share between 6 – 10 per cent which translates to a need of 295 to 430 mmscmd (million metric standard cubic meter per day).
8. As I just mentioned, the Committee projects that the share of natural gas would grow upto 10 per cent. In the advanced countries, the share is now almost 25 per cent. In other words, if the supply of gas is abundant, India’s demand can even grow more, probably exceeding 500 mmscmd. The report has detailed a number of policies for different sectors such as nuclear energy, renewable energy sources such as solar and conventional energy sources such as coal and hydrocarbons. However, when it comes to natural gas, it seems that the policy regime that it has envisaged is more following the present policies which I believe requires a paradigm shift.
9. Natural gas will be the key driver of the global economy for this century. What oil was for the 20th century, natural gas will be for the 21st century. This is due to several compelling reasons.
10. Worldwide reserves of natural gas at the current production rates are of the order of 60 plus years, about 20 years longer than Crude Oil. This does not take into account non-conventional sources of natural gas like shale gas, gas hydrates and potential as a result of technological developments to convert coal into natural gas. Once these become technically viable, reserves could increase exponentially. We must also keep in mind that as far back as early 80s, most oil companies would walk away from gas finds. Only when the world accepted that crude oil will peak in early part of this century, natural gas got its due importance. This would mean that new discoveries of hydrocarbon are more likely to be in the form of natural gas. Present discovery in the KG basin in India is a good example. Similar examples are available worldwide.
11. Compared to the petroleum products, natural gas burns cleanly and efficiently in any fuel application. This is amply borne out by the fact that when Metros started using compressed natural gas (CNG) in lieu of gasoline or diesel in transport vehicles, there was a significant reduction in pollution. In other words, natural gas is a “green” fuel compared to coal or oil.
12. As discussed, control of the CO2 emission to the environment is of utmost importance. As compared to liquid petroleum products, natural gas would emit 25 to 30% less carbon dioxide and roughly half when compared with coal per unit of heat generated. This in itself would be a compelling reason to substitute natural gas in place of petroleum products and or coal in any and every application possible.
13. International price of natural gas on heating value basis, including transportation costs, has always been significantly lower when compared with petroleum products. For the last decade, it has been nearly half. Almost in every application, natural gas can substitute petroleum products. However, success of natural gas substituting petroleum products in transport sector has been somewhat less effective. Some countries with abundance of natural gas like Russia has as much as 50% share of natural gas in commercial energy basket as compared to world average of about 25%.
14. Finally, the availability of natural gas is widespread geographically or less concentrated geographically than crude oil and thus enhancing energy security and market stability. This will become an issue of growing importance for our country.
15. The present policy approach for gas seems to be derived from a mindset that India is relatively “gas short” and this scarcity is attempted to be met through rationing or in other words, allocating available gas through quantitative allocation with its consequent under-pricing. Ironically, this approach only reinforces the shortage phenomenon as this discourages supply and enhances demand as prices are not allowed to play their full role. This policy which creates “rent” in the gas markets gets reinforced through the “political economy” factors as a number of important players share these rents. The other conceptual shortcoming of the present framework is that when people think about gas, it is thought of as something distinct from crude oil while in reality both being hydrocarbons, are close substitutes. The fact that they are close substitutes is vividly reflected by how closely they are tracked in terms of prices in the international markets. For instance, if you look at the international LNG prices or Henry Hub price for domestic gas in USA, both track very closely to the corresponding crude oil prices. Yet another shortcoming in the approach is forgetting Rajiv Gandhi’s insight that we have to think long term and that is of even greater relevance to natural gas. As buyers and sellers usually adopt long term contracts, our own policies need to be stable and the authorities should always honour explicit or implicit commitments as this reduces policy uncertainties and encourages buyers and sellers to enter into long term commitments. I cannot overemphasize the importance of this issue to the development of gas sector. In describing in this manner the present policy framework, I may be criticized for being less than fair to extant policies, but I would submit that I may be closer to the evolving state of affairs in this sector.
16. The current procedure for determination of gas pricing being somewhat non-transparent, there is an element of uncertainty and enormous variance in gas prices in the same markets in India. For instance, both in Gujarat and Andhra Pradesh, amongst consumers, the gas prices vary by almost 200 per cent. Such price variation and non-transparency in price determination ironically discourages anchor customers such as fertilizer and power sector creating further difficulties for making any large investments required for laying the pipeline infrastructure. In other words, the present pricing policy framework is not leading to more rapid development of natural gas sector in India – whether in terms of creating supply or demand. This is unfortunate as with better policies for the gas sector, one can foresee a reduction in total imports of hydrocarbons in our economy and enhancement of the country’s energy security.
17. How do we achieve this paradigm shift? Firstly and most importantly, the policy makers will have to change their perspectives or their mindset by recognizing three important factors. Firstly, both oil and gas being hydrocarbons are close substitutes and these markets move in tandem internationally where the infrastructure for gas is well developed; Secondly, although oil and gas are both hydrocarbons, one is liquid and the other gaseous and therefore requires different logistics in terms of supply infrastructure. Hence, these two energy infrastructures create different market structures which has some regulatory implication. I will come to this point a little later.
18. The third factor is that India is potentially a “gas abundant” country. I am using the word “abundant” compared to availability of oil and compared to the present projections of demand for gas in the next 20 years. Given right incentives for producers, it is possible to foresee India to achieve over a decade or so gas output level of more than 500 mmscmd from current supply level of 120 mmscmd. These supply projections may be somewhat speculative, but I would argue these are not without basis.
19. I have talked to a number of knowledgeable experts and I think it is possible to argue that from the current gas reserves of 30 tcf (trillion cubic feet), we can increase the reserves to more than 120 tcf within the next decade. This is based on likely reserves in the eastern deep waters which is estimated between 70-90 tcf and the CBM (coal bed methane) gas reserves which are estimated to be 10-15 tcf and the west coast gas reserves which are again 10-15 tcf. With these reserves, we can sustain production of even more than 500 mmscmd for 15 years or so. Mind you, I have not added to these reserves either the shale gas reserves or the gas supply possibilities from in situ gasification of the country’s deep coal reserves.
20. The new technology of horizontal drilling makes it possible to access shale gas. For instance, in USA, in a decade or so, the share of shale gas increased by 20 per cent. Our geologists in India also estimate the presence of shale gas in Gujarat and Assam. All these potentially large gas reserves can become a reality only if we allow incentives to the producers. This requires that our exploration contracts should have transparency and complete stability. In recent years, there have been instances of unilateral deviations from the stated policy and practices regarding the Production Sharing Contracts and this needs to be eschewed if we want to make any radical gains in finding new gas which is indeed there to tap. Exploration and production of hydrocarbons is inherently hugely risky and such policy instability makes it even riskier thus discouraging the oil companies. In addition to transparency in the contracts, we should give freedom to producers to market their gas provided the price determination is at arms-length and on a transparent basis which avoids transfer pricing or deliberate under pricing. This would mean, inter alia, long term prices to be linked to international crude oil prices providing transparency like in our LNG contracts. What I am arguing is for further liberalization of gas markets in India. This will require an improved regulatory regime. One possible regulatory model to strengthen gas markets in India is the recent Australian Natural Gas Act, 2008 which has very detailed provisions for pricing, production pipelines, operations including the tariffs and safety etc. We can also learn from the OFGAR (Office of Gas and Electricity Regulator of Australia) about enforcement of competition policies to curb potential abuse arising out of possible monopolistic power. With such incentives and regulatory approach, we will find that a number of oil companies will be forthcoming to invest in our gas sector along with new technologies and improved oil field practices. To achieve such an outcome, I should reemphasize the importance of having an upstream and gas regulatory agency which is fair, transparent and technically at par with the best oil companies of the world.
21. As I mentioned, natural gas is different than oil because of its transportation requirements. Large pipelines are required to transport gas and once such pipelines are created, the market structure can become locally monopolistic. To create competitive national gas market, we require national gas pipeline grid, what I call NATGAS grid. But working of this NATGAS grid will have to be supervised by a regulator for ensuring transparency, competition and safety. This inter-state network has to work as a common carrier and all inter-state pipelines would be built either through public sector or private sector companies where construction, sizing, routing and pricing will be done on open tender basis in consultation with the regulator.
22. One possible way of promoting gas markets could be that even where the cross-country or inter-state pipelines are under the private sector, 25-30 per cent of capacity of such pipelines can be “crown” capacity which can be either on “carried interest” or “participating interest” basis and such capacity will be available to any buyer or supplier of gas with the toll charges which are determined by the regulator. This will enable the development of gas market in India where third party suppliers and buyers can use the common carrier. Given the multiple sources of gas such as ONGC, Reliance, GSPC Cairn or other operators and multiple sources of import like Petronet LNG, Shell, GAIL, or the new ones, under a new policy approach, India’s gas market will become competitive like the one obtained in USA or Europe giving consumers choice as well as supply stability. This way, the gas prices all over India will converge barring inherent transportation costs, the tendency which is already observed in the US gas market which is fully liberalized. This will also vastly improve the bargaining power of our country in organizing large scale gas imports whether in the form of LNG or gas through pipelines.
23. The new gas policy can bring large benefits to our economy due to a number of positive outcomes. Firstly, it will increase energy security by enhancing sharply the supply of natural gas from the home or domestic sources. Secondly, it will reduce imports of crude oil and thus bring in considerable macroeconomic benefits. Thirdly, it will lead to investment in power and fertilizer sectors thus benefiting agriculture as well as Indian industry. Fourthly, by reducing cost of power and fertilizers, it will improve all-round competitiveness of Indian industry and agriculture. Also, gas being more environmental friendly fuel, it will enable us to meet our national goals of sustainable development by reducing pollution. It will also lead to better price discovery and greater choice for consumers. We will see that the long term contractual gas prices will be aligned to international crude oil prices in a transparent manner and one can foresee spot market prices such as our own “Kakinada hub” price emerging and providing transparency to gas prices nation-wide. Such augmented supply of domestic gas can be further supplemented with LNG imports as well as import of gas through international pipelines from Iran or Myanmar. This will increase the system stability as well as give impetus to the growth of the neighborhood region whether Gulf or East Asia. Finally, one of the most important benefits of this policy approach is it will help us to eliminate the humongous levels of subsidies the country is incurring on the nitrogenous fertilizers and LPG. Such an elimination of subsidies will provide fiscal space to the Union government to increase investments in areas such as environmental protection and for the reduction of public debt.
24. There is a final point and this relates to the possibility of the new gas policy increasing fiscal space to the State governments also. As our increased gas resources are going to come from off-shore, it is going to create literally tens of thousands of crores of “resource rent” in the form of profit gas and royalty. This resource rent from off-shore hydrocarbon resources while belonging to the Union of India could be shared with all the States of the Union. Already, the Union government shares the profit petroleum or profit gas and royalty from the on-shore fields under the NELP with a State where oil or gas is being produced. By sharing the off-shore profit gas and royalty, considerable amount of resources will become available to all the States of the Union for increasing the supplies of critically short public goods in the important fields such as health, education, water and urban infrastructure.
25. Friends, in conclusion, what I am saying is that with these second generation reforms of the hydrocarbon sector, we can change the energy base of our economy and this will give all-round benefits to the economy. Given our human capital, natural resources endowment and the new technologies, it is possible to achieve this with a new approach or with what I call “Towards A New Natural Gas Policy”. I am mindful that I have only outlined an approach and many improvements may be necessary for the implementation of these proposals. I leave that to you all who are experts and keen students of this fascinating field.
26. I thank you all for your kind attention.
Monday, June 29, 2009
Wednesday, February 11, 2009
Swaminomics
Kelkar's $500-billion, writes Swaminathan S Anklesaria Aiyar in Economic Times
We are on the verge of a revolution worth half a trillion dollars. After almost a decade of effort, India is about to move to a unified goods and services tax (GST) to replace the current plethora of central and state indirect taxes. The Empowered Committee of State Finance Ministers is giving finishing touches to the GST, which is due to be implemented by April 1, 2010. You might ask, why should ordinary folk worry about arcane tax issues? The answer comes from Vijay Kelkar, head of the Finance Commission and former finance secretary. He estimates that the value of the GST reform to India will be $500 billion, or almost half the GDP of India. Hence, he calls the GST reform the biggest reform in India since industrial delicensing in 1991. Only time will tell whether his estimates are accurate. But if he proves even half right, he will be justified claiming that this is a silent revolution. Kelkar came out with these estimates in his convocation address at the Indira Gandhi Institute of Development Research on February 6. He observed that in Canada, which is widely recognised as having a very good GST, Professor Hamilton used a computable general equilibrium model to estimate the impact of a well-functioning GST on the economy. He came up with an estimated benefit of 1.4% of GDP for Canada. Assuming the same level of benefit for India — an additional 1.4% of GDP — Kelkar says the positive gain will be $15 billion. Using a modest 3% discount rate, he then estimates the net present value of the reform to be worth $500 billion. Moreover, says Kelkar, this incremental GDP would increase employment by 4-5 million. That represents a massive financial and human rate of return on a reform that is about to be achieved without any of the political economy storms and upheavals that usually make radical reform difficult. Why will the GST improve the efficiency of the economy so much? Because it will restore rationality and ease of administration to an existing system riddled with multiple authorities, corruption, evasion and distortions because of a plethora of rates and exemptions levied by different states and the Centre. Manufacturing in India is hit badly by cascading taxes, to the point where India truly stands out in global comparisons. Capital goods bear an especially high rate of cascading tax, a serious distortion that holds back our growth. Services in India were long untaxed, and today are still undertaxed, while some services escape taxation altogether. Services now constitute 55% of GDP, while manufacturing contributes around 24%. Service tax has plugged the tax gap to some extent. But clearly India needs a unified tax system covering both services and manufacturing, taxing only the value added at each stage. The tax needs to be levied at the destination point for maximum economic efficiency, compliance and ease of administration. And to the extent possible the GST rates should be uniform. Exports will be zero-rated and hence escape indirect tax totally, in accordance with the international norm. Currently, exporters are unable to get full refunds of sundry indirect taxes, handicapping them in the global market.
Kelkar lists four major channels through which GDP will improve after the introduction of a GST. First, the current system fails to tax all goods and services. This failure leads to distortions and a misallocation of resources from maximum-efficiency areas to undertaxed areas. GST will maximise coverage of goods and services, and thus reduce distortions and improve output. Second, the current unrefunded taxation of capital goods is a real curse on capital accumulation, hitting savings and investment. Kelkar believes that by ending such overtaxation, GST will make a huge long-term difference to outcomes. Third, indirect taxes need to be levied at the destination point to be comprehensive and non-distorting. At any given price level and exchange rate, says Kelkar, violation of the destination principle puts local producers at an unwarranted disadvantage with outside producers. A destination-based GST will end the anomalies of the current system. Fourth, differences in the tax bases of different states and the central government greatly increase the cost of doing business, and impose dead-weight losses on the economy. “This is a league table in which we have constantly languished at the bottom,” says Kelkar. GST will go a long way towards reducing the current system’s red tape, delay, hassles, corruption, leakages and waste. We can all agree with Kelkar that the potential gains from reform are high. It remains to be seen whether the full potential is realised. The immediate problems ahead relate to the finalisation of GST details by the Empowered Committee of State Finance Ministers. They will be tempted to have a large number of tax rates, and to have a large number of exceptions and exemptions. That, after all, is what enables politicians to develop patronage systems and collect kickbacks through changes in tax regime. We can only hope, along with Kelkar, that the Empowered Committee will minimise the number of different tax rates, exemptions and exceptions to the GST. If the number becomes large, that could erode the functioning, effectiveness and economic gains of GST reform. We must also hope that the state finance ministers will subsume other levies — octroi, entry tax, stamp duty — within GST. If such taxes are levied over and above GST, they will violate not only the simplicity of a comprehensive GST, they will also sabotage the aim of converting India into a true common market. Cynics will say that nothing works well in India, so don’t expect GST to work very well either. The gains may be far less than Kelkar’s estimates. I share some of this cynicism. But let me add that precisely because India is so messy, the potential gains from GST must be much higher than in Canada. So perhaps we can reap a $500 billion bonanza after all.
We are on the verge of a revolution worth half a trillion dollars. After almost a decade of effort, India is about to move to a unified goods and services tax (GST) to replace the current plethora of central and state indirect taxes. The Empowered Committee of State Finance Ministers is giving finishing touches to the GST, which is due to be implemented by April 1, 2010. You might ask, why should ordinary folk worry about arcane tax issues? The answer comes from Vijay Kelkar, head of the Finance Commission and former finance secretary. He estimates that the value of the GST reform to India will be $500 billion, or almost half the GDP of India. Hence, he calls the GST reform the biggest reform in India since industrial delicensing in 1991. Only time will tell whether his estimates are accurate. But if he proves even half right, he will be justified claiming that this is a silent revolution. Kelkar came out with these estimates in his convocation address at the Indira Gandhi Institute of Development Research on February 6. He observed that in Canada, which is widely recognised as having a very good GST, Professor Hamilton used a computable general equilibrium model to estimate the impact of a well-functioning GST on the economy. He came up with an estimated benefit of 1.4% of GDP for Canada. Assuming the same level of benefit for India — an additional 1.4% of GDP — Kelkar says the positive gain will be $15 billion. Using a modest 3% discount rate, he then estimates the net present value of the reform to be worth $500 billion. Moreover, says Kelkar, this incremental GDP would increase employment by 4-5 million. That represents a massive financial and human rate of return on a reform that is about to be achieved without any of the political economy storms and upheavals that usually make radical reform difficult. Why will the GST improve the efficiency of the economy so much? Because it will restore rationality and ease of administration to an existing system riddled with multiple authorities, corruption, evasion and distortions because of a plethora of rates and exemptions levied by different states and the Centre. Manufacturing in India is hit badly by cascading taxes, to the point where India truly stands out in global comparisons. Capital goods bear an especially high rate of cascading tax, a serious distortion that holds back our growth. Services in India were long untaxed, and today are still undertaxed, while some services escape taxation altogether. Services now constitute 55% of GDP, while manufacturing contributes around 24%. Service tax has plugged the tax gap to some extent. But clearly India needs a unified tax system covering both services and manufacturing, taxing only the value added at each stage. The tax needs to be levied at the destination point for maximum economic efficiency, compliance and ease of administration. And to the extent possible the GST rates should be uniform. Exports will be zero-rated and hence escape indirect tax totally, in accordance with the international norm. Currently, exporters are unable to get full refunds of sundry indirect taxes, handicapping them in the global market.
Kelkar lists four major channels through which GDP will improve after the introduction of a GST. First, the current system fails to tax all goods and services. This failure leads to distortions and a misallocation of resources from maximum-efficiency areas to undertaxed areas. GST will maximise coverage of goods and services, and thus reduce distortions and improve output. Second, the current unrefunded taxation of capital goods is a real curse on capital accumulation, hitting savings and investment. Kelkar believes that by ending such overtaxation, GST will make a huge long-term difference to outcomes. Third, indirect taxes need to be levied at the destination point to be comprehensive and non-distorting. At any given price level and exchange rate, says Kelkar, violation of the destination principle puts local producers at an unwarranted disadvantage with outside producers. A destination-based GST will end the anomalies of the current system. Fourth, differences in the tax bases of different states and the central government greatly increase the cost of doing business, and impose dead-weight losses on the economy. “This is a league table in which we have constantly languished at the bottom,” says Kelkar. GST will go a long way towards reducing the current system’s red tape, delay, hassles, corruption, leakages and waste. We can all agree with Kelkar that the potential gains from reform are high. It remains to be seen whether the full potential is realised. The immediate problems ahead relate to the finalisation of GST details by the Empowered Committee of State Finance Ministers. They will be tempted to have a large number of tax rates, and to have a large number of exceptions and exemptions. That, after all, is what enables politicians to develop patronage systems and collect kickbacks through changes in tax regime. We can only hope, along with Kelkar, that the Empowered Committee will minimise the number of different tax rates, exemptions and exceptions to the GST. If the number becomes large, that could erode the functioning, effectiveness and economic gains of GST reform. We must also hope that the state finance ministers will subsume other levies — octroi, entry tax, stamp duty — within GST. If such taxes are levied over and above GST, they will violate not only the simplicity of a comprehensive GST, they will also sabotage the aim of converting India into a true common market. Cynics will say that nothing works well in India, so don’t expect GST to work very well either. The gains may be far less than Kelkar’s estimates. I share some of this cynicism. But let me add that precisely because India is so messy, the potential gains from GST must be much higher than in Canada. So perhaps we can reap a $500 billion bonanza after all.
Friday, February 6, 2009
IGIDR Convocation Address on 6th February '09
Click on hyperlink below to view it http://fincomindia.nic.in/writereaddata/html_en_files/IGIDR060209.pdf
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