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Economy | gkienergia.hu

Economy

Hungarian gov't to wipe out billboard market then rebuild it for itself

portfolio.hu / economy - 2016, október 11 - 11:30
Whereas the Hungarian government put up anti-immigrant billboards all over the country in the months before the October referendum against the EU’s mandatory relocation quota, it now plans to...
Kategóriák: Economy

INSTANT VIEW - Hungary inflation swings back to positive territory on base effects

portfolio.hu / economy - 2016, október 11 - 10:50
Hungary’s inflation accelerated to 0.6% in September from -0.1% in August, largely in line with the consensus of analysts in a Portfolio poll (0.7%). Core inflation edged up to 1.4% from 1.2%. ...
Kategóriák: Economy

Hungary leaves negative inflation behind, Sept CPI +0.6%

portfolio.hu / economy - 2016, október 11 - 09:00
Hungary’s consumer prices rose 0.6% year on year in September, up from -0.1% in August. In monthly terms the CPI was up 0.2%, the Central Statistical Office (KSH) reported on Tuesday. The...
Kategóriák: Economy

EU "very concerned" about abrupt closure of Hungarian daily

portfolio.hu / economy - 2016, október 10 - 16:55
The European Commission is “very concerned" about the sudden suspension of 60-year old opposition paper Népszabadság in Hungary, the EC’s chief spokesperson Margaritis Schinas told...
Kategóriák: Economy

Hungary's great fiscal health could create room for tax reduction

portfolio.hu / economy - 2016, október 10 - 16:04
Hungary’s National Economy Ministry expects the favourable budget figures to open the door for tax reduction, a ministry official said after surprisingly high surplus was reported for September...
Kategóriák: Economy

The Deutsche Bank Frenzy and what it says about European banks

Bruegel - 2016, október 10 - 16:00

The IMF released their Global Financial Stability Report (GFSR), which finds that short-term risks to global financial stability have abated since April 2016, but that medium-term risks continue to build. Financial institutions in advanced economies face a number of cyclical and structural challenges and need to adapt to low growth and low interest rates, as well as to an evolving market and regulatory environment. Weak profitability could erode banks’ buffers over time and undermine their ability to support growth and a cyclical recovery will not resolve the problem of low profitability. The IMF stresses that more deep-rooted reforms and systemic management are needed, especially for European banks.

A recent paper by Acharya, Eisert, Eufinger and Hirsch looks at why the regained stability of the European banking sector has not fully transferred into economic growth. They show that this development can at least partially be explained by zombie lending motives of banks that still remained undercapitalized after the OMT announcement (see figure  below). While banks that benefited from the announcement increased their overall loan supply, this supply was mostly targeted towards low-quality firms with pre-existing lending relationships with these banks. As a result, there was no positive impact on real economic activity like employment or investment. Instead, these firms mainly used the newly acquired funds to build up cash reserves. Finally, they document that creditworthy firms in industries with a prevalence of zombie firms suffered significantly from the credit misallocation, which slowed down the economic recovery.

Meanwhile, the European markets were agitated last week by the news of a bigger than expected fine imposed by the US Department of Justice on Deutsche Bank, which some seemed to think could put the bank in difficult position. Martin Wolf at the Financial Times says that Deutsche Bank offers a tough lesson in risk. A first lesson from the Deutsche turmoil is that banks remain highly fragile businesses. By their nature, banks are highly leveraged entities with ultra-liquid liabilities and far more illiquid assets. The high pre-crisis returns on equity promised by banks depended on their ultra-high leverage and so on the taxpayer support in the resulting crash.

A second lesson is that the way in which regulators have gone about punishing banks for their many wrongdoings is unsatisfactory. It is reasonable to punish shareholders for the misdeeds of the banks whose shares they own, yet it must be doubted whether it makes sense to impose a penalty so large that it imperils the survival of an institution. Far more important, the idea that shareholders control banks is a myth: it is management that is responsible, and it is disheartening that shareholders have been punished, but the decision makers who ran these institutions escaped more or less unscathed.

A third lesson is that banks are still undercapitalised, relative to the scale of their balance sheets. More immediately, we lack reliable means of rectifying this. So, while governments insist bailouts are ruled out, few believe this, particularly in the case of a bank of Deutsche’s importance. Overall, Wolf says, the approach taken to punishing banks for their failings is more like firing a blunderbuss than a rifle; and it is still hard to recapitalise banks without public money. Above all, more than nine years after the start of the global financial crisis, worries over the health of the financial system remain significant, especially in Europe. This should not be surprising. But it should be disturbing.

In his piece, Martin Wolf refers to a research note by Adam Lerrick of the American Enterprise Institute, who proposes an alternative form of resolution which he names “temporary bail-in”. This is intended as a response to the idea of “precautionary recapitalisation” that is part of the Bank Resolution and Recovery Directive (BRRD) and which allows government to provide the needed capital temporarily until private sector investors can step in and replace the public funds. Lerrick argues that temporary bail-outs create perverse incentives for regulators and investors and, too easily, become permanent. He argues that if the capital shortfall is really temporary, the bank’s debt holders will be temporarily bailed in and their claims temporarily converted to equity.

Under his proposed framework, the bank would be immediately recapitalized but given time to develop a viable business plan and raise the needed capital from private sector sources. Once new capital is raised from private sources, the former debt holders will have the option of retaining their shares or re-converting them back to their original debt claims. If the funds are truly needed temporarily, the debt holders will be only temporarily bailed in. If the bank cannot raise new capital from private sources, the debt holders will be permanently bailed in. Lerrick proposes that only the excess of each investor’s debt holding above EUR 200,000 would be temporarily converted to shares – so as to protect small investors – and for banks with large numbers of retail investors, 95% of retail bondholders should be completely protected from the temporary bail-in and keep their entire original debt claim. Lerrick argues that under this arrangement, the bail-in may be temporary but the increase in Common Equity Tier 1 (CET1) capital is permanent. He is convinced that the temporary bail-in is a logical extension of the concept of Contingent Capital, it will not have a significant effect on the bank’s cost of funds, it will create stabilizing incentives and will pressure banks to raise needed capital quickly.

Frances Coppola writes on Forbes that talks of “another Lehman” is way overdone. If ever there were a case of market irrationality, this is it. Deutsche Bank needs to raise more capital, that has been evident for quite some time, but Lehman was suffering from much more than a mild shortage of regulatory capital. The Department of Justice’s proposed fine makes the need for Deutsche Bank to raise capital more urgent, while a tanking share price makes it more difficult. So news that the eventual fine could be a lot less than the $14bn that shocked the markets comes as a welcome relief. But even if the fine were imposed in full, it wouldn’t push Deutsche Bank into a Lehman-style collapse because a regulatory capital shortfall is not insolvency. So even if some combination of the DoJ’s fine and other disasters that we haven’t yet heard about did bring Deutsche’s regulatory capital below the ECB’s minimum, it would need a capital plan, not a bailout. Moreover, disasters like Lehman are fundamentally about liquidity, but Deutsche Bank has a strong cash position, and in a crisis it would be backed by the ECB. So Coppola thinks that one should expect no disorderly collapse, no dramatic bailouts and emphatically no financial crisis (which makes American schadenfreude misplaced).

Dan Davies of Frontline Analysts has a rather funny Deutsche Q&A and a longer Deutsche explainer. Davis refers to a recent story by Bloomberg, according to which some hedge funds would have started reducing their Deutsche exposure. Davies says that we should not be worried by hedge funds moving excess derivatives collateral or prime brokerages: basically this is surplus cash that hedge funds have which isn’t invested, or surplus treasury bills that they don’t need to pledge against their trades, but keep in their collateral account anyway. Big hedge funds always have more than one prime broker, and they’re always moving their surplus around. But because these balances are so volatile, they’re basically unusable by the bank as a funding source, so no real funding for Deutsche has been pulled, so far, only excess balances. What would be worrying, Davies says,is if we saw corporate, retail or payments system accounts being moved, because these balances very much are part of the funding of Deutsche Bank’s business, and they do rely quite a lot on “behaviourally stable funding”.

It’s also important to remember that it is not 2008, and Deutsche is no Lehman Brothers. The bulk of Deutsche’s short term funding is secured against securities pledged as collateral, and differently from 2008, nearly all of the short term funding these days is against genuinely risk free instruments. There’s a lot less uncertainty surrounding the valuation of Deutsche Bank’s unpledged assets, if they needed to be pledged to support further funding, then there were about Lehman. The uncertainty all relates to the liabilities side of the balance sheet: the capital might not be sufficient, and the equity might be impaired by a big charge for DoJ fines. Both of these threats come from somewhere other than the asset side of Deutsche Bank’s balance sheet. Moreover, there are significantly many more ways for a bank to get hold of short term liquidity 2016 than there were in 2008. This being said, it is a state of clear and accelerating franchise damage, which could become severe. The worry that ought to be on management and the market’s minds is not a fast and catastrophic collapse, but a gradual transition to a run-off situation in which no long-term funding can be raised and therefore no new business can be initiated. This company needs to raise equity, fast, and settle its litigation, as fast as it can.

The Macro Men agrees: this is not a Lehman moment and will not become a Lehman moment.   For one thing, there is a veritable ocean of liquidity available today through various programs (LTROs, etc.) that were not in place during 2008.  It is therefore difficult to see DB running out of money as swiftly as Lehman did.  More importantly, there has been a change in the structure of the market that makes it more difficult for a systemically-important bank to be as systemically important as Lehman was. Macro Men thinks this is attributed to a decline in the velocity of collateral, which is in turn due to the fact that collateral re-hypothecation is not nearly as prevalent as it used to be. As a result, any failure of Deutsche Bank would not result in the complete freezing up of the financial system that we observed eight years ago. But just  because DB isn’t Lehman doesn’t mean that a failure wouldn’t hurt, particularly given that other banks are looking ropy on their own accord.

Jacob Kirkegaard at the Peterson Institute for International Economics says that whatever its outcome, the recent debacle of Deutsche Bank will mean dramatic changes at the bank itself and could well stress test the new euro area single supervisory mechanism (SSM). While recent events underline that Deutsche Bank’s current business model is unsustainable, this should not be seen as another Lehman Brothers. It is not credible that Deutsche Bank, which has access to essentially unlimited liquidity from the European Central Bank, could run out of cash to repay counterparties anytime soon. At the same time, given that a collapse of Germany’s largest bank would surely lead to a serious economic disturbance, Berlin could issue guarantees for new Deutsche Bank bonds or inject equity capital into the bank, within the BRRD framework. Kirkegaard argues that Deutsche’s market route will serve as a stress test of the new SSM: if the situation deteriorates and the bank were to require public support, this would be a serious blow to the credibility of the SSM, as the bank passed the recent stress tests. That Deutsche has been allowed to operate with a balance sheet this vulnerable should serve as a broader warning sign about the need for the SSM to strengthen its supervision of the largest euro area bank balance sheets.

Jim Brundsen on Brussels Blog thinks that the woes of Deutsche Bank demonstrate that Europe’s banking crisis is still not settled, but the troubles at Germany’s biggest lender have not deterred Brussels from pushing back forcefully against stringent new banking rules. He cites Dombrovskis’ statement that he would be prepared to break with Basel, unless it backs down over its latest set of reform proposals which would lead to increase the amount of loss-absorbing capital banks are required to have. For those with long memories, this can seem quite odd: once upon a time, EU regulators’ prime concern was to force banks to have more capital. It was seen as a safeguard for stability, not an unnecessary burden. After years of sluggish recovery, things seem to have changed. While supporters of the new Basel plans, notably the US and Switzerland, argue that the measures are simply a cleaning up exercise designed to avoid any rule-dodging by banks, the EU sees the exercise as re-opening a book it would rather keep closed. Underneath the technical discussions, there is a conundrum for Europe: how to convince investors that its banks are solid while dodging international rules intended to make them so. With Deutsche in the wars, the challenge is all too real.

Kategóriák: Economy

Era of negative inflation ends with excise tax hike in Hungary

portfolio.hu / economy - 2016, október 10 - 12:27
Consumer prices in Hungary rose 0.8% year on year in September, which finally ended the era of negative inflation, forecasts of analysts polled by Portfolio showed on Monday. Each respondent...
Kategóriák: Economy

Hungary budget surplus through the roof in September

portfolio.hu / economy - 2016, október 10 - 11:55
Hungary’s National Economy Ministry on Monday has reported 271.6 billion forints surplus for the state budget for September. The surprising balance is the result of the transfer of funds by the...
Kategóriák: Economy

Closure of Hungary's opposition paper blow to press freedoms - OSCE

portfolio.hu / economy - 2016, október 10 - 10:42
The closure of Hungary's main opposition newspaper is a "huge blow" to the country's media diversity and press freedoms, a European advocate for media said on Sunday. The left-leaning Népszabadság...
Kategóriák: Economy

Publisher to discuss future of Hungary's closed opposition paper

portfolio.hu / economy - 2016, október 10 - 09:39
Reconciliation between Hungarian daily newspaper Népszabadság and its publisher, Mediaworks, go on, said publisher which shut the 60-year old paper down - printed and online versions - in a shocking...
Kategóriák: Economy

This is Not a Time for Political Neutrality

Robert N. Stavins's blog - 2016, október 9 - 22:20

I have been writing essays at this blog for over seven years, and throughout that time, through perhaps 100 more-or-less-monthly essays, I have tried very hard to keep politics at bay, and to view each and every issue I discussed from a politically neutral, yet analytical economic perspective.  But I find it difficult to remain neutral in the current U.S. Presidential election cycle.

Since before the summer, I had resolved to write today’s essay, but I decided to wait until one month before the November U.S. election to post it, simply because I thought this was the point in time when people would be paying most attention to the upcoming election but would not yet have completely made up their minds.  In particular, I want to address this message to people who – like me – are political independents.

Background

I have been teaching at Harvard for close to 30 years, and every year I take pride in the fact that at the conclusion of my 13-week course in environmental economics and policy, my students cannot say – on the basis of what I have said in lectures or what they have read in the assigned readings – whether I am a tree-hugging environmental advocate from the political left, or an industry apologist from the political right (actually, I am neither, although hostile voices in the blogosphere have sometimes wanted to peg me as being on the opposite of whatever extreme they occupy).

Likewise, I have remained bipartisan in politics, ever since I directed Project 88 more than 25 years ago for the bipartisan coalition of former Democratic Senator Timothy Wirth and the late Republican Senator John Heinz.  Starting with the White House of President George H. W. Bush, and continuing with every administration – of both political parties – since then, I have worked on substantive matters of environmental and energy policy, in some cases closely and intensively, and in some cases indirectly and on the periphery.

Such professional bipartisanship and political neutrality have been important to me, and have been consistent with my voter registration, as I am officially registered as an independent (in Massachusetts, this goes by the designation of “unenrolled”).

So, over the years, I have voted for Democrats and I have voted for Republicans, for various offices ranging from the Mayor of my town to the President of my country.  And in each and every one of those elections, although I preferred one of the two principal candidates (sometimes very strongly), in no case did I fear for the future of my community, my state, or my country if my candidate lost and the other candidate won.

This time is different.  In all honesty, I fear for the United States and I fear for the world if Donald Trump is elected President.  The time for my professional bipartisanship and political neutrality has ended – at least temporarily.  And so I apologize to my readers for using this platform – An Economic View of the Environment – to express my broader, personal views on the upcoming election.  This is a departure that I hope never again will be necessary.

I am not part of a campaign, and I am not recommending a candidate.  Rather, I am recommending that everyone vote!  Of course, today’s essay, like all my posts at this blog, expresses only my personal views, and is not written on behalf of my employer, nor in my capacity as a faculty member of the Harvard Kennedy School.

What Drives My Fear of a Trump Presidency?  His Views on the Environment?

My fear of the consequences of a Trump victory in the Presidential election is not simply because of Mr. Trump’s misleading, (consistently) inconsistent, and fundamentally incorrect statements in the realm of environmental and energy policy.

Let me be clear.  I do find Mrs. Clinton’s policy positions in my area of expertise – environmental and energy economics and policy – to be superior to Mr. Trump’s positions.  I will not repeat here my views of Trump’s environmental and energy positions, because I have frequently been quoted in the press as critical of his pronouncements and positions in this realm (Climate Central, E&E News, Scientific American, New York Times, Washington Post, The Verge, New York Times, The Week, Law Street, Climate Central, New York Times, The Hill, Newsmax, Climate Central, Grist, and National Public Radio).  And a few times I have been quoted as criticizing Hillary Clinton’s policy prescriptions in the environmental and energy realm (New York Times, Denver Post, and High Country News).  (For that matter, I have been quoted perhaps hundreds of times over the past seven and a half years as sometimes supportive and sometimes critical of Obama administration environmental and energy policies.)

So, yes, I believe that the world would be worse off with what I anticipate would be a Trump administration’s environmental and energy policies.  But that is not what really frightens me.

What Really Does Scare me about a Trump Presidency?

What frightens me is much broader and more profound.  I worry about what a Trump presidency would mean for my country and for the world in realms ranging from economic progress to national security to personal liberty.  This comes not from any analysis of policy proposals, but from Trump’s own words in a campaign in which he has substituted impulse and pandering for thoughtful politics.  From the first day – his June 16, 2015 announcement of his Presidential bid (in which he described Mexican immigrants as drug smugglers, criminals, and rapists, and promised to “build a great wall”) – until today, Mr. Trump has built his populist campaign on false allegations about others, personal insults of anyone who disagrees with him, and displays of breathtaking xenophobia, veiled racism, and unapologetic sexism.

As disturbing as Trump’s stated positions are in economic policy, national security, and personal liberties, possibly even worse is the reality that Donald Trump, if elected President, would – intentionally or unintentionally – provide cover and support for the ignorant, racist, and xenophobic tendencies that sadly inhabit a substantial fraction of the U.S. population.  In many ways, Trump represents not the best that my country has to offer, but rather the worst excesses of American culture.

Trump is clearly a politician who seeks support by appealing to popular desires and prejudices rather than by using rational argument.  That is the definition – word for word – of a demagogue.

The Bottom Line

If you are an independent, like me, please do not sit on the sidelines of the upcoming election, condemning both candidates for their failings.

It has been said many times by many people that Hillary Clinton is not an ideal candidate for President.  I do not disagree with that sentiment.  Nor can I dispute the fact that her primary campaign against Senator Bernie Sanders pushed her to adopt positions of the left, including her unfortunate reversal regarding the Trans-Pacific Partnership Agreement.

But Mrs. Clinton would bring significant, positive experience to the presidency from four decades of public life, including as a member of the U.S. Senate and as Secretary of State.  In contrast with Mr. Trump, she has surrounded herself with legions of smart and experienced advisers in dozens of key policy realms.  Her campaign has produced detailed proposals on the most important challenges facing the country (although I do question some of her environmental positions).  But she is, if anything, a realist – not an ideologue, and certainly not a demagogue, which is precisely how I would characterize Mr. Trump.

I recognize that many people harbor very negative feelings about Mrs. Clinton.  The low approval ratings (of both candidates) validate that.  I respect those voters who have serious concerns about a Clinton presidency.

My core argument is that there are great differences between the two major candidates.  I disagree strongly with those of my fellow political independents (and others) who say that because both candidates are flawed, they will not vote.

In my view, that would be a mistake.  The fate of the United States and the fate of the world are really in our hands.  If you are an independent, please do not sit out this election.  It is much too important.

Kategóriák: Economy, Green energy

Hungarian opposition daily Népszabadság suddenly shut down

portfolio.hu / economy - 2016, október 8 - 21:33
Let’s pretend you’re a journalist. In Hungary. In 2016. At an opposition newspaper. It’s Friday, you work as you do on any other weekday. Plus you’re packing your stuff into...
Kategóriák: Economy

What consequences would a post-Brexit China-UK trade deal have for the EU?

Bruegel - 2016, október 7 - 15:43

Brexit means that the United Kingdom could be able to run its own trade policy, which opens the door for the potential negotiation of a free trade agreement between the UK and China. Alicia Garcia-Herrero and Hianwei Xu show that a UK-China FTA will be neither easy nor clearly advantageous for the UK:

  1. It will be difficult for the UK to reach an agreement with China without first establishing a new post-Brexit partnership with the EU. Negotiating tariffs with other WTO members will be a pre-condition if the UK exits the EU customs union, and this process will require time and effort.
  2. Even if the UK reaches an agreement with China, the UK cannot serve as a back door for Chinese products to enter the EU, because the EU is very likely use rules of origin to close any such loopholes.
  3. The UK and the other EU economies differ in most of their exports to China, so there would be very limited substitution between them.

It therefore seems that establishing a new trade relationship with the EU would be a more urgent task for the UK in the post-Brexit world, rather than an FTA with China. Under such circumstances, the UK might need to postpone its trade negotiations with other economies outside of EU, including China.

This goes beyond the current discussion of the illegality of the UK starting to negotiate trade deals before it leaves the EU. The issue is whether it makes economic sense for the UK to do so, and the answer is no. In fact, the more the UK reaches an independent favourable trade agreement with China after Brexit, the harder it will be for the UK to strike a good deal with EU.

In the meantime, it is also urgent for the UK to negotiate with the main WTO members on tariffs, because outside the EU, the UK might not participate in the EU schedule of concessions. The best strategy for the UK would be to negotiate with the other WTO members with the EU-based tariffs as a starting point, to avoid negotiating over terms separately and also to maintain a close relationship with the EU.

Kategóriák: Economy

The yuan’s SDR entry is more symbolism than substance

Bruegel - 2016, október 7 - 14:26

This op-ed was originally published in Nikkei Asian Review.

First, central bank purchases of yuan to comply with the Special Drawing Rights (SDR) basket are relatively tiny, equivalent to just $29 billion. This is because even though the yuan is the third-largest currency in the SDR basket behind the U.S. dollar and the euro, with a nearly 11% weighting, the basket itself represents a very small part of foreign exchange reserves — just 0.3% of the global total.

Second, since the IMF’s announcement on Nov. 30, 2015, about adding the yuan to the SDR basket, central banks have had nearly a year to rejig their holdings to reflect the new allocations. This means the bulk of yuan purchases by central banks should have already taken place. Some data suggests that as much as 70% of central banks already had enough yuan to comply with the new SDR allocations even before the initial announcement last year.

Drawing power

The real question, then, is whether SDR entry will act as a catalyst for capital flows into China beyond the tiny required amount of yuan purchases. In fact, even during the April-June quarter, when China’s foreign exchange markets calmed considerably from the previous three months, capital outflows reached $133 billion.

The figure for the July-September quarter was probably even larger. This means 2016 may end up being pretty similar to 2015 in terms of capital outflows, reflecting expectations of protracted yuan depreciation.

While some foreign investors may still want to tap the increasingly large onshore bond market and bet money within China, it seems unlikely that many will follow this trend at least until the People’s Bank of China reverses course and starts to move up benchmark interest rates. In the event of another rate increase by the U.S. Federal Reserve in the coming months, more attractive yields in China will become even more important to draw investors.

The tensions seen in the offshore yuan market in mid-September, with overnight interest rates to borrow yuan spiking, illustrate how little the market outlook on the Chinese currency has changed. It is still in depreciation mode in the eyes of most market participants, notwithstanding intervention by the PBOC and other parties.

Against this background, it seems clear that the need to stem depreciation pressure in the offshore market has taken a toll on China’s ambitions of internationalizing the yuan.

The usual measures of international yuan usage are all heading down.

The currency accounted for just 6.7% of total deposits in Hong Kong in August, barely half as much as in 2014. Cross-border settlement in yuan represented 21% of total trade logged in August, compared with 37% at the peak in March 2015. Issuance of offshore “dim sum” bonds denominated in yuan halved from 2014 to 2015.

These measures reflect investors’ doubts about the true value of the currency and the management of its movements, as even offshore investors get less and less say in deciding the yuan’s exchange rate.

This means that despite the symbolism of becoming an official SDR currency, the reality is that more will be needed for China to attract inflows and for the yuan to become a truly international currency. The perception of a currency as a dependable, strong store of value is essential to it becoming so, and that is exactly what the yuan is missing now.

It seems that a lot of fuss and rush has been created around China’s quest for SDR status. In the short run, China does not really seem ready to put up with the unintended consequences of becoming a reserve currency. It would have been much better for China to consolidate domestic and external financial reforms before applying for the yuan to become an SDR currency. The country could then be sure of attracting the interest of investors as a fully fledged reserve currency.

Kategóriák: Economy

Hungary's Orbán will soon need new "enemy" to bash - The Economist

portfolio.hu / economy - 2016, október 7 - 12:45
The Economist published an article headlined ‘The Wizard of Budapest’ about Hungary’s Prime Minister Viktor Orbán and his government’s migrant policy. The article kicks...
Kategóriák: Economy

Goods and services tax: Landmark tax reforms in India

Bruegel - 2016, október 7 - 12:22

The most awaited economic reforms in India, for a simplified and uniform tax rate, were passed in the Indian parliament on 3 August 2016. After 11 years of political logjam, debate, and discussion, the biggest tax reform in independent India, and also the biggest economic reform since the structural reforms in 1991, has now been passed in both houses of the Indian parliament. The general sales tax (GST), which subsumes 15 Central and state taxes on goods and services, will create one single indirect tax rate across states, and make India a truly unified market.

The GST required an amendment to the constitution, and approval by two-thirds majority in both houses of parliament. As the National Democratic Alliance had absolute majority in the Lower House (Lok Sabha), the GST bill was passed easily, in 2014. But the bill was pending in the Upper House (Rajya Sabha), due to opposition from the opposition political parties, led by the Indian National Congress, and as the National Democratic Alliance (NDA) government did not have adequate numbers in the Upper House. The irony was that the GST was the initiative of the Congress-led UPA government, which lost power in 2014, after 10 years in government. When the UPA was in power, it had tried to pass the GST, but the Bharatiya Janata Party (BJP), the party Mr. Modi belongs to, did not allow it. That is the real reason the Opposition tried as hard as they did to prevent the ruling NDA from passing the bill, although they did raise a few reasonable issues. However, after prolonged debate and negotiations, sense prevailed, and the Rajya Sabha passed the landmark GST bill unanimously, which is a rare event in Indian politics.

The existing system of Central Value Added Tax (CENVAT) and State VAT suffers from the cascading effect, and thereby leads to high tax on consumers, and different input tax credit from the Centre and states, as the two were not inter-linked, and to differential state VAT rates. The proposed integrated or Dual GST, where there will be central GST and state GST, would replace this system. As the proposed GST is a destination-based tax, the tax burden will shift from the state of origin to the state of consumption, and result in less revenue for manufacturing and developed states. Therefore, there was a proposal of 1 per cent tax on inter-state movement of goods and services, which was earlier meant to help developed states with a manufacturing base, and which has now been dropped in favour of a common market. Though the GST would compensate states for any revenue loss for the first five years, it is not good news for developed states, which have invested in infrastructure and other utilities to attract investment and industries for growth. Therefore, consumption or destination states (like Odisha, Uttar Pradesh, Bihar, and Kerala) stand to gain, while origin states (like Tamil Nadu, Gujarat, and Maharashtra) stand to lose. Overall, one single indirect tax rate all over India will create a common market and lead to a less effective tax burden on final consumers. Come April 2017, for taxation purposes, there will no longer be geographical boundaries across states.

This is by far the biggest milestone of the Modi government in terms of economic reforms. Though the Modi-led NDA has been trying for incremental reforms—though a little cautiously, after the failure to amend the Land Acquisition Bill of 2013 for easier land acquisition for infrastructure projects and industry—this is a landmark achievement, and will be a game changer in coming years. The complicated tax system in India with multiple rates at both the Centre and at states is one of the most difficult issues investors and industry face. In fact, industry and firms spend enormous amounts of time dealing with taxation issues, from tax calculation to availing input tax credit, etc., both at the Central and state level. Over the past decade, this has been one of the most demanded reforms from industry and investors to improve the business environment in India.

A uniform GST for the whole of India will facilitate seamless input tax credit, and thereby eliminate the tax cascading effect and the free flow of goods and services across states. This will help manufacturing firms achieve economies of scale across the supply chain, and they can now source rawmaterial without any additional tax burden, like central sales tax (CST), with proper input tax credit, and sell their products without any additional taxes, which will result in scale economies in production. Ultimately, transaction cost would be lower, and consumers would benefit. The existing differential tax structure across states creates distortionary incentives for different players. For production and logistics, investors prefer locations that offer the least tax rate and administration. Now, this tax incentive-influenced skewed production structure will go, which is good for ‘Make in India’. Therefore, simplifying the tax system through the GST would be a game changer, though other important reforms, like land acquisition and flexible labour laws, will remain to be made.

As more countries adopt a simplified tax structure to attract investment and business houses, the passing of the GST bill has come on time to boost the Indian economy and maintain its ranking as the most favoured destination for investment and growth. The international evidence so far, from countries like Australia and Canada, which adopted GST, like tax reforms, is that they experienced better fiscal finance with price stability in the medium term. Of course, in case the GST rate is high, there is always the fear of price hike immediately after GST implementation in the short-run.

As the main hurdle of constitutional amendment is over, the operational issues of effective implementation are likely to be taken care of soon, as the finance minister has promised to implement the GST from 1 April 2017. And many issues need sorting out.

The successful implementation of GST requires fixing the appropriate GST rate, which is the revenue neutral rate (RNR), and requires an efficient IT infrastructure and capacity building of the entire tax administration. There have been many recommendations for fixing the revenue-neutral GST rate at between 11 per cent and 12 per cent. But the report of the Committee on Revenue Neutral Rate and Structure of Rates for General Sales Tax (2015) headed by Dr. Arvind Subramanian (Chief Economic Adviser to the Government of India) recommended that the RNR should be between 15 per cent and 15.5 per cent, with a standard GST rate of 17-18 per cent.

Second, the government needs to go all out for a successful ‘Digital India’ programme, as the GST will require a state-of-the-art IT infrastructure all over India for effective implementation. Ensuring high-speed IT connectivity across states with huge geographical disparity is such a short time is going to be challenging. Moreover, the entire tax administration needs capacity building to handle the GST.

The proposal to give states the freedom to impose the state GST within a band will dilute the purpose of unified GST. Therefore, the GST Council, the proposed highest decision taking body, made up of voting representatives from the states and the Centre, should stick to one GST rate for every state. There are also issues of balance of power in favour of centre in most powerful GST council with one-third share in voting rights.

For the first time, all political parties came together and passed the GST Bill unanimously. This is not only a mature act but truly an achievement for the Modi government. The GST is called the world’s most complex tax reform, where 7.5 million businesses can register, make payments, and file returns on a GST portal. It is really a big relief for business, as even today, because of layers of taxes and exemptions, the cost of tax compliance in India is too high. In sum, it is a much needed landmark reform.

But, although the merit of the GST is evident and indisputable, the devil lies in the details, as they say, and only time will tell if it is a success.

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