Riding the Elephant

China warns India could become a “centre of geopolitical rivalries”

New Delhi doesn’t really trust Washington and many US policy experts regard India as a tiresome non-performer, but both countries need each other because of China’s increasing adventurism and aggression, and this is leading to a flurry of activity before President Obama’s time in office finishes at the end of this year.

A historic defence deal called LEMOA, or Logistics Exchange Memorandum of Agreement to give it its full name, was signed in Washington on Monday (Aug 29) between the two countries’ defence ministers, Ashton Carter and Manohar Parrikar (below). After tortuous negotiations lasting some 14 years, it provides for both countries making their naval, air force and army bases available to each other for servicing and repairs on a case by case basis. 

At the same time, America’s Secretary of State, John Kerry, was arriving in Delhi for the second India-US strategic and commercial dialogue that includes India’s foreign minister, Sushma Swaraj, and both countries’ commerce ministers. Their agenda has ranged from climate change and clean energy to cyber co-operation and arbitration arrangements.

Obama, who has a built a constructive relationship with Narendra Modi, India’s prime minister, may be in the closing months of his presidency, but there is a continuing momentum in the country’s overall strategic links. These began in 2004, though India is intensely wary, and both sides have let progress slip at various times. 

The US see India primarily as a buffer against China and would like to build a closer relationship as allies, but India is prepared to go no further than being a partner on various fronts while pursuing its own independent interests. In the past that has included refusing to join US-led boycotts of Iran and Myanmar.

The US has emerged as a major supplier of defence equipment with orders totalling some $4.4bn in just the past three years, and has taken part in several joint military exercises. Russia however remains India’s most consistent defence supplier and partner and, significantly, the US failed to make the short-list on a key multi-billion jet fighter deal that it coveted.

The defence logistics agreement is historic because it shows what can eventually be achieved, while also illustrating India’s concerns. The signing owes much to the sensitivity and persistence of Ashton Carter, America’s secretary for defence and India’s most prominent supporter in the Obama administration. He said after the signing that he had spent more time with Parrikar since taking on his job than with any other defence minister anywhere in the world.

“Over the last two years, Carter and Parrikar have built up an unlikely rapport – the former a defence and security technocrat and academic; the latter a street-savvy politician, albeit with an Indian Institute of Technology degree,” says Ajai Shukla, an Indian defence journalist and analyst.

“Foundational pacts”

When the discussions on the logistics deal began in 2002, it was one of the four “foundational pacts” that the US had expected to push India into agreeing quite quickly, but Washington’s defence officials seriously under-estimated the time it would take to achieve just two of them.

An End User Verification Agreement, which was signed in 2009, paved the way for the US to become a major defence supplier by laying down restrictions on India passing technology on to other countries. But a Communications Interoperability & Security Memorandum of Agreement and a Basic Exchange & Cooperation Agreement on Geo-spatial Services have not been agreed and seem unlikely to make much progress in the near future.

This is because of concern both in India’s defence establishment and among opposition political parties that India is gradually moving into what could become a formal military alliance that would drag it into America’s international action in places such as Iran and Syria.

“We resisted this agreement for long because we didn’t want to give the perception that we are ganging up with Americans against somebody else, in particular China,” says Pallam Raju, a defence minister of state in the previous Congress-led government.

India’s defence ministry has tried to answer that point by stressing that the agreement neither created “any obligations” on either India or the US “to carry out any joint activity”, nor provided “for the establishment of any bases or basing arrangements”. It would be used “exclusively during authorized port visits, joint exercises, joint training, and humanitarian assistance and disaster relief efforts.”

India’s powerful neighbour China is of course far from happy, as one of its official mouthpieces has made clear (reported above on Indian tv news). After praising India’s traditional international independence, the Global Times warned: “If India hastily joins the US alliance system, it may irritate China, Pakistan or even Russia. It may not make India feel safer, but will bring strategic troubles to itself and make itself a centre of geopolitical rivalries in Asia.”.

China is getting into the habit of warning other countries about what or what not to do as it becomes more aggressive internationally, though there is of course nothing new in it coercing others to follow its line. Some 25 years ago, when I was reporting for the Financial Times from Hong Kong, it was providing economic aid for small countries to persuade them not to recognise Taiwan as a sovereign country,

Now the stakes are far higher, as the Chinese ambassadors in both London and Delhi have shown in recent weeks with dire warnings to their host countries about failing to  fall in with Beijing’s wishes. One was over a China-backed nuclear power station project at Hinkley Point in Britain that the UK government is reconsidering.

The other was about India’s concern over China’s recent belligerent adventurism in the South China Sea, where the new agreement could become significant if India allows US ships patrolling in those waters to use its naval bases.

Perhaps India would have been less willing to sign up with the US if China had responded constructively to friendly moves initiated by Modi. Instead, it has blocked India’s entry into an international nuclear supplies body, has strengthened its ties with Pakistan, and has failed to make progress resolving differences on its disputed Himalayan border.

With Modi’s friendly overtures leading to that sort of negative response from Beijing, India seems to have had little to lose by doing the logistics deal while Obama and his friendly defence secretary are still in office.

New goods and services tax passed by Rajya Sabha

It has taken 16 years, which is sluggish even by India’s dreadfully slow approach to change, but finally it has happened – late last night the upper house of  India’s parliament passed a constitution (amendment) bill that paves the way for the introduction of an epoch-making tax reform known as the goods and service tax (GST).

The government optimistically hopes to introduce the tax at the start of the next financial year on April 1, merging myriad taxes into one value added measure that will straddle the whole country and abolish different tax regimes run by India’s individual 29 states. There will then be one national tax system for the manufacture, sale and consumption of goods and services, and India will in effect become a single common market.

This is being touted as the single biggest change since India’s major burst of economic reforms in 1991, and it probably is, given its potentially enormous benefits for business efficiency and tax collection. Arun Jaitley (below), the finance minister, says it will add 2% to gdp growth, which is currently just above 7%.

The business welcome was well summed up by Chanda Kochhar, ceo of ICICI, a leading private sector bank. She has described it as the “most important reform in indirect taxation in India ever”, which would benefit all parts of the economy. “Consumers will see lower prices in the medium term, businesses will able to operate more efficiently and the government will see a broadening of its tax base along with ease of tax collection”.

One of the biggest benefits will be faster road transport times, which are more than double those of developed economies, partly because trucks have to pay taxes at each state border. Companies’ distribution and warehousing systems will also be simplified. It should also be possible for the government to restrict tax evasion.

Jaitley and Narendra Modi, the Bharatiya Janata Party prime minister, claim this as great victory for the government, and proof that they are bent on economic reforms.

Such a claim is not wrong, but it is biased because both the BJP and the Congress Party deserve equal praise for backing the measure over the past 16 years – and both also need to be strongly condemned for blocking it when the other was in power.

It was Atal Bihari Vajpayee (below) who, as the then BJP prime minister, launched the first GST discussions in 2000 and set up a committee with states’ finance ministers to design the tax and the systems required.

The BJP however refused to support Manmohan Singh, the Congress prime minister from 2004, when he tried to push the measure with a 2010 target implementation date. It then changed tack when the Modi government was elected two years ago, but that was met by obstruction from Congress, which wanted to build up its credibility in opposition. The Modi style was arrogant, which made co-operation with other parliamentary parties, as well as Congress, virtually impossible

In the past few weeks however, the BJP has improved its political tactics. It won support from almost all regional political parties, which would have left Congress isolated had it not ended its opposition.

Consequently, the bill was unanimously passed last night after nearly eight hours of debate in the Rajya Sabha, where Congress has a majority of the seats. Opposition came only from Tamil Nadu’s AIADMK party MPs who walked out. The bill now needs to be cleared by the Lok Sabha (lower house), which is a certainty given that the BJP has a majority there.

States’ ratification needed

But the bill only paves the way for change. It needs first to be ratified by individual states, which then have to draw up their GST laws, and that will be a substantial task. At least 15 of the states must do this for the measure to be implemented. Most will fall into line, though states such as Tamil Nadu with strong manufacturing industries have reservations because they fear they will lose out, unless they are adequately compensated, by the benefit the value added tax brings to consumer-based states.

All the states, and individual businesses, need to prepare for what is in effect a totally new tax regime. That seems somewhat unlikely to be achieved by the government target date of April 1, even if the legislative process is completed with the central government setting the tax rates. Congress wants the tax capped at 18%.

The Business Standard, a leading Indian newspaper, has said this morning that almost 98% of Indian companies are not ready with the software infrastructure, accounting systems and human resources training that are needed to handle the tax. The indirect tax regime “would require all companies, their suppliers/vendors, retailers, dealers and even shopkeepers/entertainment centres/restaurants to install computers, which could access the centralised GST network so that tax credits can be logged into the system”, it said.

The GST will be collected at each stage of sale or purchase of goods or services and will provide funds for both the central and state governments. Nationally, it will subsume central excise duty, additional excise duty, service tax, countervailing duty, and special additional duty of customs. At the state level, it will absorb state value added tax/sales tax, entertainment tax, central sales tax, octroi (state border tax), purchase tax, luxury tax, and taxes on lottery, betting and gambling.

Government veto

It will be run by a council where the states will have two-thirds of the seats, but the national government will have a veto because, while it will have only a third representation, decisions will need a 75% vote in favour. This strengthens the central government’s overall powers because it will be able to control tax rates in the states, which goes against the general approach of encouraging the states to led development. This could lead to tensions and political clashes.

Critics have suggested that there are some inflationary risks and that states, which have always over-spent in order to improve the political credibility of their ruling parties, will feel even more free to spend recklessly and wait to be baled out by the council and central government.

So while there is much to celebrate today, now that the GST has crossed a major parliamentary hurdle, there is plenty of scope in the future for disagreements and lack of progress.

Successful implementation will test the government’s political leadership and skill in the coming months. That gives Modi an opportunity to prove that he can do what he was elected to do and change the way India is run.