Tuesday, June 28, 2011

Time to kick start the reforms.....enough time wasted already

Sitting here in London and meeting a few people from the financial community brings out instantaneously the scary prospect of India missing the bus. This time for it’s own mistakes. There is enough frustration among fund managers here that nothing is moving in India. There is a policy logjam. Reforms, pending for long, have stopped in the tracks. Everyone’s attention inside India is on the politics. Everyone’s attention outside India is on moving on to the several other countries that are stepping on the gas. India, I am worried, is getting left behind.

Global investors dont care for the spate of corruption charges beyond a point. If the civil society agitation helps reduce corruption, that’s great. But if it leads to a policy freeze, then they lose interest. Most investors here mock the Indian media for having gone too far. Ratan Tata had said this once that we have become so self-critical of ourselves that it will harm our decision making. It’s the same feeling I get here. Intelligent Indians and global investors are saying that the political environment in India is such that no one wants to take a decision. Remember the question that I had asked in one of my earlier blogs (June 9th.....We need efficiency, risk taking.....)? Well, it appears that AK Antony (a clean minister who simply doesn’t take decisions) is preferred over Praful Patel (a minister who changed the shape of the airlines sector, but was embroiled in controversies). For the foreign investor, and for the thousands of domestic investors and industrialists waiting for reforms, India has already got waylaid. Foreign inflows are slowing down. Manufacturing growth rates is slowing down. Q4 GDP growth came in at some 7.5% levels. And the mood of confidence has become one of tentativeness.

It’s time for some decisive action. The government has to take its eyes off Anna and Ramdev and the ilk. The Lokpal Bill is only one of the jobs the government has to do. They need to do several more things to kick start the economy which is already starting to sputter.

The problems in the economy are not difficult to spot. Basically, to curb inflation, the RBI has been increasing interest rates. According to Indian experts I met here in London, there are still one or two more rate hikes likely to happen. Increasing rates will help clamp down on demand. It’s a very temporary solution to curb inflation. It’s like when you get cut by a knife and are bleeding; the immediate solution required is some kind of a bandage to stench the blood flow. But after that, there is need for a more permanent corrective treatment. If there is an infection, an antibiotic is required. Likewise, the interest rate hikes will reduce inflation only temporarily. The long term solution to inflation control is always to incentive higher production. If production increases, higher supply will force prices down. For this, we need smarter fiscal policies which encourage industry to invest more. We also need sensible FDI policies which bring in foreign capital. Our domestic savings rate is high at 35% or so (of the GDP), and that will drive up GDP growth. But we need even more investments. For a developing country, we should try and garner as much global finance as we possibly can.

Here are some important reforms pending for a long time:

1)      The GST Act – Essentially, the GST (Goods and Service Tax) will replace a plethora of central taxes and state-imposed taxes which have made doing business in India difficult. The GST Act proposes to remove several central and state taxes like Excise duty, Service tax, VAT, Octroi, Central Sales tax, State sales tax, entry tax, stamp duty, turnover tax, tax on consumption of electricity, tax on transportation etc etc etc and replace them all with one single GST. The GST will be levied at the consumption point rather than at both, the production as well as consumption points today. There are two problems largely in implementing the GST act. One is that this will take away the powers of the states to levy taxes and give those away to the Center. States worry that this will affect their autonomy. Their ability to use fiscal incentives to attract investments will disappear. Second, there are likely to be some states which benefit from GST because they are strong consumption centers.....some others which will lose because they are stronger in production than in consumption. The center plans to offset these imbalances at least in the short run and hopes that things will iron themselves out in the long run. The other advantage of the GST is that it will reduce paper and cost of collection of taxes. It will also reduce corruption as the tax department interface will now be just at one point. The problem in implementing the GST is that it has become a political issue. The Act is an amendment to the Constitution and so requires a 2/3rds majority in Parliament as well as the support of half the states. Without the BJP’s support, the GST cannot be passed. The BJP instinctively supports GST and would try to get it passed if it was in power. But it has now decided to oppose the UPA’s efforts to get it passed. Why? Apparently because Narendra Modi is upset with the Congress chasing down his home minister (Amit Shah) in the Sohrabuddin murder case.
2)      The Direct Tax Code – will remove the several profit-linked exemptions provided under the present act and replace those with investments-linked exemptions. This will help increase foreign investment in India. It will cut tax rates and get more people under the tax net. This is an act that can be passed quickly because it enjoys wide political support.
3)      FDI in multi-brand retail: I was lucky to meet Mr. Nagesh of Shopper’s Stop yesterday in London. And he explained the benefits of allowing FDI in India. Clearly, FDI was being blocked by the Kishore Biyanis and the Mukesh Ambanis who wanted to build their own retail empires before foreign retailers came in. The debate on whether allowing the Walmarts and the Carrefours will increase or threaten employment is an ongoing one. In the end, I would support FDI in multi-brand retail....at least in the major cities (and with conditions as reported in the press).
4)      Increasing FDI limits in insurance – The insurance business needs lots of capital. Every time someone buys an insurance policy (for which the insurance company assumes a future liability), the insurance company has to “provide” capital. As insurance penetration grows, insurance companies need more and more capital. Hence the need for higher FDI. The Left traditionally opposed a more liberal FDI regime. What’s stopping this reform now?
5)      Land acquisition and Mining: We need a more modern and more humane act that facilitates easy acquisition of land and yet rewards land owners a lot more generously. We need mining laws that protect the environment and the local population, but which also make it easy for industry to invest. The logjam over Posco is a point in case. India’s largest FDI investment is stuck in red tap and confusion for several years now. It’s good to give global investors the message that we care about the environment.....but isn’t it also good to give the message that we mean business and are willing to move fast?
6)      Labor reforms – one of the reasons why manufacturing moves to China and not India is that the labor laws in India are way too restrictive (protect labor....disallow industrialists from sacking labor). Now I am not an expert in this, but I am told that the industry has managed to bypass the restrictive labor laws by engaging more and more contract labor. These are not even covered by the protection of the labor laws. So the whole leftist purpose of protecting labor has already been defeated. Why not reform the laws in a way that helps hire more labor in the correct manner and which encourages more manufacturing. The ultimate savior for the millions of unemployed has to be manufacturing.....not retailing or other services.

The real truth is that the government has paid too much attention to Anna and Lokpal and their ilk and has taken its eyes off the economy. The media in India has forced the government in this direction.....but media is known to be irresponsible. It’s the government’s job to set the agenda and move ahead forcefully with reforms....and it will find widespread support for itself when the reforms help the economy grow faster and create jobs faster. For the sake of the country, I hope the government will act quickly.....

1 comment:

  1. Great post !! I've never understood why the Indian government and the media wastes so much time on things that don't hold much significance; instead of focusing on the core issues .. and your post gave a lot of clarity on that.

    The GST act & Direct Tax code would really change the way things work out here; and by introducing multi-brands to enter the market here can only help increase employment within the country and create new jobs (in my opinion)