By Tracie Frost
As 2015 came to a close, the Bharatiya Janata Party (BJP)-led National Democratic Alliance (NDA) government was eager to emphasize its successes over the last 18 months. Speaking at the ASEAN Business and Investment Summit in late November, Prime Minister Narendra Modi said his government has brought down inflation while increasing GDP growth and foreign investment. He stressed that while the world economy has stalled, India’s economy has continued to grow as a result of his policies.
However, not all has been smooth sailing for the Prime Minister. Modi’s party, the BJP, lost a major election in the state of Bihar in November and remains the minority in the upper house of parliament. As a result, Modi has not been able to pass several of his priority reforms, including the landmark goods and services tax (GST) bill. In fact, detractors say that although the Modi government is good at creating sound bites and slogans, it has failed to make meaningful progress in substantial reforms. Despite a sizable legislative majority, India is still running a substantial deficit, banking is still state-run, foreign investment is restricted, the legal system is woefully out of date, privatization has disappointed, and starting a business is still plagued with hurdles.
Here’s what to expect as the Modi government enters its third year.
Various reforms remain on the agenda, among them the GST, bankruptcy and, banking reforms, opening of the legal sector to foreign attorneys, increased ceiling for foreign institutional investment, and simplification of business start-up procedures.
GST: The goods and services tax, once approved, will simplify India’s tax regime by integrating the central excise tax, service tax, and state value-added tax. By some estimates, India’s growth will increase as much as 2% per year with the move to GST. GST is expected to promote exports, create employment opportunities, encourage competition between states, and generally boost growth. The government stopped short of extending the September parliamentary session in order to pass the GST Constitutional Amendment Bill, nor was the bill passed in the winter session, which ended on December 23, 2015. However, in an address to the Indian Revenue Service on January 2, Finance Minister Arun Jaitley said that he is “reasonably optimistic, as far as the next session is concerned, that we may be able to push [the GST Bill] through.” The next parliamentary session begins at the end of February.
Bankruptcy Reform: Bankruptcy reform is much-needed in India where the average time taken for insolvency proceedings is 4.3 years, compared to 1.5 years in the US and one year in the UK. While the new law is expected to reform domestic bankruptcy law, it also sets the framework for developing an effective system for addressing cross-border insolvencies in India. The Insolvency and Bankruptcy Code Bill, which was introduced in the 2015 winter parliamentary session, is currently stalled in a joint committee between the two Indian houses of parliament. However, because bankruptcy reform is a priority area for the Modi government, we expect to see movement on this important matter in the next parliamentary session.
Banking Reform: During 2015, the Modi government made preliminary announcements towards reforms of the banking industry. State-run banks are notoriously starved for capital and prone to corruption. In the announcement, Finance Minister Arun Jaitley unveiled a seven-point plan to revitalize public sector banks, which by some estimates, own close to 70 percent of the country’s banking assets, but only earn a third of the profits. State-run banks are hampered by high levels of non-performing assets and stiff regulations that don’t apply to private banks. The revitalization plan includes creation of a Bank Board Bureau, improving governance standards, and additional capital infusions. Critics argue that what the banking industry really needs is privatization, but Modi has always been more pro-business than free-market. Thus far the Modi government has refused to initiate privatization of public sector banking. Expect to see the banking reform plan rolled out in phases during 2016.
Opening the Legal Sector: Allowing foreign law firms to establish offices and practice law in India will improve the ease of doing business. One of the barriers to foreign direct investment in India is concern over legal representation and arbitration. Companies investing in India want the assurance that they can rely on sound legal advice, judges, and courts. In 2015, the government began discussions surrounding a gradual opening of the legal services sector to foreign attorneys. The Bar Council of India has long opposed allowing foreign lawyers to litigate in India; however, it has signaled a willingness to consider opening the legal sector as long as litigation services remain the exclusive domain of Indian lawyers. After the Committee of Secretaries approves the preliminary conclusions, the Cabinet, chaired by Modi, will take up the issue. Modi has been vocal in his support of legal sector reforms.
Increased ceiling for Foreign Direct Investment (FDI): The Modi government has raised the ceiling on foreign institutional investment in several sectors since taking office in May 2014, but there is still room for improvement. The long-standing 10 percent limit on single institutional investors still exists and continues to inhibit growth. Furthermore, even in sectors where the investment limit has been increased to 49 percent, barriers still exist. For example, in the insurance sector, even though the government raised the FDI cap to 49 percent, no foreign company has been able to increase its investment due to India’s restrictive interpretation of management control. Look for reforms in the foreign direct investment arena to continue to evolve during 2016.
Simplification of business start-up procedures: The World Bank’s “Doing Business” report notes that India requires 11.9 procedures to start a business. In the report, India also had the lowest regional performance indicators for starting a business and ranked 130 out of 189 countries in ease of doing business. The World Bank observed, “India made starting a business easier by considerably reducing the registration fees, but also made it more difficult by introducing a requirement to file a declaration before the commencement of business operations.” However, India eased business start-up by establishing an online VAT registration system and replacing the physical stamp previously required with an online version. Look for more of this kind of reform in 2016 with the Modi government’s push for deepening digital governance. Indeed, in a facebook post in November, Jaitley stated that more reforms are on the way which will reflect positively in 2017 “Doing Business” rankings. He exhibited confidence that India can break into the top 100 in 2016 and the top 50 within three years.
India is a bright spot in the midst of a weak global economy. The International Monetary Fund (IMF) in its World Economic Outlook forecast India’s economic growth at 7.5 percent during 2016, an increase from 7.3 in 2014 and 2015. Further, domestic demand in India is projected to remain strong. The IMF noted that India’s economic growth will benefit from recent policy reforms, a consequent pickup in investment, and lower commodity prices. India’s near-term growth prospects remain favorable, especially given the faster-than-expected decline in inflation. In order to take full advantage of its growth position, the IMF recommends continued fiscal consolidation, enhanced financial sector regulation, and strengthened debt recovery.
The ability to pass significant reforms depends on the willingness of India’s political parties to reach agreement on big-ticket items such as GST. Both parties mush show greater political will to make the difficult decisions that will make India the political and economic powerhouse that it aspires to become.
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