Monday September 21, 2020

Make in India - September 2020

Speaker:  Adit Jain, IMA India September 2020

Make in India

Shekhar Viswanathan’s recent comments about Toyota’s decision not to further investments in India, is a view shared by several multinational corporations. Many came with higher expectations about market potential, especially in its ability to sustain growth, but were sadly disappointed. The overriding fact is that foreign investment seeks both risk adjusted returns on capital and a certain level of annual growth. India seems to have failed on both counts.

The post pandemic economy, having slumped to levels never seen before, is worse than what policy planners may have possibly expected or were willing to admit. The bigger worry is that the recovery will remain painfully slow adding to the woes of businesses, particularly of the multinational variety. They have a challenge lobbying head-offices for a share of global commitments. The government’s ‘Make in India’ initiative may consequently find it hard to achieve its objectives. Investors are attracted to destinations based on local demand, more so when infrastructure and other constraints undermine productivity and competitiveness for global distribution.

The challenges before the government are overwhelming. With unemployment having escalated post lockdown, crumbling consumer confidence and very little new investment; policy planners have few palatable options. There is a body of progressive economists who have been crying out for more government spending to prop up the economy. But this is not without a flip side. A rising fiscal deficit will lead to unsustainable levels of national debt, which in any case is likely to cross 85% of GDP in a couple of years. There is sizeable evidence to suggest that public debt at such levels, tempers growth in national output. Consequently, India’s future expansion will remain muted around the 5-6% mark. A larger sum in government spending, based on historical evidence, will at best provide a temporary jab that will taper off in a couple of years and also come with high inflation. This is precisely what happened in the wake of the 2008 global financial crisis, when the government pumped prime the economy.

So, what are the options available to India? Unfortunately, none that are easy or quick. This paper will list a few issues that the government may wish to consider, both as a response to the current crisis but really as a structural adjustment to attract capital. The very first, are tax reforms. The attractiveness of the Indian market is based on size and growth which, over the past five years, have begun to moderate. Higher indirect taxes curb consumption, including those of products that enhance household productivity. For instance, taxes on home appliances such as washing machines, two-wheelers, cars and other goods that enrich lives are at a forbidding rate of 28%. This is a sin-tax rate which suppresses consumption and should only be reserved for unhealthy goods such as tobacco. Lower taxes result in lower prices, which incentivise consumer spending and consequently new investment. The principles of price elasticity of demand kick in. There is ample evidence to suggest that following a brief knock, government revenues, too, would rise upwards.

Second, personal income tax rates for high income earners at around 50% with surcharges and other loadings, create a deterrent for wealth creation. Direct tax rates should be capped at 25% but everybody should pay taxes in proportion to their income levels. Those with annual income of up to Rs 1 lac could contribute a marginal rate of 3%, increasing to say 5% for income between Rs 1 lac and Rs 5 lacs, rising to 7% for a slab between Rs 5 lacs and 10 lacs and so on. This way, the tax base is enlarged from the current limitations of a ceiling of 90 to 110 million tax-payers. Compliance becomes easier and revenue collections, based on a back-of-an-envelop study, would jump by over 50%. A previous paper entitled Time for a Tax Rethink, November 2019 explained the basis of these calculations. Engagements and interviews with members of the Asia CEO Forum in Singapore, Hong Kong and Shanghai, managed by our sister company, clearly indicate that high-quality top management talent, considered essential for investments in India, are hard to find. High taxation proves a serious deterrent to competent executives shifting to India, consequently derailing investment plans.

Tax compliance, with a complicated administrative system, is considered another insurmountable hurdle by multinational corporations. This needs to be simplified, if even to attract new overseas investment. A template is readily available in a report authored by the Tax Administrative Reforms Commission, chaired by the eminent tax economist Dr Parthasarathy Shome. The recommendations contained in the report would ensure better compliance and a more customer friendly administrative regime.

Third, structural reforms are overdue in the three factor markets of Land, Labour and Capital. While, a few states have announced changes to their labour laws, the manner in which that was handled is open to legal scrutiny and thus hardly assuring to investors. Labour reforms require a national consensus involving all political factions, state administrations, unions and industry. This necessitates an open debate. Land reforms are like labour and, according to the constitution, within the purview of states. But even before they can begin, India needs to get its land titling in order. Currently, land rights are presumptive rather than absolute, leading to widespread litigation and making acquisitions by investors quite daunting. Capital reforms concern debt markets, something that has been on the discussion board for the past two decades. A market for long term debt which is essentially retail in format, rather than institutional, much like the National Stock Exchange (NSE) is for equity instruments, will serve to provide better financial mediation. Before the NSE was created, a small coterie of equity traders controlled almost everything through the ancient walls of the Bombay Stock Exchange, undermining transparency and the interests of retail investors. Debt market reforms would enlarge the universe of investors and consequently the size of the market, lowering costs of funds quite dramatically.

Finally, a need for banking reforms that eliminate the monopoly and interference of the state and open their books to public scrutiny. Banks desperately need to be recapitalised, so that credit flows can rise. As the government is starved for funds, the only available sources are retail investors and foreign institutions. But this strategy will effectively privatise the banking system, something which may be politically unpalatable.

India’s economy is currently perched on a cusp. The situation is as fragile as in 1991 when bold first-generation reforms were first ushered in. Unemployment has jumped by millions, government revenues have collapsed leading to frictions between Centre and States, thousands of Small and Medium Enterprises have shut shop disrupting supply chains and consequently, the economy has lost a fourth of its value in the last quarter. Hundreds of millions have been pushed into poverty. A critical step would be for policy makers to recognise the fragility of this situation. Things are not going to get better in a hurry and will actually worsen before stabilising into some form of a new normality. This would define growth in the 4-5% range. If the intent is to reduce poverty and generate employment, the economy needs a sustained growth rate of 8-9% per year, for a decade. This in turn necessitates a serious bout of reforms. When the Asia CEO of a major European industrial manufacturer recently remarked at a Forum session in Singapore, “Investing in India is akin to a post-dated cheque drawn on a failing bank” he, perhaps with an unfair degree of nastiness, shared the cynicism of others on investment prospects.