Indian reforms: looking beyond the rear-view mirror

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Having inherited a regime with high inflation, elevated interest rates and a perceived lack of transparent governance, the current government, to live up to its ‘collective efforts, inclusive growth’ election manifesto and development agenda has indeed achieved a great deal over the last three years through landmark reforms. While these initiatives (explored in more detail below) have put the economy more firmly on the recovery path, more needs to be done on job creation by improving areas such as the investment climate and the labour market.

Jan Dhan-Aadhaar-Mobile Trinity: structurally reforming government efficiency

The Unique Identification Authority of India (UIDAI), set up by the central government in 2009, aims to assign a 12-digit unique identification (UID) number termed Aadhaar to all residents of India. As of February 2017, an estimated 99% of the adult population now has an Aadhaar number. The current government has moved beyond just providing valid IDs to all citizens towards using Aadhaar to ensure only the truly needy receive subsidies, thereby removing multiple layers of middlemen. This has allowed for a more targeted and efficient way to provide subsidised government services such as the supply of liquefied petroleum gas (LPG) connections, kerosene and fertiliser. Pension payment now reach recipients directly and opening a bank account has become easier.

India’s biggest-ever financial inclusion drive

In August 2014, India’s Prime Minister launched the flagship Pradhan Mantri Jan-Dhan Yojana programme to ensure affordable access to financial services such as savings accounts, remittance, credit, insurance and pensions for more than 15% of the country’s unbanked population. More than 280 million so-called no-frills bank accounts have been opened since November 2015 with the Aadhaar electronic ID card acting as a catalyst. More than 90% of Indian households now have access to a bank account. Out of the 550 000 so-called Fair Price Shops, 200 000 are now equipped with biometric identification to ensure only those authorised to do so purchase the subsidised items on offer.

Similarly, of the estimated INR 1.6 trillion in government welfare payments, 95% is now paid electronically under the Direct Benefit Transfer programme. The government’s overarching JAM Trinity welfare services delivery framework (Jan Dhan-Aadhaar-Mobile i.e., bank account-UID-mobile) is set to scale up. We believe the benefits of direct electronic payments are hard to exaggerate in terms of reduced leakages and potential total estimated savings of INR 500 billion (source: CLSA).

Demonetisation, Goods and Service Tax (GST), debt recovery and other reforms

To fight corruption and black money, the government demonetised higher-denomination banknotes in November 2016 and has now introduced what is arguably the biggest indirect tax reform since independence in the Goods and Services Tax legislation. GST implementation should provide Indian industry with a competitive edge globally, leading to increased exports, as trade shifts from the unorganised to the organised sector (the unorganised sector is able to sell the same goods at a lower price as most of them evade tax). The GST is expected to help reduce inflation in the medium term and should provide a fillip to foreign direct investment (FDI) as interstate barriers to trade fall, making it easier to do business in India. In fact, early ground feedback suggests the transit time for truck operators are down between 5-20% on account of GST. GST implementation should also lead to increased tax revenues, aiding the reduction of the fiscal deficit. General government revenue is currently growing at 16% year-on-year in an economy where nominal GDP is rising by 11% YoY (see Exhibit 1 below).

Exhibit 1: Government revenue as % of nominal GDP


Note: fiscal years beginning 1 April

Source: IMF, as of June 2017

The government also made progress on key initiatives such as the Insolvency and Bankruptcy Code and amendments to the Debt Recovery Acts. It put in place an institutional mechanism to tackle the mountain of bad loans that public sector banks are saddled with, empowering the Reserve Bank of India to intervene in specific cases of default and giving the central bank the authority to order specific defaults to be sent to the insolvency court if lenders and borrowers cannot reach resolution. The RBI estimates that stressed loans in India stand at about 12% of total loans.

Affordable housing

After promising to make banking available to all, India’s Prime Minister launched the flagship Pradhan Mantri Gramin Awas Yojna housing scheme with the aim of ensuring affordable housing for the 40 million people living below the poverty line by 2022. Under the scheme, the government will pay INR 120 000 in financial assistance to build a home. An additional INR 12 000 would be provided for toilets in houses. About 41 000 houses had been built by end-March 2017, out of the approved 1.63 million houses foreseen under the scheme. In addition, a new scheme has been introduced since February for middle-income housing, lowering the cost of houses by up to INR 240 000.

Cause and effect: a surge in FDI inflows

For financial year 2017, gross FDI inflows amounted to USD 43.8 billion, after USD 44.9 billion and USD 35.3 billion in the preceding two financial years. Net FDI inflows have been significantly higher than foreign portfolio investor (FPI) inflows in the last two years (see Exhibit 2 below).

Exhibit 2: FDI flows have substantially increased to outpace FPI flows


Source: CEIC, Deutsche Bank, as of June 2017

Indian reforms: scope for more

Indeed, the government’s achievements have been remarkable: improved governance, increased investment through rising FDI and higher government expenditure, lower inflation and interest rates, reduced fiscal and current account deficits and a strong currency. However, it may still be early to celebrate, in our view. Several interconnected decisions are required for India to regain its growth momentum and move the economy ahead.

Broadly speaking, the government needs to work on three major areas:

  1. Governance: Reduce excessive bureaucracy by streamlining decision-making and introduce single-window clearance and strong regulators in many sectors. Institutions such as Comptroller and Auditor General (CAG) and the judiciary need to be strengthened.
  2. Fiscal reforms: Implement a new Fiscal Responsibility and Budget Management (FRBM) act with medium-term fiscal targets. Follow a more pragmatic approach to privatisation of public assets; approve the sale to ordinary investors.
  3. Investment: Improve the investment climate to increase potential GDP growth. Improve centre-state relations to align economic agendas, particularly in areas such as clearances and labour reforms. Creation of a proper institutional framework for awarding, approving and monitoring large infrastructure projects through the facilitation of land acquisition and environmental approvals.

We believe further improvements to governance and economic reforms should clear the way for improved job creation that can help drive stronger, more broad-based and sustainable growth.

Written on 01/08/2017

Anand Shah

Head of Investments and Deputy CEO, India

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