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India: Turning The Corner On Investment And Economic Reform?

Narendra Modi

Prime Minister Narendra Modi

Two years after the election of Narendra Modi, India is slowly moving forward in overhauling an outdated and inefficient bureaucracy, that has hampered investment and economic growth for decades. The assorted rule and regulations that vary state by state, have failed to provide the country with an internal market that allows goods and services to move freely. This is a prerequisite for the creation of a modern economy.

India is a nation of 1.3 billion people, the second most populous in the world. The country is divided into 29 states, that pursue a plethora of different economic policies and regulatory procedures.

Indian GDP (Gross Domestic Product) is expanding rapidly, with a projected rate forecast at 7.4% for both 2016 and 2017. It has been above 7%, for the last two years. The Indian economy is finally growing faster, than neighboring China.

India on a Global Map

India on a Global Map

India now has the 7th largest economy in the world, with a nominal GDP equal to $2.29 trillion USD (United States Dollar). In Purchasing Power Parity (PPP) it comes in at $8.64 trillion USD. This places the country in the 3rd position globally for PPP.

GDP per capita, remains at a low nominal level of $1,820 USD. This places the country in the 129th position worldwide. Although according to PPP it increases the rate to $6,664 USD, this only moves it up to the 108th slot.

Economic growth is still being stifled by a number of factors. These would include a moribund and corrupt government system, in addition to a legal system that suppresses development through endless paperwork and statutes.

Jawaharlal Nehru (left) became India's first prime minister in 1947. Mahatma Gandhi (right) led the independence movement.

Jawaharlal Nehru (left) became India’s first prime minister in 1947. Mahatma Gandhi (right) led the independence movement.

On top of this is an infrastructure that is so antiquated in many areas, that it is incapable of bearing the demands placed upon it by a thriving economy. Even basic services like water and sanitation, can be problematic.

There has been inadequate investment in upgrading the transportation network through countless administrations. This can be easily traced back to when the country first became independent from the United Kingdom in 1947.

The communications system also lags in comparison to many other emerging markets. There are areas of the country where the internet and even regular phone service, are sporadic and unreliable. As more banking and business is being done electronically, it leaves parts of the country totally out of the loop.

A farmer in Rajasthan milks his cow. Milk is India's largest crop by economic value. Worldwide, as of 2011, India had the largest herds of buffalo and cattle, and was the largest producer of milk.

A farmer in Rajasthan milks his cow. Milk is India’s largest crop by economic value. Worldwide, as of 2011, India had the largest herds of buffalo and cattle, and was the largest producer of milk.

The energy grid remains entirely deficient to meet the needs of a rapidly expanding economy. Brownouts and even blackouts occur, when demand for power peaks. This can be disastrous for businesses dependent on electricity for production and communications.

Efforts at reform can languish for years in various government departments and even in Parliament itself.

The first major effort towards market reforms began in 1991. This started the massive deregulation of the economy. It finally began moving India away from decades of socialism, which had utterly failed to provide the vast majority of the citizenry a path to upward mobility.

A recent example is the new goods and services tax (GST), which was introduced more than a decade ago. This value added tax would replace numerous levies and fees, with a single payment. India’s upper house finally passed the measure earlier this month. It already has the sufficient support needed in the lower house, where the present government has a majority, unlike the upper chamber.

If the bill becomes law, it will go a long way in moving India towards a more common market.

A feeder ship in Diamond Harbor, West Bengal. International trade accounted for 14% of India's GDP in 1988, 24% in 1998, and 53% in 2008.

A feeder ship in Diamond Harbor, West Bengal. International trade accounted for 14% of India’s GDP in 1988, 24% in 1998, and 53% in 2008.

Goods would then be able to flow freely from one state to another. There would no longer be the long lines of commercial trucks, that can presently be viewed at the borders of some of the largest states. It would increase business efficiency enormously. Distribution could be conducted from a single site, rather than attempting to replicate a supply chain in individual states.

Furthermore, since the GST would be placed only on the value added, it no longer puts local production at a disadvantage, when compared to previously cheaper imports. It will also force businesses to document the price of the needed inputs for production, as well as the price when the products are sold. This expands the ability of the country, to raise revenue on a more equitable basis.

This single reform could boost GDP growth by between 1% and 2%, maybe more.

Women attend a literacy programme in Thiruputkuzhi, Tamil Nadu.

Women attend a literacy program in Thiruputkuzhi, Tamil Nadu.

Yet, it will still take months to become law. It order for it to pass constitutional muster, at least 15 individual states must voice their approval of the measure. To be sure, there will be calls for exemptions by special interests and disputes at the overall rate of the tax.

One can also expect conflict between the central and state governments as the tax is implemented. As the tax is federal, it will shift more economic power from the state level back to the central authorities.

It is also true that attempts at tax evasion, will become more difficult with the GST.

Mumbai, Maharashtra is considered the financial capital of India.

Mumbai, Maharashtra is considered the financial capital of India.

Of course, the more productive areas of the country will experience the benefits of the new tax more speedily. The advantages of better infrastructure, access to public services and more skilled workers will enrich the most cost-efficient companies first. These firms will also gain access to additional foreign investment ahead of more static enterprises.

Less effective businesses, will consequently now be exposed to further market competition. These outfits will either have to change methods of operation or become bankrupt. Unfortunately, many of these less economical firms are located in rural or impoverished regions of India.

The Bombay Stock Exchange in Mumbai, is the oldest stock exchange in Asia.

The Bombay Stock Exchange in Mumbai, is the oldest stock exchange in Asia.

Knowing that a number of states and various parts of the country will be at a definite disadvantage as competition increases, there will be new demands on the central government for more equitable funding. It is almost certain, that requests for more infrastructure and social spending in less wealthy states are due to rise.

States that have been more successful in manufacturing though, will now have less leverage in attracting foreign business and investment through tax advantages. Conversely, it allows less prosperous states to operate on a more level playing field.

Furthermore, it still does not deal with the 2011 legislation that introduced retroactive taxation. This law has discouraged many foreign investors, considering business opportunities in India. Despite governmental promises to stop enforcing the measure, the practice has continued regardless.

It is expected that if the GST is set at or near 18%, the price that businesses charge for many goods will subsequently drop. This in turn will spur higher demand throughout the economy.

1951_to_2013_Trend_Chart_of_Sector_Share_of_Total_GDP_for_each_year,_India (1)The tax structure is only one impediment of many, that has been gripping the Indian economy for decades. The grinding poverty and lack of basic education among a sizable portion of the population, has hindered development in many states on a massive scale.

Many votes are cast on the basis of language, religion, caste, ethnic background, gender and age. Celebrities and political dynasties have dominated state and national politics since independence. This situation has allowed corruption and bribery to become rampant as well as widespread.

The GDP of India has risen rapidly since 1991.

The GDP of India has risen rapidly since 1991.

It also had led to a powerful deterrence for the promised economic reforms, that have previously failed under past administrations.

Outside the GST, Prime Minister Modi has watched his program for change in labor laws and land reform, remain bottled up in Parliament. As a result,job growth has remained moribund. This is a major problem for a country, with millions of individuals entering the workforce on a monthly basis.

His promise to revive growth which has been partially successful, has more to do with declining fuel and energy costs, than the passage of actual reforms. The lower global price for oil and natural gas has been a major benefit to heavy industry and manufacturing, that are heavy users of electricity.

Bharatiya Janata Party भारतीय जनता पार्टी

Bharatiya Janata Party
भारतीय जनता पार्टी

The continued popularity of Prime Minister Modi has more to do with maintaining law and order as well as keeping his political party, the ruling Bharatiya Janata Party (BJP) away from any major scandals.

BJP has long been business friendly, but it also exhibits a strong inclination of economic nationalism. There is a contradiction in wanting more foreign investment, but still keeping India mostly self-reliant in the majority of economic activity.

A major factor in preventing a further streamlining of the economy, is the vast bloated public sector which is an unfortunate legacy of decades of soft socialism. If real competition is to be allowed across the board, the public enterprises with their huge payrolls and swollen staff must be downsized. They are enormously inefficient and comprise a huge drain on public financial resources.April_2013_to_March_2014_Export_commodities_from_India,_by_percent_value_in_US$

The problem remains that in any attempt to begin a privatization of these entities, it soon brings a strong protest from the well organized and very powerful public labor unions. Since almost all political parties within India need some voter support from this sector to remain in power, major reforms will fail to materialize.

This is part of the issue with any kind of legislation dealing with labor. Over the years, it has been made difficult for firms to shed or lay off excess workers. Whether is is due to technological advances or a downturn in the economy, these surplus workers must remain employed. Organized labor as aforementioned, stymies any real progress with the problem.

As previously mentioned, any land reform efforts have been placed on hold as well. Although BJP opposed the land acquisition passed by the previous government, there has been no real alternative put forward. The present regulation limits the purchase and development of property. In reality, it places further burdens on companies needing property for business and industrial purposes.

In response, the Modi government is permitting individual states to make their own policies on land sales and zoning laws. This makes it far more complex, for firms looking to expand operations. This is especially the case, with foreign entities and investors. It again, shows a lack of national consensus on economic development.

Although the progress being made on taxation is a step in the right direction for reform, it is only a part of what needs to be done to overhaul the Indian economy. After two years in office, investors and business leaders were expecting far more from the Modi government. They are bound to be disappointed, change in India does not come easily or quickly in the financial and economic arena.

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