Will the proposed reforms in India’s financial, energy and retail sectors really make a difference? Is this 1991 all over again?

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Pavneet Singh Kochhar's picture

“We have to bite the bullet. If we have to go down, let us go down fighting,” confident Prime Minister Manmohan Singh opined after unveiling a slew of reforms for the economy battling high inflation and billowing fiscal deficit. United Progressive Alliance (UPA), the ruling government, had come under fierce criticism with economic growth falling below 6 percent, weakening of rupee against major currencies, high oil prices, and drying foreign investment. Low rankings given by credit rating agencies like Standard and Poor’s (S&P) and Fitch jolted the beleaguered government to bring in key reforms.

Recently conducted Heritage Foundation's index of economic freedom ranks India as the 119th freest economy in the world1, whereas small countries like Hong Kong and Singapore tops the chart with first and second position. These ranking reinforces the concern expressed by analyst and rating agencies towards bringing economic reforms.

Last year, Mr. Singh’s government battling hard the widely held perception of economic stagnation opened up retail, civil aviation, media and insurance sectors for foreign players. This is seen as the last attempt of government marred by corruption scandals and political paralysis to revive the economy ahead of the general elections due by mid 2014.

The rest of the essay is divided according to reforms planned in three key sectors: power, retail and finance.

POWER

Power failure last July that plunged millions of Indian households into darkness, also India’s worst blackout in the last decade, pointed out several infrastructure bottlenecks and reinforced the need to find alternatives to satisfy the burgeoning energy demand. The gap between revenues and costs in the energy sector was nearly $6 billion between 2008 and 20092. This leaves little room for State Electricity Boards (SEBs) to invest in new infrastructure or explore other alternatives. Analyst have expressed their disappointment over several states distributing free electricity to farmers and poor households which leads to large scale theft and misuse.

Some of the issues that confront India’s energy sector are insufficient fuel supply, improper pricing, failing infrastructure, pilfering of electricity and fewer investments in cleaner and greener fuels. One-quarter of India’s population lives below poverty line who have become dependent on subsidies especially farmers. These subsidies have become entrenched in the mind of citizens. The condition turns worse when the benefits are not passed to the intended beneficiaries due to inefficient public distribution system. Energy subsidies are a big burden on the exchequer and also have significant implications on environment due to overuse of fossil fuels and misuse of free electricity and groundwater. Government on several occasions failed to increase the prices of diesel and cooking gas fearing a possible outrage from common public.

Currently most of the middle income and even some high income groups enjoy the benefits of these subsidies. The government needs to ensure that subsidies are delivered to the target group in an effective and efficient manner, while gradually phasing them out2. The gradual phase out will give people time to adjust before it becomes difficult for the government to remove them if these are existing in the system for a long time. Phasing out the energy subsidies would increase the economic efficiency. Further, government needs to ensure the periodic monitoring and adjustment of reforms to understand the implications and adapt future policies as needed3.

Recently, the Cabinet Committee on Economic Affairs announced the debt restructuring package for SEBs. Although this is a positive step, future direction would be to ensure land acquisition and environmental clearances for new plants, rationalizing tariff, increasing fuel availability, bringing agriculture power reforms and bipartisan political support so that energy companies continue to deliver services to the citizens, while being profitable themselves.

With a growing population yearning for a better quality life, India’s energy demand growth is inevitable. The government needs to ensure unprecedented commitment to satisfy an ever increasing energy demand in a sustainable way.

RETAIL

One of the key reforms announced by Indian Government for the beleaguered economy is Foreign Direct Investment (FDI) in retail sector. FDI policy mandates foreign investor to invest minimum of $100 million with at least half of this allocated for development of back end infrastructure4. This will lead to strengthening of delivery system including cold chains, transportation, refrigeration, sorting and processing. FDI allows upto 51 percent ownership for multi brand retailers like Wal-Mart and TESCO. The policy has risen bar from 49 percent to 100 percent for single brand retailers. The policy also gives prerogative to states to choose whether to implement FDI or not.

Retailers will buy products directly from farmers eliminating the middlemen, thus, enabling farmers to receive better remuneration. The policy also mandates buying 30 percent of the products from small and medium scale industries, thus, creating employment and strengthening the manufacturing industry. These industries can leverage the expertise of global retail chains resulting in increased profitability and opening plethora of opportunities for small and medium enterprises.

Several people have expressed their apprehensions that entry of retail majors may lead to closure of small stores, also called as kirana shops located in the nook and corner of the country. But these small stores are existing inspite of several Indian retailers have forayed into the market. Rather these stores are constantly upgrading by following the best business practices to keep these big players on their toes. Countries like Singapore, Brazil, Argentina have allowed 100% FDI in retail sector which provide examples of economies where small retail stores co-exist along with major retail chains.

Foreign retail majors like Wal-Mart and TESCO have decades of experience in supply chain management and use of new technologies to efficiently deliver products to end consumers. Likes of Wal-Mart and Ikea will infuse huge investments creating enormous employment opportunities. Several industry experts predict creation of close to 1.5 million jobs in the front end in the next 5 years. Further end consumers will enjoy the benefit of lower prices due to elimination of supply chain inefficiencies, higher quality control practices, and thus strengthening the retail chain sector. Not only will the policy transform the retailing landscape but will also give boost to the nation's ailing infrastructure.

FINANCE

Financial sector is in the dire need of reforms. Banking sector is already under stress in the wake of global slowdown, rising debts as well as lack of reforms for past few years. The Government has failed to address the needs for equitable and inclusive growth. Recently, President Pranab Mukherjee also emphasized the need for economic reforms so that “inclusive growth” not only remains a mere slogan. Several credit rating agencies have warned towards giving junk status to the country if the government failed to bring in reforms. Fitch forecasted the real GDP growth to fall to 6.0% in FY 20135. Moreover, reforms implemented now will take time to revive the economy back on track.

Financial sector reforms can be traced back to 1990s when Mr. Singh, the then Finance Minister, brought several key reforms to transform the battered economy. Prior to the liberalization in 1991, the financial sector suffered from excessive government regulations, weak banking structure, lack of accountability, use of outdated technologies, and poorly developed market structure which lead to low productivity and highly inefficient financial system.

While there is similarity between the current reforms and the reforms of 1991 in terms of opening the economy for foreign investors to fight the staggering fiscal deficit, earlier reforms were focused on strengthening the banking system, technology innovation, removing bureaucratic hurdles, providing autonomy to financial institutions, promoting financial stability and opening sector to new players in order to make the sector competitive and efficient. Whereas current reforms are inclined towards bringing foreign investment, opening up key sectors like retail and aviation, the newly launched direct cash transfer using Aadhaar card, cutting repo rate and Cash Reserve Ratio (CRR), equity raising by banks and increase in fuel prices. The government also plans to bring in foreign investment in insurance and pension sectors.

Indian economy welcomed several laws passed by the parliament. Banking Laws (Amendment) bill has paved way for the corporate houses to enter into banking segment6. The sector is expected to see several mergers and acquisitions in the coming years. The reform gives rights to the central bank to inspect enterprises associated with banks in case of a possible misuse of funds. The Prevention of Money Laundering (Amendment) Bill which seeks to expand the definition of money laundering offences can help curb funding of terrorist operations7. Thus, bringing greater transparency into the system. Disinvestments, eliminating poorly designed welfare programmes, bolstering investor sentiment and hastening economic reforms are the need of the hour to consolidate the battered government finances.

Although the reforms were announced after government came under vociferous criticism, with these reforms India faces less risk of losing investment-grade credit ratings8. These pro-investor reforms have the potential to change the face of Indian economy and eventually the world market. After all there is a maxim in Hindi “Der Aaye Durust Aaye” which translates in English as “Better late than never”.

References:

  1. 2013 Index of Economic Freedom, retrieved from {http://www.heritage.org/index/country/india}
  2. OECD Economic Surveys: India 2011, retrieved from {http://www.oecd.org/india/economicsurveyofindia2011.htm}
  3. A Citizens’ Guide to Energy Subsidies in India, retrieved from {http://www.iisd.org/gsi/sites/default/files/ffs_india_czguide.pdf}
  4. FDI POLICY IN MULTI BRAND RETAIL, retrieved from {http://commerce.nic.in/pressrelease/pressrelease_detail.asp?id=2864}
  5. India Jul-Sept GDP Confirms Slowdown, Need for Reform, retrieved from {http://www.fitchratings.com/gws/en/fitchwire/fitchwirearticle/India-Jul-...}
  6. The Banking Laws (Amendment) Bill, 2011, retrieved from {http://www.prsindia.org/billtrack/the-banking-laws-amendment-bill-2011-1...}
  7. The Prevention of Money Laundering (Amendment) Bill, 2011, retrieved from {http://www.prsindia.org/billtrack/the-prevention-of-money-laundering-bil...}
  8. India faces less risk of credit rating downgrade: S&P, retrieved from {http://in.reuters.com/article/2013/01/31/india-rating-sp-idINDEE90U07D20...}