Hugh Young: India needs to speed up reform

Hugh YoungOn a trip to the US last month, India’s Prime Minister, Narendra Modi, claimed: “The 21st century belongs to India.” The prophecy was bold and emphatic. The speech was a triumph among the largely Indian American crowd. But it is events at home that will determine whether Modi’s prediction becomes reality. Here are six key areas he needs to address to get India moving:

1. Keep going with Make In India

Modi’s Make In India campaign is one of his flagship policies designed to boost manufacturing and investment, and create new jobs. Currently, manufacturing makes up only 15 per cent of GDP in India (compared with China’s 32 per cent). The aim is to increase that to 25 per cent. Part of the campaign is Digital India – Modi’s plan to expand India’s digital infrastructure and improve internet connectivity, particularly in rural areas.

The results so far have been positive. Foreign direct investment in India has risen by 27.3 per cent in the year to August and industrial production is rising steadily. Notably, Foxconn, Taiwan’s contract manufacturer, announced plans to invest $5bn in a plant in Maharashtra state. Digital India has also been a success story, with internet access and smartphone subscriptions expanding rapidly.

2. Improve ease of doing business

The government has a detailed road map for improving the ease of doing business and some states, particularly Gujarat, Andhra Pradesh and Madhya Pradesh, have made good progress. Some have shifted the provision of many government services and licences online and provided a single window system for setting up a business. This will simplify previously tedious processes and should result in substantial productivity gains.

India now needs to formalise a clear bankruptcy code to speed up the pace of liquidation in stress cases. Modi’s proposed laws will govern businesses formation, contract enforcement, debt repayment and bankruptcy. These reforms are urgently needed and should, at least in theory, face little political resistance.

3. Push through LAB reform

The 2013 Land Acquisition Bill required consent from affected populations before the government could acquire their land. This made acquiring land for building factories, roads and other infrastructure very difficult. Modi has tried to push through amendments to the existing law, but continuing opposition in the upper house of parliament has left a long-term solution out of reach.

One way forward may be through state legislation. Rather than wait for central government approval, 10 state governments are looking to implement their own land laws consistent with the 2015 amendments to the original Bill. These states constitute 47 per cent of India’s GDP, 40 per cent of the population and 48 per cent of the land area. In the absence of land reform at the state level, this may be a way forward.

4. Reform the banking sector

While India’s nominal GDP growth is on the rise, credit growth has been on a downward trend since 2011. Poorly capitalised public sector banks with a high proportion of non-performing loans explain much of the decline in lending. Infrastructure investment has been curtailed as a result. The Reserve Bank of India has introduced some reforms, including those ensuring banks’ capital adequacy and sufficient asset quality, but the government will need to do more. Recapitalising the banks and improving their governance structures is a start.

5. Improve trade links

India is not a participant in the Trans-Pacific Partnership. And because it is not a member of the Asia-Pacific Economic Council it would also not be involved with the potential Free Trade Area of the Asia Pacific. If India is not able to join the TPP, then it could lose out, as other countries will benefit from these expanded multilateral free trade areas. If India wants to be competitive, more progress on these trade agreements will be required.

6. Implement a uniform tax

India has many states, each with its own tax code. Modi’s proposed goods and sales tax will mean producers pay one uniform national tax rather than several layers. The benefits are better tax compliance and a broader tax base. Unfortunately, progress has been slow and Congress’s support of the Bill has been lacking. However, we do not view this as a major concern yet as other reforms, including the bankruptcy code and land reform, are more important to India’s development.

Modi has a state visit to the UK next month, with a planned talk at London’s 70,000-capacity Wembley Stadium sold out. His popularity remains high at home but there is also a growing perception among the public and investors that the government needs to make progress on reforms. While Modi has impressed with rousing rhetoric abroad, his actions at home will determine his lasting legacy.

Hugh Young is managing director of Aberdeen Asset Management Asia.