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India – Fast-tracking stalled reforms
We outline India’s key pending reforms and their expected timeline
The need to incorporate diverse views in a democratic system often slows the reform process
Lack of urgency on reforms could worsen supply bottlenecks and damage medium-term growth potential
A popular anti-corruption movement is dominating the government‟s attention at a time when slow progress on economic reforms is creating significant near-term headwinds and might even be lowering the country‟s medium-term growth potential. The government showed some urgency on reforms in June and July – foreign direct investment (FDI) in the retail sector received a key approval, a draft land acquisition bill was proposed, and guidelines for various financial-sector reforms were announced. However, with the government‟s focus now on responding to the anti-corruption movement – which has involved street protests by tens of thousands and a highly publicised hunger strike since mid-August – enacting economic reforms has again moved down the list of policy priorities. To achieve the GDP growth rate of 9.0- 9.5% targeted under the 12th Five Year Plan (FY13-FY17), these reforms need to be fast-tracked.
In this report, we take stock of India‟s pending economic reforms, which are necessary to push the economy onto a sustained growth path. We have focused on key reforms that are stuck at different levels of the complex decision-making process, and we do not discuss those on which the government has not initiated any concrete action. This is not an exhaustive list, but it covers a diverse set of issues including land, taxation, FDI, subsidies and financial services. Some of these reforms are being held up by contentious disputes over implementation, while others lack agreement on their basic premise.
India‟s first wave of economic reforms was ushered in during the early 1990s, when the economy faced a balance-of-payments crisis. The licensing regime – which controlled everything from imports to setting up factories – was dismantled and various product markets were liberalised. In the second generation of reforms (late 1990s to early 2000s), the focus was more on financial markets and services and the opening of the economy. These reforms improved productivity and created a platform for sustained average growth of close to 9% from 2004-08. A third generation of reforms is now urgently needed, particularly to improve institutions (the judiciary, the bureaucracy, corporate governance) and the functioning of input markets (land, labour, minerals). The Indian economy enjoys positive fundamentals in the form of favourable demographics and a good macroeconomic balance, but this must be complemented by prudent policy. The current period of relatively slow growth and high inflation may be a warning signal that reforms need to be accelerated immediately.
The private sector has been clamouring for such reforms for some time now, and policy makers seem to appreciate the urgency of the issue. Investors had hoped that the government would use the current monsoon session of Parliament (between 1 August and 8 September) to legislate on some of these pending issues. However, differences of opinion over the proposed anti-corruption law have stalled parliamentary proceedings, and there is a fear that none of the vital economic reforms will be introduced during the monsoon session. Delaying these reforms, however, threatens to thwart growth. Slower growth in the current inflationary environment threatens to create frustration, further fuelling the anti-corruption movement. In our view, inertia on such reforms is a critical bottleneck to improving the supply side of the economy. As we grow increasingly concerned about the slow pace of progress, we think now is a good time for a status check on key reforms.
The legislative process
Before we discuss each of these reforms in detail, it is important to understand the process by which a particular reform is legislated in India‟s democratic system. The relevant ministry generally publishes a note outlining the broad contours of the proposed reform and invites comments from stakeholders, which can include any party affected by the legislation – corporates, banks, individuals, other ministries, etc. After incorporating these comments, the proposal is either referred to a Group of Ministers or to the Cabinet Committee (comprised of all key ministers). If the reform falls under the jurisdiction of several ministries, a Committee of Secretaries may deliberate on the proposal before it reaches the cabinet.
Following cabinet approval, a formal bill is prepared with help of the Law Ministry, and is then introduced in Parliament. After introduction, the bill is commonly referred to a Standing Committee of the Parliament comprised of members from ruling and opposition parties. The Standing Committee also takes note of other petitioners who might be impacted by the provisions of the bill. After the government receives the suggestions of the Standing Committee, it is free to modify the bill but not obliged to incorporate all the comments. The modified bill is then presented separately to the Lower House (Lok Sabha) and Upper House (Rajya Sabha) for debate and voting. Once passed by both houses, the bill goes to the President for his final approval.
Given the coalition structure of the ruling United Progressive Alliance (UPA), it is often difficult to even forge consensus among the coalition partners. The legislative process can therefore drag on for years. The Standing Committee is often unable to return the bill to Parliament on time because of a lack of consensus among ruling-party and opposition members. The cabinet might be preoccupied with other pressing issues and fail to give prompt attention to a particular reform. In addition, the Parliament convenes only three times a year (budget session, monsoon session and winter session), sometimes delaying the final passage of a bill. For the past two sessions, proceedings have been stalled as opposition parties have made various demands of the government (Charts 1 and 2). The pace of cabinet decisions on pending bills has also slackened considerably in the second term of the UPA government (UPA2), which began in 2009. It is therefore difficult to predict how long it will take a reform to go from proposal to law. If there is an inordinate delay and the Parliament term expires, the bill lapses and has to be reintroduced.
Outline of pending reforms
The monsoon session of Parliament started on 1 August and is expected to run until 8 September. The government had expected to consider 35 pending bills and introduce 32 new bills during the session, according to PRS Legislative Research, a private think-tank. To date, only 10 new bills have been introduced in either of the two houses, and 13 bills have been passed by at least one house. None of the key pending economic reforms has been tabled, and if anti-corruption agitation continues to affect the normal functioning of the Parliament, the situation may not improve by the end of the session. Below we list the key pending bills, their salient features and their current status.
Land Acquisition and Rehabilitation and Resettlement (LARR) Bill
India‟s land acquisition laws have been largely unchanged for almost 118 years. Numerous industrial and infrastructure projects are delayed because of problems in acquiring land. The affected parties (those living on the land) often obstruct these projects to demand better compensation from the government. Obstacles to land acquisition have become a key impediment to industrial development – a government study found that of the 190 public-sector projects that are currently delayed, 70% have been held back on account of land issues.
After long deliberation, the government has finally released a draft bill on this issue for public comment and hopes to introduce it in the monsoon session of Parliament. However, given that the government is accepting comments until the end of August and the monsoon session ends on 8 September, this leaves very little time to incorporate comments into the bill. The chances of introducing this bill during the current session are therefore slim.
Features of the bill:
Compensation to the landowner will be at least six times the market value of the land in rural areas, and twice the market value in urban areas. The land value is to be determined on the basis of transactions in the last three years.
The government can acquire land on behalf of private companies only if it is for „public purpose‟. This broadly covers strategic purposes (national security), infrastructure and industry, but needs to be defined more precisely to avoid confusion.
The consent of at least 80% of the owners is required for any land acquisition, but the draft bill does not mandate how much of the land should be acquired by private parties before the government steps in. An earlier version proposed that the private buyer would have to purchase at least 70% of the land before the government would acquire the rest.
A detailed rehabilitation and resettlement package has been announced for both existing landowners and people who will lose their livelihoods due to the sale. The package covers subsistence allowance, annuity, sharing of the appreciated land value in case of transfer within 10 years, employment for one person from each displaced family, and alternative land to be given to families displaced by certain types of projects.
A social impact assessment is mandatory when the land acquired exceeds 100 acres.
A key ruling-coalition partner that had opposed earlier versions of the bill appears to support this draft. In addition, the relatively generous compensation structure would probably encourage landowners to sell their land to industry. However, from an industry standpoint, the need to obtain the consent of 80% of landowners and the higher cost of land acquisitions could be near-term deterrents. These land acquisition costs would be prohibitively high for small manufacturers and bias the LARR towards large industry. It will also be important to avoid potential conflict with existing land acquisition acts at the state level.
Features of the bill:
Compensation to the landowner will be at least six times the market value of the land in rural areas, and twice the market value in urban areas. The land value is to be determined on the basis of transactions in the last three years.
The government can acquire land on behalf of private companies only if it is for „public purpose‟. This broadly covers strategic purposes (national security), infrastructure and industry, but needs to be defined more precisely to avoid confusion.
The consent of at least 80% of the owners is required for any land acquisition, but the draft bill does not mandate how much of the land should be acquired by private parties before the government steps in. An earlier version proposed that the private buyer would have to purchase at least 70% of the land before the government would acquire the rest.
A detailed rehabilitation and resettlement package has been announced for both existing landowners and people who will lose their livelihoods due to the sale. The package covers subsistence allowance, annuity, sharing of the appreciated land value in case of transfer within 10 years, employment for one person from each displaced family, and alternative land to be given to families displaced by certain types of projects.
A social impact assessment is mandatory when the land acquired exceeds 100 acres.
A key ruling-coalition partner that had opposed earlier versions of the bill appears to support this draft. In addition, the relatively generous compensation structure would probably encourage landowners to sell their land to industry. However, from an industry standpoint, the need to obtain the consent of 80% of landowners and the higher cost of land acquisitions could be near-term deterrents. These land acquisition costs would be prohibitively high for small manufacturers and bias the LARR towards large industry. It will also be important to avoid potential conflict with existing land acquisition acts at the state level.
The Parliamentary resolution also accepts the demand for a „citizens‟ charter‟ which will detail the people‟s entitlements and mandate various government bodies to deliver services within a stipulated time period.
The Lokpal commission will have both investigative and prosecution powers. It can recommend the transfer and suspension of public servants and has the power to seize their property acquired through corrupt means.
The Lokpal can seek the help of the central government and state investigative agencies in its probes.
An immediate flashpoint between the government and the anti-corruption activists appears to have been averted after Parliament unanimously passed the resolution adopting the activists‟ demands. However, the final passage of the bill could be some way off, as the Standing Committee needs to deliberate the details of the bill. While there is general agreement that a strong Lokpal is necessary to check corruption, there are concerns that giving the Lokpal too much power would allow it to evolve into something akin to a „parallel government‟, undermining the executive and judiciary. With the Lokpal controversy out of the way, it will now be imperative for the government to use the rest of the monsoon session as productively as possible.
National Food Security Act (NFSA)
The UPA government has already passed bills ensuring the right to work, the right to education and the right to information. The right to food is seen as the fourth pillar of the set of fundamental citizens‟ rights that the UPA government has promised. The NFSA is a step towards attaining this goal.
With more than 32% of the population living below the poverty line, assuring the supply of food at affordable prices remains a policy priority. However, major stumbling blocks to achieving this ambitious plan include ensuring adequate supply of food grains and managing the fiscal impact of the food subsidy.
The Group of Ministers approved a draft bill with diluted scope in July 2011. In the current form of the bill, food is no longer defined as a universal, basic right for all citizens. The legal right to subsidised food grains is granted only to a specified segment of the population. Even so, delivering food to the needy is expected to increase their productivity, countering growing economic inequality and positively impacting growth.
Features of the bill:
75% of the rural and 50% of the urban population (68% of the total population) will be covered under the NFSA.
In rural areas, 7kg of grain per person per month will be supplied to poor households. In urban areas, the amount will be 3-4kg. The price of rice under the scheme is likely to be only INR 3/kg, against current market prices of INR 20-50/kg.
An estimated 61 million tonnes (mt) of food grains will be required for this scheme. The government‟s food subsidy cost could rise to INR 950bn from the INR 600bn budgeted in FY12 (began 1 April 2011).
The bill also envisages moving towards a cash transfer- or food coupon-based system and leveraging the unique identification (UID) scheme to better target subsidies.
Ideally, the NFSA should have covered a larger segment of the population. However, the lack of food-grain storage facilities and the need to rein in the fiscal deficit have forced the government to limit the scope of this scheme. Storage capacity, currently at about 55-60mt, needs to be increased even if the scheme is implemented in its current form. With the government under pressure to narrow the fiscal deficit in an inflationary environment, additional food subsidies would create further demand-side pressures.
A more efficient system for administering the subsidy programme is therefore necessary. Some studies have found that only 17% of the people in the poorest 20% of the population receive subsidised food grains under the present public distribution system (PDS). Also, 54% of the food grains under the PDS are diverted to the open market and sold at higher prices. The direct transfer of subsidies to beneficiaries in the form of cash or food coupons would be a step in the right direction. The experience of implementing direct transfer of subsidies for kerosene, LPG and fertiliser could be useful in designing such a system for food subsidies.
The draft NFSA will now be reviewed by the Law Ministry and then sent to the state governments for their opinions. Although the government is hopeful that it can introduce the NFSA in the current session of Parliament, the timelines are quite tight. The law is unlikely to be implemented in FY12, which means the NFSA guidelines will not push up the government‟s food-subsidy costs in the FY12 budget. However, since a large segment of the population would benefit from this extension of the social safety net, the ruling coalition will benefit politically if the bill is enacted quickly.
Mines and Minerals (Development and Regulation) Bill (MMDR), 2011
Most of India‟s mineral-rich areas also have a large proportion of forest cover and are home to tribal peoples. About 60,000 hectares of land was diverted to mining between 1998 and 2005, but land acquisition and large-scale deforestation may have negatively affected the livelihood of tribal peoples, worsened economic inequality, and bred Maoist extremism. It was therefore necessary to reassess the MMDR Bill of 1957 to achieve a better balance between socio-economic considerations, fair compensation and viability of mining projects. The new bill puts greater emphasis on exploration and introduces more transparency to the allotment process.
This bill has been under debate by various stakeholders for almost two years now. A ministerial panel finally approved the draft in July 2011, and it is now awaiting cabinet approval. The bill is likely to be introduced in the monsoon session of Parliament after the cabinet clears it.
Features of the bill:
Part of the coal-mining blocks will be reserved for government companies and the rest will be auctioned out to private parties – including foreign companies – through competitive bidding (details are not yet available). At present, private companies apply for these blocks and are selected on the basis of various criteria.
Only one approval is needed for surveying deposits, prospecting and mining.
26% of the coal mines‟ profits will have to go towards the welfare of the people displaced by the mining project (up from zero at present). For other minerals, 100% of annual royalties will have to be paid for this purpose.
The new mining bill is expected to reduce red tape, and will be key to easing bottlenecks in a critical input to industrial activity. India has more than 100 years of coal reserves, but insufficient coal production is forcing power generators to depend increasingly on imported coal. If environmental concerns related to coal mining (which have stalled production) are addressed promptly along with the passage of the MMDR bill, this should enhance coal production and remove a key bottleneck to capacity addition in the power sector.
However, mining companies are worried about sharing such a high proportion of their profits. While the extra compensation for displaced people might reduce local opposition to mining projects, it could reduce the viability of some projects. A substantial decline in profitability might make the sector less attractive to foreign investors. Auctioning of mining blocks could be one way of generating revenue for the government and a short-term way to bridge the fiscal gap.
Uniform Goods and Services Tax (GST)
The government has been trying to overhaul India‟s indirect tax system for the last four years by introducing a uniform Goods and Services Tax (GST) to replace the existing plethora of excise, sales and services taxes. The GST, at a proposed initial standard rate of 20%, is expected to improve tax efficiency and turn India‟s economy into a truly single market – eliminating the incentive to locate production facilities in states offering tax benefits and allowing the smooth transfer of goods across states. This is likely to reduce supply-chain rigidities and bottlenecks, and to improve production and distribution efficiency.
The constitutional amendment bill to introduce this legislation was put forward in the budget session of Parliament (in March 2011). The bill has been referred to the Standing Committee on Finance, whose report is expected by the end of 2011. The Finance Minister had hoped when presenting the budget in February 2011 that the GST could be introduced in April 2012, but chances of meeting this deadline now appear slim.
General agreement has been reached among states and the central government on most aspects of the GST, but a few contentious issues remain.
Uniform Goods and Services Tax (GST)
The government has been trying to overhaul India‟s indirect tax system for the last four years by introducing a uniform Goods and Services Tax (GST) to replace the existing plethora of excise, sales and services taxes. The GST, at a proposed initial standard rate of 20%, is expected to improve tax efficiency and turn India‟s economy into a truly single market – eliminating the incentive to locate production facilities in states offering tax benefits and allowing the smooth transfer of goods across states. This is likely to reduce supply-chain rigidities and bottlenecks, and to improve production and distribution efficiency.
The constitutional amendment bill to introduce this legislation was put forward in the budget session of Parliament (in March 2011). The bill has been referred to the Standing Committee on Finance, whose report is expected by the end of 2011. The Finance Minister had hoped when presenting the budget in February 2011 that the GST could be introduced in April 2012, but chances of meeting this deadline now appear slim.
General agreement has been reached among states and the central government on most aspects of the GST, but a few contentious issues remain.
In July 2011, a Committee of Secretaries approved 51% FDI in multi-brand retail and forwarded the proposal to the Commerce Ministry, suggesting a few clauses to protect the interests of existing small players.
Features of the bill:
Prospective foreign investors would have to make an investment of at least USD 100mn in the sector.
They would have to source at least 30% of their requirements from small and medium-sized enterprises (SMEs).
They could open stores only in cities with populations of more than 1mn (there are 36 such cities in India).
At least 50% of the investment and jobs created by each investment should go to rural areas.
Back-end infrastructure creation should receive at least half of the total investment, but companies could self-certify adherence to this limit.
Mega-stores would be required to sell non-branded items.
Some companies have questioned whether it is possible to track adherence to the targets set by the Committee of Secretaries – particularly, sourcing 30% of requirements from SMEs and channelling 50% of investment and jobs to rural areas.
The Commerce Ministry is likely to take a quick decision on these suggestions and put the bill forward for cabinet approval. However, given the political opposition, it is difficult to estimate when this reform will be implemented.
Pension Fund Regulatory and Development Authority (PFRDA) Bill
The bill is an attempt to create a National Pension System (NPS) which will provide income security to retirees from both the organised and unorganised sectors. This is particularly important for India because only 13% of the workforce is covered by pension schemes.
The PFRDA, the regulatory body responsible for the NPS, has already been created through executive orders; however, it does not enjoy any statutory powers because the legislation is pending parliamentary approval. Going forward, the NPS will play an important role as a social safety net. Over the medium term, this could potentially increase consumption through higher security and returns. The pension liabilities of the government will also be capped, reducing fears of an escalating public debt burden.
This bill was first introduced in 2005 but it lapsed. A new bill was proposed in Parliament in March 2011. The Standing Committee is examining the bill and had been expected to give its comments quickly so that the bill could be passed during the monsoon session. However, recent media reports suggest that the bill has a low chance of being passed in this session.
Features of the bill:
The NPS will be run by private pension fund managers offering different schemes with varied risk-return profiles.
Participation in the scheme will be optional for the private and unorganised sectors. Optional participation from the non-government sector is still very low.
For government employees, the default risk of the government (in repaying pension liabilities under the current scheme) will be replaced by market risk under the NPS. So the NPS is a „defined contribution‟ scheme rather than a „defined benefit‟ scheme.
A proposal to allow 26% FDI in pension fund intermediaries has been shelved for now (FDI is currently not allowed).
Companies Bill, 2009
This bill is an attempt to overhaul a 55-year-old regulation that provides the legal framework within which companies function. The objective of the new bill is to improve corporate governance, ease regulations for setting up companies, and remove sections of the old bill which have become redundant. The role of independent directors has come under scrutiny in a few high-profile recent corporate financial mismanagement cases. To improve corporate governance, it is necessary to define their function more clearly.
A substantial overhaul of the bill has been deferred from 2003, although the framework has been amended several times over this period. When the bill was introduced in Parliament in 2009, it was referred to the Standing Committee. The Ministry of Corporate Affairs has consulted 36 ministries after taking account the recommendations of the Standing Committee and is ready to send it to the cabinet for consideration. The Law Ministry will then review the bill, and it will then be presented to the Parliament.
Features of the bill:
The bill requires publicly listed companies above a certain size (to be defined in the final version) to appoint at least one-third of their board members as independent directors. These independent directors should not have significant financial relationships with the company.
The bill would allow for online incorporation of companies within 24 hours – a facility which is available in only a handful of countries. This part of the bill has already been published on the Ministry of Corporate Affairs website.
A series of procedural simplifications will expedite regulatory approvals and smooth the M&A process.
Under the proposed bill, mergers could be approved by the newly established National Company Law Tribunal (NCLT), which will specialise in such cases and will likely be able to process them more quickly, rather than the High Court.
To enable faster restructuring of sick or insolvent companies, the new bill would give creditors more control over the assets of a sick company.
Companies above a certain size would be required to spend 2% of their average profits over the last three years on corporate social responsibility (CSR) activities.
A company‟s auditors would be prohibited from offering other services to the company, such as accounting and financial services, in order to avoid potential conflicts of interest.
In last month‟s cabinet reshuffle, a new minister of corporate affairs was appointed. The activity level within the ministry has increased since then, with a focus on simplifying procedures. However, it looks unlikely that the bill will be presented during the monsoon session of Parliament because it has not yet been sent to the cabinet for consideration. Industry bodies still oppose the compulsory CSR clause. Legal experts point out that some parts of the bill contradict existing regulations, and the jurisdiction of the NCLT could interfere with other regulators.
New National Manufacturing Policy (NMP)
In his budget speech in February 2011, the Finance Minister promised to lay out his plans to increase the share of manufacturing in GDP from 16% currently to 25% by 2020. We estimate that India will have to generate 13-15mn jobs every year to provide opportunities to its growing working-age population (see Special Report, 25 May 2011, ‘India in the Super-cycle’). Also, there will be a natural shift of employment from agriculture to manufacturing, where prospects are brighter and productivity higher. Increasing the share of manufacturing in the economy is therefore essential to sustaining growth and creating job opportunities.
To realise this vision, the Commerce Ministry has drafted a policy that proposes to set up National Manufacturing Investment Zones (NMIZs) which would benefit from world-class infrastructure, business-friendly labour and environmental laws, and tax breaks. These mega-industrial zones are likely to create 100mn jobs. The Commerce Minister has stated that differences with the labour and environment ministries have been addressed, and hopes that the NMP will be in place very soon.
Other financial-sector reforms
Direct Tax Code (DTC): This bill is likely to overhaul the current income tax and wealth tax laws. It proposes to restructure the tax brackets and simplify the tax structure through fewer exemptions, lower corporate tax rates, and different treatment of short-term capital gains tax. The bill was introduced in Parliament in August 2010 and referred to a Standing Committee. In his budget speech, the finance minister announced that the new tax code would be implemented in April 2012. However, the Standing Committee is yet to submit its recommendations, and media reports suggest that they might not be tabled during the monsoon session. If the Standing Committee report is tabled during the winter session (December 2011) and passed by the Parliament in the budget session (February 2012), this may not leave enough time to implement the tax code by April 2012.
New banking licences: The last new banking licence was issued in India in 2004. Given the rapid pace of economic growth, the demand for banking services has increased manifold since then. There is a need to ensure that future growth does not suffer from a lack of financial intermediation. Banking services also need to extend their reach to largely unbanked rural areas. So, when the finance minister announced in his budget speech in 2010 that new bank licences would be issued, the markets cheered this as a positive step.
Last year, the Reserve Bank of India (RBI) published draft guidelines for comments from various stakeholders. Based on their feedback, the RBI sent draft guidelines to the government in March 2011. The government is likely to get back to the RBI with its suggestions very soon. The RBI will then issue the final guidelines and invite applications from banks. These applications are likely to go through a three-stage
screening process before the new licences are granted. However, amendments to the Banking Regulation Act and the Banking Laws may be needed before the new guidelines can be announced. In particular, the RBI‟s powers to obtain information about the non-banking activities of a bank‟s parent company, and to supersede a bank‟s board of directors in the public interest – might be required before the new licences are issued. The amendments to the Banking Regulation Act are also likely to be tabled in the Parliament soon. It is unlikely that the new licences will be issued anytime soon, but increased clarity on the guidelines would improve sentiment.
Increase of FDI limit in insurance sector: In December 2008, a government bill introduced in Parliament proposed increasing the FDI limit in the insurance sector to 49% from 26%. This was after five years of resistance to the bill from the Left Front. After being introduced in Parliament, the bill was referred to the Standing Committee. Media reports suggest that the committee has asked the government not to go ahead with the proposed legislation. The committee felt that there was no pressing need to increase the limit because adequate funds were available domestically to invest in this sector. However, the final IPO norms for life insurance companies might be announced soon.
Establishment of infrastructure debt funds (IDFs): In July 2011, the Finance Ministry announced that mutual funds and NBFCs can set up IDFs as trusts or companies to be regulated by the Securities Exchange Board of India (SEBI) or the RBI. In his budget speech, the Finance Minister announced that foreign investment in these IDFs would benefit from lower withholding tax (5% rather than the existing 20%) and income tax exemptions. The IDFs issuing bonds (INR- or USD-denominated) would be able to benefit from credit enhancement in public-private partnership (PPP) projects and attract foreign insurance and pension funds with long-term resources. This would be an important way to channel foreign investment into the infrastructure sector. However, with the limit on FII investment in infrastructure bonds (USD 25bn) largely unutilised, the success of the IDF is questionable. Also, the RBI is yet to issue guidelines on NBFCs setting up IDFs.
Allowing foreign individuals to invest in mutual funds: The Finance Minister proposed this in February 2011, and SEBI proposed guidelines in August. Foreigners would be allowed to invest up to an aggregate USD 10bn in equity schemes and USD 3bn in debt schemes.
The Micro Finance Institutions (Development and Regulation) Bill, 2011: The Finance Ministry put up a draft microfinance bill last month that is likely to address some of the issues that have plagued the sector in recent years. The bill establishes the RBI as the key regulator for the sector and tries to resolve ambiguities arising from conflicting state-level regulations. The government has invited comments from various stakeholders on the draft bill. The final bill will then be prepared and presented in Parliament, although this is unlikely to happen during the monsoon session. Also, some state governments might challenge the constitutional validity of the bill, claiming that the central government is impinging on states‟ jurisdiction.
New Takeover Code: In July 2011, SEBI made significant changes to the existing Takeover Code. The acquiring investor will have to make an open offer only if its shareholding rises to 25% (versus 15% previously), and the minimum size of the open offer will be 26% (20% previously). So investors will be able to remain strictly financial investors but still increase their size of holdings without triggering the open offer. The increase in the minimum holding to 25%, along with the minimum open offer of 26%, will give the investor a controlling stake of 51%. This is likely to change the dynamics of India‟s M&A space, but the acquirer will have to arrange for more funds if the open offer is triggered.
Reforms are vital to removing supply bottlenecks
Apart from the key reforms discussed above, there are several others for which the legislative process is either in its early stages or has not started yet. For example, power-sector reforms (particularly to address the problems of state owned-distribution companies), labour reforms, subsidy reforms, recapitalisation of public-sector banks, and administrative reforms of the bureaucracy are all important areas where meaningful action is required. After the general elections in mid-2009, there was an expectation that some of these reforms would be expedited because the Left Front (which had opposed some of them) was not part of the ruling coalition. The inability to push ahead with these reforms has been a primary reason for the deterioration in the investment climate in recent quarters. Investment growth has declined steadily, and supply-side bottlenecks are emerging in several sectors.
We are disappointed in the progress of the monsoon session of Parliament so far. Investors had hoped that progress on pending reforms could be made if legislative business proceeded as usual. However, Parliament has been mostly stalled after citizens began protesting against the government‟s version of the anti-corruption bill on 16 August. There is a risk that this issue may paralyse the remainder of the monsoon session (which ends on 8 September). Pending bills will be carried forward to the winter session, and with each passing session, the backlog of bills increases. The current challenging economic environment would have been the right backdrop to push through ambitious reforms, but political consensus and resolve are sorely lacking.
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India – Fast-tracking stalled reforms
We outline India’s key pending reforms and their expected timeline
The need to incorporate diverse views in a democratic system often slows the reform process
Lack of urgency on reforms could worsen supply bottlenecks and damage medium-term growth potential
A popular anti-corruption movement is dominating the government‟s attention at a time when slow progress on economic reforms is creating significant near-term headwinds and might even be lowering the country‟s medium-term growth potential. The government showed some urgency on reforms in June and July – foreign direct investment (FDI) in the retail sector received a key approval, a draft land acquisition bill was proposed, and guidelines for various financial-sector reforms were announced. However, with the government‟s focus now on responding to the anti-corruption movement – which has involved street protests by tens of thousands and a highly publicised hunger strike since mid-August – enacting economic reforms has again moved down the list of policy priorities. To achieve the GDP growth rate of 9.0- 9.5% targeted under the 12th Five Year Plan (FY13-FY17), these reforms need to be fast-tracked.
In this report, we take stock of India‟s pending economic reforms, which are necessary to push the economy onto a sustained growth path. We have focused on key reforms that are stuck at different levels of the complex decision-making process, and we do not discuss those on which the government has not initiated any concrete action. This is not an exhaustive list, but it covers a diverse set of issues including land, taxation, FDI, subsidies and financial services. Some of these reforms are being held up by contentious disputes over implementation, while others lack agreement on their basic premise.
India‟s first wave of economic reforms was ushered in during the early 1990s, when the economy faced a balance-of-payments crisis. The licensing regime – which controlled everything from imports to setting up factories – was dismantled and various product markets were liberalised. In the second generation of reforms (late 1990s to early 2000s), the focus was more on financial markets and services and the opening of the economy. These reforms improved productivity and created a platform for sustained average growth of close to 9% from 2004-08. A third generation of reforms is now urgently needed, particularly to improve institutions (the judiciary, the bureaucracy, corporate governance) and the functioning of input markets (land, labour, minerals). The Indian economy enjoys positive fundamentals in the form of favourable demographics and a good macroeconomic balance, but this must be complemented by prudent policy. The current period of relatively slow growth and high inflation may be a warning signal that reforms need to be accelerated immediately.
The private sector has been clamouring for such reforms for some time now, and policy makers seem to appreciate the urgency of the issue. Investors had hoped that the government would use the current monsoon session of Parliament (between 1 August and 8 September) to legislate on some of these pending issues. However, differences of opinion over the proposed anti-corruption law have stalled parliamentary proceedings, and there is a fear that none of the vital economic reforms will be introduced during the monsoon session. Delaying these reforms, however, threatens to thwart growth. Slower growth in the current inflationary environment threatens to create frustration, further fuelling the anti-corruption movement. In our view, inertia on such reforms is a critical bottleneck to improving the supply side of the economy. As we grow increasingly concerned about the slow pace of progress, we think now is a good time for a status check on key reforms.
The legislative process
Before we discuss each of these reforms in detail, it is important to understand the process by which a particular reform is legislated in India‟s democratic system. The relevant ministry generally publishes a note outlining the broad contours of the proposed reform and invites comments from stakeholders, which can include any party affected by the legislation – corporates, banks, individuals, other ministries, etc. After incorporating these comments, the proposal is either referred to a Group of Ministers or to the Cabinet Committee (comprised of all key ministers). If the reform falls under the jurisdiction of several ministries, a Committee of Secretaries may deliberate on the proposal before it reaches the cabinet.
Following cabinet approval, a formal bill is prepared with help of the Law Ministry, and is then introduced in Parliament. After introduction, the bill is commonly referred to a Standing Committee of the Parliament comprised of members from ruling and opposition parties. The Standing Committee also takes note of other petitioners who might be impacted by the provisions of the bill. After the government receives the suggestions of the Standing Committee, it is free to modify the bill but not obliged to incorporate all the comments. The modified bill is then presented separately to the Lower House (Lok Sabha) and Upper House (Rajya Sabha) for debate and voting. Once passed by both houses, the bill goes to the President for his final approval.
Given the coalition structure of the ruling United Progressive Alliance (UPA), it is often difficult to even forge consensus among the coalition partners. The legislative process can therefore drag on for years. The Standing Committee is often unable to return the bill to Parliament on time because of a lack of consensus among ruling-party and opposition members. The cabinet might be preoccupied with other pressing issues and fail to give prompt attention to a particular reform. In addition, the Parliament convenes only three times a year (budget session, monsoon session and winter session), sometimes delaying the final passage of a bill. For the past two sessions, proceedings have been stalled as opposition parties have made various demands of the government (Charts 1 and 2). The pace of cabinet decisions on pending bills has also slackened considerably in the second term of the UPA government (UPA2), which began in 2009. It is therefore difficult to predict how long it will take a reform to go from proposal to law. If there is an inordinate delay and the Parliament term expires, the bill lapses and has to be reintroduced.
Outline of pending reforms
The monsoon session of Parliament started on 1 August and is expected to run until 8 September. The government had expected to consider 35 pending bills and introduce 32 new bills during the session, according to PRS Legislative Research, a private think-tank. To date, only 10 new bills have been introduced in either of the two houses, and 13 bills have been passed by at least one house. None of the key pending economic reforms has been tabled, and if anti-corruption agitation continues to affect the normal functioning of the Parliament, the situation may not improve by the end of the session. Below we list the key pending bills, their salient features and their current status.
Land Acquisition and Rehabilitation and Resettlement (LARR) Bill
India‟s land acquisition laws have been largely unchanged for almost 118 years. Numerous industrial and infrastructure projects are delayed because of problems in acquiring land. The affected parties (those living on the land) often obstruct these projects to demand better compensation from the government. Obstacles to land acquisition have become a key impediment to industrial development – a government study found that of the 190 public-sector projects that are currently delayed, 70% have been held back on account of land issues.
After long deliberation, the government has finally released a draft bill on this issue for public comment and hopes to introduce it in the monsoon session of Parliament. However, given that the government is accepting comments until the end of August and the monsoon session ends on 8 September, this leaves very little time to incorporate comments into the bill. The chances of introducing this bill during the current session are therefore slim.
Features of the bill:
Compensation to the landowner will be at least six times the market value of the land in rural areas, and twice the market value in urban areas. The land value is to be determined on the basis of transactions in the last three years.
The government can acquire land on behalf of private companies only if it is for „public purpose‟. This broadly covers strategic purposes (national security), infrastructure and industry, but needs to be defined more precisely to avoid confusion.
The consent of at least 80% of the owners is required for any land acquisition, but the draft bill does not mandate how much of the land should be acquired by private parties before the government steps in. An earlier version proposed that the private buyer would have to purchase at least 70% of the land before the government would acquire the rest.
A detailed rehabilitation and resettlement package has been announced for both existing landowners and people who will lose their livelihoods due to the sale. The package covers subsistence allowance, annuity, sharing of the appreciated land value in case of transfer within 10 years, employment for one person from each displaced family, and alternative land to be given to families displaced by certain types of projects.
A social impact assessment is mandatory when the land acquired exceeds 100 acres.
A key ruling-coalition partner that had opposed earlier versions of the bill appears to support this draft. In addition, the relatively generous compensation structure would probably encourage landowners to sell their land to industry. However, from an industry standpoint, the need to obtain the consent of 80% of landowners and the higher cost of land acquisitions could be near-term deterrents. These land acquisition costs would be prohibitively high for small manufacturers and bias the LARR towards large industry. It will also be important to avoid potential conflict with existing land acquisition acts at the state level.
Features of the bill:
Compensation to the landowner will be at least six times the market value of the land in rural areas, and twice the market value in urban areas. The land value is to be determined on the basis of transactions in the last three years.
The government can acquire land on behalf of private companies only if it is for „public purpose‟. This broadly covers strategic purposes (national security), infrastructure and industry, but needs to be defined more precisely to avoid confusion.
The consent of at least 80% of the owners is required for any land acquisition, but the draft bill does not mandate how much of the land should be acquired by private parties before the government steps in. An earlier version proposed that the private buyer would have to purchase at least 70% of the land before the government would acquire the rest.
A detailed rehabilitation and resettlement package has been announced for both existing landowners and people who will lose their livelihoods due to the sale. The package covers subsistence allowance, annuity, sharing of the appreciated land value in case of transfer within 10 years, employment for one person from each displaced family, and alternative land to be given to families displaced by certain types of projects.
A social impact assessment is mandatory when the land acquired exceeds 100 acres.
A key ruling-coalition partner that had opposed earlier versions of the bill appears to support this draft. In addition, the relatively generous compensation structure would probably encourage landowners to sell their land to industry. However, from an industry standpoint, the need to obtain the consent of 80% of landowners and the higher cost of land acquisitions could be near-term deterrents. These land acquisition costs would be prohibitively high for small manufacturers and bias the LARR towards large industry. It will also be important to avoid potential conflict with existing land acquisition acts at the state level.
The Parliamentary resolution also accepts the demand for a „citizens‟ charter‟ which will detail the people‟s entitlements and mandate various government bodies to deliver services within a stipulated time period.
The Lokpal commission will have both investigative and prosecution powers. It can recommend the transfer and suspension of public servants and has the power to seize their property acquired through corrupt means.
The Lokpal can seek the help of the central government and state investigative agencies in its probes.
An immediate flashpoint between the government and the anti-corruption activists appears to have been averted after Parliament unanimously passed the resolution adopting the activists‟ demands. However, the final passage of the bill could be some way off, as the Standing Committee needs to deliberate the details of the bill. While there is general agreement that a strong Lokpal is necessary to check corruption, there are concerns that giving the Lokpal too much power would allow it to evolve into something akin to a „parallel government‟, undermining the executive and judiciary. With the Lokpal controversy out of the way, it will now be imperative for the government to use the rest of the monsoon session as productively as possible.
National Food Security Act (NFSA)
The UPA government has already passed bills ensuring the right to work, the right to education and the right to information. The right to food is seen as the fourth pillar of the set of fundamental citizens‟ rights that the UPA government has promised. The NFSA is a step towards attaining this goal.
With more than 32% of the population living below the poverty line, assuring the supply of food at affordable prices remains a policy priority. However, major stumbling blocks to achieving this ambitious plan include ensuring adequate supply of food grains and managing the fiscal impact of the food subsidy.
The Group of Ministers approved a draft bill with diluted scope in July 2011. In the current form of the bill, food is no longer defined as a universal, basic right for all citizens. The legal right to subsidised food grains is granted only to a specified segment of the population. Even so, delivering food to the needy is expected to increase their productivity, countering growing economic inequality and positively impacting growth.
Features of the bill:
75% of the rural and 50% of the urban population (68% of the total population) will be covered under the NFSA.
In rural areas, 7kg of grain per person per month will be supplied to poor households. In urban areas, the amount will be 3-4kg. The price of rice under the scheme is likely to be only INR 3/kg, against current market prices of INR 20-50/kg.
An estimated 61 million tonnes (mt) of food grains will be required for this scheme. The government‟s food subsidy cost could rise to INR 950bn from the INR 600bn budgeted in FY12 (began 1 April 2011).
The bill also envisages moving towards a cash transfer- or food coupon-based system and leveraging the unique identification (UID) scheme to better target subsidies.
Ideally, the NFSA should have covered a larger segment of the population. However, the lack of food-grain storage facilities and the need to rein in the fiscal deficit have forced the government to limit the scope of this scheme. Storage capacity, currently at about 55-60mt, needs to be increased even if the scheme is implemented in its current form. With the government under pressure to narrow the fiscal deficit in an inflationary environment, additional food subsidies would create further demand-side pressures.
A more efficient system for administering the subsidy programme is therefore necessary. Some studies have found that only 17% of the people in the poorest 20% of the population receive subsidised food grains under the present public distribution system (PDS). Also, 54% of the food grains under the PDS are diverted to the open market and sold at higher prices. The direct transfer of subsidies to beneficiaries in the form of cash or food coupons would be a step in the right direction. The experience of implementing direct transfer of subsidies for kerosene, LPG and fertiliser could be useful in designing such a system for food subsidies.
The draft NFSA will now be reviewed by the Law Ministry and then sent to the state governments for their opinions. Although the government is hopeful that it can introduce the NFSA in the current session of Parliament, the timelines are quite tight. The law is unlikely to be implemented in FY12, which means the NFSA guidelines will not push up the government‟s food-subsidy costs in the FY12 budget. However, since a large segment of the population would benefit from this extension of the social safety net, the ruling coalition will benefit politically if the bill is enacted quickly.
Mines and Minerals (Development and Regulation) Bill (MMDR), 2011
Most of India‟s mineral-rich areas also have a large proportion of forest cover and are home to tribal peoples. About 60,000 hectares of land was diverted to mining between 1998 and 2005, but land acquisition and large-scale deforestation may have negatively affected the livelihood of tribal peoples, worsened economic inequality, and bred Maoist extremism. It was therefore necessary to reassess the MMDR Bill of 1957 to achieve a better balance between socio-economic considerations, fair compensation and viability of mining projects. The new bill puts greater emphasis on exploration and introduces more transparency to the allotment process.
This bill has been under debate by various stakeholders for almost two years now. A ministerial panel finally approved the draft in July 2011, and it is now awaiting cabinet approval. The bill is likely to be introduced in the monsoon session of Parliament after the cabinet clears it.
Features of the bill:
Part of the coal-mining blocks will be reserved for government companies and the rest will be auctioned out to private parties – including foreign companies – through competitive bidding (details are not yet available). At present, private companies apply for these blocks and are selected on the basis of various criteria.
Only one approval is needed for surveying deposits, prospecting and mining.
26% of the coal mines‟ profits will have to go towards the welfare of the people displaced by the mining project (up from zero at present). For other minerals, 100% of annual royalties will have to be paid for this purpose.
The new mining bill is expected to reduce red tape, and will be key to easing bottlenecks in a critical input to industrial activity. India has more than 100 years of coal reserves, but insufficient coal production is forcing power generators to depend increasingly on imported coal. If environmental concerns related to coal mining (which have stalled production) are addressed promptly along with the passage of the MMDR bill, this should enhance coal production and remove a key bottleneck to capacity addition in the power sector.
However, mining companies are worried about sharing such a high proportion of their profits. While the extra compensation for displaced people might reduce local opposition to mining projects, it could reduce the viability of some projects. A substantial decline in profitability might make the sector less attractive to foreign investors. Auctioning of mining blocks could be one way of generating revenue for the government and a short-term way to bridge the fiscal gap.
Uniform Goods and Services Tax (GST)
The government has been trying to overhaul India‟s indirect tax system for the last four years by introducing a uniform Goods and Services Tax (GST) to replace the existing plethora of excise, sales and services taxes. The GST, at a proposed initial standard rate of 20%, is expected to improve tax efficiency and turn India‟s economy into a truly single market – eliminating the incentive to locate production facilities in states offering tax benefits and allowing the smooth transfer of goods across states. This is likely to reduce supply-chain rigidities and bottlenecks, and to improve production and distribution efficiency.
The constitutional amendment bill to introduce this legislation was put forward in the budget session of Parliament (in March 2011). The bill has been referred to the Standing Committee on Finance, whose report is expected by the end of 2011. The Finance Minister had hoped when presenting the budget in February 2011 that the GST could be introduced in April 2012, but chances of meeting this deadline now appear slim.
General agreement has been reached among states and the central government on most aspects of the GST, but a few contentious issues remain.
Uniform Goods and Services Tax (GST)
The government has been trying to overhaul India‟s indirect tax system for the last four years by introducing a uniform Goods and Services Tax (GST) to replace the existing plethora of excise, sales and services taxes. The GST, at a proposed initial standard rate of 20%, is expected to improve tax efficiency and turn India‟s economy into a truly single market – eliminating the incentive to locate production facilities in states offering tax benefits and allowing the smooth transfer of goods across states. This is likely to reduce supply-chain rigidities and bottlenecks, and to improve production and distribution efficiency.
The constitutional amendment bill to introduce this legislation was put forward in the budget session of Parliament (in March 2011). The bill has been referred to the Standing Committee on Finance, whose report is expected by the end of 2011. The Finance Minister had hoped when presenting the budget in February 2011 that the GST could be introduced in April 2012, but chances of meeting this deadline now appear slim.
General agreement has been reached among states and the central government on most aspects of the GST, but a few contentious issues remain.
In July 2011, a Committee of Secretaries approved 51% FDI in multi-brand retail and forwarded the proposal to the Commerce Ministry, suggesting a few clauses to protect the interests of existing small players.
Features of the bill:
Prospective foreign investors would have to make an investment of at least USD 100mn in the sector.
They would have to source at least 30% of their requirements from small and medium-sized enterprises (SMEs).
They could open stores only in cities with populations of more than 1mn (there are 36 such cities in India).
At least 50% of the investment and jobs created by each investment should go to rural areas.
Back-end infrastructure creation should receive at least half of the total investment, but companies could self-certify adherence to this limit.
Mega-stores would be required to sell non-branded items.
Some companies have questioned whether it is possible to track adherence to the targets set by the Committee of Secretaries – particularly, sourcing 30% of requirements from SMEs and channelling 50% of investment and jobs to rural areas.
The Commerce Ministry is likely to take a quick decision on these suggestions and put the bill forward for cabinet approval. However, given the political opposition, it is difficult to estimate when this reform will be implemented.
Pension Fund Regulatory and Development Authority (PFRDA) Bill
The bill is an attempt to create a National Pension System (NPS) which will provide income security to retirees from both the organised and unorganised sectors. This is particularly important for India because only 13% of the workforce is covered by pension schemes.
The PFRDA, the regulatory body responsible for the NPS, has already been created through executive orders; however, it does not enjoy any statutory powers because the legislation is pending parliamentary approval. Going forward, the NPS will play an important role as a social safety net. Over the medium term, this could potentially increase consumption through higher security and returns. The pension liabilities of the government will also be capped, reducing fears of an escalating public debt burden.
This bill was first introduced in 2005 but it lapsed. A new bill was proposed in Parliament in March 2011. The Standing Committee is examining the bill and had been expected to give its comments quickly so that the bill could be passed during the monsoon session. However, recent media reports suggest that the bill has a low chance of being passed in this session.
Features of the bill:
The NPS will be run by private pension fund managers offering different schemes with varied risk-return profiles.
Participation in the scheme will be optional for the private and unorganised sectors. Optional participation from the non-government sector is still very low.
For government employees, the default risk of the government (in repaying pension liabilities under the current scheme) will be replaced by market risk under the NPS. So the NPS is a „defined contribution‟ scheme rather than a „defined benefit‟ scheme.
A proposal to allow 26% FDI in pension fund intermediaries has been shelved for now (FDI is currently not allowed).
Companies Bill, 2009
This bill is an attempt to overhaul a 55-year-old regulation that provides the legal framework within which companies function. The objective of the new bill is to improve corporate governance, ease regulations for setting up companies, and remove sections of the old bill which have become redundant. The role of independent directors has come under scrutiny in a few high-profile recent corporate financial mismanagement cases. To improve corporate governance, it is necessary to define their function more clearly.
A substantial overhaul of the bill has been deferred from 2003, although the framework has been amended several times over this period. When the bill was introduced in Parliament in 2009, it was referred to the Standing Committee. The Ministry of Corporate Affairs has consulted 36 ministries after taking account the recommendations of the Standing Committee and is ready to send it to the cabinet for consideration. The Law Ministry will then review the bill, and it will then be presented to the Parliament.
Features of the bill:
The bill requires publicly listed companies above a certain size (to be defined in the final version) to appoint at least one-third of their board members as independent directors. These independent directors should not have significant financial relationships with the company.
The bill would allow for online incorporation of companies within 24 hours – a facility which is available in only a handful of countries. This part of the bill has already been published on the Ministry of Corporate Affairs website.
A series of procedural simplifications will expedite regulatory approvals and smooth the M&A process.
Under the proposed bill, mergers could be approved by the newly established National Company Law Tribunal (NCLT), which will specialise in such cases and will likely be able to process them more quickly, rather than the High Court.
To enable faster restructuring of sick or insolvent companies, the new bill would give creditors more control over the assets of a sick company.
Companies above a certain size would be required to spend 2% of their average profits over the last three years on corporate social responsibility (CSR) activities.
A company‟s auditors would be prohibited from offering other services to the company, such as accounting and financial services, in order to avoid potential conflicts of interest.
In last month‟s cabinet reshuffle, a new minister of corporate affairs was appointed. The activity level within the ministry has increased since then, with a focus on simplifying procedures. However, it looks unlikely that the bill will be presented during the monsoon session of Parliament because it has not yet been sent to the cabinet for consideration. Industry bodies still oppose the compulsory CSR clause. Legal experts point out that some parts of the bill contradict existing regulations, and the jurisdiction of the NCLT could interfere with other regulators.
New National Manufacturing Policy (NMP)
In his budget speech in February 2011, the Finance Minister promised to lay out his plans to increase the share of manufacturing in GDP from 16% currently to 25% by 2020. We estimate that India will have to generate 13-15mn jobs every year to provide opportunities to its growing working-age population (see Special Report, 25 May 2011, ‘India in the Super-cycle’). Also, there will be a natural shift of employment from agriculture to manufacturing, where prospects are brighter and productivity higher. Increasing the share of manufacturing in the economy is therefore essential to sustaining growth and creating job opportunities.
To realise this vision, the Commerce Ministry has drafted a policy that proposes to set up National Manufacturing Investment Zones (NMIZs) which would benefit from world-class infrastructure, business-friendly labour and environmental laws, and tax breaks. These mega-industrial zones are likely to create 100mn jobs. The Commerce Minister has stated that differences with the labour and environment ministries have been addressed, and hopes that the NMP will be in place very soon.
Other financial-sector reforms
Direct Tax Code (DTC): This bill is likely to overhaul the current income tax and wealth tax laws. It proposes to restructure the tax brackets and simplify the tax structure through fewer exemptions, lower corporate tax rates, and different treatment of short-term capital gains tax. The bill was introduced in Parliament in August 2010 and referred to a Standing Committee. In his budget speech, the finance minister announced that the new tax code would be implemented in April 2012. However, the Standing Committee is yet to submit its recommendations, and media reports suggest that they might not be tabled during the monsoon session. If the Standing Committee report is tabled during the winter session (December 2011) and passed by the Parliament in the budget session (February 2012), this may not leave enough time to implement the tax code by April 2012.
New banking licences: The last new banking licence was issued in India in 2004. Given the rapid pace of economic growth, the demand for banking services has increased manifold since then. There is a need to ensure that future growth does not suffer from a lack of financial intermediation. Banking services also need to extend their reach to largely unbanked rural areas. So, when the finance minister announced in his budget speech in 2010 that new bank licences would be issued, the markets cheered this as a positive step.
Last year, the Reserve Bank of India (RBI) published draft guidelines for comments from various stakeholders. Based on their feedback, the RBI sent draft guidelines to the government in March 2011. The government is likely to get back to the RBI with its suggestions very soon. The RBI will then issue the final guidelines and invite applications from banks. These applications are likely to go through a three-stage
screening process before the new licences are granted. However, amendments to the Banking Regulation Act and the Banking Laws may be needed before the new guidelines can be announced. In particular, the RBI‟s powers to obtain information about the non-banking activities of a bank‟s parent company, and to supersede a bank‟s board of directors in the public interest – might be required before the new licences are issued. The amendments to the Banking Regulation Act are also likely to be tabled in the Parliament soon. It is unlikely that the new licences will be issued anytime soon, but increased clarity on the guidelines would improve sentiment.
Increase of FDI limit in insurance sector: In December 2008, a government bill introduced in Parliament proposed increasing the FDI limit in the insurance sector to 49% from 26%. This was after five years of resistance to the bill from the Left Front. After being introduced in Parliament, the bill was referred to the Standing Committee. Media reports suggest that the committee has asked the government not to go ahead with the proposed legislation. The committee felt that there was no pressing need to increase the limit because adequate funds were available domestically to invest in this sector. However, the final IPO norms for life insurance companies might be announced soon.
Establishment of infrastructure debt funds (IDFs): In July 2011, the Finance Ministry announced that mutual funds and NBFCs can set up IDFs as trusts or companies to be regulated by the Securities Exchange Board of India (SEBI) or the RBI. In his budget speech, the Finance Minister announced that foreign investment in these IDFs would benefit from lower withholding tax (5% rather than the existing 20%) and income tax exemptions. The IDFs issuing bonds (INR- or USD-denominated) would be able to benefit from credit enhancement in public-private partnership (PPP) projects and attract foreign insurance and pension funds with long-term resources. This would be an important way to channel foreign investment into the infrastructure sector. However, with the limit on FII investment in infrastructure bonds (USD 25bn) largely unutilised, the success of the IDF is questionable. Also, the RBI is yet to issue guidelines on NBFCs setting up IDFs.
Allowing foreign individuals to invest in mutual funds: The Finance Minister proposed this in February 2011, and SEBI proposed guidelines in August. Foreigners would be allowed to invest up to an aggregate USD 10bn in equity schemes and USD 3bn in debt schemes.
The Micro Finance Institutions (Development and Regulation) Bill, 2011: The Finance Ministry put up a draft microfinance bill last month that is likely to address some of the issues that have plagued the sector in recent years. The bill establishes the RBI as the key regulator for the sector and tries to resolve ambiguities arising from conflicting state-level regulations. The government has invited comments from various stakeholders on the draft bill. The final bill will then be prepared and presented in Parliament, although this is unlikely to happen during the monsoon session. Also, some state governments might challenge the constitutional validity of the bill, claiming that the central government is impinging on states‟ jurisdiction.
New Takeover Code: In July 2011, SEBI made significant changes to the existing Takeover Code. The acquiring investor will have to make an open offer only if its shareholding rises to 25% (versus 15% previously), and the minimum size of the open offer will be 26% (20% previously). So investors will be able to remain strictly financial investors but still increase their size of holdings without triggering the open offer. The increase in the minimum holding to 25%, along with the minimum open offer of 26%, will give the investor a controlling stake of 51%. This is likely to change the dynamics of India‟s M&A space, but the acquirer will have to arrange for more funds if the open offer is triggered.
Reforms are vital to removing supply bottlenecks
Apart from the key reforms discussed above, there are several others for which the legislative process is either in its early stages or has not started yet. For example, power-sector reforms (particularly to address the problems of state owned-distribution companies), labour reforms, subsidy reforms, recapitalisation of public-sector banks, and administrative reforms of the bureaucracy are all important areas where meaningful action is required. After the general elections in mid-2009, there was an expectation that some of these reforms would be expedited because the Left Front (which had opposed some of them) was not part of the ruling coalition. The inability to push ahead with these reforms has been a primary reason for the deterioration in the investment climate in recent quarters. Investment growth has declined steadily, and supply-side bottlenecks are emerging in several sectors.
We are disappointed in the progress of the monsoon session of Parliament so far. Investors had hoped that progress on pending reforms could be made if legislative business proceeded as usual. However, Parliament has been mostly stalled after citizens began protesting against the government‟s version of the anti-corruption bill on 16 August. There is a risk that this issue may paralyse the remainder of the monsoon session (which ends on 8 September). Pending bills will be carried forward to the winter session, and with each passing session, the backlog of bills increases. The current challenging economic environment would have been the right backdrop to push through ambitious reforms, but political consensus and resolve are sorely lacking.
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