Resets for a cleaner economy: investors will benefit

 By Dr. V K Vijayakumar

The famous economist John Maynard Keynes once famously remarked: “In economics there are no miracles, only consequences”. Keynes was emphasizing the need for bold policy initiatives to produce desirable consequences in the economy. Good policies produce good results. Sometimes good policies lead to short-term pains; but long-term gains can be substantial.

Transformational reforms for a cleaner Indian economy

It is important to appreciate the fact that India is presently going through some major structural reforms that can produce profound consequences. This is similar to the liberalization initiatives of 1991, which made India the second fastest growing economy in the world during the quarter century spanning 1991-2017. But the reforms of 1991 produced recession in 1991-92 and attracted criticism from within the ruling congress party itself.

Even though politics has often trumped economics in India, surprisingly, now we can discern a near political consensus on some key reforms. Of course, the consensus is subtle, and political antagonism is apparent and loud. However, the significant fact is that the political consensus will ensure that the reforms are sustained and become structural. These reforms have the potential to reset and transform the Indian economy to a cleaner and more transparent economy.

GST- a major structural reform

Of all the reforms being implemented in India now, the GST is the most revolutionary. GST, implemented by consensus among all political parties, had many deficiencies. These are being addressed now. There is room for further simplification and reduction in rates. This will happen in due course. The major consequence of GST will be the mainstreaming of economic activity and formalization of the economy. As this happens, over the medium term, not only GST but direct tax collections also will improve since the business turnover of those who formerly escaped the tax net will be recorded in the GST Network. GST will help improve the GDP growth rate.

RERA for reforming the real estate sector

RERA (Real Estate Regulation Act) is another path breaking reform. During 2003-10 the Indian economy grew at 8.4%. This was also the period that witnessed massive scams. It is important to note that this period also witnessed massive speculative bubble in real estate. Scam money and speculative purchases by those who wanted to make a fast buck fuelled this asset price bubble. Around 30 percent of most deals were in black money. This has almost stopped.  Along with demonetization, RERA is likely to change the face of the real estate market paving the way for the healthy growth of the real estate industry. Declining housing loan interest rates and government’s interest rate subventions on affordable housing would contribute to boom in this segment.  Speculative real estate transactions have already disappeared.

The Aadhaar linking initiative

Yet another reform, which can produce far-reaching consequences, is the Aadhaar linking initiative. After Aadhaar has been made compulsory for LPG, 3.5 crore illegal connections have disappeared. Crores of bogus ration cards have disappeared. Some issues and concerns related to Aadhaar linking can be easily addressed. Once Aadhaar linking with PAN is complete, millions of fraud PAN cards, which were used to escape the tax net, will disappear. Linking of Aadhaar with bank accounts would produce similar results. This cleansing process would produce substantial beneficial effects on the economy. India should be grateful to Nandan Nilekeni for this revolutionary reform.

Benami property will come under attack

The prime minister has already made it clear that he would go after benami property. The Benami Property Acquisition Prevention Act passed in August 2016 has strong provisions for confiscation of benami property. Once a property is proved benami, the benamidar will have to pay 25 % of the value of the property as fine and will have to undergo 7 years imprisonment, apart from losing the property. In future, the black-monied would be really scared to invest in benami property.

The Insolvency and Bankruptcy Code

Yet another landmark legislation is the Insolvency and Bankruptcy code passed in May 2016. Under the new law, the defaulting company will be referred to the NCLT, which in turn will hand over the firm to insolvency professional to initiate the liquidation of the assets to recover the dues. Proceedings under the law have already begun. The old practice of  ‘sick companies and rich promoters’ is likely to become history.

These reforms, along with the power of data analytics and data mining can render hiding black money extremely difficult. The ultimate consequence of these resets would be that India would become a more tax-compliant society. It would be naïve to believe that all Indians would become honest overnight. But going forward, the reward for compliance would be high and the cost of evasion would be excessive. Therefore, these reforms have the potential to alter the financial culture in India, to a large extent.

Tax revenue will spurt

It is important to note that India’s tax-GDP ratio is the lowest among Emerging Markets. It is 16.6% against the Emerging Market average of 21%. The resets discussed above can easily raise our Tax GDP ratio by at least 1 % in the medium term. One percent increase in tax GDP ratio means additional revenue of around Rs 1.7 lakh crores at current levels of GDP. It is important to note that the loss in GDP due to demonetization is a one off; but the increase in tax collections would be permanent. This is a near certainty.  With increased tax revenue, welfare programs targeting the poor and needy can be stepped up, the Mudra initiative can be expanded in a big way and infrastructure spending can be substantially stepped up. The beneficial effects of these initiatives will be substantial.

Global recognition of reforms

The recognition that these resets are in the right direction came from the World Bank and the rating agency Moody’s. Moody’s upgraded India’s credit rating to Baa2 from Baa3 and the World Bank sharply upgraded India’s ranking in Doing Business from 130 to 100. Earlier, the IMF chief Christian Lagarde had remarked that the Indian economy is on strong track. This recognition from three of the World’s leading financial institutions is, indeed, a triumph of the government’s economic policy and significant boost to investment.

As mentioned earlier, a major consequence of these resets would be the mainstreaming of economic activity and formalization of the economy. Major chunks of the informal sector would cede market share to the formal organized sector. Increased government spending would further aid the growth of the organized sector and the listed players in the market. More companies will get listed on the stock exchanges. Financialization of savings and increasing preference for equity as an asset class will gather momentum accelerating the flow of money into the capital market. India’s growth rate will move to a higher trajectory. Ordinary people will benefit from these resets; investors will benefit disproportionately.