Unprecedented opportunity of radical reforms - NDA 2.0

The absolute dominance of the ruling Narendra Modi-led NDA coalition can be gauged via nearly two-third share of parliament and bestows an unprecedented opportunity to undertake radical reforms. While we agree on the positives of stability and continuity at the Centre, we also would like to highlight the need of immediate steps to rejuvenate the sagging economy, as evident from downward trend in GDP expansion, reduced consumption growth and constrained liquidity profile. We believe the following steps will go a long way in infusing growth momentum in the economy.

Liquidity boost for the NBFC sector: The non-banking financial companies (NBFC) sector is the last-mile creditor of the country and a key lender to MSME sector in semi-urban, rural markets. The sector has faced a credit squeeze ever since IL&FS default and has resulted into liquidity gap, estimated at nearly INR3.2bn. This insinuates towards need of urgent measures to normalize the situation in the NBFC sector. Banks are reluctant to lend to NBFCs in the current environment and there have been cases of withdrawal of existing credit lines. Also the credit lines of the banks are getting concentrated within a handful of large NBFCs, leading to further shrinking of bank funding pie for the other players.

Potential steps to alleviate stress in the sector include nudging the PSU banks for opening up credit lines to the sector, upward revision in NBFC sectoral cap by banks, creation of a liquidity window and allowing investment from pension funds, insurance companies into better-rated entities (AA- and above). Normalization of the sector woes is critical in easing funding issues for the MSME sector as well as shoring up of consumption demand for big-ticket purchases including housing and automotive.

Reforms in factor markets to boost manufacturing: Since 1991, the reforms have mostly centred on the product markets in India marked by opening up of various sectors for foreign investment. However, the factor markets of labour and land remain highly constrained.

The labour regulatory landscape is India has more than 200 labour laws, with archaic regulations like Industrial Disputes Act and the Industrial Employment (Standing Orders) Act. The former requires companies with 100 or more workers to get government permission for any downsizing. Similarly, the Standing Orders Act requires government approvals for any change in job description of a corporate with 100 or more workers. As a result, firms are reluctant to hire workers for fear of being stuck with excess labour if business conditions change. This Act puts seasonal industries (like garment industry) at a disadvantage as companies find difficult to manage workforce in accordance to the prevailing demand. This results in key long-term negatives like many companies choosing to operate out of the informal sector and organizations preferring contractual labour.

Akin to labour markets, land acquisition presents an equally (if not more) complicated regulatory regimen characterized by high taxation on deals and steep acquisition costs. High taxes on transactions encourage massive under-declaration of the true sale values to avoid taxes leading to usage of the sector as a store of “unaccounted money”, which leads to undue increase in the prices. The Land Acquisition Act, 2013 led to multi-fold rise in acquisition costs as well as made the overall process more time-consuming leading to numerous delays and associated cost escalations for projects. Thus, wide-scale reforms in factor markets are critical for ensuring success of the government’s “Make in India” initiative.

Clarity of data protection bill and Aadhaar usage for private entities: We live in times where bulk of the world’s data has been created in the past two years and insights gained from this are the major driver behind artificial intelligence and machine learning. Blessed with one of the largest data stacks in the world and backed by tech expertise, India is in an enviable position to emerge as the leader in this field. However, for this opportunity to materialize, clarity on the regulatory front is a must have and speedy enactment of Aadhaar Amendment Bill as well Personal Data Protection Bill will be a right step in this direction. The allowance of Aadhaar for customer authentication for private entities will have a positive cascading effect on numerous sectors including insurance, micro-lending, fintech and will go a long way in boosting the financial inclusion in the hinterlands.

Pro-active steps to boost insurance penetration: While government initiatives including demonetization, Pradhan Mantri Jan Dhan Yojana has resulted in higher penetration in the financial services, insurance seems to have lagged behind. While the new premium in the insurance sector has grown at a double digit CAGR since 2000, the insurance penetration has fallen from 4% levels in FY07 to 2.8% in FY18. This is supported by the fact that the new policy issuance in the FY07-18 period has grown at an abysmal CAGR of 2.1% in the past decade.

In our opinion, the rapid rise in insurance premium collections with slow increase in new policy issuance is caused by divergence between urban and semi-urban/rural areas with low participation from the later category. Government may look to increase insurance penetration by promoting pure-term protection policies (via GST waiver) and ULIPs (via reducing lock-in period to 3 years to attain parity with ELSS).

Boost for the housing sector: Housing is one of the key sectors of the economy and a major driver of growth as well job creation. In Indian context, it has been observed that for every unit invested in housing; nearly four-fifth of the amount gets directly added in the GDP. That said, country housing sector has been in a protracted slowdown post peaking out in 2013 with negligible price appreciation in the major cities, pilling up of inventories and marked decrease of new launches. Government has taken multiple steps to boost the housing sector including supportive tax policies in the budget, interest subsidy on affordable housing etc.

Another supportive step in our opinion will be to issue deposit licenses to more housing financial companies (HFC). Deposit acceptance has the advantage of being the most stable of the funding sources. Diversification of borrowings provides critical support to the institutions in times of credit crunch in capital markets. Deposit taking license regime has been stringently regulated and rightly so as retail deposits represent safest asset class to the investors. Only 18 out of 96 HFCs operative in India hold the deposit taking license creating a disparity between the banks, deposit taking HFCs and other HFCs where the second category has to depend upon banks and capital markets for their funding requirements. We believe the approach of allowing deposit licenses to more HFCs while tightening the financial benchmarks to safeguard the interest of deposit holders will be the best approach to remove the current disparity among HFCs.

Aggressive infrastructure creation: The government in the previous term invested heavily in infrastructure (mainly towards roads, airports and ports). We believe this should continue in the next term as well with major emphasis on coastal shipping, dedicated freight corridor and urban infrastructure in non-metros. Source for funds for this infra creation drive can be mobilized from cashing out of mature infra projects. While this spending will constrain the state’s balance sheet, we believe the long term benefits of investment including job creation and positive rub-off for manufacturing sector will outwiegh any short term negative impacts like higher fiscal deficit.

Strategize to gain from prevalent global trade scenario: The protracted as well as turbulent USA-China trade negotiations has resulted in global players recognizing the need to diversify their supply base outside China which has resulted in surge in FDI proposals to South-East Asian countries including Indonesia (USD28 billion), Vietnam (USD 18 billion) and Philippines (USD 12 billion). This presents a never-before opportunity for India to boost exports and normalize the skewed current account deficit (courtesy dependence on imported oil imports), promote manufacturing and generate incremental employment opportunities. However, to substantively benefit from this situation, India requires a strategic approach to convert this opportunity into a major gain. Major focus on policy side should be on most affected export categories like intermediate components in electronics and machinery, automotive, agricultural products.

Further the disinvestment agenda: Enterprises should derive legitimacy from their holistic performance rather than their existence as strategic assets. However, in case of our country this is easier said than done with involvement of multiple stakeholders like employee unions and political repercussions. The inability to privatize loss making PSUs has led to creation of big white elephants in the eco-system which not only block capital but also alter the economic landscape of the sector. As per an audit report by the Comptroller and Auditor General of india, in 2014-15, 157 central public sector enterprises had accumulated losses worth USD16.5 billion. An important reason behind the lacklustre performance of PSUs is poor governance characterized by excessive government control. This makes privatization of such enterprises all the more crucial. The proceeds from disinvestment could give the government the necessary leeway to spend on important sectors and boost capital expenditure.

Conclusion: While we acknowledge the positive steps taken by the incumbent government including RERA, IBC and Make in India programs initiated to boost manufacturing; the current economic scenario insinuates the need to further the reform agenda. With the elections returning a unanimous verdict, the government will have some leeway on balancing between populist and reforms agenda. Both radical as well as supportive continuation steps are the need of the hour to inject growth back into the economy and ensure long-term sustainable growth.