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The Economy Story: World Bank Economic Prospects Report & Latest FDI Reforms

Economy

India is likely to regain its position as the fastest growing major economy globally in 2018, with growth expected to accelerate to 7.3%, according to the World Bank’s Global Economic Prospects report, released January 10, 2018. China comes second, with a likely fall in growth rate from 6.8% in 2017 to 6.4% in 2018.

At a time when there has been a lot of negative commentary on the Indian economy, especially from political quarters and also certain sections of the media, the World Bank’s report appears to put Indian economic performance and prospects for the Indian economy in perspective.

This is the big picture, as opposed to shorter-term disruptions which major structural reforms (such as GST or demonetisation) are usually seen to cause in any economy. Moreover, the World Bank’s vote of confidence in the Indian economy — and in what it calls an “ambitious government undertaking comprehensive reforms” — has come on the back of several economic reforms, be it FDI regulations, GST or demonetisation.

Latest FDI Reforms

On the very day the World Bank projected India to have the highest growth rate in the coming fiscal, the Central government took the important decision to further liberalise FDI policy in key sectors:

  • 100% FDI under automatic route for Single Brand Retail Trading (SBRT)
  • 100% FDI under automatic route in Construction Development
  • Foreign airlines allowed to invest up to 49% under approval route in Air India
  • Foreign Institutional Investor (FIIs)/ Foreign Portfolio Investments (FPIs) allowed to invest in Power Exchanges through primary market

 

It is not surprising that easing of the norms in the recent past has led to an increase in FDI inflows, which was at US $36.05 billion in 2013-14, and increased to an all-time high of US $60.08 billion in the financial year 2016-17.

Again, it is also not surprising that protests have already been made against allowing 100% FDI in SBRT, arguing that this is going to ruin local industry and traders. What they seem to be missing again is the bigger picture.

The further simplification of FDI policy is aimed at greater ease of doing business in India and thereby ensuring that more foreign investment comes in. For the Indian economy, and its employment seekers, this cannot but be good news: the eased norms will lead to larger volumes of FDI, which in turn would translate into more income and employment generated in the economy. No logical sweep can deny that.

What the government has done is consistent with several steps it has taken over the last few years to liberalise the SBRT FDI regime. This was necessary to attract global players and their investments. However, there were still lingering issues which were being seen as both hindering and confusion the foreign investor in India. For instance, it was not found to be easy or even possible to convert the local franchisee into a JV. On the other hand, the local sourcing norms by which SBRT with more than 51% needed to source 30% of goods value from India were found to favour certain industries against others. As an example, it would be easy and make perfect sense for a garment/ apparel retailer to source mostly or wholly from India. But what would a mobile smartphone manufacturer do whose manufacturing and sourcing network could well be wholly abroad? That is why the rules had to be modified for certain kinds of products and technology, but the confusion and related problems had persisted.

Now, as far as SBRT is concerned, the government has relaxed the sourcing norms to be rid of such confusing sub-norms as far as possible currently. It is wrong to say that with the relaxation of the sourcing norms, too, local producers and traders are going to be harmed. Let us see what exactly the new norm says:

As we can see, the reform aims at ensuring the SBRT entity functions smoothly and optimises its operations, and yet, after the stipulated relaxation of 5 years, it must meet the 30% local sourcing norms. Therefore, this particular aspect of the reform keeps the long-term interest of the Indian economy in mind, and nobody is being provided a free pass.

FDI is a very important driver of economic growth and it is also a very source of non-debt finance for an economy. The Indian economy must necessarily have much more of it and much more smoothly. There is no gainsaying that. The removal of the FDI cap vis-à-vis SBRT via the automatic route is going to make investing in India a lot more attractive. Along with that, certain problematic conditions also appear to have been eased.

This is only logical and expected, given how the government has already brought in FDI reforms in various sectors, such as defence, construction development, insurance, pension, Other Financial Services, asset reconstruction, civil aviation, pharma, trade, and so on.

Economic Growth

Despite apprehensions coming from various quarters about India’s economy slowing down due to demonetisation and GST, the facts clearly show a different story. Both the economic reforms were structural changes that have introduced important changes to the Indian economy and look set to bolster the economy in the longer term. Let us have a look at the following developments that give us a clearer picture:

Demonetisation’s overall impact on the Indian economy and beyond, details of which may be found in The True Picture article Demonetisation: A Historic Success. On the other hand, GST is still a work in progress, still in an early phase of rollout. The modifications of rates, problems or compliance, etc are all illustrative of the fact that this is still an early phase. The so-called disruption caused by GST may make an impact on revenue projections and estimates, often causing a distortion. This is what seems to have happened to GST and the economy, but that appears to be for the shorter term. GST collections are likely to pick up in the coming months as the GST Council keeps pointing out.

This has been argued earlier, and the following is what precisely the World Bank report says: “Private investment is expected to revive as the corporate sector adjusts to the GST; infrastructure spending increases, partly to improve public services and internet connectivity; and private sector balance sheet weaknesses are mitigated with the help of the efforts of the government and the Reserve Bank of India”.

The report also says that, over the medium term, GST is likely to boost economic activity and fiscal health of the economy as it will reduce compliance costs since various and overlapping tax systems have been replaced by a single one. At the same time, the report also notes that, along with all this, the economy is also being increasingly formalised and the taxpayer base is being expanded. In fact, the World Bank report also commends the PSB recapitalisation policy of the government.

As we can see, the myth about demonetisation and GST hitting the Indian economy long-term has been busted. In fact, it has led to greater tax compliance and has increased direct tax collections. China’s growth rate, which was just 0.1% ahead of India’s 6.7% growth rate in 2017, is likely to fall behind with a 6.4% growth rate projected in 2018 while India is likely to surge ahead with a 7.3% rate.

The World Bank projections and the latest reforms in FDI policy clearly indicates a shift that the Indian economy has never seen before.