By Knowledge@Wharton

The Make in India lion has not yet begun to roar. Unveiled by Prime Minister Narendra Modi in September 2014, all the initiative has attracted so far are foreign direct investment (FDI) promises. Modi has been globetrotting; his end of December excursion was, according to the rival Congress Party, “breakfast in Kabul, tea in Lahore (an unscheduled stopover to meet Pakistani Prime Minister Nawaz Sharif) and dinner in Delhi.” That was cheap political sniping, but Modi’s trips to other capitals — Washington, Moscow, Paris — have been far more expensive. Big-budget defense deals were signed in all three places; the high-cost imports seem to negate the Make in India philosophy of promoting domestic manufacturing.

At home, meanwhile, the reforms process has hit a major roadblock. The key Goods and Services Tax (GST) bill has been delayed thanks to a filibustering Opposition, which dragged in all sorts of peripheral issues — among them, Modi’s “intolerance,” the alleged financial irregularities of finance minister Arun Jaitley and the “vendetta politics” of the government — to hold up proceedings in Parliament. The GST would impose a tax on the manufacture, sale and consumption of goods and services across India and replace the indirect taxes that are currently collected on goods and services by the state and federal government.

“The GST bill, everybody agrees, has substantial benefits to all segments of the economy namely the government, the industry, the intermediaries and, more significantly, the ultimate consumer,” says Ashvin Parekh, managing partner of Ashvin Parekh Advisory Services.
 

Made in Spite of India

The GST bill delay is one more example of what Ravi Aron, professor at Johns Hopkins University’s Carey Business School, calls the “made-in-spite-of-India” business model. Work on GST started in 2000 when Prime Minister A.B. Vajpayee (of the ruling Bharatiya Janata Party or BJP) set up a committee to design a model. The committee submitted its report in 2009. By then, a Congress government was in power. But it, too, backed the GST, setting a schedule for implementation by April 1, 2010. The BJP-led Opposition boycotted Parliament and the bill never saw the light of day.

Today, the BJP is back in power and the same GST bill is up for discussion; the government wanted it made applicable from April 1, 2016. But now the Congress is boycotting the Rajya Sabha (the upper house of Parliament, where it enjoys a majority) and the bill has not been passed. It’s an anomalous situation: All political parties want GST (think-tank NCAER estimates that it will add 2% to GDP growth). But it has fallen victim to tit-for-tat tactics.

“Unification of indirect taxes — to the extent possible under GST — greatly adds to the ease of doing business,” says Aron. “Octroi, interstate cess and discretionary indirect taxes on manufactured goods make doing business harder. The tax base should be wide and the rates low in an ideal tax regime. GST enables both broadening of the tax base and makes it simpler to administer indirect taxes. Any rationalization of indirect taxes and the removal of discretion in administering indirect taxes — keep in mind the GST is a destination tax — and granting exemptions also lower the potential for graft.”

In some quarters, the GST is viewed as acting against the Make in India theme. Coca-Cola has threatened to close down some of its 57 factories in the country. It does not like being put on the sin side of the ledger. Under the GST, aerated drinks attract 40% tax, the same as that for tobacco products.

“I expect the GST to get implemented in 2016 (though it will need a miracle for it to happen by April 1),” says Hemant Kanoria, chairman of infrastructure finance company SREI. “That will unify India into a common market and bring in further clarity in the indirect tax structure thus providing a major boost to economic activity.”

The GST bill is obviously the major initiative on the reform docket, but other elements, too, play a role in determining the outlook for business in India during 2016. “Four major factors will shape business and the economy in India in 2016,” says Parekh. “The first and foremost is the ability on the part of the government to take the reform program through the parliamentary process. Within the policy areas, the government’s ability to remove hurdles in infrastructure and also to create opportunities for foreign funds to flow into India will be tested.

“The second factor is inflation, to which the lending rates are tied,” Parekh continues. “The substantial premium that the government has arising out of the fall in oil prices is getting eaten up by food inflation. The third factor will be the monsoon. After two successive years of successive weak monsoons, the economy will suffer adversely if there is one more year of poor rainfall. The fourth important factor will be state federalism in terms of participation in reforms in the areas of energy distribution, education and public health.”
 

Positive Economic Analysis

The Mid-Year Economic Analysis 2015-2016 released by the ministry of finance in December is largely positive. Its highlights:

Inflation has continued to moderate steadily.

The external position appears robust.

The current account deficit has declined to 1.2% of GDP.

Foreign exchange reserves have risen to $352 billion on December 4, 2015.

Net FDI inflows have grown from $15.8 billion in H1 (April-September) 2014-2015 to more than $17 billion in H1 2015-2016.

The decline in nominal GDP growth relative to the budget assumption will pose a challenge for meeting the fiscal deficit target of 3.9% of GDP. Slower-than-anticipated nominal GDP growth (8.2% versus the budget estimate of 11.5%) will itself raise the deficit target by 0.2% of GDP.

“The economic outlook indicates steady growth in 2016 supported by greater access to banking, technology adoption and other structural reforms,” says S. Raghunath, professor, corporate strategy and policy, Indian Institute of Management, Bangalore. “The economy has made considerable progress, but challenges remain,” sums up the mid-year analysis.

Another significant challenge is how India can attract more foreign investment in the stock markets. At the beginning of 2015, the bulls were pawing the turf; the Bombay Stock Exchange Sensitive Index (Sensex) crossed 30,000. Amid predictions that it would scale 35,000 by the end of the year, came a bear-hug: The Sensex dropped to around 26,000. (Morgan Stanley says that the best-case scenario is the index will reach 34,000 by the end of 2016.)

Part of the reason for the fall of the Sensex index is poor corporate performance. As company after company failed to meet street expectations, brokerage houses down-rated them and investors sold. FIIs (foreign institutional investors) also sold as though the bottom were falling out of the market. In January, the net FII investment was around $27 billion. This got converted into an outflow of around $3 billion by December. The domestic financial institutions took up the slack, but only partly. “Investors may need to brace for challenging times in 2016 as diminishing appetite for emerging markets as far as foreign funds are concerned, worries about a weakening rupee and delay in clearance of pro-business measures by Parliament could hurt sentiment,” business daily The Economic Times reported.

What is true of FII money is equally true of FDI. The Reserve Bank of India (RBI) points out in its quarterly report: “After a sharp pick up in the first quarter, net FDI moderated in second quarter of 2015-2016.”

RBI governor Raghuram Rajan has, meanwhile, set another cat among the pigeons in his charge by insisting that all banks clean up their act by March 2017. The banking sector has more than $120 billion in stressed assets, not all of it acknowledged. Some Indian banks could have red daubs on their balance sheets next year.

Credit rating agency Moody’s has red flagged these asset-quality concerns. “India’s investment story is showing nascent signs of recovery,” it says in a recent report. “Nevertheless, a broad-based and sustainable revival in the private sector capital expenditure cycle will likely take longer to materialize, given high corporate leverage, asset-quality concerns in the banking sector, and subdued external demand.”
 

Beyond the Numbers

India’s economy is forecast to grow at 7.5% for 2016, which takes into account a slower investment recovery, continues the report: “We are forecasting GDP growth of 2.8% in the G20 economies.” In an October review, the International Monetary Fund said India is on track to remain the world’s fastest-growing large economy.

Raghunath looks beyond the numbers. “With a higher degree of coordination among government departments, the outcomes in terms of program implementation are expected to be better than last year,” he says. “The advent of digital transformation, smart cities, higher adoption of cloud computing, and requisite talent shortage may occupy attention in 2016. A ‘mobile-first strategy’ for most public utilities and services including banking will go a long way in transforming the lives of Indian citizens.”

Modi is also looking beyond the numbers. His latest initiative, to be launched on January 16, is a program styled Start-Up India, Stand-Up India. Various tech stars from Silicon Valley are scheduled to attend the high-profile launch. Meanwhile, another of his initiatives — a $6 billion infrastructure finance fund — is proceeding apace. The government will put $3 billion into this fund. “Several sovereign funds and pension funds from abroad are willing to participate and cooperate with the National Investment and Infrastructure Fund,” says Jaitley. Activity in the government, despite the Opposition boycott, has moved into the fast lane.

“Amidst a scenario of global slowdown, the Indian economy today looks like an oasis of opportunity,”says Kanoria. “With the right reforms in place, I can foresee at least a three-decade period of growth for India from here onwards.” Nandan Chakraborty, managing director for institutional equity research at Axis Bank, adds: “Here’s hoping that 2016 is a much more rewarding year with the government being able to kickstart capex, revive the credit cycle, implement critical reforms and steer clear of parliamentary logjams.”