PROJECT REPORT OF

Miss Shreya Bajaj

In Part fulfillment of the requirements for the Course

B.A (H) Economics in Jesus and Mary College New Delhi

Project On

Reform Indian Economic Policy

Submitted to (Under the Guidance of)

Mukesh Kumar Mishra

Secretary General Krityanand UNESCO club

Jamshedpur.

By

Shreya Bajaj

B.A (H) Economics,

Jesus and Mary College

Delhi University New Delhi

1st June to 30

th June 2014

Acknowledgement

I take this opportunity to express my profound gratitude and deep regards to my guide

Mr. Mukesh Kumar Mishra, Secretary General Krityanand Unesco Club, for his exemplary

guidance, monitoring and constant encouragement throughout the course of this report. His

cordial support, valuable information and guidance, helped me in completing this task

through various stages and also for making the resources available at right time and providing

valuable insights leading to the successful completion of my project.

Date 30/06/2014

Shreya Bajaj

Profile of the Organization

Krityanand UNESCO Club is a Non-governmental, non-profit and non-partisan Voluntary

organization situated in Jamshedpur, India. We are working for the aims and purpose of the

United Nations and its system. We have been working in field of Education, Health and

sanitation, (Reproductive Health, HIV/AIDS), Gender discrimination, Non –formal education

(for Disadvantage/poor people), child and women development, Agriculture, Rural

Development, Environmental issues, Sustainable Development, leadership Development

programme and Human-Rights etc. Since its inception in 1992.this is a charitable and

philanthropic organization, trying to achieve the Millennium Development Goals by

providing sanitation to all by 2025.

Overview

The Krityanand UNESCO Club, Jamshedpur is an NGO Registered Under the Societies

Registration Act, 1860, (Government of Jharkhand)

UN Relations

The Krityanand UNESCO Club is working to contribute to the work of the United Nations

within Consultative relationship with the United Nations Economic and Social Council

(ECOSOC) is governed by the principles contained in Council Resolution

1996/31. KRITYANAND UNESCO CLUB, JAMSHEDPUR has a Special Consultative

Status with the Economic and Social Council of the United Nations,

NGO Accredited Status with UNCCD, Bonn, Germany. The Coalition for the International

Criminal Court. New York, USA. United Nations Global Compact, UN Headquarter, New

York, USA. Interest Representatives of The European Commission, Working Relation with

the UN-High Commissioner for HUMAN RIGHTS, UN office at Geneva, Switzerland. The

organization does support and promote the work of the United Nations and the achievement

of the MDGs.

Its focus areas for Rural Development

Our Rural Development Program aims to improve rural livelihood options and works towards

social and economic empowerment of the rural poor and women. The organization intervenes

with the community through the following themes or programmes: institution and capacity

building, social development, and livelihood, Education, Health and Family welfare,

Sustainable livelihood, Social causes.

Education

Adult education

Non formal education

Tribal education.

ICT For Rural Development

Health and family welfare

Medical camp

Health awareness

Sanitation

Safe drinking water

Mother and child health

Reproductive health

Awareness building

Sustainable Development (Livelihood and Agriculture)

Self help group

Irrigation

Land development

Soil and water conservation

Social forestry

Plantation activities

Nursery

Farmer training

TABLE OF CONTENTS page no.

1) Acknowledgement 2

2) Profile of the organisation 3

3) List of figures 7

4) Abstract 8

5) Introduction 9

6) Accelerated and employment-intensive growth 11

7) Enhancing agricultural growth 13

8) Concerted effort to revive manufacturing 18

9) Massive investment in infrastructure 27

10) Make it easier to do business 39

11) Tax reforms and simpler tax regime 50

12) Massive push to FDI 55

13) Power sector reforms and energy policy 63

14) Reform labour laws 67

15) Banking sector reforms 73

16) Summary 81

17) Conclusion 82

18) References 84

List of figures page no.

Low investment in planning and engineering leads to high cost of implementation 28

A multitude of approvals including the required preparation adds 1-1.5 years to the pre

tendering projects 30

Most road projects suffer from land acquisition delays after tendering 31

The construction industry is facing a shortage of skilled manpower which is expected to grow

32

Construction related cases can benefit significantly from dedicated fast track courts 35

The Key objectives of nodal agency should determine its performance metrics 38

Some initiatives and further reforms to enhance business environment 41

Integrated and Comprehensive system for managing indirect taxes in Karnataka 41

Special features of initiatives taken by other states 44

Labour management system by Maharashtra 44

Maître by Maharashtra 46

Land related interventions by Gujarat 47

Implementation of e governance by Gujarat pollution control board 48

Single window clearance system by Rajasthan and Punjab 49

Number of ATM’s 75

Share of population group in increment of ATM’s 76

ABSTRACT

In this paper ‘Reform Indian Economic Policy’ we try and evaluate India’s transition from an

inward- oriented development strategy to greater participation in the world economy. The

process of major economic reforms undertaken in the Indian economy has now completed

over 20 years of implementation. The economy had entered into a new phase of development

directed towards becoming globally competitive through opening up to trade, foreign

investment, and technology inflows. While India’s tax system has been revolutionised it still

represents a number of complexities. Despite improvement over the past in power generation,

India still continues to lag behind in terms of some urgent reforms that need to be introduced.

Moreover, while the official debt flows have been largely replaced by foreign direct

investment (FDI) and portfolio investment, India's ability to attract FDI would be greatly

enhanced by further reforms. In this paper I outline the further reforms most needed- reform

of agricultural sector to enhance the productivity, concerted effort to revive manufacturing

,massive investment in infrastructure, make it easier to do business, tax reforms and simpler

tax regime, massive push to FDI, power sector reforms and energy policy, reform labour laws

and financial sector reforms.

REFORM INDIAN ECONOMIC POLICY

INTRODUCTION

Foreign exchange crisis in 1991 induced India to abandon decades of inward-looking

socialism and adopt economic reforms that have converted the once-lumbering elephant into

the latest Asian tiger. India’s gross domestic product (GDP) growth rate had averaged over 8

percent in the last decade, and per capita income has shot up from $300 to $1,700 in two

decades. India is reaping a big demographic dividend just as China starts aging, so India

could overtake China in growth in the next decade.

When the reforms began in 1991, critics claimed that India would suffer a “lost decade” of

growth as in African countries that supposedly followed the World Bank-IMF model in the

1980s. They warned that opening up would allow multinationals to crush Indian companies,

while fiscal stringency would strangle social spending and safety nets, hitting poor people

and regions. All of these dire predictions proved wrong. Indian businesses more than held

their own, and many became multinationals themselves. Booming revenue from fast growth

has financed record government spending on social sectors and safety nets, even if these

areas are still dogged by massive corruption and waste. Still, poverty is down from 45.3

percent in fiscal year 1994 to 32 percent in fiscal year 2010, and the literacy rate is up from

52.2 percent to 74 percent in two decades, India’s fastest improvement ever. Several of the

poorest states have doubled or tripled their growth rates since 2004, and their wage rates have

risen by over 50 percent in the last three years. However, India continues to be hampered by

poor business conditions and misgovernance. Almost a quarter of Indian districts have

recorded some sort of Maoist violence, and corruption is a major issue. India ranks very low

on ease-of–doing-business indicators. Rigid labour laws prevent Indian companies from

setting up large factories for labour-intensive exports, as in China.

Hence there is need for a reform agenda for India’s new government. We can state that

arguably the 2014 election is the third most important one in the post-independence history of

India. Few would contest the proposition that the 1951–52 election, the first in independent

India, remains the most important. This election brought the first democratic government into

existence and laid down the foundations of the Indian democracy. The second most important

election was perhaps the one in 1977. Having been subjected to authoritarian rule for 21

months, in this election the Indian voter resoundingly defeated incumbent Prime Minister

Indira Gandhi and thus affirmed his unwavering commitment to democracy over

authoritarianism. Though the government that came to power proved too fragile to serve its

full term, the elections sent a clear signal to future rulers that the Indian electorate would not

compromise its political freedom under any circumstances. The reason why the 2014 election

qualifies as the third most important on for the first time in Indian history, the candidate of a

leading political party, Chief Minister Narendra Modi, has had nearly all his training and

experience as a leader in a state, and almost none at the federal level. Having been the Chief

Minister of Gujarat, and now leading new government he promises to bring a very different

perspective to the Centre than that enjoyed by past prime ministers.

Reform aims and objectives

Against this background, we now need to examine the reform agenda for India’s new

government. The first point to make is that such agenda cannot be outlined in a vacuum. We

must first clearly set out the aims and objectives that the reforms are intended to pursue. The

overarching objective of the reforms that a new government must target is to build a

prosperous, strong and modern India. Underlying this objective should be more specific goals

to be achieved within a reasonable timeframe. A suggestive, though by no means definitive or

exhaustive, list of these goals might include:

• Enhancing agricultural growth

• Concerted effort to revive manufacturing

• Massive investment in infrastructure

• Make it easier to do business

• Tax reforms and simpler tax regime

• Massive push to FDI

• Power sector reforms and energy policy

• Reform labour laws

• Banking sector reforms

The immediate imperative: restoring 8 percent growth

The immediate task facing the next prime minister will be to return annual GDP growth to 8

percent, a rate that was achieved during the 2000s. This will require three major steps:

■ End the paralysis in decision-making at the Centre. Today, the economy suffers from a

high degree of unused capacity. For example, many power plants are operating at very low

plant load factors because they are unable to access coal or gas. Corporate investment has

been cut in half partially because the projects already in the pipeline are awaiting clearances

from the central or state governments.

The paralysis in decision-making responsible for this malaise must end. Upon assuming

office, Narender Modi must immediately assure the bureaucracy that the responsibility for all

their legitimate decisions rests with him. They can fearlessly take decisions they see in the

interest of the nation. Equally important, he must ensure that there are no multiple power

centres in government.

Instead, the Cabinet will have to work in full cooperation and with collective accountability

toward the common goal of advancing the interest of India. Today, some Cabinet members

owe allegiance to the Prime Minister, others to the Congress President and still others to

themselves. This complete lack of cohesion has greatly contributed to the paralysis in

government. Forge a partnership with the states. All projects are located in some state and

require land, electricity, water and other infrastructure facilities from that state government.

The next Central government will need to quickly incentivize the states to speed up

clearances for businesses.

■ Reassure investors The next government will also need to assure investors, both domestic

and foreign, that their legitimate interests will be fully protected and that they need not fear

measures such as retrospective taxation. An important condition for India to flourish is that

entrepreneurs who risk their capital reap their rightful return rather than be subject to

expropriation ex poste. There should be no room for lack of transparency, of which

retrospective taxation is a symptom.

■ Restore the health of the banks. According to official Reserve Bank of India data, non-

performing and restructured loans account for 9 percent of total bank loans. For the Central

Bank of India, this proportion is as high as 17.7 percent, and for the Punjab National Bank,

14.5 percent. As a result, the banking system is vulnerable, resulting in a slowdown in the

issue of new credits. To ensure that credit begins to flow normally again and a crisis is

avoided, the government will have to quickly move to restore the health of the banks. Two

possible options are infusing new capital into the banks, which will be at the expense of the

taxpayer, or allowing them to raise equity in the private market, thereby diluting the

government stake below its current floor of 51 percent.

Accelerated and employment-intensive growth

Policy paralysis and mismanagement are only the immediate causes of the current growth

slowdown. The deeper causes lie in the abandonment of the path of reforms that the Rao and

Vajpayee governments had chartered. The outgoing government erroneously assumed that

the economy was like the mythical Kamadhenu cow that would keep giving no matter what.

Accelerated and employment-intensive growth that India needs to transform itself into a

modern economy and to eliminate poverty, illiteracy and ill health will require work on many

fronts over the next ten years. We now turn to reforms that the government must initiate.

Revival of Agriculture

A little appreciated fact that Chand (2014) has pointed out recently is that after registering a

trend growth rate of 1.9 percent between 1996–97 and 2004–05, agriculture, including

forestry and fishing, has seen a turnaround. It grew at a trend rate of 3.75 per cent between

2004–05 and 2012–13. The latter period has also seen a decline in fluctuations, with the

growth rate remaining strictly positive every single year.

Furthermore, growth has been broad based, with crops, livestock, fisheries and fruits, and

vegetables all registering trend growth rates of 3 to 5 percent. Five states, including Rajasthan

and Madhya Pradesh, have seen trend growth exceeding 5 percent, and another four

exceeding 4 percent between 2004–05 and 2011–12. But there remains considerable scope

for productivity growth, which agricultural growth could exploit to accelerate and sustain

growth in the future. Some possible measures include:

• Paying higher prices to farmers. To ensure that farmers get a larger share in the

price of the produce paid by the consumer, the next government must complete the

reform of the Agricultural Produce Marketing Committees Act in all areas, for all

crops, and in all states. This requires giving greater play to the right to directly

purchase and sell, facilitating the emergence of competing private marketing yards,

expansion of contract farming, provision of cold storage facilities and the building of

supply chains. It is also worth considering replacing the Minimum Support Price

(MSP), and its associated procurement, by the equivalent of deficiency payments in

the United States. The latter involve cash payments to farmers whenever the average

market price drops below a certain pre-specified threshold. An important advantage of

such payments is that they do not require the government to procure food grain.

Therefore, the benefits extend to all farmers rather than only the lucky few, often the

rich ones, from whom the government procures at the MSP. Furthermore, with no

procurement required, deficiency payments can be extended to any crop instead of

only those the government wants to procure.

• Subsidies and Investments in Agriculture: One major reform needed in agriculture

sector relates to reduction in subsidies and increase in investments. Agricultural

subsidies are fiscally unsustainable and encourage misuse of resources, leading to

environmentally malignant developments. There is trade-off between subsidies and

investments. Public investment declined from 3.4% of agri.GDP in the early 1980s to

1.9% in 2001-03. At the same time subsidies increased from 2.9% to 7.4%of

agri.GDP (GOI, 2007). Rise in public and private investment is crucial for enhancing

agricultural growth. Fortunately, gross capital formation in agriculture has increased

from 12% of agricultural GDP in 2004-05 to 14.2% of GDP in 2007-08. Public sector

investment has increased significantly during this period. However, we need 16%

agricultural GDP as investment in order to get 4% growth in agriculture. In this

context, the announcement of Bharat Nirman programme in 2005 by the Government

of India in order to improve agriculture and rural infrastructure is in the right

direction. However, the pace of this programme has to be improved.

• Improving land sales and leasing markets. Land sales and leasing markets are

highly distorted in India. We need to bring the policies of those states where these

markets are less distorted to those where they are more distorted. Even liberal leasing

policies that allow the owner and the lessee to freely negotiate and write contracts

would go a long way toward promoting the consolidation of land holdings, which

would in turn facilitate mechanization and productivity-enhancing investments in

land. We will also make large gains by fully digitizing land records and making them

publicly available online. A handful of states have done this with positive results

• Promoting contract farming and food processing. We must create an enabling

environment for contract farming, which can improve technology while also giving

our farmers lucrative prices for high quality and specialty produce. India lags far

behind its peers in food processing, which can not only give remunerative prices to

farmers but can also create vast numbers of good jobs. Contract farming can be the

key vehicle for the promotion of food processing.

• Irrigation and Water Management: Water is the leading input in agriculture.

Development of irrigation and water management are crucial for raising levels of

living in rural areas. Major areas of concern in irrigation are: decline in real

investment, thin spread of investment, low recovery of costs, decline in water table,

wastages and inefficiencies in water use and, non-involvement of users. Both

investment and efficiency in use of water are needed. Major areas of reforms needed

in irrigation are: stepping up and prioritizing public investment, raising profitability

of groundwater exploitation and augmenting ground water resources, rational pricing

of irrigation water and electricity, involvement of user farmers in the management of

irrigation systems and, making groundwater markets equitable (Rao, 2005).

Watershed development and, water conservation by the community are needed under

water management. New watershed guidelines based on Parthasarathy CommitteeOs

recommendations were accepted by the Central Cabinet in March 2009. The

implementation has to be stepped up in order to obtain benefits in rainfed areas.

National Rainfed Area Authority has big responsibility in matters relating to water

conservation and watershed development. Assets created under NREGS can help in

improving land and water management.

• Research, Extension and Technology Fatigue: The yield growth for many crops

has declined in the 1990s. Technology plays an important role in improving the

yields. The National Commission on Farmers indicates that there is a large

knowledge gap between the yields in research stations and actual yields in farmersO

fields. The yield gaps given by the Planning Commission (GOI, 2007 a) range from

5% to 300% depending on the crop and State. National Food Security Mission

(NFSM) has been launched in 2007 to increase 20 million tonnes of foodgrains (10

m.t. for rice, 8 m.t. for wheat and 2 m.t. for pulses) during the 11th plan period. It has

already shown some results by increasing yields in different regions. There is a need

to strengthen this mission to increase productivity. The issue of technology fatigue in

agriculture is well known now. There is a need to shift away from individual crop-

oriented research focused essentially on irrigated areas towards research on crops and

cropping systems in the dry lands, hills, tribal and other marginal areas

(Swaminathan, 2007). In view of high variability in agroclimatic conditions in such

unfavourable areas, research has to become increasingly location-specific with

greater participation or interaction with farmers. Private sector participation in

agricultural research, extension and marketing is becoming increasingly important

especially with the advent of biotechnology and protection being given to intellectual

property. However, private sector participation tends to be limited to profitable crops

and enterprises undertaken by resource rich farmers in well endowed regions.

Therefore, the public sector research has to increasingly address the problems facing

the resource-poor farmers in the less endowed regions. The new agricultural

technologies in the horizon are largely biotechnologies. There has been a revolution

in cotton production due to success of BT cotton in this decade. Similarly, there is a

need to strengthen extension.

• Credit: According to the expert group on Financial Inclusion (GOI, 2008) only 27%

of farmers have access to institutional credit. It is true that there have been some

improvements in flow of farm credit in recent years. However, the Government has to

be sensitive to the four distributional aspects of agricultural credit.

These are: (a) not much improvement in the share of small and marginal farmers; (b)

decline in credit-deposit (CD) ratios of rural and semi-urban branches; (c) increase in

the share of indirect credit in total agricultural credit and; (d) significant regional

inequalities in credit.

• Diversification to Hi-value Agriculture and Marketing: There has been

diversification of Indian diets away from foodgrains to high value products like milk

and meat products and vegetables and fruits. Since risk is high for diversification,

necessary support in infrastructure and marketing are needed. Price policy should also

encourage diversification. The Government wants to have second „green revolutionO

by diversifying agriculture in crop sector and allied activities. To promote holistic

growth of the horticulture sector through area based regionally differentiated

strategies, the National Horticulture Mission (NHM) was launched in the country

during 10th Plan. The impact has to be strengthened further to improve productivity in

horticulture sector. The true benefit of diversification will come if more emphasis is

given to allied activities like animal husbandry and fisheries. The livestock sector

contributes 5.4% to GDP and 22.7% to total output from agriculture sector.

Ownership of livestock is more equitable than that of land and women play significant

role in animal husbandry.

For small and marginal farmers, marketing of their products is main problem apart

from credit and extension. In recent years, there has been some form of contract

arrangements in several agricultural crops such as tomatoes, potatoes, chillies,

gherkin, baby corn, rose, onions, cotton, wheat, basmati rice, groundnut, flowers, and

medicinal plants. There is a silent revolution in institutions regarding non-cereal

foods. New production –market linkages in the food supply chain are: spot or open

market transactions, agricultural co-operatives and contract farming (Joshi and

Gulati, 2003). Contract farming in India is neither backed up by law nor by an

efficient legal system. This has to be strengthened as legal system is the single most

constraint to widespread use of contract farming in India. There is a need to revamp

some of the legal hurdles for agro processing and APMC Act. Several State

Governments have already amended their APMC Acts allowing varying degrees of

flexibility. However several States are yet to notify the relevant rules that would

make the amendment fully operational. These steps should be speedily completed to

provide a boost to promotion of direct marketing, contract farming, and setting up of

markets in private and co-operative sectors. Most important problem for the farmers

is output price fluctuations. There is a big gap between producer prices and consumer

prices. There are different models for marketing collectively by the small and

marginal farmers. These are: self help group model, co-operative model, small

producer co-operatives and contract farming. Apni Mandi in Punjab, Rytu Bazars in

Andhra Pradesh, dairy co-operatives are some of the successful cases in marketing.

The real challenge lies in organising the small and marginal farmers for marketing

and linking them to high value agriculture. Thus, group approach is needed for

getting benefits from marketing.

Revisiting manufacturing policy

India is justifiably proud of its achievements in the field of services exports, especially those

related to IT services and business process outsourcing. India is not known for world

domination in any field of manufacturing, though it is competitive in a few sectors. The bias

towards services reflects not just in its share of global trade, but also in the structure of the

economy. Services command a staggering 60 per cent of India’s GDP, while manufacturing

accounts for a puny 15 per cent, and it has not changed much over the past several years. This

is quite at variance with the structure of most other developing countries. Even many of the

developed countries have a larger manufacturing sector as a share of the total economy.

According to a recent report by UNIDO, India’s per capita manufactured value added (MVA)

- a measure of income generated by the manufacturing sector per person - was one-eighth of

China's, and one sixth of Brazil's in 2010, the two other developing countries in the group of

top 10 manufacturers. To put this in perspective, India's MVA per capita in 2010 was just

USD 107, compared to USD 648 in Brazil, USD 842 in China, and USD 4880 in the

Republic of Korea. Why should it matter, one may ask? Not every country needs to follow

the same model of development. Since manufacturing is more capital intensive than services,

the economic return on capital employed (measured by incremental capital-output ratio),

would be higher. So, should a capital scarce economy not focus on services to fuel its

growth? However, manufacturing matters, especially for a country like India.

Why does manufacturing matter?

The agriculture sector in India, which accounts for just 17 per cent of India’s GDP, employs a

disproportionately high share of the population. There is vast disguised unemployment in the

farm sector, resulting in extremely low productivity. There is a need to move a large number

of people from the farm sector to other productive sectors. However, despite the growth of

the services sector in India, its ability to absorb India’s surplus labour is limited. Services

require a certain minimum level of skills which many ‘out of farm’ and ‘dropouts from

school’ do not possess. The situation will become worse as millions of people join India’s

workforce over the coming decades. What should be India’s once in a lifetime opportunity to

benefit from the ‘demographic transition’ can easily become a nightmare if they are not

provided employment opportunities. The government’s inclusive growth agenda is best

served by a robust manufacturing sector.

Second, economic growth can be sustained only when productivity in an economy keeps

rising. For this, the workforce needs to constantly shift from lower productivity sectors to

higher productivity ones. A shift from agriculture to manufacturing is needed for economy

level productivity growth.

Finally, a balanced economic structure, where each sector – agriculture, services, and

industry - is well-developed is important for de-risking the future of the economy. Economies

which were centred around a few sectors, such as financial services, or manufacturing

exports, are impacted more by global shocks than diversified ones. Also, there are linkages

among various sectors and often their growth is inter-linked. For instance, the agriculture

sector provides inputs to manufacturing and farm incomes drive consumption of

manufactured products. Similarly, the services sector provides, well, services to other

services and industrial enterprises. Therefore, a robust economy needs a balance across

various sectors.

How has manufacturing fared?

To say that manufacturing in India has not grown will not be fair. “If manufacturing has

retained its share in the Indian economy during a phase of rapid economic growth, it suggests

that manufacturing has done as well as the larger economy,” says Dr Pawan Goenka,

President – Automotive and Farm Equipment Sectors. As a matter of fact, at 7.1 per cent,

India’s average annual manufacturing growth has been second only to China’s over the past

decade. This has allowed India to increase its share in world manufacturing from 1.1 per cent

to 1.8 per cent. However, this compares very poorly with China’s share which is much

higher. The performance of the manufacturing sector has certainly improved over the past 10

years, but not enough to significantly alter the composition of the Indian economy, India’s

share in the global sweepstakes, or to emerge as a powerful absorber of surplus labour. In

other words, it has been chugging along, but not galloping, and this is not good enough.

Though it will be a long haul to become a global manufacturing powerhouse, even to increase

the share of manufacturing in the Indian economy to 25 per cent will require it to grow at 12-

14 per cent in real terms consistently for the next 10 years. This is not an easy target, but one

that the National Manufacturing Policy, recently approved by the Cabinet, seeks to achieve.

The recent trends, however, are sobering. After growing nearly 9.2 per cent in 2010-11, the

manufacturing index grew just 6 per cent in the April-August period in 2011. HSBC’s

Purchasing Manager’s Index, which is considered a barometer of the state of manufacturing,

fell to its lowest in 30 months in September 2011.Manufacturing is in trouble in India. The

sector’s share of gross domestic product (GDP) reached 16% in 2006-07, then stagnated and

has declined since 2010-11, to little more than 15%, a sliver when compared with the shares

in Thailand (36%), South Korea (31%), and China (30%). Employment in absolute terms has

fallen in the formal manufacturing sector from 55 million in 2004-05 (12.2% of India’s

overall workforce) to 50 million in 2010 (10.5%). The sector’s growth rate has been declining

for four years, actually falling into negative territory in the first quarters of 2012 and 2013.

Internal challenges

Because discussions about the problems facing manufacturing tend to begin and end with a

long finger pointed at the government, it might be useful to start elsewhere: with constraints

that flow from industry’s self-induced weakness and inertia.

Indian industry continues to face an acute skills shortage. It laments this problem but does not

even attempt to emulate the efforts of firms in the information-technology and other service

sectors, which have opened large-scale in-house training programmes. It has also been unable

or unwilling to adopt effective forms of collective action to demand government

accountability or to find solutions for shared problems. And it has made no attempt at self-

regulation to curb corrupt practices. On another front, small and medium enterprises (SMEs)

often do not receive payments on time from their larger buyers, a far cry from the nurturing

that such companies enjoy in Japan and South Korea. Finally, because Indian industry is in

large parts cartelized, there is much resistance to price competition, a short-sighted stance

works against achieving global competitiveness. All of these weaknesses should be addressed

by the industry itself if it hopes to improve its competitiveness and credibility. Industry

aspirations has been another reason Dr Goenka thinks that traditionally, Indian entrepreneurs

have been risk-averse. Manufacturing requires higher upfront investments and longer

gestation periods than services. It requires aggression and initiative to invest in large

capacities, which has sadly lacked in India, though it has been changing, believes Dr Goenka.

This recent change will itself lead to some uptick in manufacturing, he believes.

MS Unnikrishnan, Managing Director, Thermax, believes that Indian companies do not have

the scale to be globally competitive. Except in a few sectors, there are hardly any global scale

manufacturing plants in India. The reason, he says, is that Indian companies have

traditionally focused on the domestic market and have lacked a global outlook, which in turn,

stems from the millennia old culture of non-invasion in the country. This is changing slowly

and he names Ratan Tata as the symbol of this transformation in this respect.

Lack of scientific institutions is one of the most important factor. Mr Unnikrishnan believes

that it is important for companies to develop and not just buy technologies, because either

off-the-shelf technologies are obsolete or there are restrictions on their usage and further

development. He asserts that India lacks institutions with deep scientific and technological

expertise, except in a few areas, such as space. India needs many technologies to solve its

myriad problems, such as the thorium reactor, renewable energy, coal gasification, space, and

water among others. Some of the universities in the developed countries have a larger

research budget than the entire budget of UGC in India! This has to change and linkages

between industry, academia, and research institutions need to be built and it will take a while

to come about.

Government policies

That said, the challenges posed, directly or indirectly, by government policies are formidable.

Consider the following.

An inflexible and unpredictable regime The comparison between manufacturing and

services is inevitable. “The growth and margins in services drive investors’ expectations,

which are clearly hard to match,” says Prasad Chandran, Chairman and Managing Director,

BASF India. BASF is a global chemicals company with plants in India. “IT companies can

lease their premises and can shut operations easily. Manufacturing, on the other hand is like a

banyan tree, with fixed assets, owned premises, and governed by rigid labour laws. It has no

flexibility to change location, no matter how compelling the reason,” he adds. Manufacturers

in developed countries are not so handicapped. Even in China, manufacturers enjoy much

more flexibility, as provinces compete with each other to attract investment.

The comparison with China is stark in other areas too. The regime governing manufacturing

is much more predictable than in India. One walks in with full confidence that the terms

agreed to before making the investment will not change subsequently. It is not the case in

India, where mid-stream the rules of the game can change. Singur is just one example. Mr

Prasad recounts how an investment in a factory was based on the commitment to provide a

certain fixed quantity of water. However, the municipal body decided after a few years that it

wanted water for other purposes and diverted it away from the factory. Similarly, a promised

road did not materialise and the investor was asked to fund it at his own cost, something that

it had not budgeted for.

Difficult business environment: India ranked 132 out of the 185 countries in the World

Bank’s Doing Business survey in 2013. According to the official data, nearly 70 clearances

are required annually for businesses to operate. The greatest cost falls on SMEs, where the

proprietor has to bear the entire burden. Such an environment, combined with retroactive

changes in tax demands, creates much uncertainty, anathema for investment. Another

challenge is the lack of adequate protection against extortion and protection rackets.

Labour deployment rigidity: Indian manufacturing has suffered in the past from the twin

constraints of militant and competitive trade unionism and a plethora of labour legislation. In

recent years, unionism has ostensibly weakened. Nevertheless, it is still present in major

industrial centres, and its infrequent but violent demonstration discourages foreign investors

and induces others to keep employment to a minimum. India has nearly 50 laws at the central

or state level that affect labour conditions. Consequently, hardly any enterprise can claim to

be in total compliance.

Infrastructure deficit: The peak power deficit in India is estimated at 7% to 8%, and industry

is not insulated from the resultant power cuts that sweep the country. Most large

manufacturing units have had to create full backup capacity, raising capital costs. Indian

companies across the board bear a significantly higher price for infrastructure services and

utilities than their global competitors.

Regulatory delays and lack of transparency: Over time, a rather complex regulatory

structure has been established to deal with land acquisition, land use and the environment.

The process has become increasingly time-consuming, opaque and unpredictable, especially

during the past 10 years under the rule of the United Progressive Alliance. According to one

survey, 1,240 central and state regulations apply to the industrial sector.

Onerous commercial bank credit: More than two-thirds of surveyed SMEs preferred not to

utilize commercial bank credit because of long processing times and stiff collateral

requirements. Instead, they turned to the informal markets, paying higher rates but with less

onerous conditions. This defeats the avowed aim of the government’s selective credit control

policy, which requires banks to earmark 10% of their credit to SMEs.

High and rising cost: Though India is considered a low-cost location, but in reality costs can

be quite high. Even labour costs are rising rapidly and making manufacturing increasingly

less competitive, if not unviable. Dr Goenka points out that in Northern India, an average

factory worker may earn approximately Rs 30,000 per month. Even in absolute terms, the

cost of labour may be higher than in China or even Malaysia. And if productivity is brought

into the equation, the comparisons become even worse. Other costs are higher than the

competing countries. For instance, cost of power in India is much higher than in Pakistan or

even Bangladesh. With no clear strategy for fuel linkages, it may get even worse. The

plethora of taxes at central, state and local levels also add up to not just high rates, but also

high costs of compliance. The introduction of GST may improve the situation, but till then, it

will be a significant handicap.

Apart from these direct costs, manufacturing companies bear the additional cost of

transaction and inefficiency of officials. A port will charge the exporter demurrage, even

when the shipment is delayed on account of its inability to complete the documentation.

Reform Agenda

• . Infrastructure

. Improved infrastructure including roads, railways, ports and electricity is essential for

manufacturing growth. Because profit margins per worker are low in sectors where labour

costs are 80 percent or more of the total costs, it is important that transportation and

electricity are available to entrepreneurs at competitive rates

• Labour market flexibility

. Myriad labours laws—52 of them at the Centre and three times those in the states—drive

our entrepreneurs away from employment-intensive manufacturing sectors and also

encourage them to opt for capital-intensive technologies in whatever manufacturing they do.

Where a machine can do the job, they prefer not to employ workers. While we must protect

the interest of our workers when employed, we also need to create millions of jobs for those

toiling in the informal sector or who are without any job at all. Therefore, we must think of

creative ways to introduce greater labour-market flexibility such that the interests of workers

already employed and those seeking good jobs are balanced. Recognizing that labour is a

concurrent subject in our Constitution, one way to do this is to give powers to states to amend

central legislation. With 28 states (soon to be 29) in India, this could provide healthy

competition as well as greater experimentation.

• Apprentices.

Apprenticeship is a very important vehicle for skill creation. Yet, India has only 300,000

apprentices compared with 10 million in Japan. As Manish Sabharwal has written in a

number of articles, the existing relevant legislation, the Apprenticeship Act of 1961, is highly

constraining. It treats apprenticeship as employment and an associated stipend as salary, with

all attendant regulations also applying to apprenticeships. Depending on the trade, the

duration for apprenticeship can vary from 3 months to 3 years but the current legislation does

not give this flexibility. A relatively uncontroversial reform of the Act can lead to a manifold

expansion of apprentices. Many skills are learned on the job, so that an expansion of

apprentices can serve to stimulate manufacturing and greatly improve the employability of

the individuals receiving apprenticeships.

• Land acquisition.

According to the best available reports, land acquisition came to a standstill the day the new

Land Acquisition Act became a reality. A quick reform of this Act will be absolutely

essential for the new government. Land being central to all activities including infrastructure,

housing, manufacturing and services, a land acquisition law that is fair to those whose land is

acquired but that also allows land acquisition at a reasonable price is critical to all economic

transformation. There is no doubt that excesses had routinely happened under the antiquated

1894 Act that the new Act has replaced. But the 45 pages worth of regulations that the buyer

acquiring land must satisfy make land acquisition for building even rural roads prohibitively

expensive and long drawn. Once again, with land being a concurrent subject, the next

government should consider allowing states greater flexibility in bringing about their own

legislation to suit their local conditions.

• Red tape and the Inspector Raj

. Red tape and the Inspector Raj remain major sources of costs and corruption facing small

and medium firms. Larger firms are able to absorb these costs more easily. The next

government must endeavour every way it can to cut this red tape and Inspector Raj to help

small and medium size firms.

• Exit policy

. Winding up business when losses persist year after year remains an arduous task in India.

The average time to complete closure of a firm under the current Board of Industrial and

Financial Restructuring and Sick Industrial Companies Act exceeds fifteen years. When exit

is costly, businesses hesitate to take what is normal risk in other countries. They enter only

those businesses where the chance of failure is near zero. They are particularly hesitant to

enter employment-intensive sectors where political pressure against closure in order to

preserve jobs is intense. We need an exit policy that protects the interests of workers by

ensuring adequate compensation upon exit, but also allows firms to close down transparently

and within a reasonable time if they are incurring losses year after year.

• Privatization.

Genuine privatization involving transfer of ownership rather than just disinvestment to raise

government revenues, which had gathered some momentum under the NDA, has been at a

standstill during the last ten years under the United Progressive Alliance (UPA) government.

Careful work by Gupta (2012) shows that public sector units (PSUs) for which privatization

involved the sale of majority stakes, and therefore resulted in the transfer of management and

control to private hands, have exhibited vastly superior performance compared to PSUs for

which such a transfer did not take place. To quote Gupta (p. 143), “Compared to partially

privatized firms, sales and returns to sales increase by an average of 23 percent and 21

percent, respectively, when firms sell majority equity stakes and transfer management control

to private owners. Moreover, the sale of majority equity stakes is not accompanied by layoffs.

In fact, employment appears to increase significantly following privatization.” These are

important gains suggesting that further privatization could make a significant contribution to

manufacturing growth. According to Gupta (2012), even after the NDA privatizations,

Central government-owned PSUs alone accounted for 11 percent of GDP in 2005. Therefore,

there is considerable scope for the privatization of PSUs.

• Manufacturing hubs and industrial zones.

While the Central and state governments can facilitate the creation of manufacturing hubs

through the provision of infrastructure in specified zones, without appropriate policy reforms

they will not fulfil their most important objective of creating good jobs for the low skilled.

For example, creating new cities with such hubs under the auspices of the Delhi-Mumbai

Industrial Corridor project is an excellent initiative, but their potential to create good jobs will

be determined by the overall policy regime. Without reform of labour and land markets, the

hubs will remain homes to highly capital-intensive industries and mainly remain the vehicle

for obtaining tax breaks that typically accompany such initiatives

Infrastructure

Infrastructure in India is plagued with complex issues requiring urgent attention. While the

focus on infrastructure growth has led to policy initiatives such as the Committee on

Infrastructure and the PPP Appraisal Committee, much more is required to improve the

situation. Similarly, while providers of infrastructure have matured from small, unorganised

contractors to large, well-organised construction companies, notable skill gaps remain.

Challenges in the Tendering Phase Affect Viability of Projects, Delaying

Implementation

Several bottlenecks in the tendering phase of projects impact their viability and uptake, and

create delays during pre-tendering and construction stages. These include poor quality of

engineering, tendering of unviable projects, slow approval process, and inefficient contracts.

Quality of planning and engineering design is poor

Nodal agencies in India tend to focus less on design and engineering excellence than their

global counterparts. They usually select engineering consultants on a lowest price or L-1

basis, overlooking the quality aspect. This is evident in the fact that the cost of creating a

detailed project report (DPR), as a percentage of project cost, is much lower in India

compared with global benchmarks. Not surprisingly, this leads to bottlenecks and cost

overruns during the construction phase (Exhibit 2.1).

Tendering unviable PPP projects is common

Many examples of unviable projects exist in the national highways segment. NHAI follows a

blanket policy to tender projects on a toll basis.

However, the complexities of the national highways segment require a more strategic

approach to planning wherein projects are tendered on a toll, annuity and cash basis

according to traffic estimates and VGF availability. Several times recently, NHAI’s toll

projects have not found bidders. Discussions with industry reveal that they find many of the

projects unviable to execute, even with the 40 percent VGF offered by NHAI in toll projects.

Contracts in use are inappropriate

There are two distinct issues with the contracts used in India.

• Low use of lump-sum EP&C contracts: Item rate contracts are the norm for cash

projects in most sub-sectors. In such contracts, primary responsibility for project

execution rests with the nodal agencies. A more efficient approach would be to transfer

this responsibility to the providers through lump-sum EP&C contracts that are based on

more efficient and robust project designs. Since the profits of providers are dependent on

their performance on time and cost, their incentive to perform well is high.

• Ambiguity and imbalance in contractual clauses: Nodal agencies use a multitude of

contracts that are often ambiguous and unbalanced. Discussions with industry players

suggest that the clauses pertaining to variations, price escalation, advances and retention

are the most contentious and often cause disputes during construction. Providers have to

deal with such contractual risks by pricing them into the total project cost.

Pre-tendering approval process is centralised and slow

Nodal agencies need to obtain several approvals and clearances during the pre-tendering

phase. These approvals including the required pre-work, in many cases, take between one to

one and a half years (Exhibit 2.2). Despite several plans to introduce single window clearance

mechanisms, there have not been any visible improvements. For national highways, the

situation has actually worsened in the past few years. During the earlier phases of the NHDP,

approval was granted at a programme level and no project-specific approvals were required,

which is now the case. The lack of defined timelines and accountability coupled with the fact

that approvals need to be granted sequentially leads to a significantly drawn out process.

Construction Phase Beset with Over-Runs and Disputes

The construction phase faces several challenges including delays due to land acquisition,

ineffective dispute resolution, shortage of skilled manpower, and ineffective project

management by nodal agencies.

Land acquisition delays are common

In India, nodal agencies award projects with only part of the land acquired, sometimes as low

as 30 per cent. This is contrary to the global best practice of completing the land acquisition

before tendering projects. Delays in subsequent land acquisition are possibly the

single largest factor causing project delays. A study commissioned by the Planning

Commission, as well as a McKinsey survey of construction companies, suggests that 70 to 90

per cent of road projects suffer from land acquisition delays, a problem that is also very

common in other sectors (Exhibit 2.3).

Dispute resolution processes are ineffective

Construction work in India is prone to disputes. Factors responsible for these disputes include

land acquisition and clearance-related delays after tendering and scope changes, among

others. Timely and fair settlement of these is essential to maintain progress. An effective

dispute resolution mechanism is also essential to attracting foreign players. Global best

practice suggests that arbitration is the method of choice for settling disputes. While India’s

Arbitration and Conciliation Act, 1996, is a commendable regulation, its effectiveness is

below expectations. This is because of two main factors:

• Ambiguity in the Act: For example, according to Section 34, an award can be

challenged if it is against the country’s public policy. Nodal agencies often use this

condition to challenge an arbitration award. In many cases where the awards are

challenged in courts, the motivation for nodal agency officers is to avoid possible

repercussions.

• No enforcement of arbitration award: In developed countries such as the UK, the

arbitration award is enforced even if it is challenged in the court. For example, if the

contractor wins, he gets the payment (generally against a bank guarantee) without

having to wait for the court’s verdict.

Performance management at nodal agencies is weak

The performance of a nodal agency can be assessed on the basis of its track record in

completing projects on time and within budget. Despite this, the performance management

system itself is weak at some of the nodal agencies. The lack of performance orientation is

evident in agencies that under-perform on routine tasks such as providing detailed drawings

on time and collaborating with the contractor to ensure progress. Exceptions include agencies

that have strong leaders who have created an empowered culture.

The main problems include:

• Lack of transparency

• Lack of meaningful incentives (financial or otherwise) to reward the performance of

officials

• Absence of clearly defined consequences in the event of under-performance.

Reforms required-

For India’s infrastructure to grow as envisaged, stakeholders need to urgently address the

implementation bottlenecks.

In all, government, policy makers and nodal agencies need to take nine initiatives to

address the bottlenecks.

Of these initiatives, five can have immediate impact; four will need sustained efforts over the

long term. Independent of how long these initiatives will take to have impact, decisions need

to be taken immediately to address the USD 200 billion risk to India’s GDP by 2017.

Five Initiatives can have Immediate Impact

Government, regulators and nodal agencies can implement five initiatives immediately, after

due deliberation with key stakeholders to ensure alignment.

1. Change land availability norms and tighten contractual penalties for delays

Projects should be awarded only after a sufficient amount of land has been physically

acquired. Contractual mechanisms should ensure nodal agencies’ continual commitment to

land acquisition even after the award. Acquiring 90 to 95 per cent land, including the tracts

that are indispensable for normal progress of construction work, could be made a pre-

condition for tendering PPP and EP&C projects. For other types of projects, this limit could

be 80 per cent, since the nodal agency continues to hold greater ownership of project

completion. Also, the land should be considered “unencumbered land” only when it is free

from any physical encumbrance such as dwellings. After awarding the project, the nodal

agency could be bound by the terms of the contract to acquire the rest of the land. To ensure

this commitment, a penalty clause could be included in the contract. The penalty calculation

should ideally be unambiguous and could be similar to that of liquidated damages (i.e., a

fixed quantum of penalty for each day of delay). The quantum of the penalty clause should

adequately cover the typical extension costs, and could be capped in a similar way as

liquidated damages payable by the provider.

2. Establish a high-power group to monitor and de-bottleneck infrastructure projects

The existing performance tracking system covers all projects above USD 5 million that are

under implementation, but it suffers from several shortfalls. For example, it does not track

pre-tendering progress, cost overrun estimates do not include claims under dispute, and

causes of over-runs are based entirely on nodal agency inputs. A high-power group needs to

be created to monitor progress, make results transparent, and force decisions to enable

progress. This group could be a part of the Prime Minister’s Office or of the Committee on

Infrastructure, and a minister or a secretary could head it. Other ministries could be involved

as necessary. Its scope should include all sectors in infrastructure and cover a small number

of larger projects (e.g., over USD 25 million to USD 50 million). The group should:

• Monitor project portfolio and nodal agency performance on at least three key metrics:

1) on-time award; 2) actual construction progress against planned milestones; and 3) within-

budget completion

• Consolidate the performance data on a monthly basis and make them publicly

available, clearly showing where delays and over-runs are most common

• Selectively involve providers of large projects when the delays and over-runs

continue to grow, to understand the bottlenecks and collaboratively develop

solutions

• Escalate inter-ministerial bottlenecks that are impeding important projects (pre or

post tendering) to relevant authorities, and force decisions to enable progress (e.g., by

selectively convening ministers and bureaucrats from concerned areas). The group

should have the powers to expedite the resolution of bottlenecks.

3. Amend policies and regulation to hasten dispute resolution process

Making the dispute resolution process more effective can accelerate project execution, as

well as reduce costs. It can also increase India’s attractiveness as a market for global

construction companies. However, it will require measures at several levels—arbitration

laws, policy, contracts and the judiciary.

• Strengthen India’s arbitration laws

— Amend Section 34 of The Arbitration and Conciliation Act, 1996, under which the

arbitration award can be challenged in court. The amendment must remove all ambiguity in

interpretation of clauses.

— Enforce arbitration awards even if they are challenged in court. For example, if a nodal

agency loses the award, it should make the payment (protected by bank guarantees) as per the

award. Such enforceability is already the norm in several countries.

.

• Set up a dedicated tribunal for infrastructure cases: These tribunals should have

powers equivalent to high courts. The jury should include qualified judges and

industry experts. Countries such as the UK and Australia have successfully used fast-

track courts for infrastructure cases (Exhibit 3.1).

4. Judiciously adopt delivery mode to increase success rate of tendering PPP projects

India needs a robust mechanism to assess and improve the commercial viability of projects,

and to test them for PPP readiness before tendering. The government could:

• Review and modify the existing standard specifications for PPP projects to increase

their viability. In roads projects, for example, link the number of lanes to the current

and future traffic volume

Create a think tank with increased decision power within or outside the PPPAC, with

technical and analytical capabilities to test and modify project specifications to

maximise their commercial viability . The recommendations of this cell should form

an important input into the PPPAC’s decision to approve the project.

5. Select design and engineering consultants on the basis of quality and cost assessment

Most DPRs are prepared with the help of consultants and their quality has significant impact

on time and cost of project execution. Hence it is important to select technical consultants

using a quality-cum-cost based approach instead of the traditional L-1 based approach.

We suggest:

• Creating a sector-wise, centralised database of consultant ratings, based on their

performance in recently completed and ongoing projects. This database should take

project-level inputs on the performance of consultants from the respective nodal

agencies

• Issuing standard guidelines with objective scoring parameters (e.g., magnitude of

design changes during execution and underlying reasons). Nodal agencies could use

these guidelines to assess consultant performance.

Four Initiatives will need Continued Efforts for Impact

To effectively implement these initiatives, long-term commitment is imperative. This will

entail the gradual development of the right capabilities, systems and processes.

1. Reform contracts

Nodal agencies need to consider reworking their contracts to capture private sector

efficiencies, accelerate project execution, and distribute risks across parties in a more

balanced manner. Towards this end, nodal agencies could:

• Move from item rate contracts to lump-sum EP&C contracts:

— Large, complex projects usually attract sophisticated providers and could be executed

using lump-sum EP&C contracts; projects in this category include national highways, thermal

power, hydro power and greenfield airports

— Medium-sized and less complex projects that usually attract providers of medium

sophistication could also be executed using lump-sum EP&C contracts. Projects in this

category include state roads, water supply and sanitation

— Small projects in any sector (e.g., rural roads) typically attract providers with low

sophistication.

2. Carve out programmes of national importance as SPVs with world-class governance

Recent experiences suggest that programmes that capture national attention have better

chances of success, e.g., Ultra Mega Power Plants. Therefore, government could create a list

of a few large programmes, each spanning a few high-impact projects of national importance.

Subsequently, it could set up new, independent entities to own these programmes. Such new

entities have better chances of creating high performance orientation within their respective

organisations. The government should strengthen the governance and management of these

entities by instituting autonomous boards, headed by strong chairmen with stellar records of

building high performing organisations.

3. Institute strong performance management systems at nodal agencies

While external governance (the high-power group and programmes of national importance)

will go a long way in improving the performance of nodal agencies, they will also need to

enhance performance orientation internally. Some state departments of transport in the US

have institutionalised systems and processes that work to this effect, and present a good

example to follow

for Indian agencies.

• Establish performance tracking mechanisms

— Set up an independent performance monitoring committee, reporting directly to the

Chairman.

The committee can either be nodal agency specific, or a common committee across nodal

agencies

— Introduce multi-level periodic performance review process for individuals

— Create periodic dashboards to increase transparency of performance.

• Set up incentives and consequence management systems

— Link incentives (financial or non-financial) explicitly and transparently to

meeting/exceeding expectations on milestones and targets

— Define clear consequences for consistent underperformance relative to expectations.

4. Kick-start a construction-focused vocational training programme

Vocational training in India has recently seen progressive measures such as the Modular

Employability Skill Development Scheme (MESS). However, these measures alone may not

be enough to tackle the shortage of manpower. The construction industry needs skilled and

semi-skilled manpower at a rate that can match the intended pace of growth. The government

needs to create additional training capacity to generate 2 million to 3 million more skilled

workers per year by 2017

The government should secure the construction industry’s commitment for its participation in

five distinct areas:

• Set progressive, modular standards for each skill type: For example, a panel with

representation from players, industry bodies, academia and NGOs could set standards

for each skill type. These standards should have broad-based relevance,and should

become a reference point for setting the curriculum

• Improve faculty training: Given their experience and capabilities, industry players

and associations would be best poised to run courses that can generate adequate

faculty for this programme

• Provide apprenticeship: On-the-job training should be an integral part of the course

curriculum, in line with developed countries. Institutes can have formal tie-ups with

local providers for systematically providing apprenticeship

• Improve certification: A panel such as the one described above should set

certification standards and guidelines. Emphasis should be on actual skill displayed,

as against theory-based testing. Further, the industry should help conduct the actual

certification process to ensure quality

• Place trained candidates in employment: The location and capacity of training centres

under this programme could be decided on the basis of local requirements. Ideally, the

government should secure commitments from the industry for absorbing a major

proportion of the trained workers.

Policy makers and nodal agencies can significantly improve infrastructure implementation by

pursuing a set of initiatives. However, it is imperative that these efforts go hand-in-hand with

the providers’ efforts to upgrade their skills and become truly world-class.

Law, Institutions and Business Environment

The most striking fact about India’s legal system is the difference between protection of

investors by law as opposed to protection in practice. We compare India’s scores relative to

the world, different legal-origin country groups, and other emerging markets on several

different dimensions of law and institutions. With the English common-law system, India has

strong protection of investors “on paper”: The scores on both creditor rights (with a score of

4/4 in LLSV (1998), based on the Company’s Act of 1956, to 2/4 in DMS (2005), based on

the Sick Industrial Companies Act of 1985) and shareholder rights (5/6) are the highest of

any country in the world.

When we compare law enforcement and the quality of institutions in India and LLSV

countries, we employ four sets of up-to-date and widely used measures for our purpose. First,

the legal formalism (DLLS 2003) index, based on extensive surveys of lawyers and judges,

measures how efficiently the courts of a country enforce contracts. DLLS have constructed

measures based on how courts handle two types of cases: Collection of a bounced check, and

eviction of a (non-paying) tenant. A higher score in either category implies that the court

system is slower (with more bureaucracy) and less efficient. We took the average of these

(highly positively correlated) indexes to construct a single formalism index. We see that India

has a higher formalism index than the average of English origin countries, and is only lower

than that of the French origin countries. Second, measures on government corruption come

from Transparency International’s survey-based annual reports, which provide the most

comprehensive examination of corruption within the government and legal institutions

around the world. Based on its 2005 Corruption Perception Index, India has a score of 2.9 out

of 10 (a higher score means less corruption), which ranked 88th out of 140 countries (with

the range of scores from 1.5 to 9.7). In the 2003 survey, India had a score of 2.8/10 and

ranked 95th out of 145 countries. Next indicator reveals that India’s corruption score is below

that of China, Brazil and Mexico, all of which have much weaker legal protection of

investors, and is only ahead of Pakistan . Third, we have two measures for the quality of

accounting systems. The disclosure requirements index (from 0 to 1, higher score means

more disclosure; LLS 2006) measures the extent to which listed firms have to disclose their

ownership structure, business operations and corporate governance mechanisms to legal

authorities and the public. India’s score of 0.92 is higher than the averages of all LLSV

subgroups of countries, including the English origin countries, suggesting that Indian firms

must disclose a large amount of information. However, this does not imply the quality of

disclosure is also good. In terms of the degree of earnings management (higher score means

more earnings management; Leuz, Nanda and Wysocki 2003), India’s score is much higher

than the average of English origin countries, and is only lower than the German origin

countries, suggesting that investors have a difficult time in evaluating Indian companies

based on publicly available reports. The fourth and last category of Table 2-D is the legality

index, a composite measure of the effectiveness of a country’s legal institutions. It is based

on the weighted average of five categories of the quality of legal institutions and government

in the country (see Berkowitz, Pistor and Richard 2003). Consistent with other measures,

India’s score is lower than the averages of all the subgroups of LLSV countries, suggesting

that India’s legal institutions are less effective than those of many countries, and that it will

be more difficult for India to adopt and enforce new legal rules and regulations than other

countries. Finally, as for the business environment in India, a recent World Bank survey

found that, among the top ten obstacles to Indian businesses, the three which the firms

surveyed considered to be a “major” or “very severe” obstacle and exceeding the world

average are corruption (the most important problem), availability of electricity, and labour

regulations. Threat of nationalization or direct government intervention in business is no

longer a major issue in India. With rampant tax evasion, the shadow economy in India is

significant. It is estimated to be about 23% of GDP

To summarize, despite strong protection provided by the law, legal protection is considerably

weakened in practice due to an inefficient judicial system, characterized by overburdened

courts, slow judicial process, and widespread corruption within the legal system and

government.

Some initiatives and further reforms

Parameter: Finance & Tax Related Compliances

Integrated and Comprehensive system for managing indirect taxes in

Karnataka

Recommendations to further improve the system

Some of the areas where further improvement can be brought are as under:

1. Risk profiling of taxpayers

Services could be made more taxpayer centric with treatment to taxpayers being

differentiated based on the risk profile of a Taxpayer. The risk profile indicates the revenue

risk that a taxpayer poses to the tax administration based on his demographic cum business

profile and compliance history. A dynamic risk profiling system that identifies the risk

category of a taxpayer and updates it at each instance of the taxpayer’s interaction or default

with the Tax Administration can be implemented. The risk profile could then be used to

manage the Taxpayer experience throughout his lifecycle. For example, a risk based approach

to clearance of refunds can be adopted where the level of scrutiny and audit performed on the

refund request would be significantly higher for a “High risk” taxpayer as compared

to a “low risk” taxpayer. Leading tax administrations across the globe including Singapore,

UK, and Australia have adopted this approach for faster processing of refunds and to become

more taxpayer friendly.

2. Dealer Ledgers: Provisioning of dealer ledgers online that provide the dealer with an

anytime anywhere access to their complete profile including an up-to-date history of

transactions (successful / unsuccessful) such as such as details of registration, assessment

finalized, pending assessment, pending appeal, returns filed, payments made, refunds

granted. Dealer ledgers would be system maintained and available to the Dealer online

through secure access. Dealer Ledgers would be a great move towards significantly

enhancing the transparency of interaction with the Tax Administration. States like

Maharashtra and Tamil Nadu are already in the process of implementing these in their next

wave of eGovernance.

3. Phasing out of static checkposts - Once a transaction is uploaded online, its reflection in

the dealers’ books of accounts is assured and so also is the tax payment. The check posts are

required to only verify if the actual consignment tallies with the description uploaded. In

order to ensure this, random checks of goods vehicles should be sufficient. Thus, in future the

static check posts should pave the way for mobile check posts which would carry out checks

randomly.

Parameter: Labour Law Related Compliances

Recommendations

Some of the areas where further improvement can be brought are as under:

O Currently all the services are clubbed under the various Labour Laws they pertain to. The

same may also be clubbed under the type and size of business. This will make the compliance

much simpler as the businesses can provide certain information about their establishment and

will instantly get a list of all the items which they need to comply to.

O Business process reengineering in the Return forms so that a single return can be filed

instead of multiple returns asking for similar information.

O Online issuance of certificates and licenses using digital signatures. It would improve the

efficiency if a checklist of compliance requirements/standards prescribed is placed on the

website. Introduction of self-certification by certain category of businesses (non-risk/non-

hazardous activities/businesses, businesses up to a certain level of investment etc. – criteria

can be laid down) can be considered and approval in such cases made online. Inspections can

be on a random basis.

O Certificate generation can be made online. Since all the information regarding labour

legislations is available online, it would facilitate if once the user keys in his information

regarding the size and type of business, the system is able to generate information on the

forms required to be filled/ laws under which compliance is required/standards required to be

maintained.

O Forms for setting up business/filing of returns can be rationalized.

Parameter: Infrastructure & Utilities related Approvals

Recommendations

MAITRI could be further enhanced and strengthened through the following measures:

O Formulate a Single Window Clearance (SWC) Act to bind the various government

departments for receiving, processing and monitoring of applications.

O Formulate a SWC committee at District level for expediting applications – to be headed by

Collector OR GM of Industries Dept.

Mandate online submission and acceptance of all applications and supporting documentation.

Do away completely with physical copies, in a time bound manner.

O Establish a one time (single) payment by Investors wherein all departments’ money is

collected at the time of Common Application Form submission.

O Build payment calculation logic in the system for calculating and disbursing fees to various

department accounts, based on their proportion.

O Enhance the coverage of industries to be provided services through SWC, from existing

Large and Mega (investments > INR 10 Crore) to SMEs across the State.

• While the MAITRI (of Department of Industries/MAH) involves integration with other

departments of the government of Maharashtra that interface with the business community it

may be considered to provide a link to the Central Government Ministries/Departments

where clearance is necessary from the latter.

O The departments having no IT system/automation in place and not willing to receive

applications through SWC System interface could create a logjam for other enabled

departments, if the approvals by the latter are dependent on clearances by the former kind of

departments. The need is for identifying all such Government offices and causing them to

come on board/adopting IT enabled processes, to make the SWC a true success.

Parameter: Land & Building Related Approvals

Recommendations

Good practices from other states Although we have chosen to showcase GIDC’s model for

land related intervention as a best

practice but some of the other states have taken initiatives to help businesses to get land for

setting up facilities.

O Haryana State Industrial & Infrastructure Development has land rates are clearly spelled

out on its website

O If the land required is in private hands, Andhra Pradesh Industrial Infrastructure

Corporation acquires the land on behalf of the investor. However, investor has to acquire

consent of at least 70% of the existing land owners

O In Andhra Pradesh, one member of land owners family whose land is acquired is

guaranteed employment in the industry that is being set up on the land

Parameter: Environmental Clearances

Recommendations

According to the Bain-FICCI report, the GPCB system could do with some improvements in

processes. Some of these are listed below:

O Bring clarity to the environmental regulations and processes

O The information on environmental regulations should be easily available on the website so

that the industry is aware of the existing processes and information is disseminated

O Regular training programs should be conducted on compliance measures for the industry

which include the recent development in green technology

O Process for approvals and submissions should be web-based

O Online submissions and tracking of applications to be introduced

O For procedural reforms and other process simplifications a committee to be instituted

O An extension of validity of no-objection certificates from 1 year to 5 years for green

category of firms

O The introduction of self-certification for firms in the green category that are audited by

third parties

O A common application/authorization form should be implemented

O Once the user keys in his information regarding the type of business, etc. the portal should

be able to provide all information regarding the pollution related compliances required by

them.

O There seems to be no provision for tracking of application by the investor- he has to

depend upon the SMS sent at various stages by GPCB. This can be built in.

O Introduction of self-certification by a certain category of businesses can be considered and

approval in such cases be made online.

Parameter: Other Compliances

Tax reforms and simpler tax regime

The consumption tax system in India is complicated and multi-layered with levies both at the

federal and State levels. Taxes on goods are levied by the Centre at the manufacturing level

through CENVAT, on services through the Finance Act, and on sale of goods via the Central

Sales Tax Act. States levy tax on the sale of goods independently, under their own laws.

Though some degree of uniformity had been arrived at after the introduction of the Value

Added Tax, differences do persist.

Goods and Services Tax

Goods and Services Tax (GST) is a broad based, single, comprehensive tax levied on goods

and services consumed in an economy. GST is levied at every stage of the production-

distribution chain with applicable set-offs in respect of the tax remitted at previous stages. It

is basically a tax on final consumption. To put at a single place, GST may be defined as a tax

on goods and services, which is levied at each point of sale or provision of service, in which,

at the time of sale of goods or providing the services, the seller or service provider may claim

the input credit of tax which he has paid while purchasing the goods or procuring the service.

It is seen as the panacea for removing the ill-effects of the current indirect tax regime,

prevalent in the country. If adopted and implemented in its true spirit, GST may neutralise the

existing problem of taxes being levied on top of taxes. For instance, when a shoe company

produces a pair of shoes, the Central Government charges an excise duty on them as they

leave the factory. At the retail level, the state where the outlet is located, charges VAT

(different states charge different rates of VAT) without giving credit on the excise duty levied

earlier (the state tax is levied on top of a central tax). In the GST system, both central and

state taxes may be collected at the point of sale. Both components (the central and state GST)

may be charged on the manufacturing cost.

The government plans to introduce dual GST structure in India. Under dual GST, a Central

Goods and Services Tax (CGST) and a State Goods and Services Tax (SGST) will be levied

on the taxable value of a transaction. This dual structure will ensure a higher involvement

from the states, and consequently their buy-in into the GST regime, thus facilitating smoother

implementation. Both the tax components will be charged on the manufacturing cost. The

government is deliberating on fixing the value of combined GST rate at the moment, which is

expected to be between 14-16 per cent. After the combined GST rate is decided, the centre

and the states will finalise the CGST and SGST rates. All kinds of goods and services,

barring some exceptions, would be under the GST purview.

Impact of GST on industry

Manufacturing sector in India is one of the highly taxed sectors in the world. A complex and

high taxation structure has the tendency to render products uncompetitive in the international

market or eats up large portions of the cost arbitrage available in manufacturing set-ups in

low cost economies such as India. For instance, the manufacturing cost of most products in

India is nearly half than in the west. But, the incidence of multistage taxation i.e. customs

duty on imports, central excise duty on manufacture, central sales tax (CST) / value added tax

(VAT) on sale of goods, service tax on provision of services and levies such as entry tax,

octroi and cess by the State or local municipal corporations and related costs such as loss of

tax credit, compliance and litigation cost chip away this advantage to the extent of almost 50

per cent.

Cascading impact of taxes on landed costs

Let us understand the cascading impact of indirect taxes through an example of a typical

value chain.

There are multiple incidences on taxes and cascading impact on the cost of finished goods.

a) Custom Duty + Counter Veiling Duty + Cess paid on imported Goods

Sales Tax / VAT paid on domestic purchases, which include the excise duty paid by the raw

material manufacturer. Sales Tax / VAT are also charged on the excise duty element.

b) Excise duty on the cost of manufactured goods. So, this excise duty also gets levied on the

sales tax element (or custom duty & cess) paid on raw materials imported as stated above.

c) Service Tax on Transportation

Sales Tax (CST or VAT) on the sales of Finished Goods cost, which also includes the excise

duty elements, sales tax paid on raw materials and service tax paid on transportation.

Practically, the sales tax at this stage gets levied on all the taxes paid in the previous steps.

Multiple warehouses, inefficient distribution

Besides these tax implications, complex state-wise tax structures have serious repercussions

on the manufacturers. Inventory and distribution decisions are based on tax avoidance rather

than operational efficiency. Accordingly, most manufacturers maintain warehouses in

different states to evidence movement of goods from one warehouse to another to save on the

CST. Also, quite a few entities set up warehouses in locations like Pondicherry or Daman,

often impractical from a distribution point of view, as the CST rate at such locations were

previously lower than the rates prevalent in other states.

Typically, most large consumer durables or FMCG companies in India operate with 25 to 50

warehouses all over India, which is a very high number compared to developed economies

(less than 5-8) or even developing countries (less than 10-15) with similar geographical

expanse. This has severe implications on cost structure and operational efficiency levels,

which is ultimately borne by the end consumer either in terms of cost-quality trade-offs.

• More sum total space & inventory requirement: It is estimated that if tax avoidance is not a

factor for deciding distribution network, the total warehouse space can be reduced by 20-50

per cent immediately.

• Small & inefficient warehouses: Given the large spread of 4,000-10,000 sq ft warehouses,

the average size of a warehouse has remained small causing duplication of overheads and

making it unviable for owners and operators to introduce racking or automation. According to

a broad estimate, scale economies start to positively affect warehouses only when they are

larger than 30,000 sq ft.

• Distribution cost and inefficiencies: There are significant cost and inefficiency implications

of running a distribution network over a spread of 25-50 warehouses in terms of smaller

loads, smaller trucks, state boundaries being the determinant of transportation routes.

• Other Costs: High cost ERP linkages throughout the warehousing network to ensure real-

time visibility of inventory result in higher IT costs. Further, multiple handling across the

various layers of distribution and multi-layered compliance requirements result in higher

material handling and compliance costs.

The advent of GST

Dr Vijay Kelkar, chairman of the 13th Finance Commission, in a recent speech listed down

the benefits of GST. According to him, it will bring about a change on the tax firmament by

redistributing the burden of taxation equitably between manufacturing and services. It will

lower the tax rate by broadening the tax base and minimising exemptions. It will reduce

distortions by completely switching to the destination principle. It will foster a common

market across the country and reduce compliance costs. It can provide a fiscal base for local

bodies to enable them to fulfill their obligations. It will facilitate investment decisions being

made on purely economic concerns, independent of tax considerations. It will promote

exports. GST will also promote employment. Most importantly, it will spur growth.

• Tax credits: Under GST, manufacturers would be entitled to input tax credit of all inputs

and capital goods purchased from within the State as well as inter-State, from a registered

dealer for setting off the output tax liability on the sale of their finished products. Similarly,

distributors would also be able to pass on the duty burden to their customers. This would

ensure that there is no cascading effect of taxes and would result in a reduction in the cost of

doing business. Currently, they cannot claim a credit for the service tax paid on their inputs.

Restrictions also apply on claiming credits for VAT on inputs other than goods for resale

such as free samples.

• Inventory costs: Another major benefit especially to FMCG and consumer durables

companies, would be the reduction in their inventory costs. Currently, the CENVAT is

included in their inventory costs, which has to be financed by them. Under the new structure,

the GST paid on inventory would be fully recoverable immediately as input tax credit,

reducing the inventory financing costs.

• Cash flow benefits: GST will offer cash flow benefits to dealers and distributors. They

would be collecting GST from their customers as they make sales, but would be required to

remit it to the government only at the end of the month or the quarter, when they file their

returns. This extra cash float would allow them to achieve scale and invest in making their

operations more efficient.

• Lower price: This is likely to result in a reduction in the prices of commodities in the long

run as manufacturers and distributors would pass on the benefits of the lower costs of

carrying on their businesses to the consumers.

• Government revenues: Under GST, all goods and services would be subject to tax, unless

specifically exempted. Further, it is also anticipated that the number of exemptions would be

significantly reduced. Accordingly, the total revenue collections are expected to go up, as

already proven by post-GST scenarios in several other countries.

It would however be imperative for all stakeholders to deliberate upon their processes to

ensure a smooth transition into the GST regime instead of being caught off-guard after its

launch. While the government is actively preparing for the new law & procedures, businesses

would also need to gear up to be able manage this change well. Some of the key steps would

be relook at the supply chain infrastructure and set-ups and consider, in a new light, their

reluctance to outsource to professionals and experts. Some businesses may have to re-work

their pricing strategies with the changed tax regime – higher credits coupled with possible

change in rate of tax on output. For credits, each item of expenditure could yield credits,

changing the approach towards capturing, recording, and documentation. Preparedness would

also be required in terms of training personnel as well as understating documentation to be

generated / maintained including updating of ERP packages. Indeed, this will entail a

thorough revamp of the existing business model not only in terms of the business strategies,

including debate on continuity of the special exemptions presently availed, but even from a

practical standpoint involving changes in the wider software systems, invoicing mechanism,

rate changes and re-assessment of trade-offs between distribution costs and service levels.

Foreign Direct Investment

The notion of foreign capital in India was not so happening at its inception. The marks of the

footsteps of FDI in India can be traced with the establishment of East India Company of

Britain, where the capital of Britain came to India. It was after the Second World War, when

Japanese companies entered into Indian market. The issues related to foreign capital and

operations of MNCS, gained momentum after the independence, when the policy makers

realized the national interests attached to it. By focusing on the same, they framed the FDI

policy which endeavour it as a medium for acquiring advanced technology and to muster

foreign exchange resource. After various attempts made in 1966 and 1985, the economic

reform in India started with economic liberalization, on 24th July 1991. The reforms made in

1991 were proved sustainable as substantial liberalization was declared in the New Industrial

Policy.

After so much of hassle, the Foreign Direct Investment (FDI) in India was made regularised

by the FDI policy and governed by the provisions of The Foreign Exchange Management

Act, 1999. Even though India had proved itself as most attractive market for retail investment

by topped the A.T. Kearney’s annual Global Retail Development Index (GRDI) for third

consecutive years, and had registered a growth of 8% in 2007, but on a whole, Indian retail

attracted approximately $1.8 billion in foreign direct investment, in between 2000 to 2010,

which was a very small 1.5% of total investment flow into India.

Until 2010, the strings of the entire flow in India were in the hands of the intermediaries and

middlemen. Due to their dominated involvement, the pricing lacked transparency and the

norms were continuously flouted. Removal of legal restrictions on organised retail was

recommended to the Government of India repeatedly. Jagdish Bhagwati, suggested the Indian

Parliament, to extend economic reforms by breaking the shackles of the retail sector, so that

further liberalization of trade in all sectors amounts to positive change which was the need of

the hour as such step will accelerate economic growth and make a sustainable difference in

the life of India’s poorest.

On January 11, 2012, India permitted and welcomed the increased competition and

innovation in single-brand retail. FDI in multi-brand retail was prohibited in India, till 2011,

as foreign groups were not allowed to owe supermarkets or any retail outlets and sell

products from different brands to Indian consumers directly. It was on 14 September 2012,

the Government of India opened the gates for FDI in multi-brand retail (subject to approvals

by individual states), however caused many protests in opposition.

On September 20, 2012, the Government of India has formally approved 51% FDI in multi-

brand retail and 100% FDI in single brand retail, thereby making it effective under Indian

law. In Ernst & Young 2012 India Attractiveness Survey, India is placed on the fourth global

ranking for foreign direct investment (FDI) after the United States, China and Britain. India

drew FDI of $8.1 billion in March, which was the highest ever monthly inflows, despite of

the brouhaha over Rs 11,000 Crore Vodafone tax dispute.

Major FDI reforms since September 2012

⇒⇒⇒⇒ Allowing 100% FDI ownership in single brand retail trading and upto 51% FDI in multi

brand retail.

⇒⇒⇒⇒ Allowing foreign airlines upto 49% FDI.

⇒⇒⇒⇒ Increasing FDI equity from 49% to 74% in certain broadcasting sectors.

⇒⇒⇒⇒ Allow up to 49% FDI in power exchanges.

⇒⇒⇒⇒ Increasing FDI limit from 26% to 49% in insurance sector.

⇒⇒⇒⇒ Allowing 49% FDI in several sectors such as petroleum and natural gas, commodity and

stock exchanges, power exchanges, asset reconstruction, single brand retail and

telecommunications. Foreign investment up to 49% in these industries may be made under

the automatic route which does not require approval from the RBI or the Indian government

⇒⇒⇒⇒ Sectors such as asset reconstruction and telecommunications are eligible for 100% FDI

upon approval by the FIPB.

⇒⇒⇒⇒ The defence sector will also be eligible for greater FDI under the recent changes. For

present it is 26%. But 100 equity is also allowed if the project are likely to result in access to

modern and state of the art technology.

Current Policy

Foreign Investment in India is governed by the FDI policy announced by the Government of

India and the provision of the Foreign Exchange Management Act (FEMA) 1999. The

Reserve Bank of India in this regard had issued a notification, which contains the Foreign

Exchange Management (Transfer or issue of security by a person resident outside India)

Regulations, 2000. This notification has been amended from time to time. Department of

Industrial Policy and Promotion (DIPP) under the Ministry of Commerce and Industry,

Government of India is the nodal agency for monitoring and reviewing the FDI policy on

continued basis and changes in sectoral policy/ sectoral equity cap which goes from 26% to

100% at present. The FDI policy is notified through Press Notes/ Policy Circulars by the

Secretariat for Industrial Assistance (SIA), Department of Industrial Policy and Promotion

(DIPP) Ministry of Commerce & Industry. FDI is allowed under Direct Route and

Government.

Prohibition on FDI in India:

General Prohibition:

Any type of Foreign Investment in a company or a partnership firm or a proprietary concern

or any entity, whether incorporated or not, is prohibited, if found engaged or purposes to

engage in following activities:

(a) Business of chit fund, or

(b) Nidhi company, or

(c) Agricultural or plantation activities, or

(d) Real estate business, or construction of farm houses, or

(e) Trading in Transferable Development Rights (TDRs).

Prohibited Sectors:

The FDI is completely prohibited on the specific sectors, namely, Retail Trading (Except

Single Brand Product), Atomic Energy, Lottery Business, Nidhi Company, Gambling and

Betting, Chit Fund Business, Manufacture of Tobacco, Cigars. The sector of Agriculture and

Housing and Real Estate are partially prohibited.

Permitted Sectors

Subjected to the applicable laws or regulations; security and other conditions, the FDI in

following sectors is allowed up to the limits prescribed. These sectors fall under the

Government Route, unlike other sectors, which fall under the automatic route.

Sectors falling under Government Route

Percent of FDI permitted

• Upto 26%

Defence Industry subject to Industrial license under the IDRA

Terrestrial Broadcasting FM (FM Radio)

Up-linking a News & Current Affairs TV Channel

Publishing of Newspaper and periodicals dealing with news and current affairs.

Publication of Indian editions of foreign magazines dealing with news and current affairs.

Banking-Public Sector (up to 20% only)

• Upto 49%

Petroleum refining by PSU without any disinvestment or dilution of domestic equity in the

existing PSUs.

Cable Network & DTH (FDI component not to exceed 20%)

Setting up of Up-linking HUB/Teleports

Private Security Agencies

Commodity exchange

Credit Information Companies

Infrastructure Company in the Securities Market

Financial Services ARC (49% of paid up capital of ARC)

• Upto 74% (Automatic upto 49%)

Headend-In-The-Sky (HITS) Broadcasting Service

Non-Scheduled Air Transport Service

Ground Handing Services

Satellites- Establishment and operation, subject to the sectoral guidelines of Department of

Space/ISRO

Telecom services

Internet Services Providers with/without gateways, rapid paging, end to end bandwith

Banking-Private sector

• Upto 100%

Mining and mineral separation of titanium bearing mineral and ores

Up-linking a Non-News & Current Affairs TV Channnel

Publishing/Printing of Scientific and Technical Magazines/specialty journals/periodicals

Publication of fax edition of foreign newspapers

Airport-Existing Project

Courier services

Tea Plantation

Financial Services

Test Marketing

Infrastructure provider (dark fiber, right of way, duct space, tower, electronic, voice mail)

Sectors falling under Automatic Route (exceptions)

Even though the FDI on the sectors falling under Automatic Route is permitted upto 100%,

but there are limitations in to this also. There are sectors which fall under Automatic Route

but FDI limit is restricted. Like on Scheduled Air Transport Service/ Domestic Scheduled

Passenger Airline, the limit granted is 100% for NRIs and 49% for others and in case of

Insurance sector, FDI limit of 26% is granted.

FDI policy implementation in India

Regional Inequality in FDI in India

The rise in FDI flows to India has been accompanied by strong regional concentration. The

top six states, viz., Maharashtra, New Delhi, Karnataka, Gujarat, Tamil Nadu and Andhra

Pradesh accounted for over 70 per cent of the FDI equity flows to India between 2008-09 and

2011-12. The top two states, i.e., Maharashtra and Delhi accounted for over 50 per cent of

FDI flows during this period. Maharashtra alone accounted for over 30 per cent of FDI flows

to India during the same period. Despite impressive growth rates achieved by most of the

Indian states as well as aggressive investment promotion policies pursued by various state

governments, the concentration of FDI flows across a few Indian states continues to exist.

The presence of strong agglomeration effect indicates that the states already rich in FDI flows

tend to receive more of them which make it more difficult for the other states to attract fresh

investments. In view of this difficulty, a conscious and coordinated effort at the national and

the state government levels would be essential to make the laggard states more attractive to

FDI flows. The direct method to achieve this objective may be to design the national FDI

policy in such a way that a sizable portion of FDI flows to India move into the laggard states

The indirect way is to provide a boost to the overall economy of the less advanced states,

with special thrust on the manufacturing, services and the infrastructure sectors so that they

themselves become attractive to foreign investors.

SUGGESTED REFORMS FOR FORMULATING FDI POLICY IN INDIA

EEFECTIVELY

1) Regional Inequality in Foreign Direct Investment Flows to India must be catered

to. The liberalised FDI regime has failed to benefit all the states of India equally. Strong

regional concentration and regional inequality continue to exist. The lion’s share of FDI

flows are mostly attracted by the economically powerful states. 70% of the total FDI equity

flows into India from April 2000 to June 2012 have been only in the sic states of

Maharashtra, Delhi, Karnataka, Tamil Nadu, Gujarat and Andhra Pradesh, clearly reflecting

FDI concentration in specific states. FDI mainly flows to the states which are rich in natural

resources, have good physical and institutional infrastructure, and have skilled workforce and

states which are technologically advanced. Thus the crucial concern must be rapidly

developing infrastructure and promoting good governance in these states to attract FDI.

2) Decision of FDI in retail should not be left to the states. The states and Union

Territories that have agreed to open FDI in the multi-brand retail include Assam, Haryana,

Jammu & Kashmir, Himachal Pradesh Andhra Pradesh, Maharashtra, Uttarakhand, Daman &

Diu, Manipur, and Dadra and Nagar Haveli. FDI is a central subject and it is not mentioned

anywhere in the state list. Thus in the first instance itself, decision of FDI in retail must not be

left to the states. Also, India has bilateral investment treaties with 82 countries. Each of such

arrangement has the following clause:-

“ Each Contracting Party shall accord to investments of investors of the other Contracting

Party, including their operation, management, maintenance, use, enjoyment of disposal by

such investors, treatment which shall not be less favourable that that accorded either to

investments to its own investors or to investors of any third State”

The essence of any bilateral agreement thus rests of the assumption that the investor can

invest in any part of the other contracting state. The investor cannot be restricted from

investing in any particular state. This would breed regional inequalities with respect to the

FDI flows in different parts of the country due to divergent political atmosphere in different

states.

3) Need to uplift the FDI cap in important sectors Although the Government, on 16th

July 2013, approved the various recommendations of Arvind Mayaram Committee to

increase the FDI limits in most of the sectors, but still some of the vital sectors are still

untouched. Government increased the FDI limits in 12 sectors out of 20 proposed sectors.

There is a need to change the limits on sectors like civil aviation, airport, media, multi-brand

retail and Brownfield pharmaceuticals. For Example, in the last ten years, according to data

released by Department of Industrial Policy and Promotion (DIPP), India’s aviation market

has secured foreign direct investment (FDI) worth $456.84 million. The necessary changes

were made in case of defence and telecom, but it is expected from the Government to take

essential steps towards the other important sectors also because it will not only attract Foreign

Investment in India but will also provide growth opportunities to Indian Companies who can

collaborate with Foreign Companies to start business in various new sectors.

4) Loopholes in the existing FDI rules governing e-commerce must be catered to

Retail trading, in any form by e-commerce, is not permissible by companies with FDI,

engaged in activity of multi brand retailing trading. In a nutshell it can be stated that existing

FDI norms prevent brands from sell directly online through their own company Web sites.

Still, electronic brands like, Canon, Dell, Nokia, Lenovo, Amazon have found a loophole to

get around the FDI norms on e-retailing. They have found Indian distributors who are selling

their wares through special websites created only for this purpose. Even though this

arrangement is legal, but it raises a question on the existing FDI rules.

5) Clandestine flow of foreign funds into tobacco sector must be prevented.

International companies plan to enter tobacco sector in India by circumventing FDI norms.

Under the guise of brand building and marketing activities, foreign funds may clandestinely

flow into the tobacco sector. The RBI has already sent a letter to the finance ministry,

expressing its concerns on the same issue. This must be prevented by including this clause as

suggested by the central bank:-

“”Foreign fund investment received by an Indian company in any form, including that in the

guise of current account transactions for the purpose of creating band awareness, brand

building, promotion and management contract, is also completely prohibited for cigars,

cheroots, cigarillos and cigarettes of tobacco or of tobacco substitutes.”

6) Better environment for infrastructure. A better environment for infrastructure

development with an appropriate institutional framework such as a dispute resolution

mechanism, independent regulatory authority and special investment law.

7) Special economic zones. Proper design and planning of SEZs including local level

solutions for land acquisition and sector-specific policies with incentives to attract FDI

into SEZs. Proper infrastructure connectivity to SEZs and allowing the private sector

to provide infrastructure services to SEZs.

Power Sector Reforms and Energy Policy

India’s policymakers are fond of defining the country’s energy security in terms of three as:

availability, access and affordability. However, the three as appear at increasing risk in the

face of four formidable barriers: energy subsidies, systemic management inefficiencies,

competition from a resource-hungry China and climate change.

What makes these barriers even more daunting is the recent emergence in public discourse of

a misplaced debate regarding the ownership of natural resources, which has hamstrung the

country’s ability to frame long-term policies to help harness its energy potential.

Securing energy supplies for Indian citizens therefore is set to be a tall order for the new

government.

Energy subsidies

India’s energy subsidies represent a significant portion of its budget. The government spends

roughly $25 billion on fuel subsidies, $7 billion on electricity, and $10 billion on fertilizer.

One of the justifications given for subsidies is to increase fuel availability to the least

empowered. However, regardless of the billions spent on subsidies, modern fuels remain a

privilege limited to a few. National Sample Survey data for 2011-12 reveal that despite

claims of increased penetration of modern cooking fuels, such as liquefied petroleum gas,

70% of rural households still use biomass. Guaranteeing access and affordability are also

arguments advanced for energy subsidies. However, price controls have failed to expand

supplies and services, and rather ended up diminishing both access and affordability. Diesel-

fuelled sport-utility vehicles of the super-rich romp on city roads while farmers struggle to

run their pumps. Access to electricity remains directly proportional to per capita spending—

the poorest decile, constituting 40% of all households, still use kerosene to light their homes.

Rather than enhancing energy security, subsidies, by interfering with markets, are putting the

three As at risk.

Systemic inefficiencies

Contrary to popular perceptions, India is not a resource-poor country. It contains the world’s

fourth-largest coal reserves, its thorium supplies are practically limitless, potential solar

power is particularly abundant, and its 3.14 million sq. km of sedimentary basins have not

been even moderately explored, though most of these are deep offshore. India’s problem is

one of management rather than scarcity.

The management challenge is best understood by the deficiencies in the coal sector. Coal is

India’s single biggest fuel source, accounting for half of the country’s total energy use and

producing two-thirds of its electricity. Estimates are that the country has enough coal to last

for the next 100 years. However, environmental clearances, land availability and evacuation

constraints restrict access to huge swaths of coalfields, halving its extractable reserves.

Meanwhile, the state-owned Coal India Ltd, which supplies over 80% of India’s coal needs,

has struggled to raise output and meet supply commitments. In 2012-13, coal shortages of

165 million tonnes affected the availability of power. Power plants dependent on imported

coal suffered because of highly volatile international prices.

India’s 12th Five-Year Plan focuses on means to curb the country’s coal dependence, but

alternatives also have issues. Gas price controls, dismantled in 2002, were reintroduced and

extended in 2007 to encompass private producers of domestic gas. A complex system of

quotas and allocations has returned to haunt the sector. Simultaneously, gas imports are

limited by lack of infrastructure. India has yet to build its first transnational gas pipeline, and

with the Indian gas market at the mercy of policymakers, investors are wary of investing in

liquefied natural gas facilities or pipeline infrastructure. Hydroelectric, nuclear and other

renewable energy sources comprise one-third of the current installed power capacity, but

numerous issues limit their contributions. Hydropower plants have low load factors, for

example. Wind capacity grew by only about half the targeted amount after the government

withdrew accelerated depreciation and generation-based incentives. Although the US-India

civil nuclear agreement boosted the capacity of nuclear plants, the sector’s growth has been

held to ransom by what’s commonly known as the nuclear liability law. Foreign equipment

suppliers are worried that this law places a disproportionate legal burden on them in the case

of an accident

Ownership of resources

Under the planned economy model adopted post-independence, India gradually arrogated the

responsibility for guardianship, extraction and conversion of fossil resources to the state.

Thus the energy sector came to be dominated by gargantuan state companies and a host of

smaller public-sector undertakings. Policy, legislation, rules and regulations were devised

exclusively for state-led operations, leading to an incestuous relationship with parent

ministries or departments of the government.

In the 1990s, lending institutions forced structural adjustments, which initiated a process of

piecemeal reform in certain segments of this superstructure. However, a lack of fairness and

transparency eventually led the Supreme Court to uphold the public trust doctrine. In short,

this doctrine states that natural resources belong to the nation, and the government holds them

in trust, in a fiduciary capacity, for the public good. Unfortunately, despite its intention to

bring transparency into the allocation and use of natural resources, this principle has now

become an excuse to stall much needed reforms. India cannot discover, extract, convert and

distribute resources without investment, technology and competition among companies in the

private and public sectors—three things that only reform can bring.

Way forward

If there is any lesson to be learned from the piecemeal reforms that culminated in the

Supreme Court’s rulings, it is that governments are poor and inefficient allocators of

resources. Resources are best allocated by markets, rather than doled out through policy

guidelines, which, straddling half a dozen ministries and a Planning Commission, can at best

be suboptimal compromises.

To that end, policymakers must direct their support to consumers and not waste time on

administering subsidies by interfering with markets. Some experiments with direct transfer

schemes have begun, however, a quicker pace and far more efficient processes are needed.

Over the next 20 years, India’s dependence on coal will continue. Therefore, it is necessary to

expand production capacities by allowing private participation. Given the right mix of

incentives, market forces will usher in new capital and technologies for fuel extraction,

carbon sequestration, and gasification. Natural gas has been and is expected to continue to be

available at a significant discount to oil. Therefore, government policy should allow market-

led substitution of oil by gas. As for renewables, given low plant load factors, policy

emphasis and incentives must shift to generation rather than the addition of capacity.

Although renewables will play an increasing role, they will have limited utility for base-load

generation. Therefore, nuclear energy must be a viable option. The ambiguities with regard to

equipment supplier liability that have crept into the Nuclear Liability Act must be resolved.

Although the executive may issue ingenious guidelines to clarify the law, Parliament is the

only constitutional body that can amend the legislation. India’s energy landscape may

continue to be dominated by strong national energy firms, but an efficient and technologically

robust public sector is best created through competition with a strong private sector. That can

happen only if the government ensures a level playing field when it comes to policy and

regulation.

A public sector that is expected to pick up the tab for the government’s redistributive largesse

can never be competitive or have the financial ability to develop solutions to India’s unique

challenges. The treatment of state-owned companies as patronage distribution networks that

work to stall reforms must cease. With the expansion of energy markets imminent, India must

become the nerve centre for innovation rather than a mere market for others. Finally, a key

failure of India’s half-hearted reform process has been the lack of strong and independent

regulatory institutions. Organizations such as the Petroleum and Natural Gas Regulatory

Board, the Central Electricity Authority, and the Tariff Commission have been unable to cut

themselves loose from the apron strings of parent ministries. Regulatory authorities must be

given the autonomy that ensures it is they who become the standard bearers of reform.

Reform Labour Laws

The politics of labour reforms in India

The stark reality about India’s labour policy during the past 50 years is that it covers only a

small fraction (less than 8 per cent) of the labour force. It has a long way to go in protecting

the vulnerable, maintaining harmony and ensuring productivity. Neither labour policy nor

labour law has kept pace with the changes in society and in the economy. For good

governance what is required is a firmness to defend traditional values and promote change

with dual focus on both equity and efficiency.

Key concerns

The manifestoes of the major political parties in the 1998 general elections had consensus in

the thrust, though not the tone, of their concerns about labour. Broadly, these can be listed as

under:

• Job protection and employment creation

• Extending legal protection to the unorganized sector

• Some promised improvement in living standards while others talked about linking wages

to productivity

• Vocational training and skills development

• Trade union recognition through secret ballot

• Workers’ participation in management at all levels, while some mentioned workers’

takeover of sick units through cooperatives and worker ownership

• Industrial sickness and attendant problems

• Social security benefits, including pension

The agenda of the government should therefore cover, as a basic minimum, the concerns of

the pre-poll ‘political consensus’. It should also include some other issues, which are not

necessarily populist. These are:

• Paradigm shift in the labour policy environment

• Align labour policy with economic policy

• Labour law reform

• Competitive labour policies at the state level

Align labour policy with industrial policy

Fifty years ago, in the newly independent and industrializing India, the state avowed its

commitment to the welfare of workers. The politically controlled economic system required

politically oriented economic action by workers. An influential section of the union

movement tacitly endorsed the state’s preference for adjudication rather than articulate the

need to promote collective bargaining.

In today’s world the policies of protection, self-reliance and import subsistence are giving

way to policies of competition with a view to integrating the national with the global

economy and to boost foreign investment and exports. To catch up with the other

industrialized countries, India needs to attract capital, cut costs and enhance competitiveness.

In the sphere of labour, this means a new alignment between industrialization policies and

industrial relations policies.

Towards this end, labour policy should stress on: (i) the observance of a minimal number of

core/basic labour standards; (ii) free trade unions and collective bargaining; (iii) workplace

institutions capable of internalizing enforcement of labour standards/government regulations

and effecting changes at the micro level smoothly; (iv) investment in education and training;

(v) bringing the entire labour force under the purview of minimal, but effective --- rational

and rationalized --- regulatory/administrative norms; (vi) proactive labour market policies

that provide building skills/competencies, reduce/eliminate the existing mismatch between

acquired and required skills, facilitate information and counselling facilities for employment;

and, (vii) a culture of non-interference by one party in the affairs of the other.

Labour market flexibility is a factor, not the factor that influences the flow of foreign direct

investment. The minimum that foreign investors expect is: (a) a clear enunciation of the

rights and responsibilities of employers and workers/unions; (b) an unambiguous and easily

understandable legal and institutional framework; (c) predictable arrangements concerning

union recognition, collective bargaining, skills development, flexibility and workforce

adjustment; (d) well-defined, clear-cut and time-bound procedures for grievance redressal;

and, (e) an administrative and judicial system that can be trusted for its transparency,

integrity, expediency, efficiency and accountability.

Competitive labour policies at state levels

Labour is in the concurrent list under Article 246 of the Constitution of India. Given the trend

towards accentuation of regional disparities, state governments may consider the pros and

cons of competitive labour policies with a view to inducing investment and encouraging job

creation. Presently, states can and do make a difference in areas like trade union registration,

recognition, minimum wage laws, defining or redefining limits or granting exemptions

concerning the applicability of certain legislations, etc. The labour bureaucracy also can make

a difference in matters ranging from inspections and penalties to adjudication and even the

use of force (deployment of police, for instance).

Since 1991 to date, several state governments have made far-reaching changes in their

policies. For instance, Uttar Pradesh, requires the labour inspector to obtain prior permission

of the labour commissioner or labour minister; and Rajasthan granted exemption to several

firms and both Rajasthan and Andhra Pradesh simplified several forms with regard to labour

inspection. Orissa and West Bengal introduced secret ballot. While Maharashtra proposed a

new legislation, in the mid-1990s, the Maharashtra Industrial Relations Act to replace the

existing Bombay Industrial Relations Act and Prevention of Unfair Labour Practices Act; and

Kerala announced radical moves in labour policies as part of its 1994 industrial policy.

The desirability, possibility and feasibility of competitive labour policies merits serious

consideration. The industrial relations implications of centre-state relations, particularly on

public sector undertakings, also needs careful review.

Labour law reform

In a global economy labour law as an autonomous subject stands at a crossroads. Some

judges feel compelled to interpret law not on the basis of the text of the clauses, but in the

light of the preamble to that particular piece of legislation and more importantly the Indian

Constitution itself. Therefore, they might sometimes question the ‘new economic policies’ as

inconsistent with the Indian Constitution. Elsewhere in the world, there is another view

gaining ground: The social vision of labour law, which went with the old-established

institutions and practices, has come under challenge to change or risk irrelevance. The current

scenario requires striking a balance between these two extreme viewpoints.

There is a perception that the existing laws give virtual veto power to unions in the organized

sector to block changes like improvement in plant and machinery, rationalization of

manpower, and growth of productivity. Further, there is a perception that labour legislation

has paved the way for multiplicity of unions, growth of intra- and inter-union rivalry,

exacerbation of industrial strife and excessive intervention by the state in industrial relations.

There are as many as 165 legislations --- both central and state --- that address aspects

relating to labour. But more laws mean less when implementation is thinly spread out. Even

minimum wage laws have meant little when the wages fixed are too low and implementation

too lax. Study groups of the National Commission on Labour and the National Labour Law

Association (NLLA) prepared draft labour codes in 1969 and 1994 respectively. The

Commission on Labour Standards appointed by the Government of India, in its report

submitted in 1995, almost entirely endorsed the NLLA’s Draft Labour Code. It suggested a

few changes: initiate a national debate or wider consultation on the Draft Labour Code

through Project LARGE and simplify the law without further delay.

Labour law reform is not easy. The Korean experience confirms this. When the economy was

doing well organized labour organized bitter struggles against the new Korean law which was

enacted to make, among other things, workforce adjustment easy. In the wake of the Korean

economic crisis, however, a tripartite agreement provided for the very changes that were

opposed just a year before. Several economies in transition (notably China and Vietnam) and

those undertaking structural adjustment (many in Africa and Latin America) have been able

to rewrite labour law without much friction.

The Government of India has appointed the Second National Commission on Labour (1999)

to address the issue of aligning labour policy and labour laws with the contemporary concerns

of product markets. The contrast between the terms of reference of the first and the second

national commissions on labour (Annexure 1) points to the stark shift in emphasis from

labour market (First National Commission on Labour) to product market (Second National

Commission on Labour) and a palpable concern for a separate simplified approach (one

umbrella legislation) for the unorganized sector.

The major thrust of changes in labour laws should be along the following lines:

• Have fewer laws but ensure better enforcement. It would be still more expedient and

equitable to have one labour code instead of numerous legislations, as China and Vietnam

did in the mid-1990s. The nature and extent of protection for labour has little to do with

the number of laws.

• Multiple definitions should be eliminated across different legislations. Wages, for

instance, are defined in a dozen ways in as many legislations, or the legal distinction

between worker, workman and other worker is exclusionary. Unless otherwise defined

perpetrates and perpetuates discriminatory practices and confusion dictionary meanings

should be considered adequate. The Labour Code can cover all working people rather

than have variations in limitation of numbers employed, amount of wages/salaries drawn,

etc.

• There should be one national minimum wage act for all occupations rather than separate

ones for select notified industries/occupations. It should be made easy to understand, be

simple to administer and effective in enforcement.

• Several amendments to the Trade Union Act suggested earlier bipartite committees and

subsequently incorporated in the bill prepared by the Ministry of Labour do not serve any

useful purpose; they do, however, perpetrate distrust among unions and create strife.

Japan and Denmark do not have trade union acts. In Japan, the union movement is

consolidated and multiplicity reduced without legal intervention. Denmark is one of the

countries with the highest rate of unionization.

• Almost all political parties and many unions favour secret ballot. But it would be prudent

to review the experiences of Andhra Pradesh, Orissa and West Bengal before taking any

action, since the experience so far suggests that the present conditions are not conducive

to secret ballot. They have led to anti-establishment vote and destabilising recognised

unions, causing strife in industrial relations and resultant litigation.

• The provisions of the Industrial Disputes Act should be reviewed while preparing the

Labour Code. Legislations in some Southeast Asian countries as well as China and

Vietnam offer valuable insights. In the wake of structural changes and liberalization,

more than 100 developing countries and transitional economies have reformed their

labour law. The three most important changes in legislation which are necessary in the

Indian context also well are as follows: (a) Employment can be secure only so long as the

enterprise where they are employed is secure and viable. According to ILO Convention

No.168, termination of employment at the initiative of employer can be valid if structural,

technical, economic and other changes so require. Workforce adjustment as per business

needs is imperative. Notice, consultation, and compensation provisions can be and should

be tightened. The requirement of prior permission of the government should be dispensed

with in matters concerning lay-off, retrenchment and closure; (b) Section 9-A, concerning

notice of change, should be amended. Notice is required, consultation is to be

encouraged, but the employer should have the responsibility, if not the right, to make

changes necessary to maintain and improve competitiveness; (c) As in Malaysian

legislation, which forbids bargaining in respect of recruitment, transfer, promotion, work

assignment and workforce adjustment, in India also collective bargaining should be

encouraged on aspects other than the above.

• Industrial relations machinery should be made independent as recommended by the

National Commission on Labour.

• Some studies point out that job protection laws impede job creation. Increase in the price

of labour and its relative inflexibility have also been found responsible for the stagnation

of job opportunities. These studies have also found that job loss was less with adjustment

than without it. It is necessary to investigate the technological determinedness of

employment decisions, employment effects of adjustment vis-a-vis non-adjustment and

consequences of job creation on further job creation and the claims of the unemployed

and fresh entrants to the job market. The cost of job protection and its effects on job

creation require careful analysis. The ILO-South Asian Multidisciplinary Team’s study

drew attention to the need to shift the focus from job protection to income protection.

• Set up a skills development fund and a tripartite national wages council.

Banking sector reforms

Challenges and reforms

Raising capital for public sector banks

As per KPMG in India’s analysis, capital requirements of public sector banks in the future

will be based on three assumptions:

• GDP growth rate of 6-7 percent that will require credit growth of 20 percent

• Basel III norms applicable to higher risk assets that banks will have to develop in the future

(Micro small and medium enterprises (MSME), retail)

• Government ownership in the range of 50-60 percent. Assuming an annual credit growth

rate from FY12-FY21 at 20 percent and the annual risk weighted asset growth rate at 22

percent, we expect the Tier-I capital requirement for public sector banks for the same period

to be in the range of INR 9,60,000 crore. Given our current fiscal deficit, government may

not be able to infuse additional capital in public sector banks. Also, the government’s intent

to not dilute their stake leaves them with few options:

• The Government could consider creating a holding company (Holdco) and transfer its

stake in the PSBs to this company. The Holdco can raise long term debt from

domestic and international markets to infuse equity in the PSBs and act as an

investment company for the Government of India.

• The Government could consider diluting its stake in PSBs through issuance of

Differential Voting Rights (DVR) such that the economic stake dilution is also kept to

the minimum. The Government could avoid any dilution in its voting rights by first

infusing money into the banks through issuance of normal shares to itself, which

would raise its stake during the interim period, and follow this up with DVR issuance

to the extent that its effective (voting rights) holding remains unchanged. The money

can be infused either through preferential allotment of equity shares or through

allotment of warrants. • The Government may consider in the future on having a

Golden share in each of the PSBs under which while the Government’s economic and

voting stake may fall below 51 percent, it will always have the right to control the

respective PSBs due to the possession of this Golden share

Competition from foreign banks as they acquire ‘near national treatment’

The RBI announcement of a roadmap for seeking the conversion of systemically important

foreign banks to ‘Wholly-Owned Subsidiary (WOS)’ was to have a better regulatory control

over such banks, separation of ownership and management, clear and simple resolution in the

event of bankruptcy and ring fencing of the capital within the country. In simple terms, the

overall idea was to protect the tax-payer’s money being used as bail-out as was witnessed

post-2008 when some of the foreign banks withdrew funds from India.

The foreign banks operating in India with large networks would be keen to convert to WOS if

they get national treatment in terms of opening branches in metros and tier-II cities and not

just to expand branch network within the context of RBI regulations. Foreign

banks are also circumspect about adopting this route as the RBI has insisted that foreign

banks should meet the priority sector lending (PSL) norms including the sub-targets (not

portfolio buys) in direct agriculture and small scale enterprises (SSE) lending.

However, when the major banks convert to WOS, they are likely to provide another level of

competition to the domestic banks.

As on March 2012, there were 41 foreign banks operating in India with 323 branches and 46

foreign banks had their representative offices in India.

Top 5 foreign banks have over 250 branches. Considering the fact that foreign banks’ have

been successful in garnering demand deposit in their overall deposit mix, once foreign banks

acquire domestic residency and when the major foreign banks convert to WOS, and will have

more freedom in the licensing for new branches, the competition for deposits could heat up

resulting in competitive pressure on domestic banks

Closing the gap —financial inclusion will require innovative operating models

The Economist in its issue dated 19 October 1929 carried an article highlighting that there

was much truth in the observation that ‘the small man, living in the provinces, is neglected’.

The banking sector has woken to the fact that there is potential in the unbanked areas, and to

enter uncharted territories and capture unsaturated segments, the banking sector will have to

come up with innovative operating models which will be different from the conventional

ones. Technology will be essential to access this market, as extensive branch networks in

remote regions or regions with poor physical infrastructure may not be economically viable.

Break-even period for a rural branch could take upwards three years. Technology-driven

models such as mobile banking will inevitably change banks’ operating models and help

banks in lowering their cost-income ratio. Usage trends clearly show a significant year-on-

year increase in the usage of alternate channels for transactions (ATM, internet and mobile).

The number of mobile banking transactions has doubled to 5.6 million in January 2013 from

2.8 million in January 2012. The value of these transactions increased threefold to INR 625

crore during January 2013 from Rs 191 crore in January 2012. Even the number of ATMs has

increased from 74505 in FY11 to 95686 in FY12.The internet banking channel has evolved

over the years. In 2011, 60 percent of the times basic transactions in banks were conducted in

North America through online channels, whereas internet banking usage in India increased

from 1 percent in 2006 to 7 percent in 2011

Further, the easing of norms on using individuals as banking correspondents, coupled with

the proliferation of the UID enabled account, will enable banks to bring in a very large

percentage of the currently unbanked, into their folds. To enable the success of this model,

banks will have to very quickly build trust by demonstrating better control, governance and

transparency in all parts of their transaction processes

Micro, Small & Medium Enterprise – The next growth engine for banking

The Micro, Small & Medium Enterprise (MSME) sector is a major driver of growth for the

Indian economy. In 2009-10, there were around 29.8 million registered and unregistered

enterprises (as classified by the banking definition of companies with a turnover in the range

of 20 to 200 crores) across various industries. Out of these, about 60,000 are public or private

limited companies, 1.5 million are partnership companies and the rest are proprietorships.

There are another 30 million micro enterprises in the unorganised sector.

All together the MSME segment accounts for 45 percent of the country’s industrial output

and 40 percent of exports. The overall contribution of this segment to India’s Gross Domestic

Product (GDP) has been holding steady at 11.5 percent a year. And yet, the MSME sector

faces a chronic shortage of bank financing to aid its growth and improvement agendas.

The slow growth of MSME is broadly attributable to the lack of financing or lack of facilities

and skills. Given the high growth aspiration levels of MSME promoters, both are debilitating

factors. It is estimated that only 33 to 34 percent of the MSMEs had any access to bank

or institutional financing channels and in the absence of this finance, prefer to raise financing

through personal channels (friends, family, informal financiers etc). By any stretch of

imagination, this unmet demand presents a significant opportunity for the flow of banking

credit. To encourage greater bank led financing, the Reserve Bank of India (RBI) had

increased its focus on this sector through directed lending policies such as priority sector

lending (PSL) norms. However, given the significant demand-supply constraints, the

financing chasm has grown. Small Industries Development Bank of India (SIDBI) has

estimated the overall debt finance demand of the MSME sector at INR 32,50,000 crore (USD

650 billion). 22 percent of this amount is the debt financed through the formal sector, in

which banks have the largest share (approximately 85 percent). Most of this debt flows to the

registered enterprises. The risk perception attached to unregistered or unorganised enterprises

due to a lack of transparent financial data, limited immovable collateral and lack of credit

assessment skills of some sub-segments and the preference for ‘less hassled’, informal

financing, reduces addressable demand considerably. Working capital financing, and to a

lesser degree debt for capital expenditure are the two key offerings sought by MSMEs.

As awareness of formal financing opportunities grows within the addressable parts of the

MSME sector, banks have an opportunity to grow their credit exposures, limit risks and seek

better spreads by developing and implementing MSME sector specific policies and operating

models. The regulatory framework defined by the RBI (and recently strengthened by the Nair

Committee report) has set targets for banks to achieve in lending to the MSME sector (7

percent to 15 percent of lending portfolio to be allocated for financing micro enterprises) and

an overall 40 percent of their annual credit to be allocated to priority sector lending. Further,

the Nair Committee has also sought to limit to 5 percent, the indirect lending portfolio earlier

used by banks who lent to NBFCs to further lend to MSMEs, to meet PSL norms. However,

traditional challenges of bank financing of MSMEs remain: • Broad, rather than niche

segmentation of the market• Limited market assessment skills at branches (and limited ability

to gather and analyse proxy data)• Centralised product design rather than customised

products that address the needs of specific sub-segments• Vanilla models of fund based

products and limited credit assessment skills for knowledge based industries with limited

immovable collateral. Many banks also treat credit to this segment as a necessity for meeting

compliance norms, rather than as an opportunity. Many such banks tend to narrow the

definition of such enterprises (investment in assets) rather than seek a broader definition that

could include revenues, order flows, past cash flows etc

Banks will need to develop multiple operating models and go-to-market strategies for

the MSME market. Banks need to work with SMEs linked to the supply chains of their large

corporate customers and leverage this relationship to better manage and control credit

exposures.

1. Cluster based financing has already been demonstrated successfully by some banks by

focussing on small sub-sectors that are geographically concentrated into specific areas

and have very similar market cycles and supply chain linkages. By creating specialist

credit capabilities for each sub-sector, banks have been able to reduce their credit

risks substantially through the modulation of credit flows based on knowledge of

business cycles

2. Linking personal and small business accounts has enabled many banks to develop a

close link with promoters and proprietors. The availability of data linked to personal

accounts provides good insight to support credit decisions to this group.

The Aam Aadmi – profitably serving the unbanked and underbanked

Rural opportunity is large and growing- Rural India constitutes 69 percent of the total

population and drives about half the GDP of the country, a ratio which has mostly remained

unchanged over the past ten years. However, it has been observed that its per capita GDP has

grown faster than its urban counterparts, growing at ~ 6.2 percent since 2001 as against 4.7

percent for urban India, signaling higher productivity growth. The proportion of the rural

households earning an income of INR 90,000 and above has increased to 37 percent in 2011

as compared to ~18 percent in 2001 with maximum growth being seen in the higher income

brackets.

Access to banking services is still constrained despite the size of the pie- In the backdrop of

this growth in rural India, however, there is still a huge demand supply gap for banking

services. Rural India accounted for only 9 percent of the total deposits and ~10 percent of the

total credit of the banking sector in 2011 with a large number of rural households having no

access to formal sources of credit. Various challenges inherent in rural finance have led to

inadequate access to financial services for the rural population. Some of these are as below:

• Lack of adequate credit information: Credit information for rural customers is usually

constrained as the penetration of credit bureaus is not strong and the borrowers

possess limited documentation in terms of proof of income

• Limited collateral: Assets ownership is limited and generally restricted to farm land

with lack of clear title and documentation. As a result of which, this sector becomes a

high risk segment for banks to finance.

• High operational costs and complexity: Operational costs are higher on account of

low ticket sizes, low population density and higher cost of due diligence. In addition,

the rural economy is largely a cash economy, which leads to increased complexity and

risk of operations.

• Diverse profile: The sheer diversity of the Indian rural landscape poses significant

challenges as the customer profile and banking needs vary across regions.

Tapping the rural banking opportunity requires an innovative approach- The traditional

banking model has clearly not worked in rural India due to its high cost structures and

ineffectiveness in adapting to the requirements of rural customer. Tapping the rural

opportunity would require banks to focus on the following few things:

• Developing simple products -Rural customers would typically have basic needs which

can be met with simple plain vanilla products with minimal additional features and

options.

• The product terms need to be communicated clearly and in a transparent manner. A

gold loan is a good example of a highly simple and effective product to meet the

credit needs of the rural customers.

• The product can be delivered quickly in a decentralised environment, requires very

limited documentation and provides the security of collateral like gold.

• Low cost innovative delivery models-Several new alternative channels are emerging

as against the traditional branch-led model. Business Correspondent (BC) channel has

a strong potential to deliver technology enabled low cost solutions. However, the BC

channel is only a means of delivering service and the banks would still need to work

on product and market development to make the BC model sustainable and effective.

There are several instances of BCs opening a large number of accounts which

continue to stay inactive and ultimately become dormant. Banks need to work on

developing a comprehensive product suite including credit that can help BCs engage

the customer all year round. Another low cost delivery model is supply chain linked

financing. Several commodities and agricultural produce have a strong well

developed value chain, wherein the linkage of the farmer to the end buyer can be

tapped to create a financing opportunity. A case in point is sugarcane, where the

farmer is obligated to sell his produce to a sugar mill in the vicinity. The farmer’s

cash flows are dependent on the sugar mill, and the repayments for any loan the

farmer can be collected out of the money that the sugar mill owes to the farmer at the

time of harvest. The model helps banks leverage the long standing relationship of

sugar mill with the farmers to do appraisal, disbursement and collections in a cost

effective and efficient manner. The same model can be extended to other commodities

that have strong value chain linkages e.g. tobacco, milk and other crops where

contract farming model is being adopted.

• Harnessing and developing local talent- A key challenge in rural markets is

information asymmetry due to lack of documented information. A good way to

overcome this challenge is to tap the local talent which brings in immense local

knowledge and relationships which can otherwise not be accessed. Local talent is also

likely to be much more stable against talent brought in from larger cities. Banks

therefore need to actively develop the local talent base and use it as a hiring ground.

• Leveraging technology- Technology enabled solutions can go a long way in

developing low cost and efficient delivery channels for rural India. There are several

technologies which have already come up in the market – low cost ATMs, point-of-

sale terminals, mobile-based technologies etc. and are being experimented with.

Mobile- based technologies are likely to lead the way as mobile consolidates its

position as an ubiquitous connectivity device. The key to success lies in early

adoption by the customers and banks need to work extensively towards customer

education and awareness. Experiential marketing is a good way to encourage the

usage of new technologies and banks should focus on making customers comfortable

with new technologies with a sustained campaign. Targeting youngsters is also a good

idea as they are likely to be the future customers and are also strong influencers in

adoption of new technologies in the household

Optimizing the use of technology as the change agent

While many banks have invested in core systems and horizontally integrated operations

centres, most face challenges in extracting value from investments in technology. Leading

banks will be able to take a holistic view of implementing new technologies, by

simultaneously changing processes and organisation structures, and thus will be able to

measure the benefits of the effective use of new technology for improving customer-facing as

well as internal processes.

Enhanced focus on digital banking and self-service channel usage to reduce the cost of

operations

Leading global banks have focused on providing customers with more self-service options for

carrying out all banking activities. In India, the success of the ATM channel and increasing

usage of internet and mobile banking is clearly evident. However, it is highly imperative to

undertake a comprehensive risk assessment exercise and plan carefully before shifting

processes to digital/self-service mode. Many banks have struggled in this effort as they tried

to replicate a branch based or paper based process onto the internet channel. Only a few

banks have successfully transitioned a customer service to the internet, by redefining the

underlying process, the customer interface and all support systems.

Summary

India has enjoyed one of the highest growth rates in the world in recent years, propelled by

strong business investment. India was not immune from the global financial crisis but

experienced relatively a mild slowdown, despite the severe drought which hit agricultural

production. The recovery was driven by strong domestic demand, supported by expansionary

fiscal and monetary policy, and growth returned to high trajectory. But despite this from last

two fiscal years India has experienced a sub 5% growth rates and we need prudent

macroeconomic policies to set India back on the growth path. Continued structural reforms

will also be necessary to maintain high growth over the longer term. The operating

environment for private business remains challenging compared with many other countries.

While infrastructure is improving in key sectors, bottlenecks threaten to constrain the

economy and efforts to intensify competition and continued strong investment are required.

There is also a need to strengthen power sector and agricultural sector to ensure widespread

benefits. Labour market reforms are also required to promote job creation and give a boost to

manufacturing sector. We also need financial sector reforms as such reforms will improve the

financial sector and also have spill over effects on the rest of the economy.

Conclusion

There is a sense of euphoria all around. And this is not at all ill-founded. After around 30

years, we have a government in power, which has absolute majority. A government which

has all that it takes to perform and do what it wants to do for the nation. While the nation

waits for delivery and looks forward to “Acche din aane wale hai”, there are certain areas in

our economy, which need more attention than ever before. There is basically a need to work

on structural change in the economy and also ensure that hitherto neglected areas of the

economy get their due attention. While economic reforms were started in 1991 and gave the

Indian economy a new shape, the government now needs to focus on a new set of reforms

required to provide necessary impetus to Indian economy.

Some of the key questions concerning India’s development are about the impact of reforms

on the economy. How has the economy been performing over the period? To what extent has

India integrated itself into the rest of the world? What are the prospects in the near future?

Could India accelerate and sustain its GDP growth in the coming years?

Now the big debate in India is whether there is crisis of leadership or there is crisis of vision

and mission to run the country. While there can be endless debate on the leadership issue,

there exists a consensus on policy paralysis and India is in dire need of reforms at various

levels to redeem itself.

Given the 9 responses, this list is just comprehensive, and is surely not exhaustive in listing

the reforms India needs to implement under the next government. These reforms are

necessary for macroeconomic stability, a sine qua non for the maximization of the gains from

the reforms. In his parting budget speech, Finance Minister P. Chidambaram spoke about

India becoming the third largest economy in the world in 30 years’ time. This is far too long

and, frankly, well below the true potential of India. With wages in China rising rapidly and its

workforce shrinking massively, it has begun to quit the space it occupied in the global

economy in many industries. This process will only accelerate over the next two decades. No

other country except India has the potential to fill this space. India has a large and young

workforce, a high saving rate and an industrious entrepreneurial class. If India returns to

reforms, this happy configuration of circumstances positions it ideally to grow at 10 percent

per year. At this rate, we can cross Japan and become the third largest economy in the world

in less than twenty years.

While there is a lot that needs to be done, it is important we focus on areas which help long

term and sustainable growth creation in the country. An employment based growth where the

benefits are enjoyed by all is what government needs to focus on. In other words, economic

growth won’t be sufficient we also need economic development.

References

http://www.business-in-asia.com/asia/comparing_china_india.html (pg 2-3)

http://www.oecd.org/eco/48108317.pdf (pg 2-3)

http://in.reuters.com/article/2014/04/24/us-india-election-challenges-

idINKBN0DA0D120140424 (pg 2-3)

https://openknowledge.worldbank.org/discover?scope=/&order=desc&rpp=10&sort_by=scor

e&page=2&query=india&group_by=none&etal=0 (pg 2-3)

http://www.ncaer.org/popuppages/EventDetails/Feb_11_2014/CD_Deshmukh_Lecture_Note

_Feb_11_2014.pdf (pg 4-8)

http://www.livemint.com/Opinion/TOTYFyOpHVuoEo5GR1lqxO/Revisiting-

manufacturing-policy.html (pg 9-14)

http://www.cfo-connect.com/title_detail.asp?cat_id=10&art_id=953 (pg 9-14)

http://www.ey.com/Publication/vwLUAssets/FICCI_Infra_report_final/$FILE/FICCI_Infra_r

eport_final.pdf (pg 15-24)

http://www.google.co.in/url?sa=t&rct=j&q=&esrc=s&source=web&cd=7&ved=0CGcQFjA

G&url=http%3A%2F%2Fwww.mckinsey.com%2Fglobal_locations%2Fasia%2Findia%2Fen

%2Four_people%2F~%2Fmedia%2F9E20B4FAFD1D4AA796C41E51A4963561.ashx&ei=I

nOTU4OKNs-VuATl8oCgAw&usg=AFQjCNHqRW9nBN-

zLdRRcbAD900cxG7IzQ&sig2=AXnDNpW7zrjfqoL69AbiOQ (pg 15-24)

https://openknowledge.worldbank.org/bitstream/handle/10986/18500/828620India0IND0Box

0382099B00PUBLIC0.pdf?sequence=1 (pg 25-33)

http://www.maritimegateway.com/mgw/index.php?option=com_content&id=46:india-after-

gst&catid=51:article&Itemid=126 (pg 34-36)

http://www.mondaq.com/india/x/257916/international+trade+investment/Additional+Foreign

+Direct+Investment+Reforms+In+Retail (pg 37-44)

http://www.indiary.org/en/legal-advice/Foreign-direct-investment-into-india-2-79-5 (pg 37-

44)

http://www.atkearney.com/documents/10192/653464/Can+Indias+Power+Sector+Keep+the+

Lights+On.pdf/d69931a0-e883-4c08-a072-fb36c4f7c35a (pg 45-47)

http://www.livemint.com/Opinion/Tk4ZXIRh0tTTDVdFGwJbVI/Reforming-Indias-energy-

policy.html (pg 45-47)

http://www.voxeu.org/article/job-protection-reform-india (pg 48-52)

http://blogs.lse.ac.uk/indiaatlse/2013/08/28/labour-laws/ (pg 48-52)

http://www.ilo.org/wcmsp5/groups/public/---ed_emp/---

ifp_skills/documents/publication/wcms_232497.pdf (pg 48-52)

http://www.kpmg.com/IN/en/IssuesAndInsights/ArticlesPublications/Documents/KPMG_IC

C_Indian_Banking_The_engine_for_sustaining_Indias_growth_agenda.pdf (pg 53-57)

http://unpan1.un.org/intradoc/groups/public/documents/apcity/unpan048616.pdf (pg 60)