India Watch

Reform agenda aims to boost India’s stuttering growth

The long-awaited Goods and Services Tax and other reforms announced in the Union Budget are expected to reignite India’s economic growth following a slowdown in industry and the impact of demonetisation.

Economic growth in India is expected to be around 7.2% for the financial year ended March 2017, down from 7.6% in FY2016, largely as a result of weaker industrial output and last year’s demonetisation reforms (see table 1).

The limited availability of cash in the economy following demonetisation resulted in many cash-based businesses losing income, having spare capacity and deferring consumption. It is also likely to have delayed any plans to expand.  

However, the country’s growth is expected to pick up once a number of planned economic reforms kick in. In particular, the upcoming implementation of the Goods and Services Tax (GST), which has been in the making for more than a decade. This is expected to help raise India’s medium-term growth to above 8%. GST, a unified taxation regime, is expected to improve the efficiency of production and movement of goods and services as they will no longer be subject to multiple tax levies across states.

Furthermore, the abolition of the Foreign Investment Promotion Board (FIPB) in 2017/18 and the possible liberalisation of foreign direct investment (FDI) policy should make it easier for foreign companies to do business in India.

Table 1:  2016-2017 economic indicators by quarter

  Q1 2016 Q2 2016 Q3 2016 Q4 2016 Q1 2017* *Period for Q1-2017 for which data was available
GDP (Annual Growth Rate) 7.90% 7.20% 7.40% 7% 6.90% Not available. Estimated number.
GDP (Growth Rate) 2.30% 1.30% 1.80% 1.60% NA Not available.
Inflation Rate 5.26% 5.67% 5.17% 3.75% 3.41% Jan-Feb
Balance of Trade -6,437.20 -6,411.30 -7,925.00 -11,179.70 -9,368.60 Jan-Feb
Consumer Price Inflation 126.1 128.7 131 131 130.5 Jan-Feb
Wholesale price inflation -0.79% 1.38% 3.71% 3.62% 5.90% Jan-Feb
FDI (USD Million) 2,912.00 2,314.70 4,742.30 2,501.30 3,353.00 Jan
Industrial Production 0.27% 0.73% -0.83% 1.23% 2.70% Jan
GDP Constant Price (USD Million) 30,120.29 29,277.61 29,734.44 30,278.93 NA Not available.

Source: Livemint, IMF, World Bank, Fitch Ratings 

Union Budget confirms reform agenda

The recent Union Budget 2017/181 reiterated the Indian government’s intentions around a number of key reforms. These include tax breaks for smaller companies, simplifying the approval process for affordable housing projects, widening the range of financial instruments in which capital gains can be invested without paying tax, phasing out FIPB and focusing on rural development. Various provisions in the Finance Bill aim to strengthen India’s financial sector and bring in structured monetary reforms. Some of the key proposals are set out below.

Retail sector

  • Overseas investment in retail businesses will be made easier. 100% of FDI single-brand retail will be allowed through the automatic route, whereas currently investment above 49% requires the approval of the FIPB2.
  • Interest earned by foreign entities.
  • The concessional withholding rate of 5% charged on interest earned by foreign entities in external commercial borrowings or in bonds and government securities has been extended to 30 June 2010. This benefit is also extended to rupee-denominated (Masala) bonds.

Start-ups

  • Relaxation of the rules around continuous holding of voting rights will make it easier for start-up businesses to carry forward losses. Also, the profit (linked deduction) exemption available to start-ups for three years out of five years has been changed to three years out of seven years.
  • Micro, small and medium enterprises (MSMEs).
  • Income tax for companies with annual turnover of up to 50 crore (US$7.7 million) is being reduced to 25% to help make MSME companies more viable.

Fuel costs

  • Basic customs duty on liquefied natural gas (LNG) will be reduced from 5% to 2.5%.

Ease of doing business

  • The scope of domestic transfer pricing is restricted if one of the entities involved in a related-party transaction enjoys a specified profit-linked deduction.

Financial services sector

  • The allowable provision for banks’ non-performing assets (NPA) increases from 7.5% to 8.5%. Interest will be taxable on actual receipt instead of on the accrual basis in respect of NPA accounts of all non-scheduled cooperative banks also to be treated on a par with scheduled banks.
  • In the fund industry, Category I and II Foreign Portfolio Investors (FPI) will be exempted from indirect transfer provision. This will not apply to the redemption of shares or interests outside India that arise from the redemption or sale of investments in India, as these are taxable in India.
  • The government has approved 100% FDI in financial services carried out by non-banking finance companies (NBFCs). This is expected to attract more foreign capital into the country.
  • 100% FDI in asset reconstruction companies (ARCs) will be allowed under the automatic route, which will help to tackle the issue of declining asset quality in banks3.

Sources:

1. Key features of India Budget 2016/17

2. Financial Express

3. India Brand Equity Foundation