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What to do about the heavy cost of doing business in India

Sachchidanand Shukla writes: Governments must focus on lowering prices, reducing regulatory cholesterol.

Written by Sachchidanand Shukla |
Updated: October 28, 2021 8:11:43 am
While the Centre’s focus on EoDB has been commendable, several state governments have also made efforts to improve business conditions.

The IMF’s executive board recently expressed confidence in the leadership of Kristalina Georgieva in the Doing Business survey controversy that raised doubts over the integrity of Ease of the Doing Business (EoDB) rankings. India has made considerable progress on these rankings since 2016. While the Centre’s focus on EoDB has been commendable, several state governments have also made efforts to improve business conditions. This, along with the cut in corporate tax rates, the launch of Gati Shakti, the sale of Air India as part of an aggressive asset monetisation plan, the scrapping of retrospective taxation, the PLI scheme and labour reforms are likely to provide a boost to the manufacturing sector.

However, the controversy over EoDB notwithstanding, India must now sharpen its focus on the Cost of Doing Business (CoDB). There is a big underlying change that warrants this pivot to CoDB — the pandemic has made countries inward-looking in terms of their supply chain and domestic capacities, which will dictate their broader economic and trade policies. This may affect global trade and growth over the medium term and make countries extremely discerning on costs and competitiveness.

India lags behind other countries in terms of CoDB on several counts. However, only two key factors are highlighted here — energy costs and regulatory overload — which can be addressed in the near to mid-term, unlike other issues such as infrastructure. This would be critical to improving India’s manufacturing competitiveness, boosting manufacturing exports and raising its share in GDP.

Take fuel and power costs. Diesel prices in India are 20.8 per cent higher than those in China, 39.3 per cent higher than in the US, 72.5 per cent higher than Bangladesh and 67.8 per cent higher than in Vietnam. This is largely because of heavy taxation — total taxes on diesel account for over 130 per cent of the base price in India. Including fuels under GST would lower costs for businesses owing to input tax credit even if taxation levels continue to remain high.

Likewise, in the case of electricity, prices for businesses in India were higher by around 7-12 per cent vis-à-vis those in the US, Bangladesh or China and by as much as 35-50 per cent as compared to those in South Korea or Vietnam prior to the recent coal/energy crisis. Cleaning up the power distribution sector, which is largely state-controlled, could potentially lower electricity prices for businesses. Coal, which accounts for more than 70 per cent of electricity generation in India, is also pricier vis-à-vis other countries leading to higher electricity prices. Like in the case of the petroleum sector, government levies account for nearly half of the prices paid by coal consumers. And coal producers cannot claim input tax credit because electricity is not under GST. Further, coal freight costs are amongst the highest in the world as high freight rates are used to cross-subsidise passenger fares by the railways.

High fuel and power costs impart a significant cost disability to energy-intensive sectors such as steel, aluminium and cement, where they account for between 25 and 40 per cent of the cost of production. This, in turn, leads to a competitive disadvantage for sectors such as auto, durable goods and construction, which consume these intermediate goods.

Outsized regulatory levels also pose a significant burden on businesses. A Teamlease report highlights that a small manufacturing company with just one plant and up to 500 employees is regulated by more than 750 compliances, 60 Acts and 23 licences and regulations. A mid-sized manufacturing company with six plants spread across different states is regulated by more than 5,500 compliances, 135 Acts and 98 licences and registrations. Keeping track of such a large number of regulations along with the changes thereof, imposes huge operational and financial costs on businesses, particularly the MSME segment. Not surprisingly, most of them choose to remain in the informal sector.

A majority of the compliances stem from the states and reducing this burden would require a significant push on states to act on this front. The Centre could leverage the “carrot and stick” framework — using fiscal incentives to nudge the states to act and disincentivise them from maintaining the status quo. It must prioritise reducing the cost of energy and compliances for businesses rather than focusing on de jure measures to boost ease of doing business. These will boost India’s manufacturing competitiveness significantly and further increase formalisation in the economy.

This column first appeared in the print edition on October 27, 2021 under the title ‘Cost of doing business’. The writer is group chief economist, M&M. Views are personal

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