Seven years ago, the President of the European Central Bank, Mario Draghi famously declared that ECB will do “whatever it takes” to preserve the Euro. The reverberation of those utterances resound till date.
A similar event happened last week in India. Only this time, it was even more powerful, accompanied as it was by one of the biggest economic events in India’s recent history. By announcing a large corporate tax rate cut across the entire corporate sector and a much lower rate for new manufacturing companies, the government has clearly shown that it will do whatever it takes to get the economy back on track, and on target for the $-5 trillion GDP goal. This bold announcement comes on the back of several small but significant reforms in the last few weeks.
As the economy had been facing headwinds, there has been a demand for major structural reforms. Drastic reforms are hard to undertake for many reasons; First of all, in a democracy, it requires a “real” crisis – like the one in 1991, when the country did not have enough reserves to pay for imports. Though current issues with the Indian economy are worrying, they may not be in the same category. However, such high risk, high return actions can have an impact beyond the intended realm, often changing the entire perception about the country — Lee Kuan Yew’s reforms in Singapore and Deng Xiaoping’s reforms in China are good examples.
The easing of FDI norms across some sectors, tax relief for foreign portfolio investors (FPIs) and start-ups, reprieve for the automobile sector, an upfront support of Rs 70,000 crore to public sector banks with an aim to revive demand and improve liquidity and the merger of PSU banks will have a long-term beneficial impact on our economy.
The opening up of FDI in several sectors is especially timely as in this era of trade wars, India can be a beneficiary. Foreign investment is a key source of economic growth as well as non-debt finance for the country. Hence, a sustained investor-friendly policy is vital to attract foreign funds. Thus the announcement on single brand retail is very important as it gives major flexibility and ease of operations for potential investors. The government has shown enough adaptability to make the crucial local sourcing rules more flexible, which will send out a very positive signal to foreign investors, who have expressed concerns over these norms.
In fact, flexibility along with agility is the hallmark of any good government; some of the other measures, including the removal of FPI surcharge and the angel tax for MSMEs demonstrate the government’s ability to respond quickly to remove obstacles for the ease of doing business.
The merger of PSBs is also an idea whose time had come. From the global experience, it is clear that fewer, stronger banks increase productivity, lessen asset quality pressure, boost liquidity and credit flow, improve overall operating efficiency and corporate governance. It would help create banks that can play a global role (a la Chinese banks). Besides, the government has been grappling with poor asset quality in the banking sector. Hence this is a step towards long-term economic growth by removing obstacles in the efficient use of capital. Having too many weak PSBs meant a drain on resources.
However, we were still lacking the one big shot in the arm. This came with the corporate tax rate cut. Since the announcement, several people have asked how the measure will impact the ground realities. I think there are three factors that are very important at this stage: Fundamentals, sentiment and liquidity. With this bold step, the government has taken the bull by the horns to address the sentiment issue. A negative sentiment had built in the industry, the economy and investors. This push turns around the sentiment in a big way.
While several measures have been taken to address liquidity including an easier monetary policy and infusion of liquidity to banks, which will further lend to NBFC’s, and the liquidity injection into housing finance companies, there is still considerable risk aversion in banks and mutual funds to lend to NBFCs. The severe credit crunch in the last 12 months has choked the credit pipeline , or what I call liquidity cholesterol, which has been dampening demand and consumption.
So there is a willingness from corporates to kick start the capex cycle and eagerness from foreign investors to invest in India. But all this will happen if the liquidity crunch eases and demand picks up.
For those arguing that the recent big bang reforms will cause a fiscal slippage, I would argue that while maintaining fiscal deficit targets is important, India, as an important investment destination has much more to lose if it lost favour in the global arena. The current scenario is unlike anything in the past. So, it is important that the government actively tackles the low sentiment in the system by sending positive signals domestically and to the world that “we are willing to walk the extra mile” to realise the India growth story. And they have done exactly that.
Reforms, whether big bang or small continuous ones, need good implementation. Execution has been a focus area for the government and I do hope to see this continue going forward.
This article was first published on September 27, 2019 in the print edition under the title ‘Lifting the sentiment’. The writer is chairman and CEO of the Edelweiss Group.
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