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 30th 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) Profile of the organisation

3) List of figures

4) Abstract

5) Introduction

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

Matre 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 ATMs

75

Share of population group in increment of ATMs

76

ABSTRACT
In this paper Reform Indian Economic Policy we try and evaluate Indias 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 Indias 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. Indias 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, Indias 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-ofdoing-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 Indias 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 195152 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 Indias 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, nonperforming 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 199697 and 200405, agriculture, including
forestry and fishing, has seen a turnaround. It grew at a trend rate of 3.75 per cent between
200405 and 201213. 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 200405 and 201112. 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 croporiented 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 Indias 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, Indias 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 Indias 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 Indias 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 Indias
workforce over the coming decades. What should be Indias once in a lifetime opportunity to
benefit from the demographic transition can easily become a nightmare if they are not
provided employment opportunities. The governments 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,
Indias average annual manufacturing growth has been second only to Chinas 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 Chinas 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, Indias
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 1214 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. HSBCs

Purchasing Managers 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
sectors 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 Indias
overall workforce) to 50 million in 2010 (10.5%). The sectors 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 industrys 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 selfregulation 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
Banks 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 governments 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 laws52 of them at the Centre and three times those in the statesdrive
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, NHAIs 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 Indias
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 countrys 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 courts 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 requiredFor Indias 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 Indias 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 precondition 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 Ministers 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) withinbudget 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 Indias attractiveness as a market for global
construction companies. However, it will require measures at several levelsarbitration
laws, policy, contracts and the judiciary.

Strengthen Indias 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 fasttrack 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 PPPACs 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 industrys 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 Indias legal system is the difference between protection of
investors by law as opposed to protection in practice. We compare Indias 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 Companys 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 Internationals 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 Indias 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. Indias 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), Indias 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 countrys 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,
Indias score is lower than the averages of all the subgroups of LLSV countries, suggesting
that Indias 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 taxpayers 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/nonhazardous 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 GIDCs 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 productiondistribution 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. Kearneys 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 Indias 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 multibrand 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 lions 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), Indias 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

Indias policymakers are fond of defining the countrys 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
countrys 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
Indias 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. Dieselfuelled 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 worlds
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. Indias problem is
one of management rather than scarcity.

The management challenge is best understood by the deficiencies in the coal sector. Coal is
Indias single biggest fuel source, accounting for half of the countrys 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 Indias 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.
Indias 12th Five-Year Plan focuses on means to curb the countrys 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 sectors growth has been
held to ransom by whats 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 sectorsthree 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 Courts 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, Indias 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 marketled 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. Indias 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 governments redistributive largesse
can never be competitive or have the financial ability to develop solutions to Indias 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 Indias 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 Indias 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 states preference for adjudication rather than articulate the
need to promote collective bargaining.
In todays 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 NLLAs 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 Teams 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 Indias 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 governments 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 Governments 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-payers 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-onyear 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 countrys industrial output
and 40 percent of exports. The overall contribution of this segment to Indias 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 farmers

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-ofsale 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 Indias 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 wont be sufficient we also need economic development.

References
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http://www.oecd.org/eco/48108317.pdf (pg 2-3)
http://in.reuters.com/article/2014/04/24/us-india-election-challengesidINKBN0DA0D120140424 (pg 2-3)
https://openknowledge.worldbank.org/discover?scope=/&order=desc&rpp=10&sort_by=scor
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http://www.ncaer.org/popuppages/EventDetails/Feb_11_2014/CD_Deshmukh_Lecture_Note
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http://www.livemint.com/Opinion/TOTYFyOpHVuoEo5GR1lqxO/Revisitingmanufacturing-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
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0382099B00PUBLIC0.pdf?sequence=1 (pg 25-33)
http://www.maritimegateway.com/mgw/index.php?option=com_content&id=46:india-aftergst&catid=51:article&Itemid=126 (pg 34-36)
http://www.mondaq.com/india/x/257916/international+trade+investment/Additional+Foreign
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http://www.indiary.org/en/legal-advice/Foreign-direct-investment-into-india-2-79-5 (pg 3744)

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-energypolicy.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)