Can reform make a difference to India?

Indian Spices

The Indian economy is growing well, and the stock market has rallied with the emerging markets generally this year. Prime Minister Modi has been popular with many voters and with the international business community since first taking up the office. He has talked up his view that India needs to reform to accelerate its growth rate. In his early period in power he found it difficult to get any reforms through Parliament and the divergent states. He concentrated on talking of progress to come, and on engaging with the wider international Indian community on how business could grow and develop. He was keen to encourage fuller engagement by Indians living outside their home country.

More recently he has become a bold reformer. He took away large denomination bank notes in a move designed to persuade many more people and businesses to have bank accounts and to use cash for fewer transactions. He wanted to curb tax shy activity, to modernise payments, and to help expand the banking sector by adding to their deposit base. It appears that he has achieved quite a switch from cash to bank account money as a result. Indian banks now have more resource to lend to fuel growth.

Soon he is about to unleash the largest reform of all. India’s 22 states have all imposed a variety of taxes on transactions, with a different mix and different rates in each case. The Indian federal government has also imposed a range of taxes on transactions. Cross border trade between states in the Indian Union has been slowed and made more costly by the various tax impositions that have to be accounted for as goods move. Mr Modi is going to implement a comprehensive tax reform from 1 July onwards. It will impose instead a General Sales Tax country wide, with some of the money credited to the individual states and some to the centre.

The new tax will replace excise duties, service tax, entry tax, luxury taxes, VAT, sales taxes, the entertainment tax, lottery taxes and other turnover related taxes. There will be four rates, of 5%, 12%, 18% and 28%. The high rate had to be offered to deal with states who favour luxury taxes, and will be used on the more expensive items. If all goes well with this introduction, India should see faster growth in trans-Indian trade, with savings on paperwork and complexity that currently slows and impedes transactions.

Mr Modi has other reforms in mind. He is promoting modern cities with better communications. He is seeking land reform to speed infrastructure development. He has found it difficult to reform labour relations as he would like.

It looks as if the GST reform will now take place. It may have teething problems, as it a big and complex change. Overall it should assist faster growth in India, and will probably be well received by international investors and markets. Whilst Indian shares look quite expensive by international standards, these reforms will be welcome and will help generate the better earnings growth implicit in the valuations.

The above article by John Redwood, Charles Stanley’s chief global strategist, was first published by Charles Stanley on 15th May 2017.