Time for the second wave of reforms

Time for the second wave of reforms

The next wave of investment policy reforms must focus on removing barriers to investment and providing effective investment promotion mechanisms, says Rajul Awasthi


THE world economy is going through one of its worst downturns since the Great Depression. The G8 economies are in recession, which means almost 60% of world GDP is contracting . Even the ever-fast-growing China has begun to show signs of slowing down. And the latest champion of the GDP growth race, India, is also having to do with 7% growth. The Economist has quoted the Institute of International Finance as predicting that world investment flows will see a rapid fall, by as much as 30%, in 2009.
In this scenario, only those economies which provide sure growth opportunities and present a dynamic, investor-friendly policy environment can expect investment flowing their way. Now, India is continuing to grow rapidly: the growth in FY 2009-10 is expected to be about 7%. But, China will also continue to grow at about the same rate or more, and so will the ASEAN region. These economies will offer tough competition to India in attracting FDI.
India needs huge amounts of investment to sustain and improve its growth performance . Indias mainstay of growth the last several years has been a phenomenal rise in investment: the investment- GDP ratio going up from 22.8% in 2001-02 to an estimated 37.5% in 2007-08 . The same growth in investment is almost impossible to sustain without a major policy initiative.
Given all this, India must embark on a second journey of economic reforms targeted at improving the investment climate , focused on fixing the policy environment and removing obstacles to business . India must, once again, as it did in 1992, send a powerful reformist signal to the world. It is time for unleashing a second wave of economic reforms.
Indias investment environment is beset with many problems. One key is, of course, the infrastructure deficit. We have large supply gaps in power, roads, ports and airports, railways, urban infrastructure and water. But, fortunately, infrastructure gaps are being addressed, both by government and through investments by the private sector. The crux of the problem is the investment environment.
The prevailing investment environment is characterised by a complex, burdensome tax structure, inflexible labour laws, bureaucratic delays, discretionary interpretation and vested interest, high cost of entry and exit, and ineffective/slow dispute resolution. There is no single agency to act as a facilitator for foreign investors. There is no investment law in place that could provide guarantees to investors. Given that labour laws are not within the jurisdiction of the central government, the focus of the government must be on microeconomic reform efforts in two key areas : tax and investment policy.
India did remarkably well from 2004 to 2008, under the stewardship of then finance minister P Chidambaram, to grow the central governments tax-GDP ratio from 9% to 13.5%. (Tax revenue has, of course, declined in 2009-10 due to the economic slowdown and the tax cuts initiated as part of a fiscal stimulus package.) However , the tax reforms concentrated on raising revenue and were not entirely investor friendly. An investor-focused approach would consider options to reduce compliance costs, attract new investment and reduce the size of the informal sector. The goal of raising tax revenue would be met by increasing the number of taxpayers.
It is now time for initiating just such tax reforms, reforms which reduce compliance costs and increase ease of doing business: create a simpler tax system so taxpayers can calculate their tax liability easily; provide easy options to pay taxes and file tax returns ; allow for taxpayer-friendly methods of tax verification and enforcement; afford taxpayers the opportunity to redress their grievances with limited costs.
SPECIFICALLY , the fringe benefit tax, which greatly increased the compliance burden on firms without contributing much to the revenue, must go. The goods and services tax, which would merge the central excise duty, service tax and the value-added tax in the states, while eliminating the central sales tax, must be implemented . The refund banker scheme, which has proved effective in providing quicker refunds and reducing corruption, must be extended. The tax return preparer scheme, which has been of help to small taxpayers in filing returns, must be strengthened. Efiling must be simplified and improved to make it accessible to individual taxpayers.
The annual information return should be broadened to cover more areas of investment and expenditure. Returns must be selected for scrutiny using objective, riskbased criteria through the computer aided scrutiny selection mechanism so that only evasion-prone taxpayers are scrutinised and honest taxpayers treated with respect. The ambit of large taxpayer units must be extended and they should be set up in more cities to provide world-class taxpayer service to the most valued clients of the revenue . The next wave of tax reforms must focus on taxpayer-friendly simplification measures that reduce costs of compliance.
On the investment policy, what is needed is a clearer statement of policy and a strong institutional mechanism that can attract and retain foreign investment. The Investment Commission pointed out that one of the most important reasons FDI remains lower than its potential is that some sectors that attract the most investment around the world, for e.g., finance, are relatively closed in India. There is a need to revisit the FDI regime. One suggestion is to remove sector caps and entry restrictions in all sectors other than those which are strategic . In sectors dominated by public sector units, there is a need to create a level playing field. In key sectors independent regulatory institutions must be established.
India must have a dedicated, single-window , high level investment promotion agency, which also looks into issues of investor after-care . Investors, both domestic and foreign, complain of lack of coordination between central and state governments , so, often, while their projects are accorded approvals, they do not take off on the ground. An effective Centre-state resolution mechanism, akin to the Empowered Committee for VAT implementation, could be set up to resolve foreign investor issues. A special high level fast track mechanism could be put in place for priority sector projects . The next wave of investment policy reforms must focus on removing barriers to investment and providing effective investment promotion mechanisms. Microeconomic reforms are the bedrock of an investment-oriented , high growth economy. Can we expect the UPA government unfurl the second wave of reforms