The Snowball Effect

Reforms: Is there a seamless story behind the seemingly disconnected and discrete set of reform measures?

It has been three years since the current regime took the reins of governance. For anyone who had expected the government to unleash big-bang reforms in the early part of its tenure, it has been a disappointment, to say the least. Much to the chagrin of free market enthusiasts, the government has been slow on sensitive yet significantly bold reforms such as privatisation of public sector banks and other non-strategic public sector undertakings (PSUs) besides the revamping of the archaic labour and land rules.

These could have been bold measures, had they been unleashed, and could have catapulted India structurally into a higher growth orbit. But to achieve a similar objective, the government seems to have chosen a much less disruptive path (politically), yet significant in its long-term compounding effect, by systematically scripting a plot connected by seemingly discrete sets of incremental reform measures. Strangely, this plot has an equal potential to propel India's growth structurally into a higher pedigree.

To understand the plot, it is important to decipher what is behind the dots that connect the discrete measures. If there is any common thread that runs across the incremental reform measures such as direct benefit transfer or DBT (for targeted subsidy), the Real Estate (Regulation and Development) Act or RERA (to implement a new bunch of real estate regulations), demonetisation, the Insolvency and Bankruptcy Code (IBC), linking of Aadhaar with PAN, curbs on cash transactions, the Benami Act and finally, the glorious Goods and Services Tax (GST), it is a coherent strategy that runs seamlessly across to structurally swell the tax base and tax/GDP (gross domestic product) ratio to significantly higher levels.

The early signs of such a swell are already visible on the individual tax front with the personal tax kitty surging by over 20 per cent annually over the past two years or more. The GST would do the same magic in indirect tax numbers over time although, in the short term, implementation hiccups would drag the numbers briefly. Deeper mining of the demonetisation data trail, coupled with an effective execution of the Benami Act on the ground would add to the swell, both in personal tax and in corporate tax.

The crux of all these coherent reform measures is in compliance (tax). With India placed abysmally low on the tax base as well as on the tax-GDP ratio, these are critical measures for changing the structural landscape of the economy.

A closer look at the numbers on the tax base for the peer group reveal the rifts in the revenue regime here. Take, for example, the tax-GDP ratio. With 16.6 per cent of the GDP, India is placed at the bottom while most of the BRICS countries are well ahead of 20 per cent-plus. So is the case with the tax base.

As a percentage of taxpayers to voting-age population, India barely makes it to 5 per cent while most of the countries are well ahead of 15 per cent-plus. With these numbers in place, no one can deny the need for a revamp, which is precisely what the reform measures are likely to realise.

With an expected spurt in the tax kitty (a widening tax net) in the coming years, it will lead to a higher fiscal space over time, which in turn will lead to a structural downward shift in inflation/interest rates, thereby changing the structural capacity of the economy for higher growth. As the economy shifts to more formalised (from unorganised), one on these reform measures, household savings, are expected to see a dramatic shift from physical to financial assets, which will structurally push the potential growth further.

Over time, with the widening tax net along with the changing profile of household savings (from physical to financial), India can break out of the 7 per cent-plus growth range to join the elite club of 9 per cent-plus growth.

Although India has seen such a growth rate cyclically (riding on global growth as in the case of 2004-07 upcycle), to structurally (hence, it will be more sustainable) move into that orbit will be a significant achievement for this administration. In summary, the restrained reforms of this government, when they play out over the next few years, have the potential to have the snowball effect to push economy structurally into a higher growth orbit. No surprise that both FDI (foreign direct investment) and FPI (foreign portfolio investment) flows are in a rush. Domestic investors, too, are in a hurry with the trend of changing profile of household savings gathering momentum.

ArunaGiri N is Founder, CEO and Fund Manager, TrustLine Holdings