India's Economic Reforms Could Unlock Long-term Potential

Investors Should Watch These Key Reforms

India is the sixth largest economy in the world by nominal gross domestic product (GDP) at $2.4 trillion in 2017. While GDP growth fell to 6.75 percent in 2017, the finance ministry expects that growth will pick up to between 7 percent and 7.5 percent in 2018, which will help it regain its position as the world’s fastest growing major economy. The International Monetary Fund (IMF) seems to agree, predicting that growth will reach 7.4 percent in 2018.

Prime Minister Narenda Modi believes that economic reforms are the key to ensuring strong growth over the coming years. And, there are early signs that these reforms are paying off. International investors may want to keep an eye on these developments as they could translate to a potential surprise in growth rates and a more resilient economy over the long-term.

What Has Already Been Done?

Prime Minister Narenda Modi has been successful in implementing several key economic reforms over the past couple of years. Many of these changes have experienced issues upon roll out—contributing to the slower than expected 2017 GDP growth—but the country jumped 30 notches into the top 100 ranking on the World Bank’s 2018 Ease of Doing Business Index and experts believe that the top 50 is within reach.

The Bankruptcy and Insolvency Act of 2017 put in place to enable courts to appoint resolution professionals to sell off and revive investments and companies financed by loans that have turned bad. By doing so, the country’s state-controlled banks will recover some of their capital and persistent issues with stranded assets and stalled investment will be addressed. These efforts could improve the situation for foreign investors in the country.

In June 2016, the Reserve Bank of India formally adopted a flexible-inflation targeting framework to place price stability as the primary objective of its monetary policy. With a 4 percent target inflation rate, the new policy will help control inflation and has already helped stabilize the economy. These efforts also help foreign investors interested in the domestic bond market, since they can more accurately forecast the rate of inflation.

The government abruptly removed the highest value banknotes in circulation last year—the 500 and 1,000 rupee notes—as part of its clampdown on ‘black money’. While the move was well-intended, it wreaked havoc on the cash-intensive economy and contributed to the under performance in 2017. Corruption also remains an issue due to the state’s high level of involvement in many areas of the economy—an area that still requires reform.

The most recent example of reform was the introduction of a nationwide Goods and Services Tax (GST) to replace a patchwork of state-level excise tax levies. Again, while the move was well-intended, the execution of the rollout was slow and uneven, which resulted in numerous problems. The benefits of the reform could start to really appear moving into 2018 when implementation is completed across all of the states.

What Changes Are Still Coming?

There are many economic reforms that are still a work in progress and others that remain in the planning stages. According to the DIPP, there are over 100 reforms in progress that haven’t been factored into this year and just two of 42 completed forms have been accepted with two others partially accepted, as of October 31, 2017. The biggest reforms that investors are watching relate to land ownership, labor laws, and the judicial process.

As of early 2018, the enforcement of contracts and building construction permits remain a weak point, according to the World Bank’s Ease of Doing Business Index, while reforms in starting a business haven’t been factored into the equation. The government has also newly introduced 37 reforms in areas like insolvency resolution, protecting the interest of minority shareholders, and simplifying the process of filing taxes.

The improvements in the ease of doing business could be a boon for foreign and domestic investors. With corporate law and securities regulations already ranking as ‘highly advanced’, placing it fourth in global rankings, there’s a ripe opportunity for investment given the country’s large size and strong growth rates. The government is working in the right direction when it comes to implementing reforms, but bold steps are still needed to realize the Prime Minister’s ambitions of becoming a top 50 economy.