Liberalization’s lasting impact: rules-based regime, disintermediation

Much before disruption became a keenly discussed topic in global boardrooms, the mother of all such upheavals played out here when the new industrial policy of 1991 was announced. The government was no longer to be the clearing house for new businesses as a more rules-based regime was ushered in. For companies, the policy changed the rules of competition: Instead of focusing on managing government systems, firms could now make their own strategic choices and leverage their capabilities to stay ahead of the curve—to the greater benefit of the corporate sector (see chart 1).

Entry barriers have eased and more companies are able to enter and compete in India today. To make it easier for companies to start up, the government recently launched an ambitious programme of regulatory reforms, which included simplified application forms, removal of the minimum capital requirement, an online tax-filing option and a much faster process for getting electricity connections. Resultantly, the number of days to register a new business has drastically improved—to 29 days in 2015, up from the 127 days in 2004 as recorded in the World Bank’s Ease of Doing Business index—though still below the OECD (Organisation for Economic Cooperation and Development) average of 8.3 days.

It was also critical for the government to cede ground on economic affairs and divest its stake in state-run companies to facilitate the entry of private players and foster real competition. But the government’s record on disinvestment has been sketchy at best, having missed the disinvestment target 16 times in the past 25 years. Only 42% of the disinvestment target (often used for plugging revenue gaps in the budget) was achieved in 2015.

Manufacturing versus services: Coal, where government-controlled Coal India Ltd accounts for around 85% of production, is a classic example in the manufacturing sector where the government continues to own a majority share and has delivered below-par results. Services sectors (telecom and aviation, for example), on the other hand, have seen significant privatization and reaped the benefits (see chart 2).

Manufacturing, crucial for both jobs and investment, is hamstrung by the archaic Factories Act of 1948. The government has identified some long-needed amendments to the Act, which is expected to come up for voting during this monsoon session.

State-level disparities: Just six states—Delhi, Maharashtra, Karnataka, Tamil Nadu, Gujarat and Andhra Pradesh—accounted for 80% of foreign direct investment (FDI) inflows into India in 2015, highlighting the skew. Gujarat has published details on available land banks and land allotment procedures and has a robust Geographic Information System providing details of land earmarked for industrial use. However, Bihar and the north-eastern states have been slow in embracing change.

Running businesses has become easier over the years, and our nation has climbed up a few spots on the Ease of Doing Business ranking to 130 this year. Moreover, the setting up of regulators for various sectors was a critical part of the move to a rules-based system, removing direct government control. The Securities and Exchange Board of India, Telecom Regulatory Authority of India and Insurance Regulatory and Development Authority of India are examples of strong regulators that have played a significant role.

However, there are still multiple issues that Indian businesses are grappling with, including corruption and a complicated tax structure. The country ranks a poor 76 among 168 countries on Transparency International’s Corruption Perception Index. As far as tax laws are concerned, there are issues with the clarity of the tax code as well as consistency in its interpretation. The recent disputes involving Vodafone Group Plc., Royal Dutch Shell Plc. and Cairn Energy Plc. stand testimony to the problem. The World Bank Ease of Doing Business study highlights multiple areas where we still need to go a long way to improve (see chart 3).

The Economic Survey 2015–16 highlights that over the past six decades, the Indian economy moved from ‘socialism with limited entry’ to ‘marketism without exit’, underlining the limited progress that India has made in terms of offering an exit route for businesses. The Survey goes on to add that impeded exits also play a role in creating fiscal costs (subsidy), economic costs (or opportunity cost) and political costs (image). It takes 4.3 years to exit a business in India compared with 2.6 years in South Asia, and we also have a lower recovery rate of 25.7% (cents on dollar). A 2014 study by Chang-Tai Hsieh and Peter J. Klenow compared the average size of plants (based on the number of people employed) for new plants and old plants. In principle, surviving firms should expand and grow much larger, forcing out the unproductive ones. In the US, 40-year-old manufacturing plants are more than seven times larger than plants under the age of 5 in terms of employment. In India, by contrast, 40-year-old manufacturing plants are only 1.4 times larger.

To the government’s credit, it’s been seized of the issue.

The Insolvency and Bankruptcy Code 2016, aimed at addressing issues around business exits, could potentially lead to a new law that will ensure time-bound settlement of insolvency, enable faster turnaround and create a database of serial defaulters. But only time will tell how this plays out.

The government is aware that if it needs to attract investment it should improve its record on doing business. It has, therefore, set itself an ambitious target of improving the ease of business ranking to 50 by 2017 from the current 130, while the states have agreed to a 98-point action plan. To show it means business, the government should continue on its path of disintermediation, retreat from being a direct service provider in major sectors and let the private sector fill up that space. We have seen the intent, but reality needs to catch up.

Sri Rajan is chairman, Bain & Co., India. Nikhil Prasad Ojha is a partner with Bain & Co. in Mumbai and co-editor of the Mint-Bain series 25 Years of Reforms. Shyam Unnikrishnan is a principal in the firm and a member of the strategy and consumer products and retail practices in India.

This is part of a special Mint-Bain series on 25 years of economic liberalization. For more on 25 years of reforms go to www.livemint.com/liberalization