Financial sector reforms NDA-2 needs to roll out in second term

We reached out to experts to find out the key areas in the finance sector that need attention from the new government.

Big-picture reform

In order to review regulations that govern India’s financial system, the finance ministry constituted the Financial Sector Legislative Reforms Commission (FSLRC) in 2011. FSLRC holds the view that the regulatory architecture is fragmented (individual product regulators) and that leads to regulatory gaps and overlaps. So in drafting the Indian Financial Code (IFC), it proposed a big-bang reform—to move away from sector-wise regulation to a more unified one. Accordingly, the IFC draft proposed a system where the Reserve Bank of India (RBI) regulates the banking and payments system and there’s a unified agency for the rest of the financial markets.

However, the needle on this hasn’t moved much, and important reforms suggested by IFC are still languishing. “In drafting IFC, FSLRC recommended many significant reforms like creating a Financial Redressal Agency that would address and resolve consumer complaints across the length and breadth of the financial sector and drafting of consumer protection laws, again spanning the whole sector. If the entire recommendation of IFC can’t be implemented, the government should at least look at consumer-facing reforms with urgency," said Renuka Sane, associate professor, National Institute of Public Finance and Policy (NIPFP).

Drafting common consumer protection laws—which aid easy understanding of rights—and creating an effective redressal agency is the need of the hour given that sector-specific ombudsmen have not been able to effectively handle consumer grievances. Then, there are some sector-wise reforms that need to be looked into as well.

Pension reforms

Despite having a regulator—the Pension Fund Regulatory and Development Authority—the space continues to be fragmented. On one end of the spectrum is the Employees’ Provident Fund (EPF), which, despite being a voluntary scheme for those with incomes above ₹15,000 a month, is the go-to product for the salaried class. On the other end is the National Pension System (NPS) that was designed as a low-cost pension product mainly for the unorganised sector, but is yet to become popular with the intended segment. In the middle are products offered by insurance and mutual fund companies.

In order to popularise NPS and allow flexibility to employees, the government, in Budget 2015, proposed to allow portability between NPS and EPF. But that proposal is yet to see the light of day. Further, the G.N. Bajpai committee set up to review the investment pattern of NPS recommended having a single regulator for all pension products. The same was echoed by the Sumit Bose committee set up to address mis-selling and rationalise distribution incentives in financial products; the committee recommended that products should be regulated according to their function and, therefore, all pension products should come under one regulator.

“There should be a merger of EPF and NPS systems," said Sumit Shukla, CEO, HDFC Pension Fund Management Co. Ltd.

The government also needs to create capacities to mine big data for innovation, said Mukul Asher, a consultant in public financial management, and pension reforms. “The government should look at establishing a national-level centre for retirement behaviour, equipped with data analytics and artificial intelligence skills to process big data for product innovations and for designing policies and products to meet the needs of diverse groups," he said.

While the regulation part needs attention so do pension products like EPF. “There should be amendments to the EPF Act to clear the confusion created by recent Supreme Court decisions on what salary components and allowances can be included for EPF deduction and on the Employees’ Pension Scheme (EPS). The latter decision places an unsustainable burden on the EPS corpus," said Madhu Damodaran, business head, HR business services, CoAchieve Solutions Pvt. Ltd. Damodaran was referring to the SC order that allows employees to increase their EPS contribution. Being a defined benefit scheme—the pension is calculated as per a formula and not as per the amount the individual subscriber has accumulated—this would place enormous burden on EPF.

Tax reforms

The prevailing Income Tax Act is more than 58 years old and needs a review so that it is in line with the new economic needs of the country. In fact, in September 2017, Prime Minister Narendra Modi stated that there was a need to re-draft the Act and, accordingly, a task force was set up to draft the Direct Tax Law.

But not much progress has been made on this front as the term of the task force to submit the report has been extended several times; the new deadline is 31 July 2019. “The task force might recommend rationalisation of a few provisions relating to individual taxpayers to increase transparency and accountability. If this report is submitted on time, we may expect some of the recommendations of the task forces are to be implemented through the amendments in the existing Income-tax Act," said Naveen Wadhwa, deputy general manager, Taxmann. Tax equalization—similar tax treatment for similar products—is yet another reform expected from NDA-2.

Reduction of goods and service tax (GST) is another reform that needs attention. Prashant Tripathy, managing director and chief executive officer, Max Life Insurance Company Ltd., said the government can incentivise citizens to protect themselves by eliminating GST on premiums for protection covers across life insurance. Even less popular products like home insurance should have lower GST, said experts. “Reducing GST on products like home insurance brings down their price by as much as 20% for the customer, which is a great boost," said Abhishek Bondia, principal officer and managing director, SecureNow.in, an insurance aggregator.

Other reforms

Towards the end of NDA-1, the debt market was marked by credit crisis that called into question the efficacy of credit rating agencies. According to Prithvi Haldea, chairman of Prime Database Group, a primary market tracker, revamping the credit rating system is important. “It’s crucial to undertake big bang banking and credit sector reforms. We don’t want to see the crisis emanating from ratings again," he said. The government should also undertake reforms to bring in more retail participation in the stock market, said Haldea. “Currently there is a cap in the IPO market that dictates how much is available for retail. These caps should be removed. In fact, the PSU divestment should be earmarked only for retail at discounted prices. This is public wealth being distributed to the public," he added.

In the mutual fund space, fund managers have called for tax parity between equity and debt funds to encourage saving in debt funds. “This will also deepen the overall debt market, including the corporate bond market," said Mahendra Kumar Jajoo, head, fixed income, Mirae Asset Global Investments (India) Pvt. Ltd.

Even in real estate there is scope for further reforms. “There is a need to have a nodal government agency to complete stalled projects and recover dues from defaulters, maybe through the Insolvency and Bankruptcy Code route," said Ashoo Mishra, director (corporate ratings), India Ratings & Research (Fitch Group).

NDA-1 has seen some important reforms for the financial sector, but the pace only needs to increase hereon. We wish the new government all the best.

Disha Sanghvi contributed to the story