State of India's Regulatory environment- What ails it and how to build capacity around it?
1) Regulatory
environment and capacity: Indian businesses are bound by
substantially high number of laws, regulation, and compliance that
disincentivizes scale and incentivize informality. There are 15361
laws that directly or indirectly are applied to businesses, and some are
enforced by center and some by the states. These laws together account for
69,2331 compliances that businesses need to comply. More than 26,1341
clauses carry imprisonment provisions and 40%1 of the compliances have
prescribed jail terms. This has made India a repository of dwarf enterprises.
India has 63 million1 enterprises out of which just one million are
in formal sector. The moment a company scales and reaches 150 employees there
are additional 900 compliances which incurs approximately Rs.12-18 lakh rupees
in addition. One must note that this additional compliance burden is way more
for costly and cumbersome for smaller companies which generally lacks capacity,
technology and overhead room to meet the compliance requirements. Even for
bigger corporations, compliance burden requires incremental overheads. As
Manish Sabharwal of Teamlease services points out, India, post-Independence,
have an unemployment rate of 2-8 percent but poverty rate of 40%. This clearly
indicates that India has a wage problem and not a jobs problem. Keeping dwarf
firms impedes relatively well-paid formal sector job creation and hence is an
impediment to poverty alleviation. The overall “Regulatory cholesterol” makes
India one of the least attractive places among major economies to do business
at and beats down a lot of investment enthusiasm. Along with the general
administrative burden, it is also noteworthy that the pace of the changes is
also extra-ordinary. In June 2021 alone, there were 322 regulatory changes2,
856 regulatory changes from Apr’21-June’21 and 4104 changes between July’20
-June’21.
As
Gautam Chikarmane points out, it requires significant reforms to address the
regulatory cholesterol of India. Some Valid reforms in this direction can be
establishing a commission which studies the compliance burden in detail and
find out the duplicate, redundant and sometimes even contradictory ones.
Especial focus should be put to factories act2 which has more than
9000 compliances and electricity act which has over 4000 compliances. Along
with this as Chikarmane points out that despite citizens have unique ID,
businesses have to get multiple IDs for PF, tax deduction, Insurance, corporate
identification etc. India has now the digital stack to support a unique
corporate ID framework to track all the required commercial activities that the
government needs to focus on.
India’s
contract enforcement record is abysmal. Average gestation for contract
enforcement in India is 1445 days3 compared to 20 days in Singapore2
and the cost is 31.3%3 of claim value. India’s rank in contract
enforcement is 163rd in the world2. The commercial cases compete
with civil cases and hence increase the already clogged judicial pipelines. The
lack of judges and administrative staff adds to the woes. Moreover, India has a
poorly developed arbitration system for alternate dispute resolution.
Separating out the commercial courts and build judicial capacity and arbitration
capacity by faster digitization and e-courts will with faster resolution time
and would cut down the contract enforcement time and cost significantly which
alone can have sizable impact on the ease of doing business.
The
inspection regime in India relies on heavy physical contact. The Inspector
often have arbitrary power and can get into rent seeking behavior. For
instance, the Kitex group4 in Kerala in Jul’2021 shifted its base to
Telangana from Kerala as it was raided by 11 teams of officers from different
departments in just one month. This is just one example of such arbitrary and
completely overwhelming move disincentivizing businesses to invest in India.
MSMEs in India can be raided by 20 inspectors2 at any given time.
The government must strive to reduce arbitrariness in the inspection system,
make self-certification viable and easy and also digitize the system based on
risk perceptions and risk score rather than letting inspectors arbitrarily
decide on raids (which often are politically motivated).
The
regulatory update in India happens too fast and frequent (at least 4000 updates
per annum)2 as pointed out by Gautam Chikermane and Rishi Agarwal in
their article on “Regulatory cholesterol2”. He also points out that
the updates are done at Union, state and municipal levels and are done in 2233
different websites. Today the Indian state has built public digital capacity to
centralise and digitize these things and hence can reduce the compliance
turnaround significantly.
However,
centralizing the updates will not solve the problem in entirety. There should
be regulatory certainty as well. India cannot be changing rules of the game at
the pace mentioned above. Among other regulatory requirements, India also have
a marvelously fluctuating trade policy. On Aug 3rd, 2023, India
imposed licensing requirements on import of Laptops, tablets, and smart phones
with immediate effect5. Although it deferred its decision later, it
created a significant chaos and confusion among Indian businesses dependent on
imported laptops and on companies like Apple and Samsung. Similar restrictions
were applied in 2020 in TV shipments5. As per WTO report in 20196,
India applied 13.8% of import tariff on most favored nations (MFNs) which is
highest of any major economy. The tariff structure in India is generally
considered opaque and complex with many components like additional and special
duty along with cess on basic duty. Moreover, the custom rates are revised
ad-hoc and arbitrarily through Gazette notifications with complex exemptions. Further
according to WTO, India’s bound tariff rate is 48.5%6 and applied
tariff rate for MFN is 13.8%. This leaves a big room for Indian regulators to
play with leaving a lot of uncertainty among foreign exporting businesses. Many
of India’s bound tariff on agricultural products ranges between 100-300%6
which makes it among the highest in the world. A huge gap between applied and
bound tariff also is a matter of concern especially in agriculture where
applied tariff averages much below at 32.7%. It just means tariff then can be
used as a political tool to be protectionist whenever needed depending on food
production and inflation. India even maintains a very high basic duty at 20%
for life saving drugs and other drug formulation6. Moreover, the
tariffs on transmission parts, engines, brakes, airbags etc. have been doubled
from 7.5% to 15% as per the WTO data in 20196. Moreover, in the same
report it has been pointed out that India applied a ‘Social welfare surcharge’
at 10% to be applied on aggregate of duties, cesses and other taxes without any
public notice or consultation.
The
table above7 shows India’s both applied and bound tariffs being the
highest for MFN countries compared to other major economies.
Import tariffs are also
tax on exports and reverses many gains from the Production Linked Incentive
(PLI scheme). High tariff on sub-assembly component that goes into making of
mobile phones have neutralized the gains from PLI scheme. Indian Cellular and
Electronics association8 says that the current tariff puts a cost
disadvantage by 5-7% on total cost offsetting all PLI gains (4-5%)
India needs a
institutional deep thinking to reform the GOI Foreign Trade (Development and
Regulation) Act along with India’s Export Import policy which governs the
import tariffs. Narrow gap between bound rates and applied rates, elimination
of cesses and surcharges, public consultation mechanism before any increase and
also keeping a sunset provision for any surcharge led tariff increase are some
of the lowest hanging fruits. This can then be followed by a simple and
generally low tariff regime at least for non-agricultural goods is highly
desirable for India’s own assembly/manufacturing ecosystem which uses imports
as input goods.
Building regulatory state
capacity: As Lalita Som and Faisal Naru in their paper on
Regulatory policy in India9, points out “An effective regulatory
policy framework is important to lay the foundation for building integrity into
the relationship between the State, citizens and businesses”. The job of
regulator is to protect consumer interest, give them lower price, better choice
and quality. At the same time producers should be financially viable.
Regulation must be there to achieve fair competition, quality capital investment
and protection of public goods like environment9. However dominant
presence of PSUs keep generating conflicts of interest in key industries where
the state regulates and owns a commercial company. Moreover, regulatory
independence in India is not up to the mark. As per the same paper by Lalita
Som and Faisal Naru, Regulatory capture in India is more of activated at a
particular moment in time where undue influence can be created on regulators to
do something which the regulator would not have done in normal circumstances. A
good example of regulatory capture is SERCs and CERCs (State and Centre
electricity regulators) in India. The SC in one judgement during Nov ’2210
also made it clear that the state and central govt’s role is only advisory.
However, the selection committee of the SERCs are made by chief secretary of
state government, Chairperson of CERC/CEA and chief justice of high court.
Given the majority vote would decide the SERC appointment, the appointees will
have limited autonomy by design. Removal power of SERC members are vague and as
per the new draft bill, individual member may be removed for collective
decision of the committee. This makes the political interference in the
autonomy of these institutions very likely.
Keeping the conflict of
interest and regulatory capture in check is a bedrock for any meaningful
regulatory capacity. This requires solving the political economy question on
the HR processes of regulatory appointments. It is very crucial that the
appointment of regulators is done by panel constituting members from across
political aisles along with judicial officers. Regulation is mostly
technocratic job and hence eligibility criteria must be formulated based on the
nature of regulation rather than choosing a bureaucrat. The conditions of
removal of a regulator must be well defined and transparent with only limited
actions that can amount to removal. Most of the regulation in India suffers
from Institutional design questions as demonstrated by electricity sector
example above. Moreover, regulation often have overlaps between states, union
and at times even with local governments. These overlaps and inconsistencies in
application fails the idea of regulation for an integrated national market9.
Such multi-level regulatory governance requires close co-ordination between
Union and states for rule making and enforcement9. The current
federal strain of relationship depending on the political orientation of the
state executive is an impediment for any meaningful enforcement of regulation.
For instance, licensing is state subject in many sectors but the royalty rates
are determined by the union government9.
Some lessons can be
learnt from successful regulators like SEBI. However, one might argue that
financial sector is an union list subject so the co-ordination with states was
not a necessity. However SEBI’s success is beyond just this fact. SEBI and RBI
shares certain responsibilities and also with Ministry of Corporate Affairs
(MCA)9. Due to jurisdictional overlaps, SEBI and RBI and SEBI and
MCA have committees set up for collaboration and co-ordination. Moreover legal
design of SEBI Act allows it to license, supervise, investigate and enforce
through clear legal provisions. SEBI appointments are independent, and the
objective of SEBI is narrow and focused on only regulating securities market.
This contrasts with even RBI which has roles from managing inflation, to ensure
low cost of capital for government to stabilize exchange rates etc. A multi-objective regulator generally is a bad
idea as it chokes capacity and brings inefficiency and arbitrariness.
In conclusion, a
predictable, lesser compliance requiring, low tariff regime governed by
independent regulators which have transparent and clear focus is a necessary
condition for India to prosper in the medium term.
References:
1 1) https://www.businesstoday.in/india-at-100/story/regulatory-cholesterol-1536-laws-govern-doing-business-in-india-345719-2022-08-26
2) 8 Reforms To End India’s Regulatory Cholesterol - India Employer Forum
5 5) India mandates licensing for laptop, tablet imports in blow to Apple, Samsung | Reuters
6) 6) India - Import Tariffs | export.gov
7 7) https://www.annualreviews.org/doi/pdf/10.1146/annurev-economics-021622-020416
9) 9) https://www.oecd-ilibrary.org/docserver/b335b35d-en.pdf?expires=1707052505&id=id&accname=guest&checksum=763D44AAE2F93D81BB7470364E25E9FE
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