A decade is a long time. It took about ten years for a European Space Agency probe to reach a comet some 316 million miles away. It took almost the same time to widen the 50-mile Panama Canal to accommodate a new generation of supersize ships. In Homer’s epic poem, the Odyssey, the hero Odysseus spends a decade getting home from the Trojan Wars.
In modern-day India, it took ten years to get a law passed. Earlier this month, the Rajya Sabha, the upper house of Parliament, finally approved the Constitution Amendment Bill for Goods and Services Tax (GST). Palaniappan Chidambaram first proposed a nationwide goods and services levy in his 2006 budget speech, when he was Finance minister of the Indian National Congress government. He set an April 2010 deadline for implementation.
Congress is no longer in power, but the ruling Bharatiya Janata Party is pursuing one of the most ambitious reform programs in the country’s history, one that includes adoption of the GST. Prime Minister Narendra Modi won election two years ago largely because of his track record of managing the economy of his home state of Gujarat.
The GST breakthrough is important because people have been disappointed by the pace of reform. The tax is regarded as a key test of Modi’s ability to deliver on his promises. Following on the heels of new bankruptcy legislation announced in May, another step forward that will eventually help India’s government-linked banks repair their balance sheets, the news on GST is a big boost for Modi.
The bill secured the support of an upper house that’s controlled by the Indian National Congress, now the main opposition party. Party politics is a major stumbling block to faster progress on reforms, but compromises from both sides led to consensus. The Indian National Congress has seen its majority in the upper house eroded, and its position against the tax was increasingly untenable amid widespread support for the levy from other parties.
The tax is also important for India because, once fully implemented, it unifies a number of indirect taxes into one levy, enhancing efficiency. Tax compliance is likely to improve, resulting in a broadening of the tax base. Moving goods across state lines will be easier, leading to logistical benefits. The economy stands to gain from improved export competitiveness, investment should receive a boost from a lowering of the cost of capital goods, and a simpler tax code will make doing business easier.
The short-term economic effects are harder to pinpoint. Beyond the immediate improvement in sentiment, it will take at least two to three years before anything tangible materializes. That’s because further votes need to be cast at both the federal and state levels. The infrastructure to enforce the tax needs to be set up, while crucial details — such as the GST rate and dispute resolution mechanisms — have to be worked out.
All this makes meeting the government’s April 2017 implementation deadline very challenging. Depending on how GST is implemented, estimates that the levy could boost economic growth by 0.9 to 1.7 percentage points may fall short.
Nevertheless, this shouldn’t detract from what has been achieved. For a start, it’s a sign that Modi’s slow-and-steady approach to reform is making headway. It’s proof that India’s large, boisterous and often messy democracy isn’t an insurmountable obstacle to change. It also serves as a reminder of why India is one of the more attractive emerging markets.
Taken in conjunction with other reforms, the proposed GST adds to a growing body of evidence that argues for a fundamental reassessment of the risks and rewards associated with the Indian market — a so-called rerating.
Although there’s a risk that GST will accelerate inflation over the short term, other structural reforms — inflation-targeting by the central bank and building better infrastructure to improve food supply — should help control price rises in the long run. If that’s the case, assumptions about interest rate levels, and hence bond yields, will need to change.
Ten years is a long time. If you have been investing in India as long as we at Aberdeen Asset Management have, you know that nothing there happens overnight. But you also know that the market rewards those who are patient.
Kenneth Akintewe is senior investment manager, fixed income (Asia-Pacific), at Aberdeen Asset Management in Singapore.
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