Policy uncertainty

Macroeconomic stability and policy certainty are important determinants of investment as businesses are not inclined to invest in an environment of economic and policy instability. Over the last few years, India has done well to reduce uncertainty, but some decisions, particularly in the latest Budget, can undermine the benefit. 

At the macro level, for instance, the adoption of the flexible inflation-targeting framework has helped anchor inflationary expectations. This is important because it will not only help strengthen macroeconomic stability but also enable businesses to make better longer-term forecasts. Price stability, among other things, can be expected to bring down the cost of capital over time. Similarly, the goods and services tax has significantly reduced complexity in the indirect tax structure, though some of the implementation issues are still being addressed. Further, the Insolvency and Bankruptcy Code is helping resolve stressed assets and will improve credit culture in the Indian economy. Although some of these reforms implemented in recent years are still a work in progress, at the net level, they represent a significant forward movement and will improve the business environment. 

Unfortunately, some of the other decisions of the government have only helped in increasing uncertainty. The Budget is a case in point. What is surprising is that the Economic Survey, presented a day before the Budget, underscored the importance of maintaining policy certainty and noted: “…a poorly drafted law that is riddled with ambiguities, amendments, clarifications and exemptions… such uncertainty can spook investors and spoil the investment climate in the economy.”

But the Budget ended up increasing complexity and uncertainty at multiple levels. For instance, investors require stability and predictability in tax rates. But by suddenly raising the income tax surcharge for super-rich individuals, the Budget not only increased complexity in the tax structure but also affected foreign portfolio investors (FPIs), investing as non-corporate entities. That’s not all. It was first reported that the government will issue a clarification on the subject, but it later decided that it was not necessary. As investors look at post-tax returns, some of the FPIs might consider moving out of India. Among other stakeholders, with an ambitious disinvestment target, this will also affect the government.

Further, the government again decided to increase import duty on a number of items with a view to protecting domestic industry. Aside from affecting consumers, it will hurt India’s chances of getting into the global value chain, which is extremely important if India intends to increase exports. Multinational companies would be reluctant to work with Indian firms or invest in India if tariffs are regularly revised. Another example is the policy push towards electric vehicles. The Budget, for example, gave tax benefits to individuals buying electric vehicles. Containing air pollution is a worthy goal, but the government should not pick winners, as it puts the rest of the ecosystem in the sector at risk and increases uncertainty. After laying the ground rules, the government should allow the market to decide. 

There are other areas too. The government has been claiming from day one that its priority is to improve ease of doing business. But the Budget proposal authorising customs officers to detain a person for verification in the interests of revenue or for preventing smuggling has serious scope for misuse. Such measures would only increase uncertainty. The government should consider long-term implications of its decisions, taken to meet short-term objectives such as revenue targets.


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