IT WAS THE reforms of 1991 that set the ball rolling for friendlier regulations in India. With the promise of growth and competition came the fear of unfair trade practices. Stifled businesses were expecting a breather. But since then, the regulatory environment has not really enabled the smooth functioning of companies, which are increasingly being burdened by procedural and compliance issues. From the fog around the Goods and Services Tax (GST) to restrictive nature of the housing regulator to tinkering with governance structures of high-performing companies, regulators need a rethink. But is there really a gold standard of government regulation? A size that fits all? Here is a case study:
In 2013, the Indian Air Force (IAF) had a tough time arranging for plane tyres. The global recession of 2008 had still not ebbed and procurement wasn’t easy. The IAF was even forced to use tyres from its war reserves. It is at this juncture that a family-owned, homegrown tyre maker got clearance for military airworthiness and began producing the main wheel tyres for frontline Sukhoi (Su-30 MKI) fighters. The tyres were 30 per cent cheaper than the imported ones, and the company even took on the responsibility of design, development and quality tests. Homegrown production has ensured that the IAF no longer has to stock large volumes; instead of keeping stocks for three years, now six months is sufficient, further boosting the ‘Make in India’ initiative in the aerospace industry. There are numerous such examples where family-owned businesses have responded to the nation’s call in times of crisis, and therefore, have a special place in India’s economic story.
But now comes the problem of textbook corporate governance ideas.
SEBI’s Theory of Relativity
While the tyre maker’s bid outlines the contours of how a family-run business over three generations can successfully work in tandem with the defence industry, it clearly goes against what capital markets regulator Securities and Exchange Board of India (SEBI) ruled last year—that the chairperson of the top 500 BSE listed companies should be a non-executive director and not related to either the CEO or MD of such companies. It’s certainly not compatible with India’s family-owned businesses where the directors are as much accountable to the shareholders as to the family. But it is no heresy for a business to be owned by a family yet perform well. As is the case with the tyre maker. Besides, 73 per cent of the top 500 BSE-listed companies are family-owned, so the chairman is all but paterfamilias of the clan and he is very unlikely to be the almost unknown outsider that SEBI wants him to be, from early next year, as per its amended Listed Obligations and Disclosures Requirements Regulation. Under this rule, the managing director must be unrelated to the chairman.
SEBI is thus bent on rolling out corporate governance codes with global ‘best practices’, all modelled on the code that Adrian Cadbury rolled out in the 1990s. It was to be adopted by Britain, the European Union and the US. Framed in an era marked by cheap money and insider trading—Greenspan was the US Federal Reserve chief and Mike Milken had just been sent to jail—it undoubtedly had a historic role. But it obviously had its drawbacks, as it could not prevent the onslaught of a global recession in 2008 nor could it stop manufacturing from bidding goodbye to the Western world to relocate in China, a country where corporate directors are appointed not so much by shareholders’ approval as by that of the Communist Party. For a country like India, with thousands of years of trading and commercial tradition, the Cadbury model was unsuitable. The Confederation of Indian Industries (CII), the apex chamber of commerce, has argued with SEBI that the chairman and MD of Indian family-owned companies are often closely related as the family holds most of the capital, often in excess of those held by individual shareholders and large public corporations.
Though the market regulator has hit the right note by ensuring power does not concentrate in one person’s hand, the move has the potential to disrupt board structures and can severely impact a company’s image, particularly in India, where family-run businesses account for 85 per cent of all companies. Indeed, the regulator could play a constructive role by working out a mechanism to open markets without overlooking the need for corporate governance.
The GST Conundrum
Like SEBI, the GST Council too has to understand the pains some of its regulations are causing businesses. On October 9th, the council notified new rules under Section 43 of the GST Act that restricts the refund of input credit to 20 per cent of the claimed amount if suppliers fail to upload correct details in the GSTR 1 Form on the GSTN portal. (A producer is refunded ‘input credit’ for the taxes it pays on purchase of items that go into production.) Though the move came in the wake of burgeoning fake GST invoices to claim input credit, there is little clarity in the new law and businesses are in limbo. “Though the intention of the Government is to plug cases of fake transactions, almost 99 per cent of businesses indulge in genuine transactions and they will suffer because it will impact on their cash flows and they will also have to deal with procedural and law-related ambiguities of operationalising it to deal with compliance of the law,” says Abhishek Jain, Partner, EY.
“The GST is a simple tax structure, however, with certain overlaps and pre-GST duty structures. There is need for the GST Council to relook at some of the mechanisms which currently block working capital for multiple industries,” says governance reform expert Rameesh Kailasam.
In February this year, a clutch of telecom firms approached the Government to seek relief by adjusting Rs 35,000 crore worth of excess GST credits in lieu of deferred-payment obligations, licence fee and spectrum charges. Operators feel that in the last two years, though their capex has gone up substantially, revenues have nosedived by about 30 per cent, creating a mismatch in output liability and input credit. Much of the mismatch is due to the excess GST credits. ‘Such a situation has led to blocking of approximately Rs 35,000 crore of operators’ capital in the form of excess GST credits,’ Cellular Operators Association of India wrote in a letter to the then Telecom Minister Manoj Sinha. Today, the Government is taking the lion’s share of telecom revenues—from 29 per cent in 2007-2008 to 60 per cent in 2017-2018.
Even online portals, particularly e-commerce travel operators, are facing the heat on GST. According to the Central GST Act, an e-commerce operator (ECO) has to have a physical presence in the taxable territory. Ordinarily, such operators, by virtue of their digital prowess, operate out of a single office which can be located anywhere in the country. But multiple registrations are causing additional pain to the sector and also creating a mismatch with foreign operators doing business out of India, to whom GST does not apply.
So in India, ECOs such as Makemytrip and Yatra have to set up an office in every state and Union Territory, keep an army of accountants and incur huge administrative and compliance costs. “Such regulations unknowingly bind innovative online companies with multiple issues, which can only be solved by easing such regulations. The issue of uneven playing field that Indian OTAs [online travel aggregators] face is easily solvable by putting a centralised GST collection mechanism in place,” explains Kailasam. At the same time, such a move will be in sync with the all-encompassing ‘Digital India’ drive.
India’s regulatory institutions are often arthritic in responding to changes in the technology landscape. In recent times, the advent of 5G technology is poised to trigger a raft of new services, like cloud-based computing and, probably, the Internet of Things. All this brings into focus the criticality of telephone tower and the need for sufficient diesel to keep power supply uninterrupted for the transponders placed on it. The GST law restricts input tax credit on telecom towers. The Delhi High Court has, in relation to the petition of Vodafone, allowed credit on towers. But the regulator must wake up, as the future world will greatly rest on 5G connectivity and its carrier towers.
Again, internet-based startups in the textiles industry are caught in the GST net and saddled with an inverted duty structure. While the Government has levied 5 per cent GST on clothing items (the final product) below Rs 5,000, any textile business has to account for other expenses, such as marketing,
warehousing, logistics, courier etcetera, which attract 18 per cent GST. Startups operate under thin margins and delays in release of input credit hits working capital flows. The sooner the Government smoothens the refund mechanism, the easier it will be for entrepreneurs to manage cash flows.
Undoubtedly, there is need for the Government to ensure that the GST becomes smoother and conflicts among provisions are resolved. There must be a collaborative effort towards making the ‘One Tax, One Nation’ process simpler ensuring the ease of doing business across the country.
The RBI Fix
While the Reserve Bank of India (RBI) is busy fixing the problem of failing banks, regulatory roadblocks such as liberalised remittance scheme (LRS) requirements and know your customer (KYC) details are driving away foreign-bound customers from Indian travel companies to foreign portals. The central bank has made it mandatory that domestic OTAs furnish their clients’ KYC details, including PAN and tax number, which is then shared with the financial investigative unit, and, depending on the purchases, action may be taken. This alone explains why most Indian travellers going abroad nowadays prefer foreign OTAs.
Perhaps the RBI also needs to look at its rule capping the age limit for chief executives of private banks at 70 years. Though under the Companies Act, banks that are also registered companies can continue with chief executives older than 70 by passing a special resolution, the central bank has refused to relent on its guidelines. This has set the stage for some top bankers to hang up their boots. Aditya Puri, the CEO and Managing Director of HDFC Bank, will now have to retire in October and Romesh Sobti, the IndusInd Bank chief executive, is slated to do so by March-end. Though many bankers argue that the RBI should align the norm with the Companies Act that allows CEOs to continue till 75, the central bank contends that 70 is a reasonable age for a private bank honcho to step down since banking is a high-pressure job. In the last 25 years, under the leadership of Aditya Puri, HDFC Bank has proven its mettle as the largest private sector bank in the country with 8.4 per cent market share and a market capitalisation of Rs 6.3 lakh crore.
Financial players, as much as banks, can breathe easy if procedures are more conducive. For starters, the central bank needs to realise that its stringent requirements are a fillip to international OTAs, not local ones.
IRDAI in the Web
Similarly, the Insurance Regulatory and Development Authority of India’s (IRDAI) rigid structures are coming in the way of the sector’s growth. Insurance, as is well known, is not ‘a matter of solicitation’. Rather, it is the motivation to sell insurance products that keeps the trade going and this needs to be incentivised at the last mile—think sub-agents, brokers and commission agents.
While the authority needs to dwell on this, it also has to dispel the impression that businesses procured online have lower costs. For online players, the costs of marketing, technology, logistics, search engine optimisation and analytics are fairly high. Online term prices have already fallen owing to competition. If insurers are allowed flexibility in remunerating efforts adequately, it will fuel growth of digital sales, mostly concentrated around protection products like term and health insurance.
In the housing sector, after the Real Estate Regulation and Development Act (RERA) came into effect on May 1st, 2017, RERA became the sector regulator and got access to all project information, like master plans, floor area, maintenance of standards and certification. Among the punitive provisions is one which lets the regulator deregister a project if the builder defaults on promises made at the time of launch. It was meant to act as a deterrent for fly-by-night builders who shortchanged customers. But, in the real-estate framework, only the builder and the homebuyer are kept and all others in the ecosystem are left out. “Development authority, consultants and contractors are not covered by RERA. If they’ve not done their duty, they should be held accountable too,” says Rohit Raj Modi, Director, Ashiana Homes.
While RERA has done well by coming up with a recent ruling for builders to park 70 per cent of the funds collected from buyers in an escrow account, implying that these funds can only be withdrawn for the specific project for which these were collected, giving more emphasis on timely delivery of dwellings, the housing regulator needs to do a lot more by bringing every stakeholder in the sector under the ambit of law—not just the builder and the homebuyer.
The liberalisation of the Indian economy in the early 1990s was expected to reduce the overbearing hand of the state. It would, the expectation was, play a more managerial role. But the rise of the regulatory state in India has far from limited its power. The country’s hazy regulatory framework is burdening domestic businesses despite the country climbing 14 positions over last year in the World Bank’s Ease of Doing Business index to 63.
Experts have begun doubting the index, which surveys only Delhi and Mumbai, and claim that it is not a true representative of the country. “India’s position in the Ease of Doing Business may look rosy across parameters but there is room for significant improvement in registering properties, starting a business and enforcing contracts,” says Danish Hashim, Head, Ease of Doing Business, CII. But nearly a decade ago, when a survey was done on the most overregulated countries of the world by Hong Kong-based Political and Economic Risk Consultancy, India led, scoring 9.16 points on 10, followed by China. Ten years later, it’s time to check if India still leads the world with iron regulations.