Effective regulations as the lynchpin for growth

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TAPONEEL MUKHERJEE | 15 Dec, 2019
The importance of an effective regulatory mechanism for a conducive business environment cannot be over-emphasized. As India looks to push consumption and investments further up, a renewed focus on improving the regulatory framework will help the business climate significantly.

The recent decision of the Government of India to approve an amendment to the Insolvency and Bankruptcy Code (IBC) to protect successful resolution applicants from criminal proceedings against offences committed by previous managements, will undoubtedly assist the bankruptcy resolution mechanism in India. Not only will the amendment help in generating greater trust amongst the existing investors, but it will also make the bankruptcy markets in India more attractive for larger pools of capital that have so far sat on the side-lines.

Fundamentally speaking, the amendment to the IBC is an example of a regulatory change that builds trust in a mechanism to not just unlock new pools of capital but also reduce the time required for bankruptcy resolutions, thereby eventually improving the recovery rates for the creditors involved. The eventual aim of a bankruptcy process is to maximise recovery value for creditors. The amendment to the IBC mentioned above, achieves the same through both accessing greater pools of capital and reducing the time required for the resolution process.

Reportedly, the central government is considering laws to protect global investors from contract renegotiation midway through contracts. This law must protect not just global investors, but all investors in general. India's need to channel its domestic capital into investments is as critical, if not more, than attracting global capital. The aim of the regulation must be to ensure that contracts such as power purchase agreements (PPAs) cannot arbitrarily be re-negotiated midway through the contract period.

While moral hazard and corrupt practices must be ironed out of any auction system, a capricious regulatory climate is highly problematic for India and investors alike. Even as discussions around regulations for large scale infrastructure dominate headlines, the focus on further simplifying the GST regime has also picked up momentum. To indeed provide India further economic growth momentum a focus on both formalising the economy and yet providing SMEs a conducive business environment is vital. Given the gargantuan size of the economy and the complexity of the financial ecosystem in India, any change has significant impacts on the system. The aim of the GST system to formalise the economy and bring in a more substantial portion of the economy in the tax ambit is both required and commendable. However, greater thought is needed around the intricacies of the regulation.

A fundamental issue that small businesses face anywhere is a lack of access to credit, especially working capital. The real challenge for policymakers is to come up with mechanisms that allow for boosting tax collection and yet not upset the apple cart. An example in point is the recently introduced GST provision that "a buyer may satisfy all conditions to claim input tax credit (ITC) but will only be able to claim 20 per cent of the credit available in respect of invoices uploaded by suppliers" is one that needs to be reflected upon. Essentially the provision implies that till a supplier uploads the invoices, only 20 per cent of the invoice value can be claimed as ITC by the buyer. The primary aim for the tax department to enforce this regulation is to prevent the fraud and misuse of ITC in the system, and a crucial one at that, but such a provision is a double-edged weapon: it can concurrently hamper the working capital cycle of businesses.

More disturbing is the question that arises, namely, if the government cannot ensure compliance regarding uploading of invoices and ITC availability, how would individual businesses guarantee the same compliance from their vendors? While curbing frauds around ITC is necessary to plug leakages in the GST system, but placing the onus of compliance of vendors on individual businesses will impede the ability of the GST regime to spur growth and participation. While creating regulations that ensure tax compliance while improving business conditions isn't necessarily easy, India must look to incentivise and encourage its SMEs to indeed spur further growth.

Effective regulations will deliver growth for both large corporations in bankruptcy courts and small businesses being brought under the ambit of the GST. At a fundamental level, the regulatory changes to the IBC or issues around GST ITC are focused on improving the quantity and quality of credit availability in the economy. Easier and lower-cost access to credit will be the result of effective regulations, thereby allowing more significant investment and consumption. If creditors can get more substantial amounts of recovery value in lesser time from bankruptcy courts, this means the same creditor will be able to lend the money on in the economy, thereby boosting the credit cycle. Hence, an eagle eye on effective regulations in India is critical moving forward.