The recent reforms implemented by Prime Minister Narendra Modi’s government are transforming India’s economy. Already seen as an appealing emerging market to many North American investors, Modi’s demonetization and tax policies have the potential to push India’s already booming economy onto another level. For investors, it’s a market that presents some interesting opportunities.
As part of the demonetization reform, the government took all 500 and 1,000 rupee notes out of the system and replaced them with new 500 and 2,000 rupee notes. Although the removal of the old notes created something of a liquidity crunch, the long-term benefits of the move are expected to far outweigh the short-term pain. “Demonetization will play an important role in formalizing the Indian economy,” says Atul Penkar, Head of Offshore Equities at Birla Sun Life Asset Management.
Implemented on July 1st
of this year, the introduction of GST will be the “biggest reform in the history of India,” according to Penkar.
“If you look at the tax structure in India it’s highly complicated; there are different taxes at the federal, provincial and local levels, but GST simplifies and unfolds everything into one system,” Penkar says. “Both reforms have clearly caused some disruption in the short-term but in medium and long-term, the benefits will be immense.”
The reforms will play a key role in reducing tax evasion, which is currently rife in India. The average tax to GDP ratio in emerging markets is around 21%, but in India that falls to 17%. In most OECD nations, the ratio is around 27 – 28%. “There are currently sectors that have many companies that operate on a cash basis and don’t pay taxes,” Penkar says. “Even if the tax to GDP ratio moves to 20%, it will give the government a lot to invest back into the economy, possibly in terms of project development or other social schemes.”
The reforms will level the playing field between unorganized companies who operate on a cash-only basis and organized firms who run their companies in line with regulations and file the appropriate taxes. Those organized companies, who are often listed, stand to benefit from the reforms as they gain market share from the unorganized segment.
“The sectors that will benefit most will be consumer staples and consumer discretionary because we are seeing significant demand,” Penkar says. “These companies will also make big savings on logistics costs. Under the current complex tax structures, the manufacturing units of many firms are located in areas that had tax benefits but were not necessarily near to the business operations."
"The one nation tax structure under the new GST reform will mean companies move manufacturing units close to where markets are, which will create significant savings.”
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