POSITION PAPER2016

POSITION PAPER 2016

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Edited and Supported by:

Publisher:EBG Federation, India

Promote, Propagate and Safeguard European Business Interests in India

2nd Floor, Building No. 6 | Okhla Industrial Estate | Okhla | New Delhi 110 020Tel: +91 98 11 41 88 74 | Email: gm@ebgindia.com | Website: www.ebgindia.com

POSITION PAPER 2016

Disclaimer

This Position Paper is a collective expression of the views of the members of the EBG Federation and its knowledge partners on key aspects of the business environment in India that affect the development of India-EU business relationships.

The views expressed in each chapter are generally in conformity with the views of EBG Federation. Information in this Position Paper is therefore intended for general guidance only. The views and recommendations put forward in this Position Paper are proposed only to stimulate discussions and offer suggestions to make Indian business environment more competitive. Whilst efforts have been made to ensure that the information contained in this Position Paper is accurate to the best of our knowledge, EBG Federation and its Knowledge Partners namely BMR Advisors, Ernst & Young, Grant Thornton, KPMG and PwC does not assume any liability or responsibility for the outcome of any decision taken by any reader on the basis of this position paper.

This Position Paper is intended for and is strictly for the use of members of EBG Federation and other interested parties. Its contents shall not be reproduced in whole or in part without the prior consent of EBG Federation.

The exchange rates for the purpose of conversion are based on the exchange rates prevalent in the period of March-April 2016.

ACKNOWLEDGEMENTSCONTRIBUTIONSPosition Paper 2016 - Edited by BMR Advisors

Expert Review: Mukesh Butani, Managing Partner, BMR Legal & Senior Advisor to EBG National Council

Introduction: Dipti Chawla & Jyoti Bhowmick, BMR Advisors

EBG acknowledges the support from our knowledge partners.

Sector Papers contributed by BMR Advisors• Banking & Financial Services – Bobby Parikh & Jimit Shah

• Chemicals & Petrochemicals – Ashutosh Dikshit & Tushar Aggarwal

• FMCG – Kaustuv Sen & Bhupender Singh

• ICT & Innovation – Mahesh Jaising & Jayashree Parthasarathy

• Oil & Gas & Power – Gokul Chaudhri & Sumit Singhania

• Retail – Sumeet Hemkar & Jitin Asudani

Sector Paper contributed by PwC• Homeland Security – Pankaj Khurana & Ashutosh Sharma

• Defence – Dhiraj Mathur & Rajiv Chib

Sector Paper contributed by Grant Thornton• Alcoholic Beverages – Prashant Mehra & Akshay Deshraj

• HealthCare – Vrinda Mathur & Sowmya Ravikumar

Sector Paper contributed by E&Y• Automotive – Rakesh Batra

• Agro Chemicals – Paolo Prisco & Sven Brandelik

• Real Estate – Gaurav Karnik & Abhishek Arora

Sector Paper contributed by KPMG• Aviation – Amber Dubey

Our very special thanks to all the sector committee Chairs/Co-Chairs and Members for their valuable time and inputs. The Logistics and Telecommunication paper has been put together by the Sector Committee members themselves and does not have a knowledge partner.

An introduction toEBG FEDERATION IN INDIA

EBG Federation was established on 11th March, 2015 as a Section 8 company under the Companies Act 2013 in order to ensure long term stability and broaden its sphere of activities offering support and advocacy for European businesses in India. Founded as the European Business Group (EBG), in 1997 as a joint initiative of the European Commission and the European Business Community in India, EBG has come to be recognized by the Indian Government and the European Commission as the industry advocacy group representing the interest of European

companies and Indo- European Joint Ventures in India.

EBG Federation is supported by the Delegation of the European Union to India and works towards promoting, propagating and safe guarding European business interests in India. The EU Ambassador is our Patron.

Currently EBG Federation has Chapters in Delhi, Mumbai, Bangalore and Chennai with approximately 170 companies as Members.

The primary objective of EBG Federation is to actively support growth in India-EU trade relations, and become the most relevant advocacy Group for European business in India and ensure that the needs of European business are well presented to policy and decision makers.

Every year the EBG publishes an influential “Position Paper” which highlights the group’s views on policy. The European Business Group (EBG) Position Paper is a collective expression of the views of the members of EBG and supported by knowledge partners on key aspects of the business environment in India such as ‘ease of doing business’. The EBG Position Paper proposes key policy reforms that will be conducive to the growth of business and what we believe are in the realm of possibility for the Indian Government to put in place.

The 2016 edition of the EBG Position Paper will cover the following key sectors, including Agrochemicals, Alcoholic Beverages, Automotive, Aviation, Banking and Financial services, Chemicals & Petrochemicals, Defence, Energy- (Oil & Gas, Power), FMCG, Healthcare, Homeland Security, ICT & Innovation, Logistics, Real Estate, Retail and Telecommunications.

EBG FEDERATION

Message from Mr Raman Sidhu, FCA

Chairman, EBG Federation, India

EBG Federation, India, the erstwhile European Business Group (EBG) functions as the focal advocacy point for companies, which represent European Union (EU) business interests in India. EBG Federation, aims to promote Europe as India’s most preferred business partner thus creating an environment that allows European Business to flouris . It is intended that the initiatives and activities undertaken by the EBG Federation should complement and reinforce those of EU member states, EU business groups and EU diplomats.

Its principal objectives are:• To facilitate and promote European businesses in India in achieving

their business and investment goals• To improve trade and business relations, between the EU and India for mutual benefit and to further their

interests and ease of doing business• To partner with India in its progress towards realising its full growth potential

Over the years, EBG has been publishing an Annual policy document, the EBG Position Paper which has today emerged as an important document that reflects the diverse presence of European companies in India and the state-of-art technology which they bring in the different sectors that they operate in. The purpose of this document is to enable the EBGF to express the views of its members on some key aspects of the business environment that prevails in India that has a direct bearing on the ease of doing business in the country and recommend solutions which are in the realm of doability.

This paper acts as the base document for the next 12 months and intends to facilitate discussion with the relevant Ministries of the Government of India and other relevant stakeholders to seek action on the issues raised. EBGF believes that by opening a dialogue on these issues further progress can be made to resolve differences and enhance EU-India business relations to benefit both partners

EBGF has always played an instrumental role in advancing business interests of EU Corporates and EU-India Joint Ventures.

I am delighted to present to you EBG’s Position Paper 2016 which covers 17 key sectors, including Agrochemicals, Alcoholic Beverages, Automotive, Aviation, Banking and Financial services, Chemicals & Petrochemicals, Defence, Energy- (Oil & Gas, Power), FMCG, Healthcare, Homeland Security, ICT & Innovation, Logistics, Real Estate, Retail and Telecommunications. This is the 14th Position Paper in the Annual Series. This year’s paper sees an inclusion of 1 more sector coverage over the last year – Agrochemicals.

EBGF maintains, along with the EU Delegation to India and EU agencies a continuing dialogue with Government of India and its agencies to pave the way for a smoother progress for this most important EU-India partnership. EBGF thanks the EU Delegation and other EU Country Missions and Government of India for their support in our endeavors. I also thank the EU Heads of Misison for giving us their support through their message for this Position Paper which finds a pride of place in this document

Chairman’s message

EBG Federation is very grateful to its Chapter Chairs, Sector Committee Chairpersons, Co-Chairpersons/Members and Ms Neema Sunil Kumar, General Manager of the EBG Secretariat as well as its knowledge partners who with great dedication, commitment and valuable personal time inputs have helped the sector committees put together this Position Paper 2016. A very special thanks to BMR Advisors and Mr. Mukesh Butani for their valuable inputs and for editing this Position Paper. EBG expresses its sincere thanks to Ernst & Young, Grant Thornton International, KPMG and PwC for fully supporting us for certain sector papers as our knowledge partners.

I wish this Position Paper, 2016 and the sector committees which have authored them, all success.

Message from Mr. Mukesh Butani

Managing Partner, BMR Legal & Senior Advisor to EBG National Council

I congratulate the European Business Group, India, on successful release of its 2016 edition of annual compendium of Position Paper on various sectors of Indian economy which are of pivotal interest to EU investors.

Over past several years, EBG’s interactions and engagement with Indian policy makers has contributed significantly towards evolving business and investment opportunities for businesses in the EU, India’s most significant trade & investor business partner. Prime Minister Modi’s Visit to Germany, France & UK in 2015 is suggestive of the importance the Indian Government attributes to bilateral strategic dialogue between India and EU nations. EBG India has played an instrumental role in bringing together interests of the European investors, representing their views on Indian policy & regulations to shape public policy & foster ease of doing business, a tagline of the NDA government. From India’s macro-economic standpoint, the government’s endeavors is clearly to set out an unequivocal policy direction and usher fiscal & economic reforms for sustained economic growth. It is natural progression thus, that the European investors and businesses are gearing to explore new opportunities for extending know-how and technology, facilitating infrastructure development, overhauling supply chain to build efficiencies, creating job opportunities, increasing competitiveness and enhancing skill development. Interest of EU businesses are naturally aligned to Governments flagship programs such as Make in India, Digital India, Skills India, Startup India and are looking to participate in India’s success story.

At recently concluded 13th India-EU summit in Brussels, India was remarkably led by our dynamic leader Prime Minister Modi, as the summit witnessed unveiling of the EU-India Agenda for Action 2020 – a concrete roadmap to jointly guide and strengthen the India-EU Strategic Partnership over the next fiveyears. The agenda hinges on a wide range of areas for cooperation on foreign and security policy, trade and investment, economy, global issues such as environment and people to people engagement. More importantly, the summit coupled by recent announcements, reflects a serious resolve to kick start the stalled negotiations for free trade agreements.

In this dynamic policy landscape, inputs sought to be provided by EBG Position Paper 2016 will make an impact on credible policy exercise and aligning interest of EU businesses with overall regulatory and policy endeavors of the government.

Having said that, Indian regulators and the EU bloc have been working at developing closer bilateral ties to identify new areas of cooperation. EBG Position Paper is a step forward in that direction to bridge the gap. The paper aims to set the context in advocating policy reforms necessary for deepening the economic and business relations that two sides share, given the increasing involvement of EU business interests in India. I anticipate that the 2016 edition of policy paper shall pave way for a continuing dialogue between EU businesses and India policy makers & regulators to address impediments to trade & investments

I wish to convey my appreciation for getting an opportunity to lead an important initiative.

Kersi Hilloo

Chairman – EBG Federation, Mumbai Chapter

Vice Chairman – EBG Federation, India

This 14th edition of the Position Paper 2016 comes at an opportune time when the Central Government is accelerating its push towards liberalization and ease of doing business in India, and taking several initiatives to attract foreign partners. A case in point is the “Make In India” initiative taken by the National and Maharashtra Government recently when several millions of dollars’ worth of MOUs have been signed.

Further, a Road Map has now finally been laid out by the chief negotiators of the EU-India Free Trade Agreement, and we think that this Position Paper will go a long way in giving some insights to the negotiators. As always, our primary focus in EBG continues to be on ‘advocacy’ and strengthening partnership between

India and EU companies.

Rekha Khanna

Chairperson – EBG Federation, Delhi Chapter

It is an honour and great pleasure, as the new Chairperson of EBG Delhi, to express my sincere gratitude to our Sector Committee Chairpersons, Co-Chairpersons and Members for their active and valuable contribution

to our yearly Position Paper.

EBG has gone through a number of significant changes in the past year, emerging stronger than ever with a well – defined agenda to be the most effective voice of European business in India. A number of impactful meetings have been organized with key policy and decision makers ensuring that our Members issues/needs are well understood. This business driven agenda will inform and motivate all our actions moving forward so that EBG can deliver sustained value for its Members.

The 14th edition of the EBG Position Paper once again highlights the breadth and depth of EBG membership and European business presence in India. It effectively showcases the crucial role that European companies play, their requirements, the path to enhance their contribution even further and the great work done by the different Sector Committees The Position Paper plays a critical role, providing an effective platform for

information, discussion and future action.

We believe that EBG does, can and must play an increasingly pivotal role in the dialogue between European business, the authorities in India and all vested stakeholders to further develop this vibrant partnership for the benefit of all. The Position Paper is a unique expression of what is and what can be to sustain the strong link between India and the European Union as major business and trade partners.

Our goal is identify and support relevant ways to enlarge the scope of partnerships, with EBG’s Position Paper as a key instrument, for development and growth across sectors.

Anandi Iyer

Chairperson – EBG Federation, Bangalore Chapter

I am delighted that the European Business Group has continued with its tradition of putting together the Position Paper. This has indeed become a very valuable document for the Indo-EU cooperation highlighting relevant and critical challenges and opportunities for both sides so that the Policymakers can help facilitate greater economic cooperation. In fact, this seminal document is now the cornerstone of our intelligence on the basis of which we devise our programmes and activities for the promotion of the EU businesses in India.

The Bangalore Chapter leads the Sector Committees on Innovation and ICT, and as is our past practice, BMR Group particularly Jayashree and Mahesh Jaisingh have supported us incredibly since our inception to make our recommendations extremely focussed and also pitched in with important inputs on Taxation.

Innovation is the engine which catalyses growth, differentiates one company or even a nation from its competitors and finally helps the entity to achieve pole position. Europe is the hotbed of innovations, while India enjoys an enviable market size, skilled workforce and fantastic growth. Together they can be very important stakeholders in the innovation ecosystem and catapult the relationship to another very important level.

Looking forward to being part of this existing journey, on behalf of the EBG in Karnataka

Michael Berger

Chairman – EBG Federation, Chennai Chapter

It gives me great pleasure to able to represent the members of the Chennai Chapter of the EBG Federation in this Position Paper Year 2016. The past business year, 2015 has been especially challenging in the automotive industry countrywide. The environmental disaster of floods in December 2015 was an additional burden to doing business in Tamil Nadu. The GMI event was a positive development as a lot of the Business Group companies were involved. Our task for 2016 is to integrate the growing numbers of members of EU companies and to resolve and improve outstanding issues as well as expand the EU-India/Tamil Nadu partnership.

Rajeev Gupta

Senior Advisor, EBG Sector Committees & Position Paper

As we are all aware, India has been and remains to be one of the fastest growing economies of the world over the last more than a decade or so.

I though am not sure as to how many of us see the birth of a new India taking place. An India which is GENUINELY Indian and not an imitation of other “modern orders”. I do not know how many of us believe, as I do, that we will in times to come ,see a new India which is for sure bigger, better, stronger, corruption free, peaceful & prosperous than ever before.

Given the mammoth size and numbers, this kind of growth and the fundamental changes that are underway, throws up great opportunities and potential. This also throws up a lot of challenges for the decision makers in terms of channelizing this potential to make it a reality.

It is thus our endeavour at EBG to engage with Policy Makers to further facilitate an environment which results into the emergence of a more vibrant, conducive and powerful India through greater Indo-European trade and collaboration.

These position papers, which are a result of a series of intensive brainstorming sessions involving hundreds of man-hours of some of the best brains available in the business world, in the seventeen key sectors and representing the who’s who of European businesses, is our attempt to draw the attention of stake holders in general & Policy makers in particular to the contributions made by European players in this growth journey of India and the possible corrective actions required in the policies to facilitate higher growth and participation.

We feel that in the wake of the changes & the phenomenon of the birth of a new India, it has become more imperative , to have serious and open discussions from both sides, to come out with innovative solutions which while taking care of National Interests ,can hasten the pace of growth by leveraging the strengths available elsewhere .

The suggestions by way of these Position Papers are thus just the beginning. We are confident that a continued & closer engagement between the two sides would go a long way in creating a win-win for all.

Message from H.E. Mr. Tomasz Kozlowski

Ambassador of the European Union to India

It is a pleasure to present the 2016 Position Paper prepared by the EBG Federation.

I am happy to note that the EBG Position Paper gets every year more comprehensive. This year, one sector has been added: Agrochemicals - this is a very relevant industry for India and the inclusion is welcome. This Position Paper has established itself as an important tool in the contacts between EU industry and the Government of India. I trust that, as it happened in the past, it will be a good basis for fruitful discussions between the competent Indian authorities and EU business.

India is one of the fastest growing economies in the world with a large domestic market. The EU and India have much to offer each other. There is enormous potential for both to benefit from strengthened trade, economic and investment relations. Our shared commitment to research and development can lead the way in producing innovation.

The EU has welcomed Indian’s initiatives to implement Make in India, to promote Smart Cities, to roll out digitalisation plans and to encourage more Start Ups. The EU is increasing its cooperation in many of these programmes through policy dialogues, business and technology engagement, technical cooperation and financial involvement.

The EU continues to be the first trade partner and foreign investor of India. In 2015 economic relations between the European Union and India were marked by stability of trade flows, in an overall difficult global context. India’s impressive economic growth in 2015 attracted attention from around the world, including from many European operators. Against this background, our trade remains balanced, with a small trade surplus in favour of India. But it is high time that these relations shift up a gear to achieve the full potential that closer trade relations can bring to both sides.

As close trade partners, the EU and India have intense and regular contacts on all economic matters. I would like to emphasise that both sides have decided to re-engage in discussions on a possible trade agreement. At the same time we welcome the progress made by India in improving the ease of doing business in the country over the past year and we look forward to this process continuing in 2016.

Since taking up my duties as European Union Ambassador to India last October, I have been able to appreciate EBG’s work in representing the voice of EU companies in this country. A strong clear voice of EU industry in India can contribute to deepening our economic ties, identifying solutions to overcome existing obstacles and unleashing potential. I am pleased that EBG updated its structures and elected new governing bodies in 2015. The Delegation of the European Union in New Delhi is confident that such changes will strengthen cooperation and attract more EU companies to join the EBG Federation.

Message from H.E. Mr. Bernhard Wrabetz

Ambassador of Austria to India

I would like to congratulate the EBG on the release of its Position Paper for the year 2016. As in previous years, this publication is an important contribution in order to promote further progress in the Indo-European business cooperation.

The Austrian Embassy appreciates the good relations with the EBG and its effective networking which opens doors for Austrian companies in the Indian market. In an ever more vibrant economic environment the EBG’s efforts contribute significantly to widen the scope for a strengthened Indo-European partnership for growth and prosperity. The trade volume between Austria and India picked up significantly in the year 2015 and amounts to more than USD 1.4 billion which shows very clearly the beneficial economic relations for both our countries.

The potential to strengthen economic ties between India and Europe is huge, with numerous Austrian companies eager to augment their partnership with India. I therefore reiterate my appreciation for the EBG’s commitment to generate a favorable climate for investment of European companies in India as well as to improve overall business relationships.

Message from H.E. Mr. Jan Luykx

Ambassador of the Kingdom of Belgium to India

I am delighted to welcome this new edition of the EBG Federation Position Paper, even as my thoughts at this moment in time go in the first place to the victims of the terrorist attacks of 22/03 in Brussels and Zaventem.

The Position Paper 2016 comes at a perfect time, shortly after the 13th EU-India Summit, which took place in the Belgian capital on March 30th. I hope this Summit, which was long overdue, will lead to a new momentum in the dynamics between India and The European Union. With the EU continuing to be India’s biggest trading partner, Belgium has high hopes for the enormous potential of growth between the two and for the benefits from a strengthened trade relationship

On March 30th too, just before the EU-India Summit, Belgian PM Charles Michel and Prime Minister Narendra Modi met for bilateral talks. The joint statement which was issued afterwards underscores the dynamic trade and other relations Belgium has with India. The solid bilateral trade figures are for a large part due to the contribution of the diamond trade. But diversification is taking place in the bilateral economic ties as we can see in areas such as i.a. railways, logistics, cleantech, life sciences and the food industry.

Commerce and trade are vital elements in the multi-dimensional relationship between India and the European Union. Through trade our citizens exchange ideas and expertise and help to reinforce the bonds between our continents. In this regard, the Government of India has provided avenues for investment in important sectors such as defense, e-commerce, clean energy, railways and allied infrastructure sectors. The successful fulfillment of these ambitious projects requires expertise, technology, equipment and investments. Belgian and European companies in this regard offer the complete range of skill sets and R&D know-how that are required.

I appreciate the good relations we, as an embassy, have with the EBG. Its active networking opens doors for our firms in the Indian market. In an ever more vibrant economic environment the EBG’s efforts contribute significantly to widen the scope for a strengthened Indo-European partnership for growth and prosperity. I would also like to commend the endeavours of the EBG in publishing its yearly Position Paper. These papers continue to be the best representative of the views of European businesses in India.

Message from H.E. Dr. Demetrios A. Theophylactou

High Commissioner of Cyprus to India

I am delighted to address, on behalf of the High Commission and the Cyprus Government, this 14th edition of the EBG Federation Position Paper. We have been actively engaged in the work of EBG thus far and highly appreciate its systematic efforts to foster closer economic ties and enhance collaboration between India and Europe. This is obviously one of the main channels whereby new synergies and partnerships can emerge for the mutual benefit. We are happy to further engage our private sectors and business community to join the High Commission’s engagement with EBG with a view to promoting Public Private Partnerships. In this context, the Position Paper provides the added value whereby new partners can get on board and inject new ideas into the process.

Undoubtedly, information channels and exchange forums like EBG provide significant venues of cooperation and innovation, where India and Europe can share experiences and best practices. They also open up new opportunities to foster research and development, particularly in innovative sectors where new talents and start-ups on both sides can gain tremendously, both in terms of business and knowledge. In this context, EBG actively helps promote people-to-people contacts, notably amongst young entrepreneurial groups and highly motivated professionals who eagerly look for new frontiers to expand and engage with. India is no doubt a fertile ground for young Europeans, much as Europe no doubt continues to be a sought after destination for Indian entrepreneurs. New initiatives like Make in India create the added impetus to this end.

In order to further articulate this process and chart a clear path for practical and results oriented collaboration, exchanges at the highest level, particularly at Ministerial level, must be increased in frequency and scope. Ministers from Europe are now eager to visit and experience firs -hand what Prime Minister Modi means, in practical terms, when he declares innovative policies such as Start-up India or Make in India. The common objective, on both sides, is to foster growth and promote employment, particularly amongst the youth, though innovation and partnerships. India and Europe can achieve wonders when they work closely together and can maximize the benefits of collaborative work and synergetic approaches in business. It requires additional political will in order to allow the private sector in Europe to reap the benefits, on one hand, of a rapidly growing Indian economy, and on the other, in India to benefit from European industrial and technological prowess, coupled with modern and efficient engineering. Working together is the way ahead, for India and Europe alike.

Message from H.E Mr Milan Hovorka

Ambassador of the Czech Republic

Maintaining great relations and increasing trade and investment cooperation between India and the Czech Republic has been one of my key objectives since my arrival in India in September 2015, and therefore when asked to write a short foreword for the launch of the EBG 2016 Position Paper, I have done it with great pleasure.

India and the Czech Republic have historically kept close ties, both politically and economically. Traces of that can be visible in India through Jawa motorcycles, Bata shops, Škoda cars, Tatra Trucks but also due to complex industrial, machinery and power generation equipment, which played an important role in the past in industrialization of India and contribute today to accelerate economic growth and help expand consumers´ choice. Traditional ties have been kept vital throughout years, but Indian and Czech relations span further.

India has remained an economic island of hope in a sea of uncertainties faced by the global economy. It has been able to restore the robust pace of GDP growth to become the fastest growing among the largest economies in the world. However, the government of Narendra Modi aims even higher and wishes to achieve very ambitious 10% growth rate. In order to fulfill this ambition and reach full potential of the Indian economy, the authorities moved towards broad based economic and social reforms.

The initiative Make in India, one of the economic pillars of the reform program as I understand it, is called to increase industry to GDP ratio and transform India into yet another global manufacturing hub through more investment, opening-up of many industrial sectors to foreign investors, transfer of modern technologies, ease of doing business and creation of new high skill jobs for Indian people.

However, the extent of reform program is much broader and embrace serious efforts to improve business environment, enhance entrepreneurial spirit, help individuals set up their own business, strengthen competitiveness of micro, small and medium sized enterprises, foster digitalization, benefit fully from the 1,3 billion consumer market and deal with pressing social challenges.

The Czech Republic is a highly industrial country, with one of the highest share of manufacturing in GDP not only in the EU, but worldwide. It has a number of companies which distinguished themselves for their professionalism, leading edge technologies, price competitiveness and high level of excellence in a number of sectors targeted by the authorities both at the central level as well as at the level of States, and that are keen to invest time and resources to expand mutually advantageous ties with Indian partners.

I am convinced that all these elements, synergies, mutual sympathies and complementarities position the Czech Republic as an ideal trade and economic partner for India and make compelling case for further strengthening and deepening of their partnership in a number of areas.

To conclude, I greatly appreciate the work of EBG and the annual Position Paper 2016, since I am convinced that it has a positive influence on the reform process in India and therefore contributes to strengthening of cooperation between India and EU member states, including the Czech Republic.

Message from H.E. Mr. Gyula Pethö

Ambassador of Hungary to India

On behalf of the Embassy of Hungary I would like to congratulate EBG Federation on the release of the 2016 edition of the EBG Federation Position Paper. This important document underlines the growing economic, social and cultural interaction between the largest dynamic country in the world and Europe. India has emerged as the next global powerhouse, with growth projections overtaking even China. On the other hand, Central European countries – amongst them Hungary, as the fastest developing one today – are the dynamo which keeps the old continent running, with the highest growth rates in Europe.

Hungary has a lot to offer to India. The burgeoning population, the aspirations of the new emerging middle class, the imperative of new job opportunities, the challenges of the quickly dwindling water supply, the alarmingly high levels of pollution in some cities in India - all these call for immediate solutions which Hungary can readily offer. Many of the countries in our region have undergone tumultuous change in the last 25 years. Using these changes as leverage to growth, these countries have succeeded to transform their economies with very little social unrest, partly due to our rich heritage. And I am not referring only to cultural heritage here. Hungary – for example – has a very long history of innovation in many fields(agriculture, food processing, engineering, water management etc.), it is perhaps enough to mention the Rubik’s Cube as the best example of out-of-the-box thinking.

India and Hungary has had a long history of cooperation, beginning in earnest at the end of the eighteen hundreds, intensifying during India’s non-aligned days, waning in the 1990s, but growing stronger again in the 21st century. Many Indian large corporates have a strong presence in Hungary. The latest additions are Apollo Tyres’s first green-field investment outside of India and a brand new factory to be built by the Sumi Motherson group. But we should also mention companies which have been present and steadily growing for a long time in my country – Tata Consulting Systems, for example, has a large delivery centre in Budapest, employing over 1500 associates.

I would like to thank EBG for its efforts in fostering European – Indian business relations and congratulate them on playing their important part in improving the Indian business landscape by collecting opinions from our European companies and channelling their views and comments to the appropriate Indian parties. The position paper is an important contribution to expressing European views about the Indian business climate.

Message from H.E. Mr. Brian McElduff

Ambassador of Ireland to India

Trade and investment ties between Ireland and India are booming, with double digit growth in trade in recent years. The value of trade in goods between our two countries surpassed the one billion euro mark for the first time in 2015 and we estimate that trade is services is likely to be worth twice that amount

More and more Indian companies look to Ireland as a base for their European operations, while simultaneously Irish businesses seek to link up with their Indian counterparts or to establish a foothold in the Indian market. There are now more than 30 Indian companies with operations in Ireland, employing approximately 2,500 people while over 70 Irish companies operate in India, employing almost 4,000 people here.

While India is currently the strongest performing large economy, Ireland has enjoyed a remarkable economic turnaround in recent years following a severe financial crisis. Last year Irish GDP grew by almost 8%, the highest rate in the Eurozone by some margin. The strong economic performance of both countries augurs well for the future of Irish-Indian trade and investment links.

Ireland has benefitted enormously from its EU membership and as a country highly dependent on trade is strongly supportive of renewed moves to revive negotiations on a comprehensive and ambitious Free Trade Agreement between the EU and India. The conclusion of such an Agreement could only have an invigorating effect on EU-India trade. I hope that points of disagreement can be overcome and that we will witness real progress on this issue in the coming months.

In the meantime, the EBG continues to play a valuable and much-needed role in promoting European business in India and I would like to join my EU colleagues in welcoming the launch of their 2016 Position Paper.

Message from H.E. Mr. Lorenzo Angeloni

Ambassador of Italy to India

I wish to congratulate the EBG Federation on its endeavors in support of European companies in India and its commitment to strengthen business ties between them and their Indian counterparts. We look forward to the release of the 2016 edition of the EBG Position Paper, an important reference tool for both the EU and India in their quest to improve their partnership, remove existing hurdles and explore ever new pathways of cooperation.

The Indian and European industrial worlds of both large corporations and small and medium businesses are progressively integrating their respective activities in India and servicing each other’s needs to mutual benefit. Prime Minister Modi’s programs such as Make in India, Digital India and the economic reforms promoted by his Government will certainly serve to increase such synergies even further. Yet, there are still challenges to overcome.

In the recent EU-India Summit held in Brussels the EU leaders and PM Narendra Modi welcomed the steps that the two sides have taken to foster the resumption of BTIA negotiations. The resumption of the Trade and Investment Agreement negotiations is indeed the need of the hour as such a treaty would give a major boost to the further growth of EU-India business partnership, considering that the EU is the first investor and first trading partner of India

In the huge and complex market that is India every source of sound information and well researched analysis is indeed precious. I commend the EBG Federation for their efforts and encourage them to continue to expand the scope of their Position Paper, as they have been doing in the past years, by progressively adding new sectors and new suggestions for improving EU-India partnership.

I wish the 2016 edition the best of success.

Message from H.E. Mr. Sam Schreiner

Ambassador of the Grand Duchy of Luxembourg to India

The EBG’s position paper is aptly timed as the trade relations between India and Europe are bolstered by new opportunities and positive developments on both sides. The Luxembourg government and its private sector are eager to be a part of campaigns such as ‘Make in India’ and ‘Digital India’ and contribute to India’s initiatives.

Between 1st and 5th March 2016, a high level trade delegation from Luxembourg visited India. The delegation led by HE Minister Etienne Schneider, Deputy Prime Minister and Minister of Economy was received by the key ministers, Shri Narendra Singh Tomar (Minister of Steel); Shri Arun Jaitley (Minister of Finance) and Shri Anant Geete (Minister of Heavy Industries).

Two well-attended seminars happened during this visit, in which HE Mr. Schneider shared his views on strengthening economic ties between the two countries. Luxembourg companies signed several memorandum of understanding with Indian counterparts, reaffirming Luxembourg’s commitment for developing trade relations and sharing latest technology with India.

The Luxembourg economy offers multiple opportunities to India. This year, Luxembourg is once again rated a ‘triple A’ by all the rating agencies. High GDP growth (4.7% in 2015), political stability, strong public finances, a multilingual workforce and trade openness and easy access to decision makers are hallmarks of Luxembourg’s economy. Luxembourg, once a predominantly a steel based economy, is today diversified into different sectors like finance, banking, steel, information & communication technology, space technology, renewable energy, e-commerce and logistics. The Grand Duchy offers an investor friendly economy and very competitive costs. It is home to Europe’s largest investment fund center (world’s 2nd largest fund center after the US) supported by a robust banking and financial infrastructure

The economic ties between Luxembourg and India are on a steep rise. Luxembourg is India’s 16th largest investor. Many Indian companies raise capital on the Luxembourg stock exchange through various securities and the Luxembourg Stock exchange was the first in the world to issue Rupee denominated bonds. Luxembourg based Cargolux, Europe’s largest all-cargo airlines, operates direct flights between Luxembourg and Chennai and Mumbai, guaranteeing a reliable and fast access to the European market for Indian exporters. Luxembourg is glad to welcome a rapidly expanding Indian diaspora who not only enjoy great business opportunities but also a very high quality of life.

I encourage European Business Group’s for its role as the voice of European business community in India and congratulate them for this substantial position paper.

Message from H.E. Mr. Alphonsus Stoelinga

Ambassador of Netherlands to India

I am pleased to welcome the 2016 edition of the Position Paper of the EBG Federation.

Over the last year, India has further improved its business climate. The Modi government has started a series of reforms that should result in greater business opportunities and more trade and investment between India and Europe.

Being the gateway to Europe, the Netherlands stands to benefit from these reforms. At the moment, the Netherlands is the first recipient country of Indian exports to Europe, with 20 % of Indian exports to Europe entering Europe through Dutch ports and airports. At this moment, more than 180 Indian companies are based in the Netherlands, including almost all major IT companies. Jet Airways, who just recently started direct flights between Delhi/Mumbai and the Netherlands, is the latest addition to this impressive list. About the same number of Dutch companies are present in India. The Netherlands is also a major source of FDI, being the third largest foreign investor in India in 2015.

During his last year’s visit to India, Prime Minister Mark Rutte agreed with Prime Minister Modi on a wide range of areas of bilateral collaboration, including water management, agriculture, infrastructure and logistics, renewable energy, life sciences and health, as well as science and technology.

We strongly believe that India has a lot to offer to Europe: it holds the biggest future “talent pool” in the world, it has the highest projected BNP growth figures among the world’s large economies (with the consumer goods market expected to grow by 15 % in the coming years) and with its huge proportion of young people (50 % under 25) it will soon have the largest population in the world.

These figures, as well as the economic reform agenda of the Modi-government, make India an attractive business partner. The European Business Group is well-placed to highlight business opportunities between India and Europe. I am convinced that this year’s Position Paper will further contribute to these efforts.

Message from H.E. Mr. João da Camara

Ambassador of Portugal to India

It is a big pleasure to write some words for the EBG Federation. I will try to be short and concise in making a bid for stronger economic relations between Portugal and India in the scope of the EU.

Europe has been through challenging times lately and Portugal had its share of difficulties that we are just overcoming.

History provides us with many examples of societies which withstood and dealt successfully with terrible crises. It is important to learn lessons from them. Societies which looked at their crises and saw them as an opportunity for change were those which were more successful in overcoming them.

Portugal’s relations with India are excellent. Politically there are no issues to resolve. Culturally, we all know of our common heritage and history. It is economically that an added effort needs to be done, as we are certainly well below our potential. My Embassy’s main concern is thus to help our companies come to India and introduce them to this country. Nothing gives me more joy than seeing Portuguese business in India.

We count with EBG as a privileged partner in our relation with India and the position paper that EBG is publishing every year is an important tool, not only for us in the Embassy, but also for the Portuguese companies seeking success in this market. I hope that in a near future EBG might count as well with the support and cooperation of more companies from Portugal. That would mean that our combined efforts were achieving its goals.

Message from H.E. Dr. Magdalena Cruz

Chargée d’affaires of the Embassy of Spain to India

This year’s EBG position paper coincides in time with an occasion brought about by the calendar and the passing of time. In the current year 2016, sixty years have passed since the Kingdom of Spain and the still young Republic of India established full-fledged diplomatic relations. This sixtieth anniversary is the perfect occasion to underline everything that has brought our countries together, as well as to look ahead to what is to come.

The full integration of Spain in the European framework, to which it had historically belonged, became the leitmotif of our recent history. So is India’s development as an undeniable economic, political power in Asia with legitimate aspirations to become even a world power. Spain in Europe and India in Asia, our regional projection can be a two-way road to deepen our bilateral relations and become aware of the potential of each other.

This potential is ready to be tapped into, and Spain already is a reliable partner. While it may be true to say that Spain has arrived late in Asia, in India in particular, our engagement in the last fifteen years proves our commitment to development and economic growth. Only ten years ago, less than fifty Spanish companies had any presence or assets in India. Today we have more than quintupled that number. But the increase is not measured only in quantity, but in quality. The schemes and initiatives of the Government of India, most notably «Make in India», have outlined the priorities in economic development, and it is in those priority areas that Spanish companies, Spanish expertise and Spanish entrepreneurs are globally recognised leaders: infrastructure (roads, trains and bridges), clean energy, water and sanitation, smart cities, rejuvenation and recuperation of rivers, etc.

The EBG is tasked with a difficult yet indispensable burden: to present the economic reality of India through the eyes of a wide range of actors. The Embassy of Spain therefore salutes this effort. The European Union and India are natural-born partners. Let us bring, though private and bilateral cooperation, a deeper regional one.

Message from H.E. Mr. Harald Sandberg

Ambassador of Sweden to India

The long and close ties between India and Sweden have fostered a broad and comprehensive relationship, characterized by mutual cooperation in international affairs, as well as deepened investment and trade. This saw further prominence with the visit of the President of India Mr. Pranab Mukherjee to Sweden last year and our Prime Minister, Mr. Stefan Löfven’s meeting with Prime Minister Narendra Modi and visit to India during the Make in India Week this year. The high-level Sweden-India Business Leaders’ Roundtable, launch by the PMs, will serve as a platform for continuous and closer discussions to enhance business-to-business dialogue between the two countries.

Sweden has a long history of investments in India and our companies began establishing a presence here in the early 1920s and since then the influx has continued at a steady pace. The inflow of Swedish direct investments to India has increased amounting to slightly above two million dollars that could grow even further. In fact, Indian export of goods to Sweden has also surged, for example in the area of IT we have around 20 Indian companies in Sweden, and it is estimated that around ten thousand people in India are providing IT-support to Swedish companies.

Innovation and adaptation to new circumstances have made Swedish companies globally competitive and played a major role in their ability to create jobs, achieve economic growth and provide welfare, and, importantly, translate research findings and ideas into products and services, for the benefit of everyone. India is attractive for companies and stands out compared to other emerging markets. India’s economy is marked by several overarching trends, including robust levels of domestic consumption, increased public investment in infrastructure, a renewed focus on manufacturing, rapid pace of urbanization and an aspirational young population who are looking for new lifestyles, goods and services. At the same time, given the scale and complexity of India, this mega and multi-faceted transition has presented a number of challenges that cut across key sectors like telecommunication, logistics, energy and power, retail, transportation, health, education, information and communication, water supply, sanitation and waste management. The EGB Position Paper has very aptly captured the interests and challenges of the European companies.

PM Modi’s Government has expressed its intention to implement reforms aimed at changing the Indian economy and has set concrete targets for India’s ranking in the World Bank’s Ease of Doing Business Index. India’s initiatives and programs, like the Make in India, Digital India, Smart Cities, Skills India etc. have generated positive response from Swedish companies to invest, innovate and built quality manufacturing infrastructure in the country. For India’s continued growth, it is crucial that these policies build on integration in the world economy, and that India’s manufacturing industries are further integrated into global value chains, through freer trade between leading economies, global standards etc. Also, SMEs seem to be the next wave of Swedish companies coming to India. The companies are putting their best efforts in bringing high quality to make India a manufacturing hub and are also increasingly choosing to export from India, thereby contributing to India’s economic growth.

In the Swedish Business Climate Survey conducted last year, the 160 Swedish companies that generate about 160,000 direct and more than 1 million indirect jobs characterized an overall positive sentiment of the business climate in India. While cost of material and availability of workers contribute to India’s competitiveness, high inflation, increased labour costs, long and complex sales processes impact the cost

advantage negatively. Both, the large enterprises and the SMEs struggle with the same challenges as in earlier years with regards to import regulations, customs duties, labour laws, lack of the right skill-set across all sectors.

Despite a slight dampening of their sentiments compared to last year, Swedish companies are as committed as ever to make long-term investments in India across all business sectors, and both for the domestic market and for exports. Skilling and training, and research and development are other focus areas for companies. Sweden embodies sustainability, innovation, creativity and gender diversity - a workforce balancing the input of both men and women is good economics! I see great opportunities for European and Swedish companies to build strong partnerships in India and also for Swedish public authorities to collaborate with Indian counterparts in various ways, for example in knowledge exchange of regulatory policies and practices. Also continued cooperation is made easier by the many Memoranda of Understanding that have been signed between our two countries in areas such as sustainable urban development, environment, renewable energy, science and technology, health etc. For an open and innovative country like Sweden, India is a perfect match!

As India takes a long-term and strategic view on creating sustainable economic development, Europe, including Sweden, which has significant experience in growing into a competitive and innovative powerhouse, can contribute with best practices in technology, innovation and sustainability. There is a great potential for India and Europe to share their knowledge and expertise, and collaborate to create solutions in fields that best suit their specific mutual needs

I congratulate the EBG Federation and its members for preparing this Position Paper which highlights the interests, views and challenges of the European companies. The paper can provide significant inputs to the advancement of a dialogue for sustainable business development between EU and India.

CONTENTS

Introduction 1

Agrochemicals 13

Alcoholic Beverages 21

Automative 35

Aviation 45

Banking & Financial Services 57

Chemicals & Petrochemicals 87

Defence 97

FMCG 109

Healthcare 123

Homeland Security 133

ICT & Innovation 139

Logistics 149

Oil & Gas 155

Power 167

Real Estate 177

Retail 191

Telecommunication 199

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1. India’s Macroeconomic Assessments and Prospects

1.1 India’s recent economic evaluation supports a stable macroeconomic outlook backed by fundamental shift in policies and favourable external factors. The Indian government’s policy agenda of ‘reform to transform’ has made India a steady anchor in a deteriorating global landscape. In fiscal year 2015-16, India became the fastest growing emerging economy in the world with an estimated GDP growth rate of 7.6%. On the diplomatic front, the government demonstrated dexterity in foreign policy which has paid off in the form of increased inflow of foreign direct investment (FDI). Other crucial macroeconomic parameters like inflation, fiscal deficit and current account balance exhibited distinct signs of improvement.

1.2 India’s economic performance can be measured against two distinct benchmarks: versus other countries and versus its own medium-term potential. On the first, the Indian economy has fared well on the second, steady progress is being made to translate potential into actuality.

1.3 India’s share in world GDP has increased from an average of 4.8% during 2001-07 to 6.1% during 2008-13 and further to an average of 7.0% during 2014-15 in current PPP terms.

1.4 The services sector has remained the largest contributor to India’s GDP in 2015-16. The sector grew at a growth rate of 9.2%. FDI inflows to the sector in the first seven months of 2015-16 grew by 74.7% to reach US$ 14.8 billion (€13 billion). During the same period, the agricultural sector grew at 1.1% and the industrial sector grew at 7.3%. Lower than normal rainfalls for a second successive year limited the growth of the agricultural sector. The government in its annual budget has

announced an 84% increase in budgetary allocation of 2016-17 for the agricultural sector with focus on creating a long term irrigation fund within National Bank for Agriculture and Rural Development (NABARD) to buffer the agriculture sector against another weak monsoon.

1.5 Growth in industry, for 2015-16 has shown acceleration on the strength of improving manufacturing activity. The Index of Industrial Production (IIP) showed that manufacturing production grew by 3.1% during April-December 2015-16, vis-à-vis a growth of 1.8% in the corresponding period of the previous year (9.5% vis-à-vis 5.5% in 2014-15). According to United Nation Industrial Development Organization’s (UNIDO’s) assessment, India was ranked 6th largest manufacturing country in the world in 2016 mainly due to increase in IIP and Manufacturing Value Added.

1.6 The global economic landscape is currently witnessing weak growth in economic output. Declining prices of crude oil and commodities, turbulent financial markets and volatile exchange rates have made investors risk-averse. Amidst this, FDI inflows to India have risen. From, April to November 2015 FDI equity inflows to India amounted to US$ 34.8 billion (€30.4 billion) as compared to US$27.7 billion (€24 billion) for the same period in fiscalyear 2014-15. In relative terms, it implies a growth rate of 26% over the last period. With launch of flagship initiatives like the Make in India, Digital India and Start-up India, investor confidence in the economy has surged. FDI inflows increased by nearly 40% during the nine month period from April to December 2015.

1.7 Fiscal sector registered three striking successes in 2015-16. Ongoing fiscalconsolidation, improved indirect tax collection and improved quality of spending at all levels.

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With this, the government is hoping to meet its fiscal deficit target of 3.9% of GDP. On the tax front, the direct tax revenue grew by 10.7%. Tax performance reflected an improvement in tax administration because revenues increased even after stripping out the additional revenue measures (ARMs).Indirect tax revenue grew by 10.7% (without ARMs) and 34.2% (with ARMs). Increased accountability and efficiency has been witnessed in government spending and a shift in the quality of spending from revenue to investment and towards social sector is observed.

1.8 Exports and imports of India together constitute 42% of GDP. Though India’s exports fell sharply on account of low global demand, the impact on trade deficit was buoyed by a fall in India’s import bill due to fall in global crude oil and commodity prices. This kept the trade deficit low. During April-January 2015 period, India’s exports and imports declined year-on-year by 17.6% and 15.5% respectively. In absolute terms, India’s exports amounted to US$217.7 billion (€190.6 billion) while its import bill was US$324.5 billion (€284 billion). As a result, trade deficit declined to US$71.6 billion (€62.6 billion).

1.9 India’s foreign exchange reserves have strengthened. Forex reserves at US$ 351.5 billion (€307.7 billion) (as on February 5 2016) mainly comprised foreign currency assets amounting to US$ 328.4 billion (€287.5 billion), accounting for about 93.4% of the total.

1.10 Current account deficit (CAD) (April-September 2015-16) remained at comfortable levels at 1.4% of the GDP due to lower trade deficit and a modest growth in invisibles. The Indian equity market remained relatively resilient compared to other major emerging market economies. During 2015-16 (April-January), the average exchange of the rupee depreciated to INR 65.04 per US dollar as the US dollar strengthened against all other major currencies on account of stronger growth of the US economy. However, the Indian rupee performed better than other currencies of most other emerging economies (except Chinese yuan).

1.11 A tightened monetary policy aided by a fall in global crude oil and commodity prices helped reduce inflation to moderate levels. The Wholesale Price Index (WPI) fell to an estimated -2.8% during April-January 2015-16 while the Consumer Price Index (CPI) slid down to an estimated 4.9% during the same period.

1.12 The economy has made substantial improvements in its macroeconomic fundamentals and impressive strides in reducing macro-vulnerability with reforms in key areas, pursuit of fiscal prudence and consolidation, focus on price stability and the resultant benign price situation and comfortable level of external account. With improved industrial growth supplementing the buoyant services sector, overall economic growth has picked up.

2. India-EU Relations2.1 Bilateral relations between the European

Union (EU) and the republic of India date back to 1962.

2.2 A renewed attempt to develop relations between India and EU was made in 1994. A landmark agreement (Cooperation Agreement) was reached in 1994 to govern bilateral economic and trade relations between the two sides. The relationship was upgraded to a ‘Strategic Partnership’ at the 5th India-EU Summit at The Hague in 2004 Joint Action Plan in 2005 further strengthened their bilateral relations.

2.3 The realm of engagement of India and EU includes a wide gamut of themes relating to political, economic and strategic issues. In 2007, India and the EU envisaged a bilateral Free Trade Agreement, officiallycalled the broad-based trade and investment agreement (BTIA). Negotiations on the BTIA were unofficially suspended in 2013 as the consensus on some issues could not be reached. The 13th EU-India summit held in Brussels on 30th March 2016 reinvigorated discussions on the EU-India BTIA. This along with a shared commitment to have a fair,

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transparent rule based trade and investment regime would help unlock potential of EU-India trade relations.

2.4 During the EU-India Summit the leaders of the participating countries also reaffirmedtheir commitment to strengthen the EU-India Strategic Partnership based on shared values and principles. India and EU confirmed their strong interest in building global peace, security and prosperity, fostering non-proliferation and disarmament, creating jobs and inclusive economic growth, promoting sustainable development, and tackling global challenges.

2.5 The summit witnessed unveiling of the EU-India Agenda for Action 2020 – a concrete roadmap to jointly guide and strengthen the India-EU Strategic Partnership over the next five years. The agenda hinged on a wide range of areas for cooperation such as foreign and security policy, trade and investment, economy, global issues as well as people to people contacts.

3. India-EU Trade and Investment Relations

3.1 The EU and India remain committed to increase their bilateral trade and investments. India is an important trade partner for the EU. The value of EU-India trade grew from €28.6 billion in 2003 to €77.3 billion in 2015. India was EU’s ninth largest trading partner in 2014 with a value of total trade at €72.5 billion. United Kingdom, Germany, Netherlands, Belgium, Italy and France were among India’s top 25 export destinations in 2015-16 (April-December) while Switzerland, Germany, Belgium and United Kingdom were amongst top 25 import partners to India for the same period.

3.2 The top five Indian goods exports to the EU in 2014 were: textiles and textile articles comprising a share of 19.2%, products of the chemical or allied industries (14.1%), machinery and appliances (11.5%), base metals and articles thereof 9.0% and mineral products with a share of 8.4%. On the other

hand, EU goods exports to India comprised prominently of machinery and appliances (28.2%), pearls, precious metals and articles thereof (24.1%), products of the chemical or allied industries (10.4%), base metals and articles thereof (9.5%) and transport equipment (6.7%).

3.3 European investment in India approximated €187 between 2004 and 2013 with UK, France and Germany accounting for 64% of the total investments. In 2014 EU was the second biggest foreign investor in India. The total stock of EU FDI in India at the end of 2014 was €38.5 billion.

3.4 The Indo-EU relations are embedded in a strong institutional architecture. Annual Summits and ministerial meetings are the most visible feature of this ongoing political dialogue. Vibrant political and business partnership can further strengthen the fair, balanced and forward looking India-EU relations.

3.5 In the past year, visits of the Indian and European counterparts were organized to support the flagship initiatives and other important development initiatives in India. India’s relations with Sweden, Finland, France Germany and Netherlands were augmented by two-way visits in 2015-16

3.6 Prime Minister Modi’s visit to France in April 2015 focused on energy and defence cooperation. Several collaborative efforts and initiatives were undertaken at both government and private sector levels. Around 17 agreements were signed in the area of defence, space, nuclear and renewable energy. French President Francois Hollande’s visit as a state guest for the Republic Day celebrations in January 2016 and for the India-France Business Summit is viewed as a landmark in the history of bilateral relations between the two countries. The visit ended with the two countries signing 30 agreements in the area of defence, agriculture, development of infrastructure, energy etc. The long awaited deal to buy 36 Rafale jets from French defence giant Dassault was agreed in principle. France

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committed to invest over €2 billion for Smart City projects in India with special focus on three important cities viz. Chandigarh, Nagpur and Pudducherry. In a significantdevelopment, Alstom, the French engineering group has won two major contracts with the Indian Railways worth € 3.7 Bn. This is among the first major FDI received by Indian Railways for manufacturing electric locomotive engines. The deal also includes a smaller contract worth about €200m to provide signaling, electrification and telecommunications equipment for a dedicated freight corridor.

3.7 India and Germany also agreed to enhance ties in key areas of defence manufacturing, trade, intelligence and clean energy India and Germany also agreed to enhance ties in key areas of defence manufacturing, trade, intelligence and clean energy As an initiative to foster business-business interactions and knowledge sharing, India partnered with Germany at Hannover Messe business fair in April 2015, thereby fueling the national agenda of ‘Make in India’. During the German Chancellor Angela Merkels’s three day Visit to India in October 2015, India and Germany agreed to enhance ties in key areas of defence manufacturing, trade, intelligence and clean energy including signing of 18 bilateral MOUs and agreements. India also promised to make arrangements to expedite the process of German companies incorporating into India. According to a new agreement that came into force in October 2015 German companies will have a single point of contact who will help the foreign firms make their way through the entire process of investment and development.

3.8 On the sidelines of recent EU-India Summit, PM Modi held talks with his Belgian counterpart Charles Michel to discuss bilateral issues between the two countries. During the meeting, ways to enhance bilateral economic cooperation between India and Belgium were discussed and the two leaders stressed the need to consolidate and enhance bilateral trade and cooperation in the services sector to tap the trade potential.

4. Current State of India’s Business Environment

4.1 The Narendra Modi-led government took over at a time when the macroeconomic credentials of the economy were not as sound. The world economy was witnessing a decelerating growth and rising inflation. Initiating reforms remained a prudent step in this direction. The government undertook a slew of measures to reinstate investor confidenc in the country. Prime among these are measures to increase the ease of doing business. These measures have made the business environment conducive and led to improvement in India’s ranking in international forums. India secured the 130th from 142nd in the World Bank Ease of Doing Business Report 2016. It also moved up 16 spots to the 55th position in the World Economic Forum’s Global Competitiveness Index.

4.2 The Government of India has taken a series of measures to improve the business environment in India. The emphasis has been on simplification and rationalization of the existing rules and introduction of information technology to make governance more efficientand effective.

4.3 To remove impediments in attaining maximum efficiency in the business sector, the initial validity period of Industrial License (IL) has been increased to three years from two years. This is to provide enough time to businesses to procure land and other necessary clearances. In another instance, to obviate the hardship of licensees to get their IL extended, partial commencement of production is being treated as commencement of production for all the items included in the license. Also, a number of defence products and dual use items have been excluded from the purview of industrial licensing.

4.4 The government launched its Digital India campaign in July 2015, to ensure that government services are made available to citizens electronically by improving online infrastructure. Under this 20 services have been integrated with the eBiz portal which

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will function as a single window for obtaining clearances from various government agencies. It includes the process of applying for Industrial License (IL) and Industrial Entrepreneur Memorandum (IEM). Along with it, the process of applying for environment and forests clearances has also been made online. A unified portal for registration of units for LIN (unique labour identification number), reporting of inspection, submission of returns and grievance redressal has been launched by Ministry of Labour and Employment. This has led to ease of filing applications, obtaining clearances and online payment of service charges. The government has made the filing of returns online and also provides for a check-list of required compliances. An integrated process of incorporation of a company, wherein applicants can apply for Director’s Identification Number (DIN) and company name availability simultaneous to incorporation application has also been made online.

4.5 The Ministry of Corporate Affairs introduced an integrated process of incorporation of a company, in May 2015 wherein applicants can apply for DIN and company name availability simultaneous to incorporation application.

4.6 The Companies (Amendment) Act was passed in May 2015, to remove requirements of minimum paid-up capital and common seal for companies.

4.7 The number of documents required for export and import has been reduced to three. Besides this, online filing of applications, a single window customs clearance, e- Importer-Exporter Code (IEC) has been operationalized. This has met with a lot of optimism by the traders.

4.8 In order to create a paradigm shift in the resolution of commercial disputes the government enacted the Commercial Courts Act and the Arbitration and Conciliation Amendment Act in October 2015, which would bring an end to the lengthy and inefficientdispute resolution system.

4.9 The Department of Industrial Policy and

Promotion conducted its first assessment to take stock of reforms implemented by states. The results were released in a report titled ‘Assessment of State Implementation of Business Reforms’ in September 2015. The assessment revealed that states were at different stages of reform implementation. The implementation status of each state had been converted to a percentage and state rankings had been calculated on the basis of this. Gujarat topped the list followed by Andhra Pradesh and Jharkhand. Chhattisgarh, Madhya Pradesh, Rajasthan, Odisha, Maharashtra, Karnataka and Uttar Pradesh were in the top 10.

4.10 The government has set-up agencies to promote and facilitate businesses in India. The prime among such initiatives are Invest India, Investment Facilitation Cell under the Make in India initiative to guide, handhold and liaise with various agencies on behalf of potential investors.

5. Challenges to India’s Growth5.1 In 1991, a new course of economic

development was charted out based on decontrolling the economy and exposing it to market forces. The liberalization polices followed in the last 25 years have met with success, though still a lot needs to be done to help India reach a pinnacle of high economic growth and development. Currently, the Indian economy is roughly US$ 2 trillion (€1.75 trillion) and in a sweet spot with stable macroeconomic credentials when other developed and emerging economies are reeling through tough times. But, impediments remain in India’s growth story and are being suitably addressed by the current government.

5.2 Private investments have been at sub-optimal levels due to low capacity utilization and high operating costs. Exports have also declined due to faltering global demand. According to Morgan Stanley Research, operating margins of companies are approaching an all-time high and are at 27.5%. That apart, corporates are over-leveraged. Private sector debt at present

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equals 70% of GDP, compared to 40% when the investment cycle picked up in 2004-05. There is also the issue of high interest rates. For this, boosting consumption and creating domestic demand is necessary to utilise excess capacity and start investing. Also, public investment has to be revived to create world class infrastructure and other facilities. Efficienc , accountability and transparency are the key to deliver outcome from any investment, public or private.

5.3 The government remains committed to decreasing its fiscal deficit as the existing deficit leaves lesser opportunity for the government to increase its spending on areas of high priority. Expanding tax base, austerity measures and using PPP (public private partnership) mode to develop large cost infrastructure projects are some of the ways to achieve the targeted fiscal defici level of 3.5%.

5.4 India’s labour laws and trade unionism often make it difficult for businesses to operate efficientl . Due to stringent labour laws, firms with more than 100 workers often face the brunt of existing labour regulations in the form of strikes and agitations. Labour reforms protecting the legitimate interests of the workers and ensuring that output and efficiency are maintained are the need of the hour.

5.5 Land acquisition is another challenge with which the Indian government is trying to cope with, absence of the Land Acquisition Act, the government is working towards bringing a new (liberal) model law for leasing of land for agricultural and industrial activities. NITI Aayog – the government’s premier think tank, has outlined several steps including legalization of land leasing, removal of adverse possession clause in land laws and enabling tenants to avail short-term credit among others. The leasing formula would help unlock the value of farmland.

5.6 India’s exports are at an all-time low due to weakening of global demand. In 2015-16 (April-December) India’s total merchandise

exports was US$ 196 billion (€172 billion) while its total merchandise imports was US$ 294 billion (€258 billion). For the same period, India’s total trade deficit was US$ 98 billion (€86 billion). To boost export demand, providing incentives to exporters may help India’s exports.

5.7 Falling agricultural output due to deficientrainfall leading to fall in rural income has negatively impacted rural demand. Rural distress and low agricultural sector output are amongst the prime focus for 2016-17. The government has announced an 84% increase in budgetary allocation of 2016-17 to buffer the agricultural sector against another weak monsoon.

5.8 Crippling infrastructure shortages constraint rapid growth. Infrastructural bottlenecks hinder the growth of export oriented manufacturing and supply chains. Increasing public investments in infrastructure, using the vehicle of PPP to develop new assets while maintaining the existing ones are necessary.

5.9 Another challenge plaguing the Indian economy is the exit problem of businesses. The government is undertaking several initiatives such as introducing a new bankruptcy law (presently with selected joint committee of Parliament), rehabilitating stalled projects, and considering guidelines for PPP that can help facilitate exit, thereby improving the efficiencyof the economy.

5.10 Despite these many challenges, there is considerable optimism towards India’s growth, largely reinforced by reforms in the past couple of years.

6. Policy Measures

India’s exemplary performance in the past few years owes acknowledgement to the implementation of a number of meaningful and incremental reform measures. With focus on reforms in key sectors and stable macroeconomic conditions, the growth prospects for India appears bright in the coming years.

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6.1 Macroeconomic Reforms• India has made dramatic strides in reducing

its macro-economic vulnerability. Since 2013, India’s index of macro-economic vulnerability has improved by 5.3% points compared with 0.7% points for China, 0.4% points for all countries in India ‘s investment grade, and a deterioration of 1.9% points in the case of Brazil.

• The correlation between India’s growth rate and that of the world has risen sharply to reasonably high levels due to India’s growing globalization. For the period 1991-2002 the correlation was 0.2. Since then, the correlation has doubled to 0.42. A one percent point decrease in the world growth rate is now associated with a 0.42% point in Indian growth rates. Thus, if the world economy remains weak, India’s growth will also face considerable headwinds.

• Agricultural policy in India is characterized by unusual volatility. When world prices go up or there is domestic scarcity, export restrictions or bans are imposed. Likewise, when the reverse happens, import tariffs are imposed. This policy volatility hurts farmers and eventually the consumers. In agriculture, the interests of the producer and consumer have to be balanced. Farm policies like minimum support prices and import and export policies should be announced well in advance of the crop growing season.

• India’s external debt stock increased by US$8 billion (17%) (€7 billion) to US$483.2 billion (€424 billion) at September 2015, over March 2015. This rise in external debt occurred on account of long-term debt, particularly commercial borrowings and NRI deposits. Long-term debt accounted for 82.2% of India’s total external debt. Correspondingly, the proportion of short-term debt declined. India’s external debt has remained within safe limits, with an external debt to GDP ratio of 23.7%.

6.2 Reforms in Manufacturing• Growth in industry is estimated to have

accelerated during the current year on

the strength of improving manufacturing activity. The private corporate sector, with approximately 69% share of the manufacturing sector, is estimated, from available data of listed companies, to grow by 9.9% at current prices in April-December 2015 - 16. The Index of Industrial Production (IIP) showed that manufacturing production grew by 3.1% during April-December 2015-16, vis-à-vis a growth of 1.8% in the corresponding period of the previous year. The ongoing manufacturing recovery in the current year is aided by robust growth in petroleum refining, automobiles, wearing apparels, chemicals, electrical machinery and wood products and furniture.

• The government has encouraged the development of industrial parks in every state for the setting up of industries. Apart from that, National Investment and Manufacturing Zones (NIMZ), which is a combination of production units, public utilities, logistics, residential areas and administrative services are also being set up.

• India has developed Special Economic Zones (SEZs) that are specifically delineated enclaves treated as foreign territory for the purpose of industrial, service and trade operation, with relaxation in customs duties and a more liberal regime in respect of other levies, foreign investment.

• With the objective of making India a global hub of manufacturing, design and innovation, the Make in India initiative, which is based on four pillars—new processes, new infrastructure, new sectors and new mindset—has been taken by the government. The initiative is set to boost entrepreneurship, not only in manufacturing but in relevant infrastructure and service sectors as well.

• The government provides sector specificsubsidies for promoting manufacturing. It provides capital subsidy of up to 25% for 10 years to electronic manufacturing units. Incentives are also provided for units in SEZ/NIMZ or setting up projects in special areas like North East Region, Jammu and Kashmir and Himachal Pradesh and Uttarakhand.

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INTRODUCTION

• In Budget 2016, Finance Minister started the phase-out of exemptions to corporate taxpayers. In his budget speech, the financeminister announced phase-out of exemptions such as accelerated depreciation and benefitsto Special Economic Zones (SEZs).

• The government has provided investment allowance at the rate of 15% to a manufacturing company that invests more than US$-4.17 million (€3.6 million) in any year in new plant and machinery.

• The Department of Industrial Policy and Promotion (DIPP), in consultation with various central ministries, state governments, industry leaders, and other stakeholders, has formulated a strategy for increasing the contribution of the manufacturing sector to 25% of the GDP by 2020.

• The Government of India has set up Invest India as the national investment promotion and facilitation agency. An Investment Facilitation Cell has been set-up under the Make in India initiative, primarily to support all investment queries as well as to handhold and liaise with various agencies on behalf of potential investors.

6.3 Reforms in FDI• In November 2015, the government announced

tangible measures to increasing FDI caps in select sectors, placing more activities under the automatic route and easing entry conditionalities. Reforms are broad-based, touching upon a variety of sectors, including, defence, construction and development, retail, broadcasting, civil aviation, banking and manufacturing.

• In a further move towards liberalizing FDI, the Government, recently on March 2016, has allowed FDI up to 49% under automatic route in the insurance and pension sectors, subject to certain regulatory formalities.

• In regards to FDI in Asset Reconstruction Companies (ARCs), the ceiling of 49% has been replaced with 100% that shall be permitted through automatic route. Similarly, subject to specific conditionalities, 100 percent FDI has now been being allowed in e-commerce.

• Key aspects of reforms are summarized below:

Sector/Activity Foreign Investment Cap Entry Route

Tea, Coffee, Rubber, Cardamom and Palm oil tree plantations

100 % Automatic

Defence Industry subject to Industrial license under the Industries (Development & Regulation) Act, 1951

49 % Automatic upto 49 % Above 49% under the government route on case to case basis, wherever it is likely to result in access to modern and ‘state-of-art’ technology in the country

(1) Teleports (setting up of up-linking HUBs/Teleports);

(2) Direct to Home (DTH);

(3) Cable Networks;

(4) Mobile TV;

(5) Headend-in-the Sky Broadcasting Service (HITS)

100 % Automatic upto 49 % Government route beyond 49 %

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Sector/Activity Foreign Investment Cap Entry Route

Terrestrial Broadcasting FM 49 % Government

Up-linking of ‘News & Current Affairs’ TV Channels

49 % Government

Up-linking of ‘News & Current Affairs’ TV Channels, Downlinking of TV Channels

100 % Automatic

(1) (a) Scheduled Air Transport Service/ Domestic Scheduled Passenger Airline

(b) Regional Air Transport Service

49 % (100% for NRIs)

Automatic

(2) Non-Scheduled Air Transport Service

100 % Automatic

(3) Helicopter services/seaplane services requiring DGCA approval

100 % Automatic

(1) Ground Handling Services subject to sectoral regulations and security clearance

100 % Automatic

(2) Maintenance and Repair organizations; flying traininginstitutes; and technical training institutions

100 % Automatic

Satellites- establishment and operation, subject to the sectoral guidelines of Department of Space/ISRO

100 % Government

Credit Information Companies 100 % Automatic

Construction-development projects 100 % Automatic

Single Brand Product Retail Trading 100 % Automatic upto 49 % Government route beyond 49 %

Duty Free Shops 100 % Automatic

Insurance & Pension 49 % Automatic

Asset Reconstruction Company 100 % Automatic

E-commerce (market place model) 100% Automatic

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INTRODUCTION

• The Real Estate Bill passed by both houses of the parliament is expected to facilitate more foreign direct investments in the sector. It will essentially work towards strengthening transparency, information in the public domain, accountability and responsibility for developers.

• FDI in India increased by US$ 4413 million in January 2016. In the January-June period of 2015, India surpassed US and China as the biggest FDI destination, garnering total investments worth US$ 31 billion compared with US$28 billion by China and US$27 billion by the US. India is being viewed as the most favored destination followed by China and US.

6.4 Reforms in the Financial Sector • During 2015, the Government of India initiated

a number of reform measures in the financialsector. One such measure is the merging of the Forwards Markets Commission (FMC) with the Securities and Exchange Board of India (SEBI) which came into effect from September 28, 2015, to achieve convergence of the regulation of the securities and commodity derivatives markets and to increase the economies of scope and scale for exchanges, financial firms and other stakeholder

• A Monetary Policy Agreement was signed between the government and the RBI in February 2015. The government intends to deepen such reforms including amendment of the RBI Act for providing a statutory Monetary Policy Framework and Monetary Policy Committee, strengthening and upgrading the Securities Appellate Tribunal to the Financial Sector Appellate Tribunal and creation of a Resolution Corporation.

• With a view to strengthening and institutionalizing the mechanism for maintaining financial stability, enhancing inter-regulatory coordination and promoting financial sector development, the Financial Stability and Development Council (FSDC) under the chairmanship of the union financeminister was set up by the government as the apex-level forum in December 2010.

In 2015-16, the Council assessed issues relating to macroeconomic financial stability and discussed important matters such as corporate bond market development, building effective deterrence in bank frauds, NPAs (non-performing assets) of banks, corporate sector balance sheet stress, report of activities under the Financial Stability Board (FSB) and Financial Action Task Force (FATF) and followed up on the recommendations of the special investigation team (SIT) on black money.

• The FSDC sub-committee set up under the chairmanship of the RBI governor discussed issues such as global and domestic factors impinging on financial stability, the Financial Stability Report, standards and protocol for setting up account aggregation for financialassets, allowing insurance companies and mutual funds as protection sellers in credit default swaps (CDS) and corporate bond market development.

• On November 5, 2015, the government launched the sovereign gold bonds and gold monetisation schemes with the objective of reducing the demand for physical gold and shifting a part of the gold imported every year for investment purposes into financia savings.

• As a part of its financial inclusion agenda via its Jan Dhan Yojana plan, the government has successfully created bank accounts for over 200 million people in the initial few months. The government plans to further its mission of financial inclusion by the licensing of 11 payments banks and 10 small banks.

• In the Union Budget 2016, the government announced the setting up of a Monetary policy committee. The committee shall be mandated with the task of guiding interest rates in the economy.

6.5 Reforms in Taxation• In respect to taxation, the Government of India

envisages establishment of a progressive tax policy with robust tax administration and better voluntary compliance to bolster

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taxpayer confidence. Towards this, the government has delivered on a variety of structural tax reforms

• A significant outcome is the non-levy of Minimum Alternate Tax (MAT) on Foreign Institutional Investors (FIIs) which aims to discourage tax disputes particularly in the context of portfolio as well as strategic foreign investors.

• The Central Board of Direct Taxes (CBDT) rolled out rules for implementing range concept and facilitating use of multi-year data in transfer pricing assessments. Clarificationon rollback provisions in applying for Advance Pricing Agreements (APAs) enhances the taxpayers’ understanding and should help to promote a negotiated approach to settlement of transfer pricing disputes. Further, CBDT has issued guidelines (vide Instruction No. 3/2016 dated March 10, 2016) to provide more clarity on how TP cases would be referred/ selected on a going forward basis for audit purpose, the role of Transfer Pricing Officer’s (TPO)/ Assessing officer’s (AO) for determination of arm’s length price (ALP).

• In October 2015, the Ministry of Finance set up an expert group, under Justice (Retd.) RV Easwar, to elicit recommendations for simplification of direct tax laws. The Easwar Committee submitted its first report in January 2016 dealing with simpler issues; more complex issues to be taken up in subsequent reports. The FM during the Budget speech for 2016-2017 acknowledged the recommendations made by the Easwar Committee and accepted some of these in the proposals made by the Budget.

• The government announced its intention (in 2015 budget) of reducing corporate tax rate from 30% to 25% over a period of four years, coupled with announcements in rationalization and phasing out of tax exemptions and incentives (in 2016). The draft roadmap for phasing out incentives has canvassed for doing away with profits and investment-linked incentives; areas based concessions for corporate and non-corporate taxpayers.

As a part of the overall plan to reduce the headline rate to 25 percent, vide Budget 2016, the Government has announced proposals to include further clarity on account of phasing out of various tax holidays and incentives under the Income Tax Act.

• In June 2015, India became signatory to the multilateral agreement on automatic exchange of information; the move underlines India’s commitment to adopting best practices in tax administration.

• In December 2015, detailed guidance was rolled out vis-à-vis implementation of reporting requirements to track reportable transaction of financial institutions in line with Foreign Account Tax Compliance Act (FATCA). Also, to ensure compliance with FATCA, India is embracing intergovernment agreements (IGAs) in tandem with such disclosure norms. Enhanced rigors on disclosures in tax matters is bound to promote governance standards.

• From indirect tax reforms standpoint, the government stays committed to implement unified goods & services tax (GST).The GST will bring about a qualitative change in the system by redistributing the burden of taxation equitably between manufacturing and services. It has been assessed that a well-defined GST can bring about a 2-2.5% growth in GDP.

• From tax dispute reforms standpoint, the government has rolled out several measures aiming to curtail the burden of tax litigation. Under one such measure, the government has raised the monetary limit for filing appeals to INR 1 million (€13,252) in appellate tribunals and INR 2 million in high courts, and directed withdrawal of appeals in the two forums where the new threshold did not apply. This is expected to bring down the number of cases drastically and reduce the quantum of taxes in litigation.

• The Ministry of Finance has set-up a Tax Policy Research Unit (TPRU) and Tax Policy Council (TPC) to bring consistency, multidisciplinary inputs, and coherence in tax policy. The two units are designed to manage tax policy and

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legislation issues. The TPRC shall focus on conducting independent research on fiscaland tax policies while the Tax Policy Council

shall suggest broad policy measures for taxation based on the research findings of the TPRC.

Endnotes

1. Economic Survey 2015-16, Ministry of Finance, Government of India, pp 132

2. Joint Statement 13th EU- India Summit, Brussels, March 30th 2016

3. European Union, Trade with India 2015, Directorate-General of for Trade, European Commission

4. Union Budget 2016, Ministry of Finance, Government of India

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AGROCHEMICALSPosition India to be a global Agrochemical producer by encouraging R&D, keeping a check on spurious products, providing data protection to innovators and increasing the awareness of farmers for correct use of the Agrochemicals.

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AGRICULTURE SCENARIO IN INDIA WITH FOCUS ON AGROCHEMICAL SECTOR

Agriculture plays a vital role in the Indian economy, evident from the fact that 58% of India’s population is dependent on agriculture for their livelihood and the sector contributes around 13.9% to India’s GDP1. India is the third largest agricultural producer by value right behind China and the U.S. and it has the second-largest agricultural land holdings (180 million hectares) in the world.2 Total food grains production in India reached an all-time high of 252.7 million tons in FY153.

The average size of operational holdings in India has declined from 1.23 hectares (ha) in 2005-06 to 1.16 ha in 2010-11. Small and marginal holdings constituted 85% of total holdings in 2010-11.4 Further, the 2011 Census of India shows that 68% of farms are less than two acres in size. The decrease in average size of landholding and increase in the number of operational holdings is leading to poor harvest and low incomes for the farmers.

Supply-demand gap looming large: Supply side: 1) According to FICCI (Federation of Indian Chambers of Commerce and Industry), per-capita arable land has declined from 0.34 ha in 1951 to 0.15 ha in 2001 and is further expected to reduce to ~ 0.07 ha by 20305. 2) Productivity on this land is sub-optimal with per hectare yield in India being lower than the rest of the world (3 tons/ha as compared to the global average of over 4 tons/ha).

Demand side: One major reason of increase in demand is the increasing population of India, which is expected to reach 1.6 billion by 2050. The other is the increase in per capita net national income, which is estimated to be INR 88,538 (€1,142) in FY15, an increase of 10.1% over FY14.

Crop productivity in India is lower than other major crop producing countries due to the following reasons6: 1) High dependency on monsoon in India with rainfall being the primary source of water and 60% of land under cultivation watered only by rainfall 2) Impact of climate change on crop productivity 3)

Low average seed replacement rate (only 25% of the farmers buy new seeds every year) 4) Low penetration of agrochemicals (Only 35% of the area under cultivation is treated with agrochemicals) 5) Low levels of mechanization (40%–45% as opposed to levels as high as 95% in the US) 6) Illiteracy amongst farmers and consumers.

Furthermore, post-harvest losses which amount to 35% of produce every year result in reduced overall output. These losses are caused due to the low availability of storage space and an under-developed food processing industry. The government has tried to address this need by raising the overall budget for the agriculture sector by over 44% -- from INR 249.1 billion (€3.5 billion) in 2015-16 to INR 359.8 billion (€5 billion) in 2016-17 (budget estimates).

Indian agriculture industry has various allied sub-sectors, the major ones being seeds, fertilizers and agrochemicals. The Indian seeds sector grew at a CAGR (compound annual growth rate) of 8.4% from FY09 to FY15 to reach 3.5 million tons in consumption.7 The industry was valued at INR 120 billion (€1.5 billion) in FY14.8 Globally, India is the fifth largest seed market measured in value terms. The availability of quality hybrid seeds is to be focused upon by all stakeholders to enhance productivity. While adoption of Bt. cotton is currently driving most of the sector growth, increased adoption of cotton through techniques such as high-density planting, improved demand for corn and increased hybrid seed penetration in crops such as paddy are likely to be key future growth drivers for the industry.

The Indian fertilizer industry was estimated to account for revenues of around INR 3.1 trillion (€38.9 billion) in FY14. Fertilizer consumption was 24 million tons in FY14.9 The union cabinet has approved the New Urea Policy 2015 that is aimed at making India self-sufficientin urea production in the next four years and ensuring its timely supply to farmers. It targets increasing domestic production by two million tons per annum (tpa). Under the new policy, companies operating at

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100% utilization rate will get import-parity price for 85% of their production, while those producing additional urea with brownfield expansion will get a subsidy for 90% of their production. In addition, the government has discontinued the supply plan for phosphoric and potash (P&K) fertilizers, which will allow fertilizer companies to sell their products anywhere in the country. The union cabinet recently removed the minimum capacity utilization criteria for single super phosphate (SSP) units to be eligible for subsidy under the nutrient based subsidy (NBS) scheme with immediate effect.10 The Make in India campaign is also expected to give a boost to the domestic fertilizer industry by reviving sick fertilizer plants.

According to FICCI, the Indian agrochemical industry, valued at US$ 4.3 billion (€3.7 billion) in FY14, is the fourth largest in the world and the second largest in Asia-Pacifi 11. To increase productivity, the agrochemical sector needs to be a priority for the Government of India so that avoidable losses in fieldand in storage can be reduced.

1. INTRODUCTION

Market description

1.1 The industry is expected to grow at a CAGR of 12% to reach US$7.5 billion (€6.5 billion) by FY19.12 The total installed capacity of the agrochemical industry in India was 329,100 tons in 2015 and is expected to reach 493,700 tons by 2020, growing at a CAGR of 8.5%.13 Globally, India is the thirteenth largest exporter of pesticides.

1.2 1.2. Around 35%–45% of crop production is lost due to insects, weeds and diseases. The total value of crops lost annually due to pest and disease attack in India is estimated at INR 900 billion (€12.5 billion).14 While the global average consumption of pesticides is 3 kg/ha, India’s consumption is only 0.6 kg/ha. Furthermore, area under crop protection is only 35% indicating the untapped potential for pesticide usage in crop cultivation.15

Source: FICCI Agrochemical report, November 2015

1.3 The Indian agrochemical market is dominated by insecticides, with major applications in rice and cotton crops. Fungicides and herbicides are the fastest growing segments. The sale of herbicides is seasonal, since the weeds grow in damp and warm weather and die in the cold. Rice, wheat, sugarcane and soya bean crops are the major application areas for herbicides. Rising wage rates and reducing labour availability are the growth drivers for herbicides.

Source: FICCI Agrochemical report, November 2015

1.4 Fungicides are mostly used for fruits, vegetables and rice. The key growth drivers for fungicides include a shift in agriculture from cash crops to fruits and vegetables and government support for exports of fruits and vegetables. Bio-pesticides constitute only 3% of the Indian agrochemical market; however, there are significant growth opportunities for this product segment due to increasing concerns of safety and toxicity of pesticides, stringent regulations and government support.

Recent Developments

1.5. Make in India initiativeMake in India is a Government of India initiative to encourage companies to manufacture their products

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in India. The initiative is aimed at enhancing the ease of doing business in India and is expected to attract foreign capital. The government could also consider giving same excise exemption to agrochemicals as given to fertilizers and seeds as all of them facilitate the agriculture sector. Exports currently constitute almost 50% of the Indian agrochemical industry and are expected to grow at a CAGR of 16% to reach US$4.2 billion (€3.6 billion) by FY19.16 As of now, close to 50% is exported to ASEAN and Latin American countries. Going forward, the number of countries is expected to increase owing to the initiative.

1.6. India as a global manufacturing hub

Currently, around 50% of agrochemicals are exported. This shows that there is huge export potential in the industry. Further, there is a growing trend of labour migration to cities and thereby their availability due to higher wage expectations. In addition, India has a large pool of qualified and skilled chemical engineers which constitute the backbone in this technology oriented segment. The government has recognized the immense potential and is focusing efforts on developing R&D capabilities, technical skill training, infrastructure reforms, etc. to support the endeavour to create India as a global manufacturing hub for agrochemicals.

1.7. Improving productivity

Steps include the Pradhan Mantri Gram Sinchai Yojana (Prime Minister’s Village Irrigation Plan) that ensures improved access to irrigation. Creation of a unified national agricultural market would help boost the incomes of farmers. The government is continuing with National Food Security Mission in the Twelfth Five Year Plan, with new targets of additional production of 25 million tons of food grains by the end of the Plan. Under Budget 2016-17, fertilizer subsidy has been pegged at INR 700 billion (€9.7 billion). Direct benefit transfer (DBT) scheme for fertilizers has been introduced on a pilot basis in few districts. Further, the accelerated irrigation benefits program (AIBP) will help fast-track the 89 projects, which will help irrigate nearly eight million hectares. The government will spend INR 170 billion (€2.4 billion) on these projects in 2016-17, and INR 865 billion (€12 billion) in the next five years 17

1.8. Protecting farmers Most Indian farmers are small and marginal with limited resources to spend on agrochemicals and better varieties of seeds. They are also exposed to the threat of vagaries of the weather impacting crop output. The government has realized this and has taken some major steps to protect the farmers. Some notable steps are:

1. Crop insurance scheme: In January 2016, the government approved a crop insurance scheme — Pradhan Mantri Fasal Bima Yojana (PMFBY) — under which farmers’ premium has been kept at a maximum of 2% for food grains and oilseeds; and up to 5% for horticulture/cotton crops. Private insurance companies, along with the Agriculture Insurance Company of India Ltd., will implement the scheme. All claim liability will be on the insurer and the government will give upfront premium subsidy. It is notable that in Budget 2016, the outlay for PMFBY has been more than doubled to INR 55 billion (€0.8 billion) from INR 25.9 billion (€0.4 billion) in 2015-16 (budget estimate).

2. Agriculture credit: In Budget 2016, the government has set a target of INR 9 trillion (€125.1 billion) of agricultural credit, up INR 500 billion (€7 billion) from the previous budget. The government has continued the Interest Subvention Scheme for short-term crop loans and has allocated INR 150 billion (€2.1 billion) towards this scheme. This facilitates lending to farmers at a concessional rate of 7%, and on timely repayment of loans, further lending at 4% interest per annum. The credit push is possibly due to the government’s focus on banks’ meeting their priority sector lending requirements.

1.9. Foreign collaborationThe Ministry of Agriculture has signed memoranda of understanding (MoUs) with 52 countries to provide better agricultural facilities for cooperation in the fieldof agriculture and allied sectors.18 EU has also been involved on cooperation with India on extensive EU legislation on pesticides, MRLs, etc. in different forums. In 2013, India entered into a bilateral cooperation agreement with Germany for the purpose of enhancing

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cooperation between agricultural research institutions and seed companies of the two countries. The two countries have also decided on expert visits for a defined list of interested areas such as crop protection products. In continuation to this, on October 5, 2015, the German Agribusiness Alliance (GAA) and Agriculture Skill Council of India (ASCI) signed an MoU with the objective of jointly developing the establishment of Indo-German Centers of Excellence in Agriculture, a platform for practical skill development in agriculture in India. The aim of this initiative is to raise awareness on emerging areas of agriculture technologies and their application, and to adopt best skill development practices and concepts from India and Germany. The proposed Centers of Excellence will provide practical and professional skill training on modern technologies and organize demonstrations of technological advancement for farmers and wage workers in agriculture related industries. They will encompass various areas of agriculture and shall be set up in cooperation with agriculture institutions in India.19 In addition, the government has allowed 100% FDI under the automatic route in the agriculture and allied sectors industry.

Some leading European companies in India in the sector

1. BASF2. Bayer Crop Science3. Syngenta4. Helm AG5. Rabo Equity Advisors6. Univeg7. Claas8. CNH Industrial9. ADM10. Deutz-Fahr

2. INDUSTRY CHALLENGES2.1 High regulatory burden: Stringent

environmental regulations requiring time-consuming registration procedures are increasing the cost of developing new products and simultaneously delaying the introduction of new products in the market. Generally, it takes almost over five years to bring a new product to the market in India.

2.2 Low investment in R&D: The industry is facing a serious challenge due to increasing R&D costs. There has been lack of data protection for innovators developing new molecules. This prevents companies from investing in R&D activities and they tend to focus more on generic products, which require low investments.

2.3 Low awareness among farmers leading to indiscriminate use: Only 25%–30% of Indian farmers are aware of agrochemicals products and their usage, and there is a lack of reading of labels by farmers.20 Hence, product stewardship is of paramount importance. Poor extension services, language barriers and a general reluctance toward adoption of new products on account of possible risks of crop failure add to the woes. The main point of contact between farmers and manufacturers are the retailers who don’t have adequate technical expertise and are therefore unable to impart proper product understanding to farmers.

2.4 Presence of counterfeit/spurious products: It is estimated that the counterfeit pesticide market in India was estimated at INR 3,200 crore (€421 million) in 2013. 21 These products are inferior formulations, which are unable to kill pests. They also leave by-product residues, which may significantly harm human, soil and environment. The use of non-genuine products leads to loss of revenue to farmers, agrochemical companies and government.

2.5 Lack of crop rotation leading to low-productivity: Farmers in key agriculture belts, including Punjab, Haryana and western Uttar Pradesh generally grow two major crops every year – wheat and paddy, without much crop diversification, leading to low productivit .

2.6 Lack of efficient distribution systems: The industry has been facing problems arising out of supply chain inefficiencies and inadequate infrastructure. Hence, reach to farmers is impacted.

2.7 Rising cases of breaching of maximum residual limits (MRL): There has been an

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increase in the cases of breaching of MRLs in India mainly because of indiscriminate use of pesticides by farmers and this has affected the exports of rice, fruits and vegetables to many countries in Middle East, EU and the US.

3. KEY ISSUES AND RECOMMENDATIONS

Objective: Developing India as a global hub in agrochemical manufacturing and fulfilling thedomestic as well as export demand

3.1 Issue: Regulatory hurdles

Recommendations

The process of registration by Central Insecticide Board (CIB), the regulatory body under Ministry of Agriculture, needs to be streamlined in a way that the period for getting a new registration gets minimized while meeting the safety related requirements. The guidelines need to be clearly defined to avoid interpretation challenges, which lead to confusion thereby adding to the complexities for agrochemical companies. Fast-track approvals and clearances should be provided by regulatory bodies to encourage companies to develop new products. India, being a signatory of the Organization for Economic Co-operation and Development (OECD), should implement its requirements in letter and spirit and encourage data generation under good laboratory practice (GLP).

3.2 Issue: Presence of counterfeit/spurious products

Recommendations

The government needs to come up with stringent regulations to prevent illegal imports, spurious products and spiked products being sold in India. Heavy fines should be imposed on the guilty and license of such companies should be cancelled after a pre-defined number of defaults. Farmers need to be educated on how to differentiate between genuine and fake products.

3.3 Issue: Low investment in R&D

Recommendations

The government needs to encourage R&D activities to facilitate new innovations in the Indian market. Additionally, the government must provide a conducive business environment for agrochemical companies to set up R&D labs in India. New innovations or developments should be recognized and the companies should be awarded for the same.

3.4 Issue: Low awareness among farmers

Recommendations

The government should collaborate with private companies in spreading awareness to farmers about the appropriate use of pesticides by organizing awareness camps/industry conferences more frequently. The government, private industry and retail organizations have to agree on a common focus approach for the development of education and training for farmers on the one hand, and for the increase of awareness of the consumers on the other.

3.5 Issue: Focus on Green chemistry

Recommendations

Green chemistry and sustainable agriculture are inherently intertwined. The government should focus on bringing green chemistry to the farms which are safe to environment and also to human beings with characteristics of less persistence in soil, water and plants. Bio-pesticides and safer green chemistry molecules should be given priority for introduction.

3.6 Issue: Data protection for innovators/Pesticides Management Bill, 2008

Recommendations

Global agrochemical research based companies have to wait for nine-10 years and pass more than 100 safety tests to bring a new molecule into the market with a cost of minimum US$250 million (€219 million).22 In order to safeguard the rights of innovating companies,

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the government needs to seriously bring in data protection so that generic companies follow certain guidelines or procedures vis-à-vis cost incurred by the original registrant. The Pesticides Management Bill, 2008 provides for a stronger data exclusivity regime for agrochemicals. The government needs to pass the bill at the earliest as it awaits Parliament approval.

3.7 Issue: Extension services

Recommendations

Enhancement of extension activities is required both by the government and the private sector to increase awareness among farmers on issues of safety and the right use of agrochemicals. Extension services rendered should be incentivized.

3.8 Issue: Incentivizing the agrochemical industry for enhancing manufacturing

Recommendations

The central and state governments should encourage the setting up of domestic agrochemical industries through reduction in excise duties, tax holidays etc. This would garner more investments in the country and bring employment opportunities. The government needs to continue to provide infrastructural support to the industry to develop effective marketing and distribution solutions.

3.9 Issue: Health, Safety, Security and Environment (HSSE) implementation

Recommendations

Agrochemical industry players must specifically invest and maintain best practices on HSSE. The government and public bodies must also incentivize units to adhere to safety requirements and abide by global standards. The National Chemical Policy that the Ministry of Chemicals and Petrochemicals has framed should be released at the earliest for implementation as it lays emphasis on HSSE.

3.10 Issue: Negative perception linked to the agrochemical industry

Recommendations

Industry players will need to shoulder the primary onus of enhancing the image of the industry by creating the right kind of perceptions through public awareness. Support from the government will also be vital in this regard by showcasing the importance of the industry in various public forums. These efforts will also serve well in attracting skilled technical talent to the industry. This is vital for long term growth as well as in conveying the importance of the industry within the national landscape. A roadmap in this direction needs to be put in place.

4. CONCLUSIONThe Indian agrochemical industry is highly diversifie and regulated. It operates in an environment facing many complex factors influencing the speed of adoption of new technologies. The industry is expected to gain momentum in the next few years due to increased investments in agricultural infrastructure. There are significant growth opportunities for agrochemicals due to India’s low-cost manufacturing base, under-penetration of pesticides in domestic market, huge export potential, higher production and growth of generic products, product portfolio expansion and growth in herbicides and fungicides. In coming years, the industry should focus on developing new processes and products with sustainability as the core principle. This requires developing a collaborative platform in which the academia, government and regulatory bodies, farmers’ associations, manufacturers and farmers come together to promote safe and judicious usage of pesticides.

Of the many challenges which need to be addressed to give a fillip to this sector, the most critical ones are the regulatory reforms to be pursued by the government, infrastructural investments, incentivizing R&D, ensuring data protection to innovators and educating the most important stakeholder — the farmer – about the proper usage of agrochemicals.

The future for Indian agrochemical industry, as a facilitator of the Indian agriculture and also of the Indian economy, is indeed bright.

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Endnotes

1,2,4,5 Source: A report on Indian agrochemical industry – November 2015, FICCI

3. Source: Ministry of Agriculture

6. Source: A report on Indian agrochemical industry – November 2015, FICCI and secondary research

7. Source: Secondary research

8. Source: National Seeds Association of India and Secondary research

9,10 Source: Department of Fertilizers and Secondary research

11,12 Source: A report on Indian agrochemical industry – November 2015, FICCI

13. Source: Secondary research

14. Source: Secondary research

15. Source: A report on Indian agrochemical industry – November 2015, FICCI

16. Source: A report on Indian agrochemical industry – November 2015, FICCI

17. Source: Union Budget 2016-17 and secondary research

18. Source: Secondary research

19. Source: German Embassy – German Missions in India and secondary research

20. Source: A report on Indian agrochemical industry – November 2015, FICCI

21. Source – Study on substandard, spurious/counterfeit pesticides in India,2015, FICCI

22. Source: A report on Indian agrochemical industry – November 2015, FICCI

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ALCOHOLICBEVERAGESRe-design overall architecture to minimize discrepancies across states: taxation, regulations, legislation, production and promotion of alcohol, and provide a level playing field

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Market Description

1.1 India is a key market for the global alcoholic beverage industry, consistently occupying a spot amongst the leading countries in the sector. Alcohol has increasingly become an important commodity in India’s emerging economy with the number of consumers of spirits and imported alcoholic brands growing rapidly. India is the dominant producer of alcohol (65%) in South East Asia and contributes about 7% to the total alcoholic beverage imports into the region. Consumption of legitimate commercial alcohol in India has registered a steady growth of 10% to 15% each year during the past decade with greater expansion experienced in the southern region. A key driver of this growth has been the increasing affluence of consumers, enabling them to switch from non-commercial alcohol sources to legitimate sources and bringing benefits in terms of consumer safety and state tax revenues.

1.2 Though the population of India is over 1.2 billion, the drinking population is estimated to be around 15% to 25% of the total adult population. Of this, the estimate of drinkers of quality liquor varies between two million to three million and consumers of imported liquor, who are largely confined to the metros, are limited to just over one million.

1.3 South India is the highest alcohol consuming region in India, representing over 40% of the total consumption in 2013. This was largely driven by the states of Andhra Pradesh and Kerala. The west, north and east represented approximately 26%, 23% and 10% of consumption in 2013, respectively. There are wide regional differences in consumption patterns across India. South India is a prominent

brandy market, realizing approximately 80% of India’s brandy consumption in 2013. North India, on the other hand, is a whisk(e)y-orientated region. Rum is widely consumed in the south and east.

1.4 The overall market for legitimate commercial spirits experienced one of its slowest years during 2014, realizing a paltry growth of 0.5% as compared to the previous year. The total consumption of spirits (9 litres branded) in India was a little over 310 million cases in 2014 and is estimated to reach 320 million cases in 2015. Further, the consumption of wine during 2014 was 2.7 million cases (9 litres), and is estimated to reach approx. 3.1 million cases in 2015. White spirits (such as vodka) have also registered negative growth since 2011. (Please refer to tables overleaf).

1.5 The decline in consumption of spirits in 2014 could be attributed to factors such as FSSAI (Food Safety and Standards Authority of India) labelling issues, states raising taxes and additional levy.

1.6 Consumption is expected to again register negative growth in 2015; challenging for producers in view of production costs increasing by much as 30%, increase in excise duties, levy of service tax, Swachh Bharat (clean India) tax, the demand by some states to reduce purchase price and so forth. The pricing issue gets compounded due to the unwillingness of states to offer price increases to the producers, who in turn cannot pass on the increased costs to the consumers. This leads shrinking margins.

1. INTRODUCTION

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CONSUMPTION - Spirits: 000s 9 Litre Cases

Source: IWSR India Annual Report, 2015

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1.7 The wine market has been largely represented by still light wine (estimated to be nearly 50% of the total wine market during 2014). Sparkling

wine is estimated to have constituted less than 5% of the total wine market in India during 2014.

Consumption – Wines: 000s 9 Litre Cases

Source: IWSR India Annual Report, 2015

1.8 The growth in consumption of alcoholic beverages over the last decade can primarily be attributed to the following reasons:

• increasing affluence of consumers, higher disposable income and increasing social acceptance;

• increased consumption by ‘young India’, which represents a large and growing portion of the Indian population;

• easier accessibility to alcoholic beverages, especially imported alcohol, in main cities, including Mumbai, Delhi/Gurgaon, Bangalore, Hyderabad and Chandigarh, with the opening of new outlets and the modernization of existing outlets; and

• increased international travel by Indians leading to travellers carrying back premium brands of alcoholic beverage available at duty-free outlets at arrival terminals of airports and seaports (India allows up to two litres of duty-free alcohol purchase on arrival).

Structure of the industry in India

1.9 The Indian alcohol industry is significantlydifferent from markets in other large countries. The market architecture varies from one state to another in terms of taxation, regulation, legalization, production and promotion. It is like operating in 36 different countries (29 states and seven union territories). Typically, the tax structure in two neighboring states is different, resulting in a strong incentive for unauthorized interstate movement of alcoholic beverages.

1.10 In addition to import duties imposed at the central level, alcoholic beverages are also subject to varying rates of excise duty and value added tax (VAT) or sales tax at the state level. Accordingly, the total incidence of tax (including import duty and local taxes) on products imported into India varies from 300% to 500%.

1.11 Distribution and logistics are underdeveloped in most Indian states. Outlets are thin on

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the ground in most states and development is slow. The model varies from part owned by the state government and part by private enterprise to a fully owned private enterprise. Distribution in southern states like Tamil Nadu, Telangana, Andhra Pradesh and Kerala is fully owned by state governments. Moreover, the Kerala government imposed partial prohibition during 2014.

1.12 Any form of advertising of alcoholic beverage products is strictly ‘prohibited’, thereby making brand visibility and/or introduction of new products extremely difficult. This has led to the emergence of brand extensions (within the defined regulatory framework)

1.13 Star rated hotels, stand-alone restaurants and duty-free shops (travel retail) have traditionally been the key channels of sale for international alcoholic beverages. Star rated hotels and stand-alone restaurants can spend up to 5% of their annual foreign exchange earnings to purchase duty-free alcoholic beverages. This has boosted the availability of international brands in top hotels. Travel retail continues to be a channel for international brands sales in India; the increase in international travel has boosted such sales.

Recent Developments and Industry Outlook

1.14 Based on previous indications, the industry was hoping to witness a reduction in basic custom duty (BCD) applicable on alcoholic beverages, but the proposal was not considered by the government in Budget 2016. Members of the industry believe that high BCD coupled with states taxes is one of the greatest impediments for the industry.

1.15 Increased cost pressure has become a rising concern amongst all alcoholic beverage companies in India. This has been fuelled by a steep surge in raw material prices (molasses and ethanol), increased price of packaging and the depreciating Indian rupee. Furthermore, the central government’s proposal to increase the service tax to 14%, introduce an additional

2% Swachh Bharat cess as well as service tax on bottling activities with no price increase given by respective state governments would further burden the players in the market.

1.16 The diminishing growth of alcoholic beverages can primarily be attributed to a drastic increase in taxes, which has led to an increase in unit prices. The proposed levy and increase in taxes (in line with the budget), coupled with other regulatory restrictions and bans such as advertisement of liquor, tariffs on interstate transfer of molasses and liquor, limited distribution networks due to complex licensing requirements and stringent government controls, is expected to further dampen volume growth in the short to medium term.

1.17 Increasing pressure on margins due to the rising cost of the key raw material (extra neutral alcohol) required for the manufacture of consumable liquor has resulted in divestment or withdrawal of underperforming brands by distillers. In order to improve performance through the efficient utilisation of growth capital, hiving-off of debt, rationalization of the brand portfolio and expansion of regional coverage, companies are considering mergers, acquisitions and investments.

1.18 Despite the slowdown in volume growth during last couple of years, India remains an attractive market for global brands looking to offset the sluggish growth being realized in mature markets. Indian spirits have also gained immense popularity in destinations outside India. The recent past has been witness to several transactions within the industry, including the recent acquisition of United Spirits Ltd. by Diageo Plc. Further consolidation is expected within the industry, with the possibility of big players selling stakes to international players and small breweries divesting stakes to venture capitalists or private equity firms. The table below presents a list of transactions that have taken place in the industry over the recent past:

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1.19 In 2013-14, India witnessed new launches in both the premium and standard categories of alcoholic beverages. Given the strong growth of and demand for high content alcohol in India, recent product launches have been concentrated towards high alcohol content categories. Accordingly, new international brands entering (or planning to enter) India may consider modifying their products to suit the preferences of the Indian consumer. They may also consider positioning their products differently in India where taste and refinementare not factors for most drinkers. Companies are also expected to launch premium products to maintain margins.

2. GENERIC INDUSTRY ISSUES 2.1 The government of India currently describes

all spirits and wines in the sensitive category.

Import of all types of alcoholic beverages (other than beer made from malt) is subject to a BCD of 150%, before the application of state taxes and duties. The BCD on beer made from malt is 100%. The BCD has remained unchanged since 2004, and continues to remain very high in relation to international standards (China at10%, Brazil at 20%, etc.).

2.2 As per the Constitution of India, production, sale and distribution of alcohol in India are state subject. The taxation of alcohol is based on consumption and not manufacturing and accordingly differs across states. There is no central tax imposed on the sale of alcoholic beverages. Although the industry has been highly regulated by the government in order to avoid revenue leakages, enforcement has been limited.

2.3 High taxes and different and inefficient tax

Month Type Acquirer Target

Jan-14 M&A Diageo Plc United Spirits Ltd

Feb-14 M&A Tilaknagar Industries IFB Agro - Indian Made Foreign Liquor Brands

Mar-14 M&A Piccadily Agro Industries Nirvana Biosys

May-14 M&A Emperador Inc Whyte & Mackay Group - United Spirits

May-14 M&A Reliance Capital Verlin Vest (Sula Wines)

Jun-14 M&A United Breweries Ltd Pacific Spirits Pvt Lt

Jul-14 M&A Diageo Plc United Spirits Ltd

Jul-14 M&A United Spirits Ltd J P Impex Incorp - Karnataka assets

Feb-15 M&A Anheuser-Busch InBev InBev India International Ltd- RJ Corp

Apr-15 M&A Diageo Plc United Spirits Ltd

Apr-15 M&A Molson Coors Mount Shivalik Breweries

May-15 M&A Diageo Plc United National breweries

Jul-15 M&A Allied Blenders and Distillers Shasta Bio Fuels

Jul-15 M&A Heineken United Spirits

Oct-15 M&A JMJ Group-ViikingVentures Impala Distillery and Brewery-Kings Beer

Source: Grant Thornton Dealtracker

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structures in consuming states have resulted in an increase in the sale of non-tax paid stocks of Indian and international products in the market, thereby depriving the government of taxes. This has also promoted unauthorized interstate movement of alcoholic beverages and provided an opportunity for the production of illicit and spurious alcoholic beverages that can cause serious health risks.

2.4 States mandate setting up warehouses and levy taxes (on import and export) resulting in higher tax incidence on all alcoholic beverages. This has resulted in providing larger tax benefits to local products manufactured within the states as against those imported from outside the state, thereby negatively impacting interstate trade. Although improvements in logistics are improving distribution and access to premium products, lack of cold storage and established efficient distribution networks restricts trade of temperature sensitive products (notably wine).

2.5 The differential model of tax on imported alcoholic beverage (bottled in origin) vis-à-vis domestic products (bottled in India/IMFL, or Indian-made foreign liquor) has resulted in denying market access to many international brands since low volumes become deterrent for a launch in many states. This has negatively impacted trade.

3. KEY ISSUES AND RECOMMENDATIONS

3.1 India-EU Free Trade Agreement (FTA) negotiations – Reduction of basic customs duty (BCD) on alcoholic beverages

The import of all types of alcoholic beverages (other than beer made from malt) is subject to BCD of 150%, before the application of state levies and duties. The BCD on beer made from malt is 100%. This is very high by international standards when compared to China (10%), Brazil (20%) and the average G20 countries duty of 30%.

The high incidence of customs duty coupled with state duties/taxes acts as a major hindrance for the import of alcoholic beverages. Products becoming expensive beyond the reach of majority of Indian consumers renders them non-saleable. The high level of taxes also leads to promotion of grey market trade, resulting in a loss of revenue for both the central and state governments. Moreover, there is also a high influx of counterfeit products in the market. This undermines brand equity, deceives consumers and poses a high health risk for consumers.

The size of the imported alcoholic beverage segment as compared to domestic production is currently negligible (1% of the total consumption of legitimate

The table below presents the applicable central customs duty:

Category HS Code % customs duty on CIF

Beer made from malt 220300 100%

Wine of fresh grapes, including fortified wine 220421 150%

Vermouth and other wine of fresh grapes flavoured with plants oraromatic substances

220510 150%

Other fermented beverages (for example, cider, perry, mead); mixtures of fermented beverages and non-alcoholic beverages, not elsewhere specified or include

220600 150%

Undenatured ethyl alcohol of an alcoholic strength by volume of less than 80%; spirits, liqueurs and other spirituous beverages

220710 150%

Source: Official sources (Central Board of Excise and Customs (CBEC), http://www.cbec.gov.in/excise/cx-tariff0910/chap22.pdf), trade discussions

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commercial alcohol is imported). There are strong benefits for Indian consumers in terms of increasing access to imported products including suppressing illicit and counterfeit products. This would further lead to a balancing of agri-food trade between India and the EU and in general benefit the econom .

Recommendation

There is need to rationalize the import tariff in a phased manner from 150% to 75% immediately and ultimately to 30% over a period of two-three years. However, to protect interest of the domestic alcobev industry, a threshold limit of import value CIF (cost insurance freight) of €30/case of 9L should be adopted, with duty benefit accruing to imports valued at CIF €30/case and above. Accordingly, the focus should be to work with the EU and the government of India and inter-alia seek a reduction in the BCD and develop a friendly India-EU FTA.

3.2 Goods and Services Tax (GST) regime – Inclusion of Alcohol

The 122nd Constitution Amendment Bill, which was reintroduced in the Lok Sabha on December 19, 2014, proposes to make amendments to the Constitution of India and provide for the introduction of GST. The only item excluded from the purview of the GST under the amendment bill is ‘alcoholic beverages’. Under the proposed regime, while most inputs and services of the alcoholic beverages Industry would be taxed under GST, the output, i.e. alcoholic beverages, would be outside GST, leading to non-utilization of input tax credit. However, the alcobev sector will be subject to state excise duties and sales tax.

Analysis shows that there will be substantial increase in tax costs on procurements by the alcoholic beverages industry under the proposed GST regime. There will be 22% to 26% GST cost on all inputs (local + imported) and services required by the industry. There will be a high negative impact of cascading, which counters the benefit of any rational economic policy and is against the well-adverted policy of the government to avoid cascading effect, the basic tenets of GST.

Additionally, the union finance ninistry in its Budget 2015 announced removal of alcobev contract bottling activity from the negative list of service tax, thereby imposing an additional service tax levy of 14%. This

has further led to added costs to the industry.

It would be difficult for the industry to pass on the impact of this increase in cost to consumers since alcoholic beverages are already priced high (owing to the existing tax structure). Furthermore, as selling prices in various states are controlled by the respective State Beverage Corporations, passing on of the impact may not be approved.

The implications of the proposed changes in the tax structure are as follows:

• Under the proposed regime, while most inputs and services of the alcoholic beverages industry would be taxed as per GST, the output, i.e. alcoholic beverages, would be outside GST, leading to non-utilization of input tax credit;

• GST creates an audit trail for inputs, outputs, sale and resale, which helps minimize compliance gaps. If excluded from GST, the alcohol industry will continue to be subject to current compliance gaps in the levy of excise duty and other taxes. This would result in administrative issues for both the industry and government in terms of assessment and compliance. Non-inclusion would further add to compliance costs and disputes;

• Increased grey market transactions and supply of counterfeit and spurious products;

• Decreased international competitiveness due to tax cascading; and

• The alcoholic beverages industry is the second largest contributor to the government exchequer after petroleum, contributing more than Rs.90,000 crore (approx. €12 billion) in taxes. The sector also provides direct and indirect employment to millions of semi-skilled and unskilled persons, and supports allied sectors such as agriculture, which is the primary source of raw material. A change in the tax structure may adversely impact investments and employment generation as well as tax collection from the alcoholic beverages industry. Further, support to the allied sectors may also be negatively impacted. This will lead to an all-round negative impact for the industry, the consumers and the government.

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Recommendation

The government (central and state) should reconsider their views on the exclusion of alcoholic beverages through the Constitution (Amendment) Bill. In the event of alcoholic beverages continuing to remain outside the purview of GST, the government may consider introducing a mechanism to mitigate the negative impact of the cascading effect of taxes. This may include the following options:

1. GST paid on inputs consumed by the alcoholic beverage industry may be made available as refund to the alcoholic beverage manufacturers; or

2. GST paid on inputs consumed by the alcoholic beverage industry may be made available as deemed tax credit to be set-off against state excise duty/sales tax liability.

Members of the alcoholic beverages industry believe that the above approaches are a necessary and inevitable consequence of the exclusion of alcoholic beverages from GST regime. The industry further states that these approaches have numerous precedents in law (both in India and globally). These approaches would help negate the impact of a cascading effect, discourage manufacture of spurious liquor and also help in securing an audit trail of transactions.

3.3 Food Safety and Standards Authority of India (FSSAI)

Under the Food Safety and Standards (FSS) Act 2006, alcoholic beverages have been defined as ‘food’. This has resulted in the introduction of a compliance requirement for all alcoholic beverages manufacturers and importers to apply for registration as a Food Business Operator (FBO) with the FSSAI, which is currently being done ‘under protest’. Following the notification of the FSS Packaging & Labelling Regulations in 2011, FSSAI implemented testing of alcoholic products at the point of import. Based on sustained industry representations, FSSAI permitted labelling to remove minor defects (as per notified guidelines) at customs bonded warehouses

During the first week of April, the FSSAI’s ScientificCommittee met members of the alcoholic beverage

industry for an interactive session. Several suggestions proposed by the industry were acknowledged to be acceptable to FSSAI and approved for inclusion in the draft product standards. Amongst others, the industry proposed that product standards be consistent with the international standards.

Additionally, the wine industry has made a submission to FSSAI in 2014 through the India Grape Processing Board to notify wine as a single ingredient product.

Recommendations

• Stringent controls over the sale of alcoholic beverages in the domestic market provides for a wide distinction as compared to other food products. The industry suggests that due considerations be given to such aspects by FSSAI when allowing import of alcoholic beverages into India;

• Alcoholic beverages imports are kept in customs bonded warehouses and the products cannot be distributed in the domestic market unless specific requirements prescribed under the respective state excise regulations are met by the industry. Hence, the industry urges FSSAI to consider allowing affixing labels at customs bonded warehouses in case of any deficiency appearing on the label. This will help avoid any future blockage of imports as well as assist in the reduction in cost;

• FSSAI is currently in the process of drafting ‘product standards’ for alcoholic beverages and due consideration should be given to adopt and be consistent with international standards. This will help in improving the quality of wines and spirits produced in India (with the objective of moving towards international quality products), thereby paving the way for acceptance of such products in international markets. At the same time, import of international products in the Indian market will be less likely to face any blockage; and

• Wines and spirits should be considered a ‘single ingredient’ product, as is being treated in other jurisdictions.

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3.4 Income Tax - Transfer Pricing Dispute – Advertising, Marketing & Promotion

Another area of concern for MNCs is the aggressive position taken by Indian Revenue Authorities (IRA) on transactions being subject to transfer pricing regulations between related parties. The IRA are challenging the Indian subsidiaries of multinational groups on their AMP (advertisement, marketing and promotion spends) by setting an artificial limit on allowing deduction of such spend for the purpose of tax assessments.

As per the IRA, expenditure on AMP incurred to promote international brands of MNCs has resulted in brand building and increased awareness of such brands in India, thereby resulting in value creation for an intangible owned by the foreign legal owner. Accordingly, IRA has taken a view that expenditure incurred by Indian subsidiaries beyond the IRA’s derived limits (‘Bright Line Limit’ i.e. routine AMP incurred by a purely domestic Indian company to exploit similar intangible properties) is to the enduring advantage of the foreign brand owner and therefore the Indian subsidiary of the MNC needs to be suitably compensated. Accordingly, the excess above the Bright Line Limit is treated as a cost of service provided by the Indian subsidiary to the foreign associated brand owner, and such cost of service along with mark-up in range of 15%-21% is treated as income in the hands of the Indian subsidiary.

This results in discrimination between such Indian subsidiaries of MNCs and similar domestic companies. The element of discrimination arises because the Bright Line Limit is based on arithmetic mean AMP/Sales ratio of range of so called comparable companies. Further, the fact that such MNC subsidiaries are carrying on business as entrepreneurs in terms of recognized TP (transfer pricing) rules appears to have been ignored with the sole objective to generate additional tax revenue and disregard the taxable profits generated in India.

The stand taken by the IRA has been largely upheld by the special bench ruling of the Income Tax Appellate Tribunal (ITAT), which has resulted in significant sums of money being the subject of litigation at various levels. Recently, pursuant to several tax payers filingan appeal against the ruling, the Delhi High Court

(DHC) pronounced its ruling in the case of taxpayers characterized as distributors. The DHC inter-alia held that it is not obligatory to subject the expenditure on AMP as a separate transaction and if, upon inclusion of AMP, profit margin of a distributor is within the specified range, no transfer pricing adjustment is required. The issue of AMP for licensed manufacturers is also listed for hearing before DHC and an order is expected soon.

Recommendation

The Central Board of Direct Taxes (CBDT) should desist from filing an appeal against the ruling of the DHC before the Supreme Court in order to attain finality on this matter. The CBDT may further consider advising its officers to follow the principles laid down in this ruling in relation to the AMP issue.

3.5 Valuation of bottled-in-origin (BIO) alcoholic beverages (duty-free vis-à-vis duty paid)

BIO alcoholic beverages imported by domestic market distributors are being set aside by customs authorities in order to enhance their transaction value on the basis of prices of similar goods imported by duty-free shops at airports and seaports. However, for the past several decades, it has been a trade practice to have different pricing for goods sold in the domestic market and those sold to duty-free shops.

Prices of supplies to duty-free shops and the domestic market distributor cannot be compared since duty-free shops and domestic market distributors are two separate channels of commerce and operate at different commercial levels. This is highlighted by the following key differences:

a. Duty-free shops sell goods through retail shops in the Customs Area beyond the Customs Frontier of India, which is distinct from the duty paid market addressed by the distributors;

b. Both parties have differing obligations with respect to payment of domestic taxes (customs duty, state excise duty and VAT on domestic sales) and incurring costs on promotion of goods in assigned territories; and

c. Duty-free shops are at the level of a retailer

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selling goods directly to consumers beyond the customs frontiers of India. Such sales are made by duty-free shops even before the goods are imported into India (i.e. before crossing customs frontiers). On the other hand, domestic market distributors import the goods upon payment of customs duty and such goods are indirectly sold to retail consumers through a chain of wholesalers and retailers. Apart from incurring additional costs towards domestic duties and taxes, and wholesaler and retailer margins, domestic market distributors have to also incur substantial costs towards marketing and promotion of the imported goods in their respective territory. Accordingly, the commercial level at which duty-free shops and the domestic market operate are vastly different.

The distinction between the duty paid market and duty-free channel becomes more apparent from the fact that the duty-free channel has certain specificcharacteristics with respect to the sale of BIO products by duty-free shops that do not exist for distributors functioning in the duty paid market, which include:

a. The import of goods into duty-free shops are goods not intended for the Indian domestic market;

b. Duty-free shops can be set up only in customs areas (at airports and seaports), which are restricted areas except for sale to bona fideinternational passengers with valid travel documents (passport, flight details etc.) and pricing determined in foreign currency;

c. No customs duty is leviable on purchase of liquor within the duty-free limits as permitted under the Baggage Rules, 1998; and

d. Private duty-free shops operate as private bonded warehouses under the Customs Act.

In view of the above considerations, the basis for valuation of alcoholic beverages sold in duty-free shops cannot be the same as that for sale in domestic market.

Recommendation

Given the distinct nature of sales at duty-free and duty paid (domestic market) channels, these should be considered two separate channels of sale under

the Customs Valuation Agreement to which India is a party. Prices of supplies to duty-free shops and the domestic market should not be used as reference prices for each other.

3.6 State level issuesAs per the Constitution of India, production, sale and distribution of alcohol in India is a state subject. All activities, from registration of labels to determination of retail price, are managed and controlled by the state government through state excise departments. There is a wide variation in the rates of duties and nomenclature of taxes across states. Taxes and duties are revised each year through the Annual Excise Policy document, which is announced at the beginning of each fiscal year. Although in terms of process, the government seeks the inputs of the industry and consultations are undertaken, taxes and duties finallyannounced are largely driven by state revenue, and considerations such as business profitabilit , impact of increased prices on consumers, and the effect of high duties and taxes are overlooked.

Some policies followed in certain states, which the industry believes are unjustified, unreasonable and discriminatory, are highlighted below. The excise policies and practices of these states are not in conformity with the WTO principles.

3.6.1 Delhi

There are two licenses available to wholesalers, as follows:

• License L-1: for wholesale vendors of Indian liquor (IMFL)

• License L-1F: for wholesale vendors of foreign liquor (BIO)

The terms and conditions associated with the two licenses differ. Under the L-1 license, in the case of whisky with a maximum retail price (MRP) above Rs.400 (€5.3) per 75 cl, free pricing is allowed. It is also allowed for rum, gin, vodka and brandy with MRPs above Rs.250 (€3.3) per 75 cl. In contrast, under the L-1F license, the licensee is required to declare that the wholesale prices prevalent in Delhi are the lowest in comparison to any other location in India. Despite numerous industry representations to the Delhi Excise Commissioner and agreement by the commissioner to revise the policy, discriminatory

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pricing restrictions continue to exist in the Excise Policy 2014-2015.

With regard to effective tax treatment, Delhi excise rates for domestic wine and spirits are significantl lower than for foreign wine and spirits. Excise duty in Delhi is imposed on an ad-valorem basis, on the wholesale price, within a “slab system”. In case of domestic wines, 65% duty is in place up to Rs.100 (€1.3) per bottle, with a progressive decline in duty as prices exceed Rs.100 per bottle. However, in the case of imported wines, 65% duty is in place up to Rs.1,000 (€13.2) with a progressive decline in duty for prices over Rs.1,000. Accordingly, a bottle of domestic wine with a wholesale price of Rs.1,200 (€16) would be subject to an applied excise duty of 34% as compared to applied tariff of 63% in case of a bottle of imported wine with a wholesale price of Rs.1,200.

Recommendation

Elimination of the discriminatory pricing mechanism adopted by the Delhi Excise Department may be considered. This will enable a level playing field and ensure a healthy and competitive environment, which will benefit the end consumers.

3.6.2 Karnataka

The provisions of the Karnataka Excise (E.D. AND F) Rules, 1968, recognize pack sizes of 8.64/9/12 bulk litres of IML (standard packs) for the purpose of calculating the duty liability. Packs that do not conform (non standard pack size) with the above defined standard pack size are taxed differentially ‘special fee). The rules require that the ex-factory price of non standard pack sizes, irrespective of the quantity of actual alcohol beverage contained in the pack, be adjusted in order to arrive at the cost per case containing 12 bulk litres (BL). Accordingly, the cost of a non standard pack size containing 6 BL of alcohol has to be adjusted so as to reflect the ‘ex-factory cost’ of 12 BL, which is deemed to be the ‘declared price’. Special fee is calculated and payable as per the excise duty slabs prescribed by the government from time to time, based on the declared price. Owing to the high duty resulting from the said mechanism for computation of duty on non standard pack sizes, a substantially increased MRP is charged to the consumer.

Recommendation

The government may consider rationalizing the mechanism for computation of duty on different pack sizes, whereby duties are levied on non standard pack sizes on a pro-rata basis, in line with the actual volume contained in said packs.

3.6.3 Haryana

As per the Excise Policy for 2015-16 released by the Haryana Excise Department, a new levy in the form of assessment fee has been introduced in relation to BIO wines and spirits, which are marketed in Haryana. Assessment fee leviable on BIO wines and spirits and imported wines is much higher than the slab based excise duty applicable for locally manufactured products. While the excise duty at the highest bracket for locally manufactured products is Rs.70 (little less than a euro) per proof litre (PL), assessment fee for BIO wines and spirits is Rs.600 (€8) per PL and for imported wines is Rs.400 (€5.3) per PL. Further, there is significant variation between the rates of VAT applicable on BIO wines and spirits as compared with locally manufactured products. The rate applicable to local products is pegged at 8.40% as against 26.25% for BIO.

Recommendation

Elimination of the discriminatory pricing mechanism adopted by the Haryana Excise Department may be considered. This will enable a level playing field and ensure a healthy and competitive environment, which will benefit the end consumers.

3.6.4 Tamil Nadu

The Tamil Nadu alcoholic beverage market has experienced a significant impetus over the last fiveyears, with IMFL volumes increasing by nearly 115% and total revenue from alcohol increasing by over 160%. Tamil Nadu’s revenue from alcoholic beverages during 2013-14 is reported to be around Rs 23,000 crores (€3 billion), representing over one-fourth of the state’s overall collection from taxation. The Tamil Nadu State Marketing Corporation (TASMAC), a state government undertaking vested with the exclusive right for wholesale buying and supplying of alcoholic beverages in the state, operates nearly 6,800 retail outlets grouped across over 40 depots.

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While there has been strong growth for locally produced IMFL and beer, volume growth for imported spirits has been negligible. The state mandates supply of goods from the 11 distillery licensees operating in Tamil Nadu, and does not permit the import of IMFL from within India for categories below scotch. Further, nearly 90% of the business for brandy and rum falls in the low-end category. Lack of growth of the BII and BIO segments in Tamil Nadu in comparison with the trends in neighbouring states may largely be attributed to the restrictive policies of TASMAC (Tamil Nadu State Marketing Corporation). Even in states with smaller populations with smaller alcohol beverage markets and lower per capita GDP, the BIO and BII segment is relatively stronger.

In the case of Tamil Nadu, the members of the alcohol industry have identified four broad areas of concern that can be categorized as under:

1. Brand registration – administrative discrimination of BIO and BII brands.

2. Pricing and payment

3. Off premise (retail outlets)

4. On premise (clubs, hotel bars)

1. Brand registration – administrative discrimination of BIO and BII brands

Any brand in the state needs to be registered with TASMAC. Historically, Tamil Nadu did not have a policy for dealing with imported products, so that listing any foreign brand with TASMAC was impossible. This issue was part of WTO consultations initiated by the EU, which led to a major shift in Tamil Nadu policy.

Despite a policy change, brand registration for foreign liquor is currently challenging. TASMAC purchases and sales do not appear to be made solely in accordance with commercial considerations. Furthermore, the European companies do not seem to be provided with adequate opportunities to compete with locally produced spirits in TASMAC’s system of purchases and sales.

Recommendation

TASMAC may consider rationalizing the mechanism for purchase and sale of BIO and BII in order to provide a level playing field for European companies. This will ensure a healthy and competitive environment, which will benefit the end consumers.

2. Payment and pricing

Currently, BIO products are treated as per TASMAC terms and conditions for supply of imported foreign liquor brands (2011) and BII is treated as per TASMAC terms and conditions for registration of brands of indian made scotch whisky with TASMAC limited (1997).

Under the terms and conditions, the payment for BIO and BII products is made to suppliers upon final sale of the products to consumers from TASMAC retail outlets. In contrast, IMFL products produced in Tamil Nadu currently receive the benefits of a more efficientpayment mechanism (i.e. 50% of payment on supply of the stocks to TASMAC depots and the remaining 50% of payment on sale of stocks from TASMAC depots to retail outlets - typically within 15 days of the balance payment period, which is not a prescribed period).

Further, pricing is strictly controlled by TASMAC. The open pricing systems allowed in other states do not appear to exist in Tamil Nadu, which acts as a major deterrent for BIOs/BIIs to operate in state outlets. For example, no recent price increases have been allowed for the four listed BII products. In other states, brands are allowed in order to have their own competitive price positions to allow a wide range of brands to be offered to consumers. This is a disadvantage for manufacturers/suppliers of imported products in Tamil Nadu.

As per the terms and conditions for supply of imported foreign liquor brands (2011), the basic price offered to TASMAC by the supplier should be the lowest when compared with the rate at which these products are supplied by the supplier to neighbouring state corporations and other states (i.e. lowest in the country). On the other hand (with only very few exemptions), since IMFL brands supplied in Tamil Nadu are not supplied anywhere else in India, there is the absence of a reference point for pricing of the same. Accordingly, any price submitted by the producers of domestic brands receives TASMAC’s approval, thereby resulting in maximizing profit margins for the producers in accordance with the market situation in Tamil Nadu.

Recommendation

Given India’s WTO obligations, TASMAC may consider treating BIO/BII products in a similar manner to locally made IMFL, namely only one method of payment for both domestic and foreign products

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should be allowed and applied universally. This will enable a level playing field and ensure a healthy and competitive environment, which will benefit the end consumers.

3. Off premise (retail outlets)

Disenabling retail environment for high value goods

Currently, the Tamil Nadu policy only allows for one type of off-premise retail outlet in the state i.e. outlets wholly-owned by TASMAC. The retail outlets are linked to ‘service bars’ (low-end, on-premise) that incur a license fee of 2.5% of sales of the linked off-premise retail outlet. Consumers who purchase products from the TASMAC off-premise outlets have no legal requirement to consume those products in the attached service bar. As the value of sales of the off-premise retail outlet drive up the license costs of the linked on-premise outlet, there is a strong incentive for the on-premise owner (normally operating the establishment independently under contract from TASMAC) to (i) minimize the sale of products that will not be consumed in their premise and (ii) minimize the sale of high-value products from the off-premise environment in general. This disadvantages the sale of higher value premium BIO and BII products reducing the state’s revenue and consumers’ choices.

Recommendation

TASMAC may consider linking the license fee of ‘service bars’ to the sale carried out at the bar. Alternatively, in case the current structure (linking

license fee to sales of the off-premise outlet) would need to continue, TASMAC may consider assigning a lower license fee to the sale of BIO/ BII products (in comparison to domestic products).

4. On premise (clubs, hotel bars)

FL 2 / FL 3 license requirement for 20 rooms and 40 beds

On premise trade does not fall under the responsibility of TASMAC, but rather under the authority of Excise and Prohibition Department. Currently, a majority of BIO/BII stocks are consumed through clubs and hotel bars, which represent only 8.6% of the total on-premise environment. In contrast, a vast majority of IMFL stocks are consumed through service bars attached to TASMAC retail outlets. In effect, the outlets that predominantly drive consumption of BIO/BII products operate in a very small space and their operation is tied unnaturally to the provision of rooms and beds. While it is recognized that the number of outlets serving BIO/BII brands will not be as great as those predominantly serving IMFL, legally it is important to ensure there is no artificial restriction (e.g. stipulating non-essential criteria which can have a serious cost impact and which reduces their viability) on the number or distribution of outlets which predominantly serve BIO/BII.

Recommendation

TASMAC may consider removing artificial restrictions on the points of sale for BIO/BII products. This will enable the existence of a healthy and competitive environment, which will benefit the end consumers

Endnotes

1. IWSR Annual Report 2015

2. Official sources (Central Board of Excise and Customs

3. Research reports published by Euromonitor International

4. Extracts of newspaper articles

5. Extracts of industry discussion papers

6. Grant Thornton Dealtracker

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AUTOMOTIVEPartner in realizing India’s potential of being the largest market, global leader in hybrid electric vehicles, biggest manufacturing and export hub by continuously introducing advance products, well researched sustainable technologies and state-of-the-art

production systems.

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1. INTRODUCTION

India has significant potential to become a top automobile manufacturing hub in the world,given its large domestic consumption base, a cost competitive value chain and strategic geographical location. However, for India to realize its full potential will require focused approach to address few critical gaps, such as creating an enabling regulatory environment, developing the requisite talent and skills, fast-tracking infrastructure development, incubating R&D and innovation culture, and enhancing supply chain competiveness. This automotive position paper by European Business Group (EBG) is an attempt to provide a brief overview of the automotive industry in India, its challenges and recommendations toward the next level.

1.

Market description

1.1 The Indian automotive industry is one of the world’s largest and fastest growing markets, with annual sales of 19.8 million vehicles and production of 23.4 million vehicles in FY15. The industry has achieved a leading position in several sub-segments, such as the world’s largest tractor manufacturer, the second largest two-wheeler manufacturer, the sixth largest passenger vehicle manufacturer and the seventh largest commercial vehicle manufacturer1.

1.2 The auto industry has significant growth potential owing to the country’s low passenger vehicle penetration (20 vehicles per 1,000 people in 2015). India’s passenger vehicle parc (number of vehicles in a region or market) is expected to grow to more than 48 million vehicles by 20202, clearly establishing a strong upside potential.

1.3 Most global OEMs (original equipment manufacturers) have an established presence in the market along with Indian players. Well-connected ports and proximity to South Asian and African markets make India an ideal location to develop as a regional manufacturing and export hub.

1.4 The Indian auto industry is estimated to have a turnover of around US$77 billion (€67 5 billion) by FY15. With increased focus on R&D, collaborative development and building scale

for exports, the industry is steadily working to enhance its cost competitiveness, quality output and innovation3.

1.5 In FY15, its exports grew 15% y-o-y to 3.57 million units, comprising around 0.62 million PVs (passenger vehicles) and over 2.5 million two wheelers. During the first nine months of FY16, exports grew 1.4% compared to the same period last year4.

1.6 The foreign direct investment (FDI) policy grants automatic approval to foreign equity investment of up to 100% for the manufacture of automobiles and auto components. The government of India has provided tax incentives for in-house R&D in various industries, including the automotive industry; investments are eligible for a tax deduction of 1.5X the amount spent5.

1.7 Several initiatives by the government, such as Make in India, Smart Cities, Skill India and Digital India, will support India’s development as a world-class manufacturing hub. With the “Make in India” campaign, the government aims to develop India as a global manufacturing and export hub with strong focus on R&D and infrastructure development. Initiatives such as StartUp India and Skill India and the likely rollout of GST (goos and services tax) would also improve the process of doing and establishing new businesses in

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the country. India’s rank in the World Bank’s Ease of Doing Business index has improved from 142 in 2015 to 130 in 20166.

1.8 The impact of the government’s initiatives is starting to show results, with a significantgrowth in manufacturing investments. India has emerged as the number one FDI destination in the world, with FDI capital inflows of US$30.8 billion (€27 billion) during the first half of the calendar year 20157.

Recent developments

1.9 The automotive industry witnessed fragmented recovery during the first nine months of FY16, one that was limited to select brands and segments. It faced increased regulatory activity, especially during the last quarter, driven by some bold decisions by the government and judiciary to battle the high pollution levels in Delhi and other metros.

1.10 The Indian Ministry of Road Transport and Highways has mandated the adoption of International standards for vehicle safety by October 2017. This will include mandatory crash tests for new models from October 2017 (October 2019 for existing models). The upcoming New Road Transport and Safety bill will enable the adoption of global best practices for issues related to vehicle regulation and road safety with a focus on driving faster clearances, stricter road and vehicle safety norms and defining the recall policy.

1.11 The Indian auto market recently witnessed a slew of advanced mobility offerings such as technology-based cab aggregation and ride sharing. This was driven by factors such as high cost of vehicle ownership, rising congestion, growing connectivity and mobile penetration. These technology-intensive business models provide short-term access to vehicles, enabling a shift toward vehicle ‘access’ from vehicle ‘ownership’. The concept of access to mobility is catching up quickly, challenging the traditional, manufacturing-driven profit model. Automakers would, therefore, need to take

notice of these new-age mobility providers and prepare relevant offerings for customers.

1.12 The PV segment witnessed 9% y-o-y growth during April-December 2015, driven by lower interest rates and fuel costs, coupled with new product launches and improving consumer sentiment. However, this was fragmented -- with strong growth in the compact segment driven by a jump in sales of premium hatchbacks, but slowed growth in the UV (utility vehicle) segment due to the impact of the registration ban on diesel passenger vehicles more than 2,000 cc in Delhi-NCR. Slow growth in rural demand remains an area of concern for the industry8.

1.13 CV sales have been witnessing y-o-y growth over the past 14 months, with growth in April-December 2015 driven by strong M&HCV (medium and heavy commercial vehicle) sales due to replacement demand, lifting of mining bans, anticipated increase in infrastructure spending and pre-buying on account of new safety norms from October 2015. LCVs (light commercial vehicles) witnessed a rise in demand over the past few months (after a two-year decline), owing to improved economic activity and low base effect. SCVs (small commercial vehicles) continued to report a decline in demand due to lack of financingand overcapacity in the market9.

1.14 The government’s Automotive Mission Plan (AMP) 2016–26 envisions the industry to grow around four times by FY26, with sales volumes growing at a CAGR (compound annual growth rate) of approximately 10%. According to the AMP 2016–26, vehicle sales are expected to touch 66 million units by FY26. To achieve the projections, the auto industry will require additional investment of INR4.5t–5.5t10.

1.15 While the long-term potential of the Indian automotive market remains positive, significantchallenges in the last few years have resulted in stakeholders re-working their India strategy. In line with this, they plan to increase their focus on vehicle exports, rural penetration, deep localization and dealer profitabilit .

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Further, there are some gaps that industry stakeholders need to address together. These include an enabling regulatory environment, developing the requisite talent and skills, fast-tracking infrastructure development, incubating R&D and innovation culture and enhancing supply chain competiveness.

2. EUROPEAN INVESTMENT IN INDIA

2.1 The European Union (EU) has a competitive and innovative automotive industry that is active throughout the value chain, ranging from materials and parts supply, and R&D and manufacturing to sales and after-sales services. Over the years, European OEMs have made significant investments in the country.

2.2 The automotive industry has established itself as a partner in sustainable growth in the region. Significant advances in technology have focused on reducing CO2 emissions not only from products but also across the entire value chain. Manufacturers have spearheaded significant improvements in vehicle safety. Annually, the industry invests about €79 billion in R&D globally, more than any other private sector industry. Its drive toward sustainable mobility remains an ongoing commitment.

2.3 European players have played a key role in the evolution of the automotive industry. Leading OEMs such as BMW, Daimler, Fiat, Volvo and VW Group have made substantial investments in India and have contributed to the industry in terms of development, training and employment.

2.4 Leading component suppliers such as Michelin, Bosch, Continental, Durr and Magnetti Marelli have also played a pivotal role in industry development. They have also helped bring in technology and improve product performance in the country.

2.5 The share of European vehicles in India is currently at around 6% in the PV segment and

about 8% in the CV segment during April–December 2015. It is expected to increase in the coming years owing to increasing consumer preference for sophisticated and high-end products, both in the PV and CV segments11.

3. GENERIC INDUSTRY ISSUES3.1 Infrastructure: A strong focus on developing

transport infrastructure is essential to develop India as a manufacturing hub. Decades of underinvestment in infrastructure development have resulted in major infrastructure bottlenecks, slowing down the pace of India’s economic growth. Globalizing trade is exerting pressure on India’s existing infrastructure. Thus, investments in developing railroad, port network and hinterland connectivity are imperative for the growth of the manufacturing sector in India. In addition to the poor infrastructure, multiple gaps in the supply chain lead to logistics inefficienc , compounding costs for manufacturing companies in India. The recent efforts by the government to develop the transportation infrastructure are welcome and we look forward to their on-time and efficient execution.

3.2 Labour laws: EY’s India Attractiveness Survey 2015 indicates that labour costs, labour skills and flexibility of labour laws are critical parameters for driving investment in India. Compared to other developed countries, as well as some developing ones such as China, South Korea and Malaysia, companies findit relatively difficult to hire workers in India. Labour laws have remained unchanged over the years and are cumbersome and lengthy for setting up and scaling down operations. Organizations are resorting to contract labour, skewing workforce composition toward temporary employees. We appreciate the government’s initiative to ease labour laws with the launch of a “single-window” labour compliance process for companies, simpler provident fund (compulsory employee insurance and pension) procedures and a new inspection scheme.

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3.3 Skill availability: The competitiveness of Indian manufacturing is heavily dependent on the availability of a low-cost skilled workforce. Although India’s abundant talent reserves appear sufficient to meet the overall manpower requirements of the automotive industry, the industry is faced with certain key challenges with respect to skill development. OEMs and auto component manufacturers are facing critical skill gaps. According to the EY SIAM HR study, the industry faces a gap in areas such as civil engineering and project management to build plants, concepts related to quality and manufacturing excellence such as 5S and TQM, and production operations such as total productive maintenance. The government and industry have undertaken various skill-development programmes, such as the National Skills QualificationFramework (NSQF), the Skill India mission and collaboration with academia. We appreciate these initiatives and look forward to their implementation.

3.4 Starting a business in India: New entrants have to complete 10 to 12 procedures before starting a business in India, beginning from presenting the name of the company for approval to the registrar of companies (ROC) to registering for Employees’ Provident Fund and medical insurance. This means that it takes 35 days to start a business in India, while it only takes five days in the US and six days in Singapore. We welcome government initiatives such as Make in India, Smart Cities, Skill India and Digital India that will support India’s development as a world-class manufacturing hub. India’s rank in the World Bank’s Ease of Doing Business index has improved from 142 in 2015 to 130 in 2016. However, as the automotive industry is capital-intensive and requires long-term planning on regulatory issues, a stable policy regime with clear guidelines is critical to drive growth.

3.5 High cost of capital. While India maintains a ~700 bps differential with the interest rates in advanced economies, the cost of debt capital

in the country is higher than that in most emerging markets. The massive borrowing programme of the Indian government impacts the availability of funds for industrial credit, thus crowding out private investment. Moreover, the presence of accessibility barriers to alternative sources of debt funding (i.e., non-bank domestic sources and external sources) translates into a near monopoly (for banks) over the supply of credit.

3.6 Implementation of GST: We appreciate the efforts of the government to implement GST. The experience of various countries in EU is that GST is a transformational policy with a positive impact on economic growth. The tax reform is likely to change the transportation scenario, and industry players must start thinking about realigning their supply chain — specifically the distribution network. This single reform will impact vehicle pricing, sourcing strategies, distribution costs and dealer profitabilit .

4. KEY ISSUES AND RECOMMENDATIONS

4.1 Impact on competitiveness due to duties and taxes

In recent times, the luxury and SUV market in India has started growing rapidly. In addition, the increasing demand for high-end cars across segments indicates a shift in consumer preference toward more sophisticated, durable and reliable vehicles. These vehicles are safer and cleaner and also provide better functionality to customers. However, the duty structure for both domestically manufactured and imported vehicles is skewed adversely toward larger vehicles, making them expensive. The following issues need to be tackled to increase the penetration of such vehicles:

4.1.1. High duty on import of fully built passenger cars into India: Most completely built units (CBUs) of new cars are charged at 100% for cars with FOB value > US$40,000 (€37,000)

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or engine capacity > 3.0L for petrol engines or > 2.5L for diesel engines12.

4.1.2. High excise duty on cars with more than 1,500 cc engine capacity: The excise duty on small cars (< 4m in length) is 12.5% (8% until 31 December 2014). In the case of vehicles with length > 4m and engine capacity more than 1,500cc, the excise is 27% (24% until 31 December 2014), with SUVs attracting a higher duty of 30% (24% until December 31, 2014)13.

4.1.3. Introduction of additional taxation in Budget 2016: The introduction of provision for the collection of 1% tax at source on the sale of luxury cars with prices exceeding INR 1 million (€13,252) would lead to increased compliance burden on the individual taxpayers. On the indirect tax front, an infrastructure cess of up to 4% has been imposed on all motor vehicles with effect from March 1, 2016, with a few exceptions14.

Recommendations

a. There needs to be concerted action on taxation, regulatory and standards issues (as enumerated below) along with access to global markets to facilitate India’s integration into the global supply chain and to be globally even more competitive.

b. A mutually beneficial free trade agreement (FTA) needs to be implemented for the import and export of CBUs, and parts and components between the EU and India. The FTA should entail the removal of tariff and non-tariff barriers on both sides. Differentiation between premium and volume products could be a possible solution to the government’s perceived negative effect on the Indian automotive industry. In the firs stage, the FTA can offer tariff reduction on CBU (completely built units) imports with engine capacity > 1500 cc. This can also be extended to hybrid electric vehicles to drive government’s focus on faster adoption of electric mobility in India.

c. To enable market growth, the excise duty on small cars, two wheelers, three wheelers and

commercial vehicles needs to be retained at 8% and the excise duty on large cars (> 1500cc and > 4,000mm length) needs to be reduced from the current 27–30% to 20%.

d. We appreciate the extension of the excise duty and custom duty exemption in Budget 2016 on specified components required to manufacture electrically operated vehicles and hybrid vehicles. It was set to expire on March 31, 2016, but has now been extended for an indefinite period.

e. EBG recommends further strong incentives to promote the adoption of green technology by introducing substantive reduction in basic customs duty on hybrid, plug-in hybrid, range-extenders and battery electric vehicles (CBU) — hybrid: 30%, plug-in hybrid: 20% and battery electric vehicles: 10%. This should be extended to an initial period of three years to facilitate initial market development.

f. Early adoption of GST will provide great impetus to the automotive industry. Implementing a single standard GST rate for the entire automotive industry will provide broad-based growth across all vehicle segments.

g. Policy imperatives need to be developed to make India an attractive export hub for automobiles. These will include export promotion policies and trade agreements with key trading blocs, such as the EU, to enhance access to global markets. This will enable India to become more than a small car export hub.

h. Procedural and transactional efficienciesshould be introduced in regulatory touch-points for importers and exporters. The need for certificate from the Bureau of Indian Standards (BIS)/customs examinations and the unavailability of a single window for transaction and communication elevate difficulties and complexit .

i. There is urgent need to bring clarity and transparency in tax provisions that lead to multiple interpretations. For example, the completely knocked-down (CKD) kit definitionintroduced in the 2011 budget for excise duty classification does not define “pre-assembled”

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that forms the basis for determining tax applicability.

j. Provide clarity and introduce specificguidance/ rules on the advertisement, marketing and business promotion (AMP) expenditure of multinational companies, headquarters cost allocations, royalty payouts etc.

k. EBG strongly emphasizes the need for transparent, consistent and stable tax and regulatory regime as prerequisites to driving growth. Companies need long term clarity to plan their business strategy and investment decisions.

4.2. Environmental impact of automobiles in India

There has been growing concern about pollution levels in the country, especially in urban settings. With vehicles contributing to CO2 emissions and other air quality issues, there is need to support environment-friendly policies with a focus on long-term sustenance.

The automotive industry in India is witnessing increased regulatory action to reduce pollution and congestion. EBG appreciates the government’s move to advance the standard for cleaner cars by skipping Bharat Stage (BS)-V and directly moving to BS-VI emission by April 2020, one year earlier than the previous deadline. The government has also extended excise duty and custom duty exemptions in this budget on specified components required to manufacture electrically operated vehicles and hybrid vehicles; these exemptions were set to expire on March 31, 2016.

Recommendations

a. The government launched the FAME-India (faster adoption and manufacturing of hybrid and electric vehicles in India) scheme in April 2015, which provides incentives for the purchase of green vehicles. While the scheme has pushed electric vehicle (EV) sales, efforts need to be undertaken in areas such as setting up of charging infrastructure, launching compelling EV models and reducing battery costs.

b. EBG strongly recommends imported hybrid electric vehicles (CBUs) to be significantly

incentivized through substantially reduced import duties as mentioned above.

c. Advanced modern clean diesel technology offers multiple benefits such as low CO2 emissions and low particulate matter emissions, besides addressing the country’s energy security challenges. Clean diesel technology requires higher specification of diesel fuel (BS-VI) with low-sulphur content (< 10 ppm). This diesel will be available from 2020 and would require investments of US$2 billion (€1.75 billion) by each oil company. The government should support the technology investments to fast-track the availability of clean BS VI fuel similar to Euro 6 specification . This will enable European companies to bring advanced global technologies to India earlier than 2020.

d. The Indian market is witnessing advanced mobility offerings, such as technology-based car-sharing and taxi aggregation models. A regulatory environment conducive to promoting innovation for these new mobility initiatives is needed. State governments should establish regulations based on the initial guidelines issued by the road transport ministry.

e. A comprehensive inspection and maintenance regime will also have a strong positive impact on ensuring the road-worthiness of vehicles. EBG recommends a fleet modernization programme by providing one-time financialincentives for pre-2000 vehicles (more than 15 years old).

f. The government needs to evaluate the option of introducing CO2-based taxation or incentivizing new models to reduce carbon emissions.

4.3. Road safety and fatalitiesRoad safety: In 2013, road accidents resulted in more than 137,000 deaths and around 495,000 people getting injured. The country witnesses’ one road accident every minute and one related death every four minutes, one of the highest incident rates in the world. Approximately 45% of the deaths on the country’s roads are of vulnerable road users: motorcyclists,

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pedestrians and cyclists15. According to the 2015 WHO Global Status Report on Road Safety, there are laws on speeding, seatbelt and helmet wearing and drunk driving but they are poorly enforced16. Promoting higher technology vehicles with enhanced safety features, both for occupants and pedestrians, could help tackle this systemic issue.

Recommendations

a. EBG recommends clear guidelines and a road map for regulations. The automotive industry is capital intensive and requires long-term planning on regulatory issues. Thus, a stable policy regime is critical to drive growth.

b. European companies can introduce sophisticated safety technologies such as ‘advanced driver assistance systems’ (blind spot detection, collision warning etc.). This will require delicensing of requisite frequency band. EBG recommends immediate action on frequency delicensing requirements of automotive industry.

c. Making entry-level safety products such as ABS mandatory in PVs and two wheelers could be a starting point to get the greatest benefit in a timely and cost efficient mann .

d. There should be focused information campaigns that stress on the importance of safety as a purchasing criterion, as well as allow car buyers to make informed decisions about safety technologies. The Choose ESC (electronic stability control) campaign by the European Commission is one such example.

e. Clear road safety targets should be set in terms of injuries and fatalities, achievements should be tracked and areas of improvement should be highlighted.

f. There should be a central accident database to understand the current accident patterns and identify areas of action.

g. Initiatives such as the New Car Assessment Programme (NCAP) needs to be encouraged in India. It has already proven successful in the US, Europe, Australia and Japan.

h. Best practices being followed around the world should be identified; for instance, Swedish

experience shows that a governmental fleetpolicy to buy, use and rent only vehicles with effective crash-avoidance technologies incentivizes the market. Furthermore, car buyers could be incentivized to buy definedcrash-avoidance technology.

i. Radialization of buses and trucks in India should be emphasized. While radialization of car tires in India is almost 100%, radialization in the truck/bus segment is around 32–33%. In developed countries, the proportion is much higher for the inherent benefits of greater fuel efficiency and higher safety. A case in point is China, where, in an effort to promote radialization, authorities have prohibited the construction of any new bus tire factory capacity.

j. There should be policies around certificate of fitness for on-road/in-use vehicles, defining the age of vehicles for scraping, and provisioning for inspection and retiring of inadequate, old vehicles. This would help improve road safety and emission levels.

k. The government should support the industry in making investments and offering safety features (across all vehicle segments) to ensure that vehicles meet global standards — something that has been lacking so far.

4.4. End of life (ELV) vehicles: need for legislation to monitor and regulate

In India, there is a growing need to:

a. Mitigate the air quality problem (an immediate issue)

b. Check the menace of road accidents

c. Undertake a vehicle-modernization programme

One effective solution could be a one-time incentive scheme for retirement of old vehicles and their safe disposal as acceptable to the Central Pollution Control Board (CPCB) and the Ministry of Environment and Forests (MoEF).

Recommendation

Considering the profile of vehicle population in India and the urgent need to undertake a modernization programme of all vehicles, we feel that the

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government must suitably deal with all vehicles of pre-2000 vintage (2000 being the year when BS-1 was introduced).

This incentive could be a one-time benefit of a 50% reduction in excise duty, road tax and sales tax/VAT, which would be tradable against a certificate of destruction issued by the RTA in each state.

The EU could potentially provide assistance to the India’s Ministry of Heavy Industry and/or Indian companies in this regard. In terms of the safe disposal of old vehicles (ELVs), if required, there could be a knowledge transfer from the EU (possibly from Germany), where such an issue has been successfully dealt with.

4.5. Remedy the inverted duty structureAs per the current duty rates, there is a disparity in the rate of customs duty levied on finished products vis-à-vis on the input material. There have been some attempts to address these issues, with a reduction in duty rates for certain items in Budget 2015.

Recommendations

The raw material used in the manufacture of key automotive components should be identified and incidences of an inverted duty structure should be eliminated.

4.6. Position India as an integrated automobile hub

Automotive industry ecosystem: India is already positioned as a global manufacturing hub. It now aims at establishing itself as an integrated automobile hub (which includes the development of R&D capability). However, all of this development has primarily been due to individual stakeholder efforts. There is immediate requirement to develop a cohesive, collaborative and rounded approach to create an ecosystem that can propel and support the complete product lifecycle. This entails the development of R&D capabilities and industrial clusters to support applied research enhancements, as well as provide affordable sources of energy.

Below are some of the recommendations for developing an integrated automotive product development ecosystem.

Recommendations

a. Regulations and government initiatives such as Make in India will play a critical role in driving the Indian automotive industry’s growth. Infrastructure development and skill building in the sector will encourage employability and promote the sector’s growth.

b. Training, consultancy or any other form of technical expertise sharing should be encouraged with EU institutes that have a proven track record in these areas. EBG supports the new StartUp India programme, which is likely to boost technological innovation in the industry through digitalization, innovation in advanced mobility (with initiatives such as technology-based cab aggregation and ride sharing), connected cars etc.

c. The localization of applied research and other R&D activities being transitioned to India should be incentivized. It is encouraging that the government has provided tax incentives for in-house R&D in the automotive sector, with investments eligible for a tax deduction of 1.5X the amount spent17. EBG recommends retaining the tax incentive for a longer duration to help companies plan their R&D investments.

d. Common testing capabilities should be built, including crash testing, testing tracks and advance facilities with higher bandwidth for widespread usage. In lieu of the application of international safety standards by October 2017, which require mandatory crash tests, India is likely to have seven world-class automotive design and testing centres (being set up by NATRiP-National Automotive Testing and R&D Infrastructure Project) by the end of 201618.

e. Issues such as shortage of foundries, poor quality of their processing and low availability of adequate energy and power need to be addressed.

f. Automotive component players should be incentivized and encouraged to build scale and compete globally at the same time, enabling greater job creation.

g. The government should enable restriction-free import of cars, car parts and accessories,

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including tires, for R&D so that improved products could be developed and produced for Indian roads and weather conditions. This should also be allowed for certificationhomologation requirements.

5. CONCLUSIONIndia, both as a growing domestic market and an expanding manufacturing hub, needs to address

issues of sustainable growth. The government will have to play the key role of facilitator and enabler through policy interventions and infrastructure support. European companies could contribute by introducing well-researched sustainable technologies, products and systems. They would also benefit from the rapid growth of the Indian economy, thereby making it a mutually rewarding partnership. We look forward to tearly implementation of the recommendations proposed in this position paper.

Endnotes

1 SIAM, LMC Automotive

2 Automotive Mission Plan 2016–26 (AMP 2016–26), LMC Automotive

3 AMP 2016–26 and EY analysis

4 SIAM Flash Report, FY11-FY15, 9MFY16

5 National Portal of India and EY analysis

6 EY-CII, “Making India a world class automotive manufacturing hub, 2016” and EY report, “Doing business in India, 2015-16”

7 EY’s India Attractiveness Survey 2015

8 SIAM Flash Report 9MFY16 and EY analysis

9 SIAM Flash Report 9MFY16 and EY analysis

10 AMP 2016–26, SIAM

11 SIAM Flash Report 9MFY16

12 SIAM, “Taxes”

13 SIAM, “Taxes”

14 EY, “Budget Connect 2016”

15 Government of India, Ministry Of Road Transport & Highways Transport, “Road accidents in India 2013”

16 WHO, “Global Status Report on Road Safety 2015”

17 National Portal of India

18 NATRiP: National Automotive Testing and R&D Infrastructure Project, Source: SIAM and EY analysis

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AVIATIONBecome a leading global aviation hub driven by ever increasing air trafficdomestic and international. Improve policy and regulatory framework to support this growth.

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Market description

1.1 The civil aviation market in India has grown rapidly in the past year. During the 10-month period from April 2015 to January 2016, the throughput of international and domestic passengers stood at 184 million. This is a whopping increase of 17% over the previous year. The increase in domestic traffic is even bigger at 20.6% which is the highest in the world.

India has a vision of becoming the third largest aviation market by 2020. Due to the fall in prices of aircraft turbine fuel (ATF), steady increase in disposable incomes, improvement in business sentiment, increase in tourism and better marketing of Brand India, the Indian aviation market is on the upswing.

India is building new airports and expanding existing ones to meet the growing demand. A slew of new airports are on the anvil to be developed in public private partnership (PPP) mode. Some of these projects include Navi Mumbai, Mopa (Goa), Bhogapuram (Vizag), Agra, Kannur, Singrauli and Kushinagar.

1.2 In addition, various state governments are looking to operationalize low-cost, no-frills airports which would further democratize air travel. This highlights a mindset change that air travel is not an ‘elitist’ product, but a time-saving tool and a necessity. Some state governments are offering viability gap funding (VGF) for airlines to operate on unserved or under-served routes.

There are significant challenges to be overcome. While some Indian air carriers are posting modest profits, this is primarily due to the prevailing low prices of crude oil. High fuel taxes, rupee devaluation, high interest rates and competitive airfares are some of the headwinds the industry has to contend with.

Though world class airports have been developed by the Airports Authority of India (AAI) and the private sector, there are significant challenges related to capacity expansion of airports, land acquisition, fixationof airport tariffs and delays in regulatory approvals. Growth of other key areas like air cargo, maintenance, repair and overhaul (MRO), general aviation (GA) and human resource development have been constrained due to infrastructural limitations and lack of supportive policies.

1.3 The draft National Civil Aviation Policy (NCAP), released in October 2015, presented many interesting proposals to promote growth in the aviation sector. Its vision to enable 300 million domestic ticketing by 2022, although ambitious, highlights the hidden potential of the Indian aviation sector.

1.4 For maintaining the growth momentum, urgent remedial measures are required. India needs to be promoted as a trade and tourism hub in order to derive synergistic benefits for the aviation industry. Leading aviation hubs like the US, European Union, United Arab Emirates (UAE), Singapore and China have a robust industrial, trading, maritime and tourism ecosystem that feeds to and from their aviation industry.

1.5 Close collaboration between the Ministry of Civil Aviation (MoCA), related ministries (finance,home, defence, external affairs, commerce and industry, tourism, environment, HRD etc), regulators and the industry is the need of the hour. Lack of coordination between them has hurt aviation in the past.

1.6 India is one of the very few countries in the world to have built a satellite based navigation system – called GPS Aided Geo Augmented

1. INTRODUCTION

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Navigation (GAGAN), its payload is already operational through GSAT-8, GSAT-10 and GSAT-15 satellites. The GAGAN system is a satellite-based augmentation system that complements the capability of the existing global navigation satellite system by providing reference signals that have greater accuracy, integrity, coverage and continuity primarily within India and countries in South Asia/South East Asia. It is an advanced air navigation system, which has applications beyond aviation. This next generation system is expected to enhance India’s total air capacity, flight safety and overall cost efficiencies

1.7 In the past decade, India has witnessed significant growth in the number of operators with non-scheduled operator permits (NSOP). There are 126 operators with 393 aircrafts today as compared to 36 operators and 106 aircraft in 2000. Of the total 81 NSOP domestic operators, the top 15 operators accounted for more than half the total number of domestic flights operated in the year 2014-15. Of the total 27 non-scheduled international operators, the top 15 operators accounted for 90% of the total number of international flights operated in 2014-15.

1.8 The Indian maintenance, repair and overhaul (MRO) sector has considerable potential for growth as the fleet size of Indian carriers increase. However, due to unfavourable taxation regime and lack of space and infrastructure at airports, the MRO sector in India is not achieving the potential it can reach. The current size of the MRO market in India is US$900 million (€789 million) which is slated to grow to US$1.5 billion (€1.3 billion) by 2020. An estimated 90% of the MRO spend by airlines in India are outside of India due to structural roadblocks in India.

The draft NCAP lays special emphasis on promoting civil aerospace manufacturing. Incentivising civil aerospace sourcing through defence offsets, reaching out to global original equipment manufacturers (OEM) to set up their manufacturing facilities in India and

promoting MRO facilities in India are some of the key policy initiatives.

Recent Developments

1.9 The draft NCAP

EBG welcomes the draft NCAP. This is the first time a comprehensive policy document has been put together by the government. It is futuristic, industry friendly and reform oriented. It has been drafted after several rounds of discussions with various industry bodies, aviation industry and the government ministries. The final version of the NCAP is expected to be released in April 2016.

The draft NCAP plans to facilitate rapid growth by way of fiscal support for regional connectivity, direct cash subsidies to regional carriers, reduction in fuel prices, rationalization of taxes and royalties, and various other procedural reforms.

One of the most important initiatives proposed is the regional connectivity scheme (RCS) to boost air travel in smaller towns. Under the scheme, the government will work towards revival of un-served airports, build no-frills airports and also give incentives and subsidies to stakeholders. This will be funded by way of a 2% RCS levy on all air tickets.

The Regional Connectivity Fund (RCF) so created will provide viability gap funding for airlines operating on RCS routes. This will give a fillip to the local economy, tourism and employment creation.

The draft NCAP talks of conferring ‘infrastructure’ status on MRO, ground handling, cargo and ATF infrastructure at the airport, which will lead to cheaper financingand a 10-year waiver of corporate tax.

MRO has been supported by way of zero rating of service tax and simplification of import procedures. Almost 90% of MRO expenditure of Indian carriers is done outside India, primarily due to tax anomalies. This is likely to be reversed thanks to the reforms proposed. The duty free period for MRO parts and tools is being increased and so is the

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duration of stay of foreign aircraft coming to India for MRO.

The NCAP talks of reforms in global connectivity by way of open skies with countries beyond a 5,000 km radius from New Delhi. It also plans to relax norms for bilateral seat quotas and code share between airlines.

Helicopters and small aircraft will be promoted for last mile regional connectivity and for rapid medical evacuation. They will receive enhanced seat credits that can be traded with larger carriers to meet their obligation under route dispersal guidelines (RDG). Charter operations have been significantly liberalised.

The draft NCAP talks of significant reforms at the Directorate General of Civl Aviation (DGCA), which will strive to create a single-window system for all aviation related transactions, queries and complaints. The services rendered by DGCA will be fully automated by implementing the eGCA project on priority.

All in all, NCAP 2016 will be a significant effort by MoCA to put Indian aviation on a high growth trajectory. It needs to be implemented in letter and spirit.

EBG feels that the industry now has to step up and leverage this opportunity. All this may help India achieve its ambition to be the third largest aviation market by 2020 and the largest by 2030.

1.10 The Make in India campaign

The government of India has launched the Make in India campaign to boost local manufacturing. The campaign has caught the attention of Indian and foreign investors. The government has been regularly organizing sector-specific events to understand and resolve the issues faced by the investors. Several states have come up with a state-specific policy for aerospace and defence manufacturing.

For the Make in India initiative to be a success in civil and military aeronautical manufacturing, the government will need to take a number of fundamental steps. These include replacing

the Defence Procurement Procedure 2013 (DPP 2013), redesigning the defence offsets programme, enhancing the FDI limit and ease of doing business, reducing the role and importance of the Defence Research and Development Organization (DRDO) and Defence Public Sector Undertakings (DPSUs), enhancing safeguards for intellectual property rights and promoting the India private sector.

EBG feels that fiscal and monetary incentives, faster approvals and availability of land, infrastructure and skilled manpower will be crucial to convert India into a world-class aerospace manufacturing hub.

2. GENERIC INDUSTRY ISSUES

2.1 High cost of ATFEBG appreciates the fact that the draft policy clearly acknowledges the problem of high ATF cost in India. ATF in India is almost 60-70% costlier than the global average due to policy apathy in the past, opaque pricing structure and the multitude of taxes - excise, customs, VAT.

High ATF prices in the past have led to air travel remaining the preserve of the well-off. Since international ATF prices are low, an all-expense paid trip to Thailand or Malaysia can sometimes turn out cheaper than flyin within India. India’s skewed pricing policy on ATF has brought more harm to the country than good.

EBG feels that the government should abolish central taxes of customs and excise on ATF. The multiplier effect of aviation and tourism will bring in tax revenue far in excess of the few thousand crores the government may forego at the raw material stage.

EBG supports the government’s vision for a regional transport aircraft as short haul operations are expensive to run. Regional transport aircraft is an enabler towards the social and economic development of these unserved markets. However, it will be very important to develop the right solution to suit the Indian context and requirements. It should not involve developing a fully indigenous aircraft from scratch but collaborating with other leading players and findinga best fit from available off the shelf technology and Indian customization.

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To enhance connectivity and associated growth, India is making significant progress in modernizing its established airports. EBG appreciates the government’s plans for increasing the number of low cost airports in tier II-III cities. Financial support and close monitoring will be required for timely completion of infrastructure projects.

2.2 The 5/20 RuleThe ‘5/20 Rule’ prevents Indian carriers from flyingabroad till they complete five years and have a fleet of 20 aircraft. No leading country in the world has such a rule. EBG feels that abolition of this rule would be a great step forward. Such policy impediments create artificial entry barriers and put Indians carriers at a disadvantage against foreign airlines.

Full utilization of the available bilateral slots by Indian carriers should be encouraged. On routes where global airlines have exhausted nearly 90-100% of their quota, the government should consider requests for enhancing the quota by another 20-30%.

Many airports in India are constrained by restricted landing slots during peak hours. EBG feels that incentives should be provided to airlines to operate larger aircraft, thus boosting airport capacity. This would release the immediate pressure on infrastructure whilst alternative long term solutions such as airport upgrade or development of secondary airports are sought.

3. KEY ISSUES & RECOMMENDATIONS

3.1 AirlinesThe airline landscape in India has transformed radically in recent years. In 2005, there were just four main carriers - Air India, Indian Airlines, Jet Airways and Air Sahara, all operating full service models - plus several small airlines. By 2015, there were seven pan-India carriers - IndiGo, Jet Airways, Air India, SpiceJet, GoAir, Vistara and AirAsia India. In addition, regional carriers such as Air Costa, Air Pegasus and Trujet provide much needed regional connectivity. In these two decades, 17 airlines have shut down and accumulated losses of operating airlines are a staggering INR 60,000 crore (€7.8 billion).

Indian domestic traffic grew by 20.6% during April 2015–January 2016, the highest in the world. This is despite the fact that domestic ATF prices are still 60-70% higher than global prices. If oil prices continue to be rationalised along with other measures, we may see 18-20% growth for the next three years. That may take India closer to its vision of becoming the third largest aviation market by 2020.

Recommendations

(a) Notify ATF as a ‘declared good’. ATF should have a uniform levy of 5% or less across India. ATF for aircraft weighing under 40 tons is already a ‘declared good’. It is far wiser to generate tax from downstream goods and services than an industrial raw material. F. ATF in India should be brought within 10% of the global average price for a 10-year period to give a fillip to national air connectivit .

(b) Finalise NCAP and notify changes in tax structure for aviation sector. NCAP proposes that MRO, ground handling, cargo and ATF infrastructure co- located at an airport will get the benefit of ‘infrastructure’ sector, with benefits under Section 80-IA of Income Tax Act. The restriction of being ‘co-located at the airport’ should be dropped since many of the facilities are also located off-airport. Among other things, the draft NCAP 2016 also proposes zero-rating of service tax on MRO and exemption from service tax on tickets and excise duty on ATF at airports covered under the regional connectivity scheme (RCS). These need to be implemented quickly.

(c) Allocate INR 1,000 crore (€131.5 million) as seed funding for the proposed regional connectivity fund (RCF). RCF will provide VGF (viability gap funding) funding for air connectivity in Tier 3-4 locations based on a thorough feasibility analysis. This will complement the 2% levy to be applied on domestic and international flight tickets

(d) Remove artificial constraints like FDI limit and bilateral quotas. Airlines are the last bastions of protectionism like defence, insurance and the media. Far more risky sectors like telecom and banking have been opened up with no adverse impact on Indian companies, as

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predicted by vested interests earlier.

The whole sector boomed, and so did the fortunes of the Indian players. The consumers gained and so did India. The same may happen in aviation. Doomsday theories about cash-rich Gulf carriers killing Indian carriers is sheer propaganda. If they want, Gulf carriers can collaborate with any willing Indian airline, with or without buying an equity stake, utilize the Indian part of the bilateral quotas, and get involved in the Indian domestic sectors also, all within the law.

(e) Announce a clear road-map for privatization of Air India. Else Air India may continue to bleed under increasing competition, falling market share and increasing costs. The taxpayers funds thus saved can be used to provide compensation to states for forgoing VAT on ATF and to fund the RCF.

3.2 AirportsThe Airports Authority of India (AAI) manages a total of 125 airports, which include 11 international airports, eight customs airports, 81 domestic airports and 25 civil enclaves at defence airfields. AAI also provides air traffic management services (ATMS) over the entire Indian air space and adjoining oceanic areas with ground installations at all airports and 25 other locations to ensure the safety of aircraft operations.

AAI has entered into joint ventures at Mumbai, Delhi, Hyderabad, Bangalore and Nagpur Airports to upgrade these airports and emulate the world standards. Cochin is run as a PPP airport albeit with significant involvement of the government of Kerala in its day to day management. A new model is emerging wherein Changi Airport may take over the terminal and city-side operations of Jaipur and Ahmedabad airports.

However, India is investing less than is required for the expanding passenger and cargo traffic. Mumbai, Chennai, Pune and Goa airports are severely constrained. Delhi airport may get saturated in the next 10 years.

Infrastructure needs to be ahead of the demand curve if we have to improve the level of service, along with safety and security. India’s investment pipeline for airport upgrading and expansion is around US$5

billion (€4.3 billion) which is inadequate for meeting the requirements of airport expansion in India. In comparison, China has a plan to invest US$130 billion (€114 billion) in airports over the next 15 years while UAE plans to invest over US$46 billion (€40.3 billion).

It is estimated that among the 30 largest non-metro airports operated by AAI, 40% are already estimated to be operating over their design capacity. This is despite the fact that the Twelfth Five Year Plan envisaged INR 70,000 crore (€9.2 billion) of investments in airports.

Several greenfield airport projects are at different stages of bidding and construction. The most anticipated one is the Navi Mumbai international airport. With the main Chhatrapati Shivaji International Airport (CSIA) getting increasingly congested during peak hours, it will provide much needed capacity to meet the growing demand for air transport in the Mumbai metropolitan region, which saw 14.4% growth in traffic from April 2015-January 2016

The second airport for Goa at Mopa has also seen progress with bidders being shortlisted for the RFP stage. Construction of a new airport in Kannur, Kerala, is underway. Construction of the new international terminal at Cochin airport is understood to be progressing as per schedule and expected to be commissioned in May 2016. In Andhra Pradesh, a greenfield international airport is planned near Visakhapatnam at Bhogapuram, the bidding for which is expected to commence soon.

Recommendations

(a) Top hub airports like Atlanta, Beijing, Dubai and Chicago are driven by their hinterland economy, home carriers, efficient processes and ‘open skies’. India lost out on all counts. It has a weak national carrier, the hinterland economy around leading airports is small, Indian tourism traffic is negligible, the processes -- visa, immigration, customs and airport transfers -- are inefficient and there is no open skies agreement with any country other than the US. EBG feels that there is urgent need for hubs to be developed in India so as to leverage the benefits of aviation to the maximum.

(b) In India, policymakers till recently never really

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took aviation seriously, despite its deep impact on GDP, infrastructure development, tourism and job creation. It is the spectacular success of the city-states like Singapore, Hong Kong and Dubai -- and lately Qatar and Abu Dhabi -- that woke up India. The arrival of the LCC (low cost carriers) boom and the airport privatisation around 10 years back made India realize the cost of inaction. The aviation leadership has been passed on to India’s competitors in the Gulf and ASEAN region. It will be tough to take them on but the battle has to begin at the earliest.

(c) ATF prices for international carriers at Indian airports is almost 30-35% costlier than at international hubs. It’s a self-defeating policy. Many global carriers therefore tank up in their home locations and India loses out that revenue. This will hopefully be addressed in NCAP 2016.

(d) For procedural efficiency at hub airports, mind-set changes are critical. Domestic to international terminal transfers in Delhi and Mumbai are still done through coaches moving through city traffic. It’s important to carry out minimum connect time (MCT) analysis to ensure faster movement of passengers, luggage and cargo between connecting flights. Air-side terminal transfers, dynamic gate management, dedicated bag screening for ramp to ramp transfers, dedicated immigration counters for specificairlines at a fee, inexpensive dorm rooms for transfer passengers etc. are some options. EBG suggests that central authorities like customs, immigration and the Central Industrial Security Force (CISF) need to sign service level agreements with leading airports -- they at times operate in silos and often lack the empathy that international travellers expect.

(e) The failure of the tourism sector in India has hurt its status as an aviation hub. This is despite being blessed with huge opportunities in terms of religious, cultural, historical and nature tourism. Most global tourists bypass India for places like Bali, Phuket and Langkawi primarily because of

poor air connectivity, intra city travel and inadequate hotel facilities especially in non-metros, bad last-mile road connectivity, poor maintenance of monuments etc. Harassment, overcharging and molestation of tourists and terror incidents have hurt India’s image. All this may need to be overturned with time and focused efforts.

3.3 MROThe Indian MRO is an industry with huge potential but faces hurdles in becoming an effective value chain. Every industry needs a sustainable value chain investment to create a holistic self-sustaining business. Various MROs have set up operations in India but the industry is still left wanting when it comes to getting business from airlines.

Although the hurdles are taxation and bureaucratic in nature, removing these hurdles will only solve one part of the problem. There is a need for the government and MRO players to educate and promote new investments in this long term sector with a view to develop downstream MRO support shops.

One basic of a downstream value chain in MRO is the availability and presence of aircraft spare parts warehousing and trading companies. Without the availability of such services, large inventory costs and frequent movement of parts outside India will keep the value addition in terms of ‘value for time and money’ unpredictable.

The MRO spend of Indian carriers currently stands at $900 million (€789 million), which is expected to touch $2.5 billion mark (€2.19 billion) by 2020. Only around 10% of this is carried out within India. Indian carriers prefer to get their fleet serviced in places like Colombo, Singapore and Malaysia due to the prevalent tax structure in India.

The MRO industry in India is marred by a self-defeating tax structure, troubles in customs clearances, airport royalty, space constraints and lack of quality manpower. The regulatory labyrinth has prevented the Indian MRO industry from achieving its full potential.

Recommendations

(a) Apply zero rate of VAT on MROs: VAT at the rate of 12.5-15% is levied on aircraft parts imported by MRO service providers, whereas

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no such tax is levied on airlines importing their own spares for self-consumption. Further, VAT is levied on selling price and not on cost price, which effectively makes the total tax component to be around 20-22%, when added with service tax.

Today, there is miniscule VAT collection on aircraft spares since most high value spares are purchased by Indian carriers abroad. So there’s no actual loss if VAT is zero-rated. Maharashtra is the first state to exempt VAT on MROs. Zero rating of VAT would enable development of MRO infrastructure in India. The government would earn significantlylarger revenues from the multiplier effect of MROs, generation of local employment spend and growth of ancillaries.

(b) Sale of aircrafts parts and consumables should be brought under ‘declared goods’. This would ensure uniformity of a low VAT rate across the country. If the size of the MRO pie is made 10 times larger, a smaller percentage of VAT would yield much higher revenue for the state than imposing a higher tax rate on a miniscule pie.

(c) Apply zero-rate of service tax on MROs. In case an MRO activity is undertaken in India, service tax is levied at the rate of 14.5%, which will now rise to 15% from June 1, 2016. However, in case such repairs are undertaken outside India, service tax is not charged. This makes the Indian MRO industry uncompetitive with respect to other neighbouring countries. Zero-rating of service tax would help create a level playing field for Indian MROs vis-a-vis foreign MROs.

3.4 General AviationGeneral aviation (GA) is amongst the most neglected businesses within the aviation sector. This is despite the fact that one of the biggest users of general aviation services are policymakers themselves.

The biggest challenge GA faces is its perception as an ‘elitist’ product. That has become a self-fulfillingprophecy. No policymaker wants to bat for this industry for fear of being perceived as ‘pro-rich’.

Ironically, no place in the interior of India can develop

as an industrial hub unless it has air connectivity. And the first ones to provide air connectivity are GA operators. The scheduled carriers come much later once the place becomes big enough to justify a large aircraft. GA also help in bringing in tourists – especially high end ones.

The air charter business has been done in by an unfavourable policy environment, an abnormally high 20% import duty, curfew hours at large airports during peak hours, poor infrastructure at smaller locations, stiff procedures from local authorities for landing permissions etc. and high airport charges.

The fleet size of charter aircraft in India is abysmal – around 110 jets, 220 helicopters and 75 turboprops. The number in most developed economies is in the thousands. There, it is treated as a time saving tool rather than a luxury.

The general aviation industry in India is hit by several bottlenecks. The lack of dedicated policy and separate regulatory framework is an impediment in achieving its potential. Complicated regulatory procedures, marred by delays and the cascading tax effect, makes non-scheduled operations an expensive proposition.

Recommendations

(a) GA needs urgent policy and procedural support. They need to be treated as a catalyst of economic development than a ‘rich man’s game’. The approval processes for aircraft import, safety checks and landing permissions need to be made online and faster. The heavy import duty and airport charges imposed on them need to be rationalised. Else, it will remain a rich man’s game.

(b) The draft NCAP does have some interesting reforms for charters flying to airports covered under the regional connectivity scheme and for incoming charter aircraft with foreign tourists.

(c) With the current traffic load of scheduled flights at metro airports, GA aircrafts often get lower priority as compared to scheduled operators. Delays in take-off and landing clearances defeat the purpose of investments in GA aircrafts. A joint review committee should be formed by MoCA and DGCA with representation from GA stakeholders to

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review the existing regulatory and operational framework.

(d) It is important to develop supporting infrastructure at airports in Tier 2/3 cities to boost the GA industry. This should include night-landing facilities, enhancement of passenger amenities and state support in statutory services, like security. GA facilities at metro airports need an upgrade in terms of dedicated terminal, entry point, apron and parking space etc.

(e) Non-operational airstrips need to be upgraded in places of economic significance such as ports, mines, industrial clusters and tourist locations. These need to be done at the lowest possible cost without compromising on safety. The airstrip may attract a small number of GA flights initially and if it has a strong business case, it may ultimately lead to full scale operations in future, with significant benefitsto the local economy.

(f) GA aircrafts and helicopters at times use airports and helipads that are not in regular use. It is extremely important for MoCA to create a reliable and regularly updated database of all airports and airstrips in the country. It is also important to improve coordination with IAF airfields and introduce basic low-cost navigational aids in these small airports.

(g) Development of heliports is important to support the growth of GA in India, especially in areas that cannot have runways due to financial constraints or terrain-related challenges. MoCA may consider developing a PPP policy for development of heliports. There is a need to develop standardized route operating procedures for helicopters.

(h) The draft NCAP 2016 has proposed a slew of reforms to support the helicopter industry. The same should be implemented in letter and spirit, especially for use in intra-city travel and medical evacuation.

(i) Monitoring of over 126 GA operators may be a mammoth task for DGCA. The numbers are expected to increase in future. The option of a separate monitoring and facilitation agency for GA may be evaluated by MoCA.

3.5 Air cargoAir cargo, though just around 1-2% of the global cargo movement, contributes to around 32-35% by value of cargo shipped. It is critical for industries such as pharmaceuticals, electronics, marine exports and floriculture where shipments are highly time-sensitive. Hence, the development of air cargo requires deep focus.

The Indian air cargo industry is a classic case of high potential but low achievement. This is despite the many advantages we enjoy in terms of economic growth, demographics and location.

The Indian government adopted the open skies policy for the air cargo sector in the early 1990s; under this, Indian or foreign carriers were allowed to operate scheduled and non-scheduled cargo services to/from any airport in India. The period since the adoption of the open skies policy has seen strong growth in international air cargo traffic, which can be attributed to a sizeable growth in scheduled services operated by Indian and foreign airlines.

In FY2014-15, India handled a total cargo throughput of 2.52 mmtpa (million metric tonnes per annum). This pales in comparison with airports like Hong Kong, Memphis, Shanghai and Incheon which handle more throughput than ALL Indian airports combined. In FY2014-15, domestic air cargo sector grew 18% on the back of the e-commerce boom. This year, the cargo traffic during April 15-January 16 has grown by 6.1%, with domestic cargo growth falling to just 5.4%. Surely there’s something amiss here.

Recommendations

(a) Strengthen the Air Cargo Logistics Promotion Board (ACLPB): ACLPB can help in the organized growth of this sector by enabling policies and facilitating planned development of air cargo hubs in the country.

(b) Air cargo to be afforded infrastructure status as per the draft NCAP 2016.

(c) Introduce the concept of cargo village at all hub airports. This would help consolidate all agencies, regulators, service providers and functionalities within the airport’s cargo facility and decongest the cargo terminals.

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(d) Assist in formulating the quality of service (QoS) parameters for various stakeholders in the air-cargo supply chain including ambitious objectives such as reduction of cargo dwell time to below 24 hours by December 2016 and six hours by December 2017.

(e) Facilitate development of air freight stations (AFS): AFS was conceived as a means to reduce congestion in airport premises by permitting transfer of cargo to customs notifiedfreight stations.

(f) Facilitate expansion of cargo fleet: Freighter aircrafts play a vital role in increasing the cargo throughput of the country. There is no consistent policy for allotment of dedicated facilities at any of the airports for dedicated cargo aircrafts. There is lack of dedicated terminal space and facilities for express airlines with limited scope for adequate expansion.

Restriction on night operations and high lease rentals has made setting cargo aircraft operations a costly proposition. There is urgent need for policy support and robust infrastructure to ensure efficient freighter operations in the country. Dedicated cargo-focussed airports can be developed to ensure that cargo gets priority. These airports would allow peak operation during night hours, have good connectivity with transport infrastructure and would be close to industrial areas to ensure a critical customer base for cargo.

(g) Extend risk management system (RMS) facility for exports: RMS has shown excellent results on the imports side. Customs authorities should consider introducing RMS for exports at the earliest possible to minimize congestion on the apron and the resultant damage and/or pilferage.

(h) Simplify customs processes and documentation through full adoption of EDI (electronic data interchange): Customs should go for full EDI adoption for import/export registration, clearance, drawback and e-payment of duty. This might release considerable manpower/man-hours in the existing pool, which can contribute in part to 24x7 operations.

(i) Customs and security policies and procedures for transhipment differ at various airports. There is urgent need for standardization of the same.

(j) A major thrust towards migrating to paperless environment can come from the proposed e-freight initiative of IATA being adopted in other countries. E-freight aims to take paperwork out of air cargo supply chain and replace it with cheaper, more accurate and reliable electronic messaging. Facilitated by IATA, the project is an industry-wide initiative involving carriers, freight forwarders, ground handlers, shippers and customs authorities. The government and industry should work together to ensure its rollout in India at the earliest.

Human Resource DevelopmentAviation is a capital intensive sector and one important factor that influences future expansion and investments is availability of skilled and employable manpower. Indian aviation’s growth story could be severely limited by the lack of human resource across the value chain, including but not limited to pilots, cabin crew, engineers, air traffic controllers and ground staff. The government has taken a welcome step by initiating a task force focused on skill development.

The government and industry should come together to ensure continued training and adoption of high standards of operational safety. Aviation institutions should be given financial assistance by the government and monitored for quality standards.

Recommendations

(a) Enhance pilot training infrastructure. India currently has over 5,000 commercial pilots. With the increase in fleet size due to large orders from Indian carriers, India will require a total of around 9,000 pilots by 2018.

(b) Shortage of pilots leads to an artificia increase in their salary levels which hurts the profit margins of airlines, especially the LCCs. There is a need to increase the number of world class pilot training academies by way of capital subsidies. Gradually these academies can produce pilots for global markets also.

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(c) Foreign investment in pilot training academies needs to be encouraged. The success of the CAE academy in Rae Bareli and Gondia should be replicated in other locations also. Certific tes issued by leading flyingacademies in the developed world should be made acceptable in India and should be given faster clearances by DGCA.

(d) Many developed countries allow trainee pilots to get a commercial pilot license (CPL) within 12-15 months of training vis-à-vis two years in India. DGCA should consider evaluating how the training duration in India can be brought at par with global norms without compromising on safety standards.

(e) DGCA should also consider increasing the frequency of exams from four per annum to at least one per month in the short term and on a weekly basis in the long term through use of modern fail-safe examination technologies used for GMAT, SAT, CAT etc.

(f) The Indian Air Force (IAF) has one of the finestpilot training infrastructures in the country. There is need to collaborate with them to explore ways in which their facilities and staff can be used for producing civilian pilots without affecting IAF’s operational requirements.

(g) ATC training academies: The number of air traffic control officers (ATCO) has grown to around 2,600 in 2015, but there is still a shortage of around 1,500 ATCOs. Given the unique nature of this service - zero tolerance for error and high levels of technical skills required - this shortage is a cause for severe concern. AAI runs ATC training facilities at the Civil Aviation Training College (CATC), Allahabad, and at the Hyderabad Airport. Partnership options with international ATC training institutes should be explored to enhance capacity of CATC. The enhanced capacity can also help CATC earn additional revenue in the long run by training foreign ATCOs and providing consultancy services to global ATC service providers.

(h) MoCA may consider the option of allowing private players to set up ATCO training facilities, subject to adequate supervision by

AAI. This may be started in a PPP mode firstand thereafter be made fully open to private sector in the long run.

(i) MoCA should set up four National Aviation Universities (NAU) and support the upgradation of flying academies and Aircraft Maintenance Engineering (AME) training centres across the country. MoCA may consider fiscal and monetary support to these institutes for a period of ten years and then withdraw the same once they become self-sustainable.

(j) The government should work with National Skill Development Corporation (NSDC) for skill development programmes specific to the aviation sector such as airline operations, ground handling, airport utilities and airport retail.

4. CONCLUSIONEuropean businesses and investors have been long term partners of India, working with India to develop state of art technology, products, services and talent.

In 2004, India became a strategic partner of EU. The EU-India Joint Action Plan of 2005, revised in 2008, aims at realising the full potential of this partnership in key areas of interest to India and the EU.

The EU-India Civil Aviation Cooperation Project was launched in 2010. The objective of the programme is to strengthen the institutional capacity of the civil aviation regulator in India and to help ensure a safe and secure aviation environment, mainly through improvement of skills in the sector, implementation of international civil aviation standards, policy support and harmonization with EU best practices.

EBG is convinced that India has tremendous potential to establish itself as a global aviation hub, provided it can implement some of the long-pending reforms highlighted in this paper. The draft NCAP is a timely step and will need relentless focus on its implementation in letter and spirit.

EBG believes a visionary, reform-oriented, civil aviation policy will certainly help the Indian aviation industry achieve its vision of being number three by 2020 and number one by 2030.

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BANKING &FINANCIAL SERVICESImprove access to cost effective financial servicesthrough greater participation of foreign banks and private players as a source of capital finance, thereby enhancingcompetitiveness of Indian businesses.

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Market Description

1.1 The Indian banking system is dominated by public sector banks, with the largest being the State Bank of India (SBI). Indian private sector banks account for approximately 21% of the total banking assets in India, with the share of foreign banks accounting for approximately 6% of Indian banking assets. European banks dominate the foreign banking scene in India, with approximately 59% of the total foreign banking assets in India1.

1.2 Still, access to banking services is available only to 45% of India’s urban residents and to 32% of its rural residents2. Further, India needs approximately US$1 trillion (approx. €877) of investment in the infrastructure sector as per the Twelfth Five Year Plan (2012-2017) and about half of this is expected to come from the private sector3. Foreign banks are well poised, either through their Indian operations or through direct lending, to provide capital for growth in India.

Recent developments

1.3 In August 2013, the Reserve Bank of India (RBI) released a discussion paper on ‘Banking Structure in India – The Way Forward’, which identified the need for a reorientation of the banking structure in India with a view to enhancing competition, financing higher growth, providing specialised services and furthering fina cial inclusion in India. The paper highlights the role of foreign banks in India in increasing competition, promoting efficiencyand in bringing sophisticated financial services and risk management methodologies into

India. The paper sets out the RBI’s policy with regard to the subsidiarisation of foreign bank operations in India. The paper also introduces the notion of differentiated licensing within the banking sector.

1.4 As a sequel to the ‘Roadmap for presence of foreign banks in India’ released by the RBI in 2005 and a discussion paper on the mode of presence of foreign banks in India released in 2011, the RBI released a paper in November 2013 discussing the framework for setting-up of a wholly-owned subsidiary (WOS) by foreign banks in India. From a priority sector lending (PSL) perspective, the paper provided that a WOS would be subject to a PSL target of 40% of adjusted net bank credit, which it would need to achieve within a transition period of five years

1.5 In January 2014, the RBI released the report of the committee constituted under the leadership of Nachiket Mor on ‘Comprehensive Financial Services for Small Businesses and Low Income Households’. The Committee extensively discussed the concept of differentiated licensing and acknowledges the need for a suitable mix of institutions which could collectively meet the needs of the country while simultaneously enhancing the stability of the banking system as a whole. It advocated a marked change in policy from one in which all players are relatively undifferentiated and follow a centrally designed business model, to one which permits each player to focus on its differentiated capabilities. The Committee made the case that small businesses and

1. INTRODUCTION

The Indian economy is poised for a period of substantial growth. This will require significantexpansion in the breadth and depth of banking services in which foreign banks can play a major role. This banking and finance sector position paper provides an overview of thecurrent market scenario for foreign financial institutions operating in India, specific issues thathey confront and recommendations to address these issues.

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low income households could be provided better access to financial services by allowing specialist institutions to emerge which can more effectively facilitate fina cial inclusion. At the same time, the panel suggested that the policy on banking structure and design should be reviewed to permit more functionally focused banks such as payments banks, wholesale consumer banks and wholesale investment banks.

1.6 In April 2014, the RBI granted banking license to two applicants, IDFC Limited (a financialservices firm focused on infrastructure financing) and Bandhan Financial Services Private Limited (India’s largest microfinancecompany). While granting these licenses, the RBI noted that some of the nearly two dozen aspirants who had applied for banking licenses were more suited for differentiated banking licenses, suggesting that a policy shift in this direction may be under consideration.

1.7 In his speech while presenting the union budget for 2014-15 in July 2014, Finance Minister Arun Jaitley stated that the RBI was developing a framework for licensing small banks and other differentiated banks. Shortly thereafter, the RBI released a draft framework for setting-up of small banks and payment banks with a view to furthering financialinclusion. The RBI release also noted that the RBI was formulating guidelines for the continuous authorisation of universal banks.

1.8 With a view to increasing the flow of financingto the infrastructure and low cost housing sectors, RBI issued a circular4 in July 2014 providing long term funds raised by banks (including foreign banks) for lending to these sectors would not attract statutory pre-emptions or PSL obligations.

1.9 On March 2, 2015, RBI released draft report on revised PSL guidelines. Amongst the key recommendations of the report are uniform PSL lending target of 40% for all scheduled commercial banks, including foreign banks with less than 20 branches, to be achieved in a phased manner by 2020. Other

recommendations include sub-targets of 8% for lending to small and marginal farmers, while overall agriculture target of 18% remains unchanged, sub-target of 7.5% for lending to micro enterprises, and introduction of Priority Sector Lending Certificates (PSLCs), to enable deficient banks to meet their requirements through purchase of these certificates. The final PSL guidelines were issued on April 23, 2015, which specified that the sub-target of 8% for lending to small and marginal farmers and the sub-target of 7.5% for micro enterprises may be applied to foreign banks with 20 plus branches in 2018 after an RBI review in 2017.

1.10 To streamline the regulatory framework in the sector, RBI had issued a circular dated November 10, 2014 containing revised regulations that will apply to Non-Banking Financial Companies (‘NBFCs’). The overall theme of the revised regulatory framework is to allow RBI to gradually transition to a framework wherein its supervision and regulatory oversight is focused on NBFCs which could pose significant systemic risks and contextual to the activities carried out by an NBF — instead of RBI expending its energies on actively regulating activities/NBFCs which do not pose any significantrisks to the system. The Circular stated that the changes contained therein are to address a fourfold objective, viz:

(i) Address risks wherever they exist;

(ii) Address regulatory gaps and arbitrage arising from differential regulations, both within the sector as well as vis-à-vis other financial institutions;

(iii) Harmonize and simplify regulations to facilitate a smoother compliance culture among NBFCs; and

(iv) Strengthen governance standards.

As indicated in paragraph 14 of the Circular, RBI on March 27, 2015 issued specificnotifications to incorporate the changes sought to be introduced by the Circular and ensure meticulous compliance.

1.11 On August 19, 2015, RBI decided to grant

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‘in-principle’ approval to 11 applicants to set up Payments Banks. The 11 licenses have been awarded to a mix of telecom operators, companies involved in financial inclusion, technology companies, large industrial houses and professional individuals.

1.12 On September 16, 2015, RBI awarded ‘in-principle’ Small Finance Bank licenses to 10 entities. The move is aimed at furthering financial inclusion in the country. Seven of these awardees are currently focused on microfinance while the rest are financing small businesses, micro and small enterprises, commercial vehicles, etc.to customer segments that are mostly outside the focus of existing banks.

1.13 Aiming to tap the financial services business lost to sophisticated financial services hubs like London, Singapore, Hong Kong, Dubai and New York, the National Institute of Public Finance and Policy submitted a concept note on the policy framework for finance special economic zones which was posted for public comments in February 2015. While presenting Budget 2015 proposals, the finance minister announced that the first phase of India’s first International Financial Services Centre (IFSC) at Gujarat International Finance Tec-City, will soon become a reality and indicated that appropriate regulations will be issued in March 2015. The operating rules for setting up banks, insurance and capital market activities in Indian IFSCs were issued in April 2015. In October 2015, India’s first IFSC Banking Unit became operational at GIFT IFSC.

2. EUROPEAN BANKING INVESTMENTS IN INDIA

2.1 European banks have invested significantcapital in their banking entities in India. In addition to this, many of these banks have established other financial services entities and back office businesses resulting in further capital infusions, revenue generation and employment.

2.2 There are currently 46 foreign banks that conduct banking operations in India through their branch offices; of these, 11 are European banks. Moreover, 24 of 39 foreign banks that have established representative offices in India are European banks. European banks with significant operations in India include Barclays Bank, BNP Paribas, Credit Agricole, Deutsche Bank, HSBC, Rabobank, Royal Bank of Scotland, Standard Chartered Bank and Société Générale5.

3. GENERIC INDUSTRY ISSUES3.1 Need for differentiated bank licences3.2 PSL requirements3.3 Issues relating to automated data flow and risk

based supervision3.4 Provisioning requirement for unhedged FX

positions3.5 Flexibility on pricing norms3.6 Improving access to international finance for

infrastructure projects3.7 Issues relating to bonds market3.8 Issues relating to factoring3.9 Issues relating to operating lease3.10 Regulatory considerations under the WOS

form of presence3.11 Issues in relation to expiration of guarantee3.12 Tax issues for banks in relation to Foreign

Portfolio Investors3.13 Key tax issues emanating from Budget 2015

proposals3.14 Taxation of pass through certificate3.15 Income Computation & Disclosure Standards

(ICDS) 3.16 Tax amnesty for subsidiarisation of branches

of foreign banks operating in India

4. KEY ISSUES AND RECOMMENDATIONS

4.1 BANKING REGULATIONS

4.1.1 Need for differentiated bank licences

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Background

The EBG notes that RBI’s policy on banking in India is significantly guided by the goal to provide comprehensive financial access to all segments, with particular focus on extending access to financialservices to low-income households and small businesses. Over the years, the policy framework has contributed to the development of a horizontally distributed banking system in which the basic design element is a full service commercial bank that combines the building blocks of payments, deposits and credit but is differentiated primarily on the dimensions of size, geography or sector focus.

Issues:

Foreign banks licensed to operate in India are expected to conform to the above defined overall framework. This presents a number of challenges for foreign banks:

• Foreign banks may have differentiated strategies with regard to international expansion. While many foreign banks may operate as full service commercial banks in their home markets or in certain other geographies, they often confine the scope of their activities within a narrower ambit in other international markets in a manner that permits them to leverage their capabilities to most effectively address business opportunities in different markets. In doing so, foreign banks play a critical role in facilitating foreign investments in markets in which they operate, and in better enabling cross border trade and commerce. Beyond this, foreign banks bring diversified skills, product innovations, technology platforms and differentiated risk management techniques to the different markets in which they operate. Requiring all foreign banks operating in India to provide universal banking services constrains the number of banking institutions that may seek to establish operations in India

• A number of foreign banks have evolved as specialised institutions that provide deep expertise in specific areas. Such institutions do not engage in full service commercial banking even in their home markets. Instead, by developing specialised capabilities to

address particular market needs, they play an important role in economies by providing uniquely designed products, solutions and services that cater to market needs that would otherwise remain under-served. A universal banking framework does not permit such organisations to establish a presence in India, thereby potentially denying Indian businesses access to specialised services that may assist them in more effectively conducting their business

• Even where foreign banks seek to operate as full service commercial banks in India, their ability to effectively execute such a model tends to be constrained by the policy on branch licensing. While the RBI has proposed a more liberal branch licensing model for foreign banks that incorporate their operations in India, subsidiarisation of Indian operations poses different challenges for international banking institutions.

The EBG appreciates the work performed by the Committee in its report6. This report extensively discusses the concept of differentiated licensing and acknowledges the need for a healthy mix of institutions that would collectively meet the needs of the country while enhancing the stability of the banking system as a whole. It advocates a departure from an approach that propagates industry players evolving as clones of each other following one centrally designed model to one which permits each player to focus on its unique strengths and differentiated capabilities. The report suggests that the country’s needs would be better served if diversified specialist institutions with complementary capabilities populated India’s financial landscape. While the report’s focus is on financial services for small businesses and low income households, the EBG endorses the design principles set out in the report and believes that these principles ought to be applied in considering the design of the broader banking framework in India.

Recommendation

In July 2014, RBI published a draft framework for setting up small banks and payment banks7, drawing upon the work of the Committee for public comments and issued the final guidelines in November 2014. On August 19, 2015, the RBI decided to grant ‘in-principle’

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approval to 11 applicants to set up Payments Banks. On September 16, 2015, RBI awarded ‘in-principle’ Small Finance Bank licenses to 10 entities. The EBG acknowledges this development as an important step in reorienting the banking structure in India but believes that more should be done in this direction.

The EBG recommends that the RBI adopt a differentiated policy framework for foreign banks which more effectively leverages the specialist strengths of international banking institutions, thereby facilitating the provision of a greater range of products and services in the Indian market, increasing the diversity of market participants and bringing greater depth and vibrancy within Indian financial markets. Specialist institutions with a niche focus should be permitted to operate in India for the particular capabilities that they bring and for addressing specific needs that market participants may have, without requiring such institutions to conform to policy requirements that broad based, full service commercial banking enterprises are better placed to fulfil. Rather than differentiating further banking licenses, this could be achieved by framing more flexible policies which would permit banks to pursue different business models. Equally, for institutions that have aspirations to build a universal banking presence in India, the EBG recommends a framework that calibrates policy prescriptions as such institutions gradually expand the scope of their activities in India. This should be done in a manner such that the range of applicable policy prescriptions progressively expands as the institution’s presence in India matures and it is better able to fulfilpolicy expectations.

4.1.2 PSL RequirementsRBI revised PSL norms applicable to commercial banks operating in India in July 20128. The revised PSL norms place foreign banks with 20 or more branches in India on par with Indian banks. Such foreign banks were granted the flexibility to achieve these norms within a five-year period to end on March 31, 2018. Foreign banks with less than 20 branches were permitted to retain their original PSL obligations, with no sub-limits within the overall PSL norms.

On March 2, 2015, RBI released a draft report on revised PSL guidelines and invited comments by March 15, 2015. The key recommendations of the report included uniform target of 40% of Adjusted

Net Bank Credit (ANBC) or Credit Equivalent of Off-Balance Sheet Exposure (CEOBE), whichever is higher, for all scheduled commercial banks, including foreign banks with less than 20 branches. The overall target for lending to agriculture sector has been retained at 18% of ANBC, but a sub-target of 8% for lending to small and marginal farmers has been recommended. More flexibility has been recommended for banks to lend the remaining 10% of the overall agriculture loan target to other farmers, agricultural infrastructure and ancillary activities as defined by the group. To give a fillip to agri-infrastructure and agri-processing, no caps on loan limits have been stipulated. In addition to micro and small enterprises, medium enterprises are included within the ambit of priority sector lending. To ensure that the micro enterprises are not crowded out, a sub-target of 7.5% for micro enterprises has been recommended, which is to be achieved in a phased manner. The draft also recommends introduction of the Priority Sector Lending Certificates (PSLCs) which will enable deficient banks to meet their targets by purchase of such instruments. The fina PSL guidelines were issued on April 23, 2015, which specified that the sub-target of 8% for lending to small and marginal farmers and said the sub-target of 7.5% for micro enterprises may be applied to foreign banks with 20 or more branches in 2018 after an RBI review in 2017.

The table below provides the changing scenario of PSL norms for foreign banks in India over the recent past:

Issues:

While the introduction of PSLCs, revamp in agriculture lending target by expanding the scope focus on ‘credit for agriculture’ from ‘credit in agriculture’, merging of micro enterprise targets and inclusion of medium enterprise within the overall priority sector lending target have been positive changes by RBI, the application of 40% uniform target for all scheduled commercial banks including for foreign banks having limited presence in India is materially adverse. Also, the suggested sub-targets are onerous and difficult to meet until the PSLCs scheme is stabilized.

The RBI’s stated position is that all banks in India must raise their level of operations to undertake traditional banking and also (i) participate in the financial

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inclusion plan of the RBI; and (ii) meet mandated PSL requirements.

Recommendations

The EBG seeks to address the issue from three perspectives:

• In terms of the capabilities and global experience of the EBG constituents in areas where we believe we add value to the Indian economy

• Areas where we lack both global and domestic expertise which we believe we should be exempted from

• Areas which require minor regulatory changes to increase the flow of credit to needy

segments of the economy.

The EBG makes the following recommendations:

(i) The EBG recognises the need for the approach adopted by RBI and agrees that banks present in India should all in one way or another participate in reaching RBI’s objectives. However, different banks have different expertise and capabilities; accordingly, while all banks should be required to fulfil PSL targets, the EBG recommends that the choice of achieving priority sector targets should be left to the banks’ discretion with such discretion being exercised within a wider range of RBI-approved PSL target segments

PSL Targets PSL norms before July 2012

Revised PSL norms issued in July 2012 (banks with 20 or more branches)

Revised PSL norms issued in July 2012

(banks with less than 20 branches)

Revised PSL norms issued in April 2015 (banks with 20 or more branches)

Revised PSL norms issued in April 2015 (banks with less than 20 branches)

Overall PSL targets

32% 40% 32% 40% 40%

Agricultural lending

Nil 18%9 Nil 18% (8% sub-target for small and marginal farmers10 to be decided in 2017)

Nil

MSE / small enterprises advances

10% Nil11 Nil Nil (7.5% sub-target for lending to micro enterprises to be decided in 2017)

Nil

Export credit 12% Nil Nil Nil Nil

Weaker sections of society

Nil 10% Nil 10% Nil

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(ii) Widendefinitio ofprioritysectoreligiblecategories

The EBG recommends that the components of priority sector for the purpose of achieving PSL targets be widened to include (a) export finance, (b) infrastructure sector lending, (c) indirect lending to the agricultural sector, MSE advances, lending to weaker sections of the society without any specific sub-targets, and finally (d) lending to NBFCs and other eligible institutions for onward lending to priority sectors.

(iii) Removal of sub-target in small and marginal farmers lending targets

The revised PSL guidelines indicate possibility of implementation of sub-target of 8% of ANBC for lending to small and marginal farmers, after a review by RBI in 2017. Foreign banks, including those with 20 or more branches should be exempt from this sub-target of lending to small and marginal farmers. Lending to agriculture, irrespective of farm size, should commence only from the time that the PSL certificat scheme is stabilized. This being a new target segment, it will be extremely difficult given the lack of expertise, geographic reach and credit experience, for a foreign bank to direct 18% of its entire lending to agriculture. The numbers sought to be achieved over the next 2/4 years constitute an inherent systemic risk. Foreign banks have no experience either in India or globally in lending directly to small and marginal farmers (SMF). We recommend that foreign banks, including those with 20 or more branches, be exempted from this mandatory lending to small and marginal farmers and lending to agriculture overall should commence only from operationalization of the PSLC scheme.

(iv) Targets for Micro and Small and Medium Enterprises:

• Micro enterprises typically operate in industrial clusters. Such clusters are usually at non metro centres. Accessing these centres is difficult for foreign banks.

Hence, we recommend the timelines to achieve sub-target for micro enterprises should be extended to five years post stabilization of the PSL certificate scheme.

• The service sector today is the largest contributor to GDP. With increasing urbanization this will only increase. Whilst rebalancing the economy towards manufacturing is an important goal, continuing growth of the services sector is equally critical. Hence the cap on credit limits to services sector of INR 100 million (€1.3 million) should be removed.

(v) Market Structures: On-lending, Securitization and Assignments

Over a period of time, RBI has deemed on-lending to NBFCs involved in lending to the priority sector segments as being ineligible for PSL purposes. The EBG believes that reintroduction of credit enhancement in assignment transactions can significantlyboost flow of credit. A control mechanism to check PSL contribution and KYC policy adherence could be defined for this purpose. Separately, it is the EBG’s view that the interest rate cap should be delinked from the base rate of the investing/purchasing bank to provide a level playing field for all banks. It is the EBG’s recommendation that the interest rate cap regulation should be withdrawn and free market risk based pricing should be permitted.

(vi) Credit to Housing

According to the revised PSL norms, loans to individuals for an amount of up to INR.3.5 million (€46,300) in metropolitan centres with population above 10 lakhs and INR 2.5 million (€33,000) in other centres for purchase/construction of a dwelling unit per family are considered for PSL purposes. However, the limits defined for eligibility under the long term bonds is INR 5 million and INR 3 million respectively. EBG recommends that that the credit numbers be harmonized across bonds and regular home loan lending. We therefore recommend that existing limit of INR 3.5 million to be increased to INR 5 million for

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metropolitan centres and of INR 2.5 million to be increased to INR 3 million in other centres. Also, under bank loans to Housing Finance Companies (HFCs) approved by NHB for their refinance, the aggregate loan limit should be increased to INR 1.5 million per borrower.

(vii) Other recommendations:

The EBG has the following further recommendations:

• The framework for PSLCs be widened to include RBI regulated NBFC and MFIs. These would lead to a deepening of the market place and true price discovery.

• EBG recommends that the annual target achievement should be maintained. The annual reporting pattern is suitable and adequate. Quarterly reporting would increase the challenges in reporting PSL data. Achieving current PSL levels itself is a huge challenge as evidenced by non-achievement of banks.

• There should be no weaker section targets for foreign banks. Foreign banks have limited reach in this segment, hence these targets will be difficult to achieve

• As targets/sub-targets are an equal challenge for all foreign banks, EBG recommends that the timeline for all foreign banks should be the same without any discrimination. Establish an electronic bill factoring exchange to ease the liquidity requirements of MSME enterprises

• Classify equity investment in entities that provide services to the priority sector, including credit, as PSL, to provide a multiplier effect

• Qualify activities undertaken by banks for CSR activities specific to certain areas such as finan ial literacy and promoting financial inclusion as PSL, or alternately permit a set-off against the ANBC numbers which define the overall PSL targets

• Adapt the IBPC scheme to permit full participation benefits for both originator and investor.

• Formalize regulations to allow banks to co-invest / co-originate along with regional/local financial institutions; any loans originated under such partnerships should be counted as meeting the applicable PSL target. Guidelines on co-origination of such loans with such institutions to support banks with limited branch network should be provided.

4.1.3 Automated Data Flow (ADF) and Risk Based Supervision (RBS)

Background

The RBI launched the ADF project to ensure accurate and automatic regulatory reporting by banks in India in November 2010. According to RBI’s approach paper12, the transition to ADF was to occur in two phases. In the first phase, banks were required to ensure seamless flow of data from the transaction server to their management information system (MIS) server and automatically generate all returns from the MIS server without any manual intervention. In the second phase, it was contemplated that system reconfiguration would enable the flow of data from the MIS servers of banks in a straight through process.

In June 2012, RBI advised banks to adhere to the March 2013 deadline to shift to ADF so that they could submit data to it without manual intervention.

In 2013, RBI also commenced the deployment of the RBS system. The RBS system, which is based on information regularly provided by the banks (through ADF or through data points periodically submitted to the RBI – currently more than 400 individual data organized in several tranches), aims at calibrating the intensity of supervision based on the risk assessment for each bank and controls/mitigation measures implemented by the banks. RBS was initiated in a testing mode for an initial sample of 30 banks in 2013; the second annual cycle has commenced in September 2014.

Issues:

While a few banks have been able to automate some returns by suitably adapting their existing infrastructure/systems, others have adopted a more holistic approach and sought the assistance of third party solution providers. Solutions offered by third

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party vendors tend to be based on the use of a consistent data model.

Banks currently experience a number of challenges:

• There are a number of reports for which there are no direct or exhaustive RBI guidelines to serve as a source of reference. Published guidelines, where available, are open to material interpretation differences; for example, the guidelines pertaining to balance sheet analysis, quarterly operating results, risk-based supervision, asset quality and off-balance-sheet exposures. In the absence of clear guidance from RBI, individual banks are required to interpret the reporting formats. Some of these reports are complex in nature and present the financial health of the bank in areas of asset liability management, risk management and asset quality. This subjective reporting of critical information could lead to overall under- or over-reporting of data. Further, RBI guidelines emanate from different departments within it; this leads to inconsistencies around interpretations of requirements. Third party service providers engaged by banks for the ADF project are not always in a position to obtain clarificationsdirectly from RBI.

As a result, although banks have pushed for automation of as many reports as possible, a number of reports remain excluded from the scope of ADF because of the nature of information contained therein; for example, the reports pertaining to fraud, reporting of demand and time deposits in various time buckets based on behavioural modelling of historical data, reporting of delinquencies and the long form audit report. Data for such reports continues to be collated manually outside the core systems and then uploaded as a flat file to the ADF product being used

• Requirements for key reports tend to change frequently, posing a challenge for banks to have the latest versions available in order to facilitate the testing. The new RBS framework may introduce additional scope but it is not always clear whether such initiatives fall under

the ADF scope

• Although the implementation of RBS has contributed to RBI inspections being lighter and more focused, the process of gathering preparatory information remains cumbersome, with still a certain lack of stability in the set of data points required, frequent duplications in the requests and very short deadlines imposed on banks to comply, at times under pressure of potentially heavy penalties

Recommendations

The EBG acknowledges that regulatory reporting is a very useful tool for the RBI to understand the financialhealth of the banking sector in India. Information presented via regulatory reporting serves as a key input for macroeconomics decisions taken by the RBI. It is therefore imperative that correct and accurate information is reported by all member banks. The EBG believes that the overall process pertaining to ADF would be facilitated if the following recommendations were considered:

• The RBI should issue clear and exhaustive guidelines on all regulatory reports to obviate the need for any subjective interpretation by reporting banks. A defined communication channel and process should be established with member banks and their consultants to address any queries related to reporting

• RBI should be more flexible in terms of the timeframe for automation of regulatory filings based on the technology and process maturity profile of member banks. The reporting process in the existing scenario is complex and most banks need time to smoothen this process

The EBG is convinced that the basic assumptions and principles underlying RBS mark an important progress towards a leaner, modern and more permanent supervision, differentiated for each regulated institution based on its risk situation. Nevertheless, the EBG notes that concrete improvements over the previous system have been limited so far. While the EBG acknowledges that the RBS system is still in its infancy, it believes that the desired impact might be optimized and more quickly obtained if RBI could consider the following:

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• Ensure the stability of requested information, so that banks can in turn either automate or otherwise get properly organized to gather the required data with as little impact as possible on their operational activities; RBS data requirements have already obliged most banks to dedicate significant resources (both HR and IT) and, in many cases, made it necessary for banks to organize a separate unit dedicated to regulatory reporting.

• Avoid duplication of data and request of ad hoc data within the RBS regime of reporting.

• Provide flexibility during the initial three years of RBS implementation so that banks can ensure the delivery of quality information; during this period, any trade-off that may occur between timeliness and quality of data should at first be re-balanced towards quality.

4.1.4 Provisioning requirement for unhedged FX positions

Background

Unhedged foreign currency exposure of a company is an area of concern not only for the individual entity but also for the financial system as a whole. Indeed, companies who do not hedge their foreign currency exposures could incur significant losses due to adverse exchange rate movements. These losses could in turn reduce their capacity to service the loans availed from banks posing a serious credit risk to the banking system.

Accordingly, RBI has issued various guidelines advising banks to closely monitor the un-hedged foreign currency exposures of their borrowing clients and to factor the corresponding risk in their pricing, as the extent of unhedged foreign currency exposures could increase the probability of default in times of high currency volatility. Effective June 2014, in view of the volatility in the INR exchange rate, the RBI introduced incremental provisioning and additional capital requirements for bank exposures to entities with un-hedged foreign currency positions.

The RBI circular13 requires banks to:

(i) Closely monitor borrowers with respect to their un-hedged foreign currency exposures; monitoring is required to be undertaken on a

monthly basis, and banks have been made responsible for ensuring the timely submission of data by their corporate clients in order to be compliant.

(ii) Make incremental provisions and comply with additional capital requirements based on the assessment of the respective counterparties’ un-hedged foreign currency exposures. While RBI states that the cost of provisioning and of any additional capital requirement may be built into the pricing offered to the customer, this is unlikely to occur in the current over-banked market situation.

Issues:

The EBG shares RBI’s concern with regard to un-hedged foreign currency exposures of corporate clients of the banking system, and the resultant losses that could accrue in the event of currency volatility. However, in EBG’s view, the suggested monitoring methodology and the resultant provisioning /additional capital requirements are both challenging to manage and very restrictive. In particular, the EBG notes that the suggested monitoring methodology obliges every bank, irrespective of its size and market position, to put pressure on its own clients, on behalf of the RBI, to disclose all un-hedged foreign currency exposures – but without concrete means to impose this disclosure obligation on its clients. Moreover, the inability to obtain information from its clients results in a penalty for the bank, the cost of which cannot in fact be transferred onto the client.

Separately, the EBG notes that the complexity of assessing the real net FX un-hedged exposure is such that no simple financial model can pretend to encapsulate it; the vulnerability of a client could be a function of a number of factors, including the degree of natural hedging available to it, the type of currencies it is exposed to and the ability to pass increased costs to its customers through increased product prices.

Recommendations

As an alternative, the EBG suggests that the process could be both simplified and made more efficient in the following manner:

• Monitoring by individual banks of their own foreign currency exposure to corporate clients on a monthly basis.

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• The establishment of a repository with a derivative database (the task can be given to CIBIL, similar to what they are undertaking for credit lines). Banks would then provide the information of all their foreign currency exposures (hedged and un-hedged) to their customers (the onus on Authorised Dealer banks could be higher, and they may have an obligation to collate on a regular basis foreign currency exposures from banks not incorporated in India) in a standardised format to CIBIL which will maintain the database and make available the information to all banks dealing with the client. This system would be more effective than efforts made by individual banks in trying to collate information from various banks and then assessing the corporate’s overall foreign currency exposure based on data submitted to them. Apart from being a very tedious exercise in terms of collecting, chasing and collating data, the reliability of the data so collated could also be questionable

Until this process stabilises at CIBIL, the RBI should, in conjunction with other regulators to the extent relevant, instruct corporates to furnish consolidated statements of their foreign currency exposures certified by their auditors on a quarterly basis to their banks. Banks could assess implication of unhedged FX exposures on their clients’ credit ratings on a quarterly basis.

• Requiring companies to include details of their hedged and unhedged foreign currency exposures in their audited financial statements, and supplementing the monitoring as set out above, by an annual assessment of each corporate’s overall foreign currency exposure based on its audited financial statements.

• Permitting banks to factor the credit risk arising from unhedged foreign currency exposures of their corporate clients with reference to the internal ratings of the corporate clients which would be implicitly built into the pricing offered to the corporate; direct provisioning and additional capital requirements would otherwise be unnecessarily taxing for banks for issues which are beyond their scope and control.

• Banks are required to make a provision in their books towards un-hedged foreign currency exposures (UFCE) of certain corporate borrowers. These provisions can be treated as standard asset provision. Certain banks have been holding excess standard asset provision since November 2008, when RBI changed the requirement for standard asset provision and did not allow a release of excess provisions to the P&L. It is suggested that RBI consider allowing banks to adjust the provision on account of UFCE against the excess provisions held for standard asset.

4.1.5 Flexibility on pricing norms

Background – Fair loan pricing to their customers

It is RBI’s expectation that the pricing policy adopted by banks is designed in a manner that ensures that similar pricing is offered by banks for equally rated clients for a given tenor of exposure on the same drawdown date. Further, the major elements underpinning the RBI’s logic [viz. rating (as most of clients today have local external ratings also encouraged by RBI for better RWA) and pricing (expressed mainly by way of margin over, preferably, Base Rate)] over the different tenor buckets are expected to be disclosed in the public domain permitting informed decision making by customers. Through its periodic inspections, RBI has been progressively requiring that banks apply such models across the board for effective commercial pricing, even for top corporate clients.

In January 2015, RBI also issued the following additional guidelines on pricing of credit:

(i) Banks should have a board approved policy delineating the components of spread charged to a customer. It should be ensured that any price differentiation is consistent with bank’s credit pricing policy.

(ii) A bank’s internal pricing policy must spell out the rationale for, and range of, the spread in the case of a given category of borrower, as also, the delegation of powers in respect of loan pricing. The rationale of the policy should be available for supervisory review.

(iii) The spread charged to an existing borrower should not be increased except on account

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of deterioration in the credit risk profile of the customer or change in the tenor premium. Any such decision regarding change in spread on account of change in credit risk profile should be supported by a full-fledged risk profilereview of the customer. The change in tenor premium should not be borrower specific or loan class specific. In other words, the change in tenor premium will be uniform for all types of loans for a given residual tenor.

(iv) The guidelines contained in sub-paragraph (iii) above are, however, not applicable to loans under consortium/multiple banking arrangements.

Issues:

While this is an approach largely in use by banks for their retail customer’s offering, where standard, replicable methods are at the core of the business model, and pricing transparency is a ‘must’ to protect consumers with limited negotiation powers, replicating such an approach for a bank’s corporate clients is challenging for a number of reasons:

• Most international banks are required to follow a global rating policy which is aligned with external rating scales such as those adopted by S&P and Moody’s; such rating scales are different from local rating scales mainly on account of the global industry coverage and country risk. Effectively, therefore, there will always be limitations in mapping of internal obligor ratings with local external ratings.

• Pricing to corporate clients are driven by competition in the market and relationship intensity. Competition undoubtedly translates into more transparency in pricing, which is further aided by depth of pricing curve information available in the public domain globally. Corporate clients, unlike retail clients, are relationship clients with whom banks usually associate and maintain visibility over the long term. Further, corporate clients routinely spread their banking requirements over a pool of banks in order to optimise their business needs. Moreover, owing to the globalisation of the banking industry, customer relationships are spread over multiple geographies, thereby

expanding the bankers’ role beyond the local balance sheet. Relationship intensity with respect to years of banking, bouquet of products (including non-core banking offerings as well) and business growth potential are essential considerations whilst determining the margin for pricing loans and advances to different customers. Effectively, unlike a single product and limited relationship intensity driven retail customer segment, corporate client pricing remains dynamic in nature. As a result, uniform margin for similarly rated (albeit internally rated) corporate customers at given tenor on the same drawdown date may not be practical.

• Linking of margins with base rate. While the base rate is publicly disclosed information, it is unfortunately not structurally dynamic. Foreign currency pricing evolves over mainly LIBOR (London Interbank Offered Rate) for Indian corporate clients, which is akin to ‘Cost of Funds plus margin’. That said, and respecting the RBI’s guidelines, banks do not lend to their customers below base rate; instead, the local currency lending to corporates is usually at cost of funds plus margin (which is again mutually agreeable keeping in view relationship and market conditions), subject, however, to minimum of prevalent base rate of the individual bank.

As most corporate customers have access to data of banks’ base rates, they can compare the offer pricing to deduce the extent of additional margin charged by the bank. In practice, however, corporate clients tend to be focused on market driven pricing during each drawdown and utilise the base rate information more as threshold whilst selecting a lending bank (s) at the time of drawdown.

Recommendations

The EBG appreciates the fact that banks should put in place a system of indicative pricing (spread over cost of funds or equivalent) based mostly on tenor, counterpart quality, the security package offered by the customer and any other significant element of risk.

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Nevertheless, on account of:

• the strong level of competition in the corporate / commercial banking market,

• the level of information and professional preparation of corporate clients, and

• the existence of a number of other considerations impacting pricing which are intrinsically “soft” in nature and hence impossible to incorporate into a pricing model,

It is the EBG’s recommendation that such a system remains purely indicative, as a support for internal decision making, and not be normative.

4.1.6 Key regulatory considerations under the WOS form of presence

Background

In November 2013, the RBI released the ‘Framework for setting up wholly owned subsidiaries in India’. This paper sets out the framework that the RBI will apply in considering applications by foreign banks to establish wholly owned subsidiaries in India or convert existing branch operations into subsidiaries.

Issues:

The paper does not specifically discuss voting rights for shareholders. While the Banking Laws (Amendment) Act, 2012 which was cleared by parliament in January 2013 permits RBI to increase the ceiling on voting rights from the previous level of 10% for any shareholder to 26%, such a position appears to be inconsistent in the context of a banking enterprise constituted as a wholly owned subsidiary of a foreign banking institution.

The RBI paper alludes to activities that foreign banking institutions may seek to undertake through entities other than the wholly owned banking subsidiary in India and expresses a preference for all activities to be generally undertaken through the banking subsidiary rather than through subsidiary or associate entities of the banking entity. Given that the RBI has prescribed consolidated supervision norms and requirements which would encompass the banking entity as well as its subsidiary and associate entities, this policy preference ought to be reviewed.

Recommendation

It is the EBG’s recommendation that no ceiling on voting rights should apply in the case of wholly owned subsidiaries established in India by foreign banking institutions.

Further, foreign banking institutions should be at liberty to organise their activities through a wholly owned banking subsidiary, and such other subsidiary or associate entities as they may consider appropriate for the execution of their business strategy in India. EBG requests that this flexibility be provided unambiguously so that foreign banking institutions may develop their plans appropriately in this regard.

4.2 DIVERSIFICATION OF FINANCING SOURCES FOR THE INDIAN ECONOMY

4.2.1 Improving access to international financ forinfrastructureprojects

Background

The Indian infrastructure sector has made significan progress, with more than US$400 billion (€350 billion) invested during the Eleventh Five-Year-Plan (2007–11). Private investment played an important role in the period with more than US$146 billion (€128 billion) (about 36% of the total) invested in the sector. While the original target of the Twelfth Plan (2012–17) of US$1 trillion ($877 billion) of infrastructure investment has now been revised down by the government (to US$500 billion), there will still be significant investment in the sector. Given the importance of infrastructure delivery for economic growth, the new government is very focused on facilitating infrastructure development.

Issues:

Historically, a vast majority of debt financing in India has come from domestic banks, with only a small number of international banks playing a consistent role in financing Indian infrastructure projects. However, given (i) the significant infrastructure requirements; (ii) the government’s target of increased international bank participation, [the Twelfth Plan projects infrastructure external currency borrowing (ECB) financing of nearly US$60 billion (€52.6 billion)]; and (iii) material sector

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and client exposure as well as loan performance pressure facing domestic banks, there is a compelling case for a greater role for other forms of infrastructure financing, including the wider use of international banks and the debt capital markets.

The infrastructure sector faces a number of challenges presently:

Projectrelatedissues

• A large number of previously awarded infrastructure project bids have still not made significant progress. A key impediment is the complicated and often un-coordinated procurement planning process.

• Land acquisition and permissions/clearances remain one of the biggest hurdles and the cause of greatest delays to infrastructure development in India.

• There are certain infrastructure sectors which do not have independent regulators in the Indian infrastructure sector. Some government entities (e.g. NHAI – National Highways Authority of India) often operate in the twin capacities of ‘operator’ and ‘regulator’. Pooling of operational and regulatory functions creates a regulatory giant with inherent conflict in its functions.

• Currently, renegotiation of contracts is difficult;model concession agreements (MCAs) offer limited framework for renegotiation of the terms. Lack of a definite framework providing guidance on contract renegotiation is a significant impediment to the renegotiation process. Overall, this impacts the attractiveness of such projects/sectors from an equity/debt investor’s perspective.

• There are several sector-specific issues creating further risk for investors and hindering progress, particularly:

• Fuel availability is the most significantstumbling block for development of power sector in India; both gas-based and coal-based plants are suffering due to limited fuel supply.

• There is regional disparity of investment in the power transmission sector, resulting in power surplus in western and eastern

regions and acute deficit in other regions (particularly the southern region).

▪ Indian ports have been associated with poor evacuation infrastructure. There have been instances in the past where road/rail capacity expansion has not kept pace with enhancement of port capacity, creating “project on project” risk for investors and financiers and an inability to use the increased port capacity.

All these issues are not directly related to financing but have a strong impact on the availability of financingfor infrastructure projects, due to the low visibility they create on project time lines, final costs, etc. Thus, a high proportion of projects are deemed too risky to attract proper financing.

Financing related issues

• Debt capital markets are a key source of financing in most mature infrastructure markets, even in the case of many so-called emerging economies. In India, the use of bonds has been constrained given that very few institutions have an appropriate long-term liabilities profile.

• Also, institutions are constrained by the need for a strong rating profile (domestic AAA/AA) to allow investment.

• A key issue most foreign investors encounter relates to the foreign exchange risk, since Indian infrastructure projects have domestic currency receivables.

Recommendations

Given the rapid industrialization and urbanization of the country, India has tremendous need for infrastructure investment. Such investment, to be made both by the government and the private sector, will have a multiplier effect on other sectors of the economy. In EBG’s view, there is significantinterest from international investors, banks and other institutional debt providers to participate in the India infrastructure story. The EBG believes that translating this interest into funding and investment decisions will require a number of the challenges set out above to be effectively addressed through focused effort and more effective co-ordination across the multitude of

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private and public sector stakeholders. In this regard, the EBG has the following recommendations:

Projectrelatedrecommendations

Betterprojectprocurementplanning

• Ensuring a more streamlined and coherent procurement programme at the bid stage that inter alia, (i) involves all relevant stakeholders (for example for an independent power project, the ministries of power, coal, environment); (ii) ensures substantial land is acquired and key permits secured ahead of the project award; (iii) sets and adheres to realistic timelines; and (iv) imposes strict penalties for non-compliance by all parties. This will result in more efficient implementation schedules. This is in line with international best practices and will ensure wider interest, more competition and ultimately a better deal for the procurer and end-user of services.

• The central government could also consider acting as a catalyst for good project procurement by rewarding/prioritizing fast and complete state programmes that have good documentation, regulatory certainty and have elicited local support, as seen internationally (e.g. UK council projects).

• Capacity building/training of personnel running procurement processes, increasing exposure to international best practices and investment in international standard procurement advice and documentation would also facilitate future procurement efficiencies

• Consistency in procurement documentation and transparency at all stages would ensure more buy-in from the public, and potentially avoid subsequent legal challenges.

Land acquisition/ permissions and clearances

• Land acquisition can be expedited through a coherent procurement programme at the inception that requires substantial land acquisition and all time-critical initial permits/approvals to be in place before a project is awarded.

Building independent regulatory institutions and need for capacity building

• New independent regulatory authorities should be established in sectors that do not have these. These institutions would be able to segregate project execution and regulatory functions. This is essential to manage the investor/lender risk perception of the sector and avoid any bias in action. Also, there is need for capacity building of such regulatory institutions or other government oversight bodies to be able to bring the best international practices on board, in turn, increasing the attractiveness of the infra sector for a wider range of equity / debt investors.

Regulatory certainty

• Consistent and timely treatment of regulatory issues will provide confidence to both infrastructure lenders and investors.

▪ Applying international best practice, such as embedding regulatory principles in bid documentation, will allow potential developers and lenders to take a more informed view at the bidding/development stage and assist in the evaluation of such projects.

Develop better dispute resolution mechanisms and a more comprehensive bankruptcy law

• The model concession agreement framework should be amended to permit flexibility in renegotiation of contracts in case of unforeseen changes. Further, guidelines that would allow objective re-assessment and renegotiation of contracts by government agencies should be introduced.

• A comprehensive bankruptcy law that will ensure lenders are settled fairly and quickly with reasonable recoveries possible in case of project/company bankruptcies will similarly increase attractiveness. The government has already commenced action in this regard.

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Access to Financing

Development of domestic infrastructure bond market

• Regulatory changes to allow domestic institutions greater flexibility in investments

• Existing partial credit enhancement programs for project bonds such as IIFCL/ADB should also be exploited more extensively to help catalyse the project bond market.

Infrastructure Investment Trusts

• Equity market regulator Securities and Exchange Board of India (SEBI) has issued draft guidelines towards setting up of infrastructure investment trusts14. These draft regulations have since been approved by the SEBI Board but are pending official notification.Also, the 2014-15 Union Budget has provided a taxation framework for such structures, although further clarity and consideration on the taxation structure is required to catalyse financing from this route

Attracting international institutional debt investors

• There is significant international institutional investor interest in Indian infrastructure. One way to tap this market is through offshore feeder funds, which invest in Indian infrastructure debt funds. However, foreign exchange risk is a major hurdle in development of this route of funding. The hedging products in India to cover such risks are expensive and not long-dated enough (more liquid in five-seven year bucket).

• RBI should take steps to deepen financialmarkets and encourage development of hedging products. A wider portfolio of hedging products along with longer tenor of contracts would augur well for the investors to help them mitigate the currency exposure. Support from multilateral institutions shall also be explored for developing long-term forex hedging facilities for investors in the infrastructure projects.

• Further, the government could consider providing foreign exchange risk protection

in sectors/assets which can bear increasing tariffs/ tolls (to absorb the cost of such protection).

Improve access to offshore INR bonds market

• Remove the annual cap on the issue amount for each issuer; Grant issuers in the infrastructure sector exemption from withholding tax for an initial defined period to encourage development of the offshore INR market.

Improve access to foreign currency bonds/multilateral agencies / international capital

• RBI revised the framework for ECB in November 2015. In the context of the Indian infrastructure sector, the revised framework now envisages a minimum 10-year maturity period (up from five years previously). Such measures are likely to inhibit the flow of foreign capital, particularly from the commercial bank loan market. Accordingly, it may be advisable to relax the restriction of minimum maturity period for ECB for infrastructure projects.

• Given India’s country rating, it is challenging for infrastructure projects to obtain international bond financing without credit enhancement – therefore multilateral agencies should consider providing the same to notch up the rating of such issuers to a level that allows them to access the international bond market at a reasonable cost.

4.2.2 Bonds Market

Background

SEBI registered FIIs can purchase on repatriation basis dated government securities/ treasury bills, listed non-convertible debentures/ bonds issued by an Indian company and units of domestic mutual funds either directly from the issuer or in the secondary market. The purchase of debt instruments is subject to limits notified by SEBI and the RBI from time to time. Currently, the upper limit for investment by RFPI/FII/QFI in corporate debt is US$51 billion (€44.7 billion), with a sub-limit up to US$2 billion (€1.7 billion) for Commercial Paper. The current limit for their investment in government securities is US$34 billion (€29.8 billion). Investment of RFPI’s in perpetual debt

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instruments (Tier 1) capital should not exceed 49% of each issue and investment by individual FIIs should not exceed 10% of each issue. Their investment in rupee denominated debt capital (Tier II) and upper tier II instruments should be within their stipulated level for investment in corporate debt.

Issues:

FIIs have nearly exhausted their limit in government bonds for FY15 and most corporate bond limits. Recently, RBI prohibited FIIs’ investment in short term G-sec to prevent volatility in the forex market.

Recommendations

• EBG proposes that the limit be enhanced to US$60 billion (€52.6 billion) for each of the categories with appropriate built-in checks. Increase in FII limits both in government and corporate bonds will help in the following ways:

• The increase in limits of FIIs will help to raise the foreign exchange reserves to guard against effects of global currency market volatility, if any in the future.

• The corporate debt market is still not very liquid and deep at present, as it is dominated by long-hold investors like insurers. Hence, increase the depth of the corporate bond market of the country.

4.2.3 Factoring

Background

As per the current Insurance Regulatory and Development Authority (IRDA) regulations, a trade credit insurance policy cannot be issued to banks/financiers/lenders. Trade credit insurance policies are not permitted to cover factoring, reverse factoring and bill discounting. Globally, on the other hand, non-recourse factoring is almost exclusively done on the basis of credit insurance from companies like COFACE, AIG, Lloyds, Hermes and Atradius, which offer trade credit insurance policies to banks and FIs.

Issues:

The absence of credit insurance reduces the attractiveness of the factoring product for customers

because financing is with full recourse, as banks will be reluctant to undertake without recourse financingif there is no credit insurance made available to them. This operates to the detriment, most particularly of SMEs, especially those dealing with large companies (both local as well as MNCs) who are unable to tap a source for cost effectively financing their working capital needs -- as different from the practice in most other emerging countries (for instance, China, Russia, and Turkey). As a result, despite a progressive Factoring Regulation Act, 2011, the factoring market has evolved very slowly and the share of financingthrough factoring as a proportion of total financings to corporates in India remains marginal.

There is a significant increase in open account trade, especially from suppliers in developing countries, thereby increasing the need for products like factoring as a financing option secured by credit insurance. Moreover, large international retailers and importers are increasingly using factoring as a financing option, which in most countries is supported by credit insurance. Indian traders will be disadvantaged by the current regulations and could lose out to other developing countries such as China.

Credit insurers provide critical support in ascertaining the credit worthiness of buyers in international markets. Indian banks/factors do not have exposure in these markets and are hence unable to take informed credit decisions. Credit insurance for international factoring will hence offer critical support to Indian banks/factors. This will enable them to extend relatively easier credit to SMEs. In the absence of this facility, Indian exporters will be disadvantaged by the current regulations and will lose out to other countries such as China.

Recommendations

EBG recommends that banks and factors should be permitted to take credit insurance to make the factoring product more attractive, particularly for the financingof SMEs acting as suppliers to corporates (Indian or MNCs) or as their clients, thus allowing the operation to be without formal recourse on leading corporates.

EBG believes that the availability of credit insurance would aid in the development of a robust factoring market resulting in a number of benefits

• Help to secure financing for the SME segment,

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which has traditionally more limited access to more cost effective bank financin

• In case of international factoring, help in improving export credit flows both direct and with third parties

• Improve the credit ratings for customers as well as reduce the capital requirements of banks

• Factoring transactions will be considered as an off balance sheet items for the customers (contrary to the case of recourse factoring which must be maintained on the balance sheet)

• Provide an additional tool to factors for managing their risks, with a likely reduction in their cost of risk and a reduced volatility in their profit and loss account

In addition to the measures recommended above, EBG believes that the development of the factoring market could be aided by the following further actions:

Review of the maximum limit for banks on factoring activities

For banks, factoring is considered a para-banking activity and hence exposure to such business cannot exceed 10% of their total advances. Factoring against purchase of invoices will likely be far more secure when compared to collateral which is otherwise provided to banks to secure working capital facilities in most cases. Factoring is also a preferable avenue for banks to provide financing since the funding is transaction backed, relative to working capital finance where funds could potentially be diverted by the borrower. Under the circumstances, it is the EBG’s recommendation that factoring should not be considered para-banking and should, on the contrary, be favoured by regulators. The EBG recommends that the 10% ceiling that has been prescribed presently should either be removed, or alternately, raised to a level of 20 to 25% of total bank advances.

4.2.4 Operating leases

Background

Operating leases are very well developed as an alternate support for financing to companies, not only in developed but also in most emerging economies,

where they are contracted to obviate funding that may otherwise be required to acquire the relevant asset, be it vehicles (often bundled with fleet management services) or any type of equipment (construction, healthcare, printing, etc.).

Issues:

The transaction of leasing (transfer of right to use) a motor vehicle (or any equipment) is deemed to be a ‘sale’ under Article 366(29A)(d) of the Constitution and is covered under the provisions of the sales tax/value added tax (VAT) laws. As a consequence:

• Leasing companies are required to be registered under the sales tax/VAT laws in most states in India, so that they can pay sales tax/VAT in the correct jurisdiction on the lease rentals charged.

• Vehicles or equipment given in operational lease are registered in the books of leasing companies as fixed assets, as they are the legal owner of the assets. At the same time, the Motor Vehicles Act in force in India requires leased vehicles to be registered in the name of the client; the leasing company is shown as lessor/financier in the registration certificate(RC) of the vehicles.

In the case of optional fleet management services (FMS) availed by their clients, leasing companies presently charge a service tax on the rental charges.

There is lack of clarity in the VAT and service tax laws in relation to leases generally, with the distinction between operating lease, finance lease and a simple loan not adequately addressed. This presents a number of operating challenges as a cumulative result of which the operating lease market in India has remained relatively underdeveloped.

Recommendations

(i) Erroneous view taken by service tax authorities

Service tax authorities tend to confuse operating lease with “rent-a-car” businesses and have conflicting views at times. This has led to high pitched show cause notices from service tax authorities who claim that the whole income of lease rent is liable to service tax and not VAT.

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EBG recommends that operating lease of vehicles, whether or not coupled with fleetmanagement, be properly identified and defined by tax authorities (both centrally and at states level) and that a homogeneous tax treatment be accorded to operating lease transactions under all applicable tax laws across India.

(ii) Denial of Input credit of service tax to industry players involved in the vehicle operating lease business

Leasing companies have been availing and utilizing CENVAT (central value added tax) credit for service tax paid on input services, including services like repair and maintenance management, insurance payment management and claims handling, relief car, roadside assistance, pick up and drop, etc. which were used in providing taxable output service i.e. FMS until March 31, 2011. The definition of ‘input services’ in CCR Rules 2004 (Cenvat credit rules) underwent a change with effect from April 1, 2011. Under the amended definition, such services will qualify as input service only if they pertain to a motor vehicle which is used for providing taxable output service (charged to service tax) and the motor vehicle qualifies as ‘capital goods’ as definedin CCR Rules.

As a result, operating lease companies can no longer claim credit for service tax paid for procuring various services used as input services while providing FMS to their clients. CENVAT credit was intended to be restricted only where the same was meant to be a surrogate for the use of the vehicle (possible non-business use). However, it appears that in the process of achieving the objective of excluding non-business usage from the benefit of the CENVAT credit, legitimate business credits have also been negatively impacted.

The EBG believes that the amendment results in dual taxation i.e. service tax on procurement of specified service not claimable as input service and further liability required to be discharged on FMS under the taxable category

of management, maintenance or repair of movable or immovable property. The EBG recommends that the amendment should be clarified by the appropriate authority to allow input of services to organizations who are conducting business activities in the nature of and similar to FMS. It further recommends that the amendment be brought into effect retrospectively i.e. from April 1, 2011 so as to mitigate the hardship suffered by leasing companies.

(iii) Denial of Input credit of VAT to the industry players

VAT input credit legitimately due to leasing companies tends to be denied by state VAT authorities merely on the basis of the manner in which a car dealer has drawn up a purchase invoice, or the information that is recorded or not recorded on the purchase invoice or what is recorded or not recorded in the RC of the car. In doing so, the sanctity of the operating lease agreement signed between the lessee and the lessor is ignored.

This challenge of getting purchase invoices in the formats prescribed in various state VAT acts and of having the details of operating lease companies recorded in the tax records of the car dealers is also due to the fact that ‘operating lease of vehicles ’ has not been defined or recognized anywhere in the Motor Vehicle Act. As a result, car dealers do not have a systematic process or practice for consistently recognizing the leasing companies as the legitimate owners of the vehicles and legitimate beneficiaries of the input credit of the VAT paid on purchase of vehicles.

As pointed out in (i) above, the EBG recommends that operating lease and the corresponding actors be formally recognized by tax authorities, both at centre and states level. Furthermore, the EBG recommends that their specificity be recognized as such by an amendment to the Motor Vehicle Act.

(iv) Other commonly faced tax issues and issuesaroundtradecertificate

Similar conflicting stands are at times taken

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by the Income-tax department as well -- where depreciation on vehicles capitalized by leasing companies is denied on the grounds that the leasing contracts are in fact car loan contracts since the leasing companies are not recorded as registered owners in the RC of the car.

Leasing companies need to have trade certificates which are issued by the Regional Road Transport Office (RTO). The trade certificate is required so that the name of the leasing company can appear in the RC book of the vehicle as lessor/finan ier. For operating lease companies, it is difficult to obtain this trade certificat from the RTOs that insist that the leasing companies produce a letter from RBI stating specifically that the company is in the business of ‘operating lease of vehicles’ and that no registration is required with RBI or with any other government body, which the leasing companies are unable to obtain from the RBI.

In addition to proper identification of operating lease by tax authorities, as mentioned in point (i) above, the EBG recommends that all states adopt similar criteria with regard to the inscription of the leasing company as the lessor on the vehicles’ registration certificates. Finally, the EBG recommends that such companies on application to RBI should be provided a letter by the RBI stating that the company is in the business of operating lease of vehicles and this business requires no registration with RBI or with any other government body.

(v) Limitation in access to credit bureau reports

Although operating lease companies are not engaged in financing their customers, the risks they assume over the term of the lease are similar in essence to those associated with any other credit activity:

• Any leasing transaction is exposed to a deferred risk, as lease rentals are to be recovered from the customer over the entire contract tenor of the vehicle (or any equipment for that matter).

• Moreover, once the vehicle is on the road, its value reduces significantly and there will always be a risk which an operating leasing

company is exposed to, equal to (i) Lease rentals recovered + (ii) Present value of car – (iii) Original cost of the car for the lessor.

• In an operating lease, the gap between the net book value of the asset and realizable value of the asset will always be more as compared to the position under a finance lease. Considering the same, the risk involved for an operating lease company will also be higher.

In the context set out above, operating lease companies are particularly exposed to two risks: (i) Early termination of lease contract and (ii) Default in payment of lease rent.

Given the risks that an operating lease company is exposed to, it becomes imperative that it is able to check a prospective customer’s credit worthiness and its past repayment behaviour with other lenders in order to safeguard its interests. However, credit bureau databases are currently only accessible to banks, NBFCs, insurance companies and telecom companies, excluding operating lease companies when not incorporated as NBFCs. Interestingly enough, insurance and telecom companies, for instance, incur similar or lower credit risks as compared to those to which an operating lease company is exposed.

It is the EBG’s recommendation that operating lease companies, whether or not registered as NBFCs, should be granted access to credit bureau reports. The EBG believes that this will significantly aid such companies in their credit risk management and help in expanding their product offerings to the SME and Individuals segments, thus enhancing the access of such categories to additional financing and services offers.

4.3 LEGAL AND TAX IMPROVMENTS IN RELATION TO BANKING ACTIVITIES

4.3.1 Enforcement of security by banks/financia institutions(FIs)andrelated regulations

Background

In the recent period, there has been a substantial increase in non-performing loans in the books of banks and financial institutions leading to a strain on

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their profitability and capital adequacy. Consequently, there is now greater focus and pressure on the banks and financial institutions to recover monies from these non-performing loans.

Issues:

The prevailing regulations provide for recovery of monies from non-performing loans through various legal means. The laws applicable to banks and financialinstitutions that govern the process of recovery from non-performing borrowers are as below:

• The Recovery of Debts Due to Banks and Financial Institutions Act, 1993. (RDDBFI Act)

• The Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (SARFAESI Act).

In addition to the above legislations, current laws also provide for the banks and financialInstitutions to:

• Initiate winding up proceedings against a defaulting borrower in the high court

• Initiate criminal proceedings under the Negotiable Instruments Act in case of dishonour of post-dated cheques provided for repayment of debt.

The RDDBFI Act and the SARFAESI Act are the preferred means of proceeding against the defaulting borrower for recovery of monies. The salient features of these acts are as below:

The RDDBFI Act provides for:

• Establishment of Tribunals & Appellate Tribunals for recovery of debts

• The Tribunal and the Appellate Tribunal to have powers similar to a civil court under the Code of Civil Procedure, 1908

• The Tribunal and Appellate Tribunal to have the power to attach and sale of movable and immovable property of the borrower and the guarantors.

The SARFAESI Act provides for:

• In case of a formal consortium, the secured lenders to take possession of/assign/sell/lease charged assets of defaulting borrower/guarantors

• In case of a multiple lending agreement, the secured lenders to take possession of the charged asset only when 60% of lenders provide consent

• The lenders to approach the DRT (debt recovery tribunal) for the balance amount if the sale proceeds are not sufficient to satisfy their dues.

In addition to the above, banks and financial institutions are also permitted to sell or assign their non-performing loans to asset reconstruction companies in line with guidelines issued by the RBI from time to time.

Though the above laws were framed for expediting recovery of amounts due to banks and financialinstitutions, the legal infrastructure and procedures followed in Indian courts often result in inordinate delay in taking these matters to their logical conclusion.

Further, due to an exponential increase in the amount of non-performing loans across the banking sector, the number of cases filed in the DRT, of proceedings under the SARFAESI Act, as well as of winding up petitions, has increased substantially, resulting in further delay in delivery of justice. It is not uncommon to witness cases being heard in the DRT, DRAT (debt recovery appellate tribunal) and the high court after more than four-five years.

The situation is also similar in SARFAESI cases where there is an inordinate delay in securing physical possession of the asset pending clearance from the chief metropolitan magistrate (CMM) or district magistrate/collector (DM/DC).

Recommendations

The EBG recommends the following changes to the existing laws and regulations, in order to enable more expeditious recovery of monies from defaulting borrowers:

• A redressal authority be formed to address the challenges or hurdles faced by banks and financial institutions in implementing the options available under SARFAESI and RDDBFI Acts

• A dedicated authority / officer be appointed to deal with SARFAESI applications in the CMM/DM/DC office to reduce the time required to obtain permission for physical possession

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• The DRT Act/procedures be amended -- requiring every defaulting borrower who approaches the DRT for a stay to deposit a certain percentage of the total dues owed to the bank.

4.3.2 Expiry of guarantees

Background

Section 28 of the Indian Contract Act was amended in January 2013 pursuant to which a minimum claim period of one year is required to be made available to the beneficiary of a guarantee issued by a bank even if this is not required by the underlying contract between the beneficiary and applicant.

Issues:

In the absence of a claim period, strict legal interpretation suggests that the law of limitation would apply and the issuing bank could remain liable for a period of three years after expiry for private beneficiaries and for 30 years for government beneficiaries. If this is reflectedin risk measurement, the tenors, risk weighted assets and capital requirements will all increase, resulting in additional costs to the applicant and the bank.

This amendment appears to go beyond the commercial intent and is open to multiple interpretations. Banks are awaiting a decision of the Supreme Court in a case pending on a similar matter before implementing the amendment in the Contracts Act. While the outcome of this ongoing case may not necessarily clarify the interpretation of the recent amendment, it could provide some useful guidance.

Recommendation

Given the prevailing ambiguity, it is the EBG’s recommendation that appropriate clarification be issued so that the validity of the guarantees ideally follow the tenure of the underlying contract and intention of the applicant as well as the beneficiary of a guarantee.

Tax issues for banks in relation to foreign portfolio investors (FPI)

Background

Foreign banks play a significant role in facilitating Indian portfolio investments by foreign portfolio

investors (FPIs) registered with designated depository participants notified by the SEBI by providing custody and banking services to such investors. Further, a number of international securities broking service providers have established businesses in India, and such entities provide broking services to FPIs transacting in Indian securities.

Issues:

There are material tax considerations which weigh on foreign banks and on Indian subsidiaries of international broking businesses who transact extensively with FPIs:

(i) There is an exposure under the Indian tax law that such entities could be held to be representative assesses of their non-resident clients (which will include their FII clients); as representative assesses; such entities could be held to be responsible for discharging any shortfall in tax payments due by their clients. Given that such entities are merely service providers and the fees that they may earn from the provision of services to their non-resident clients have no co-relation with the possible tax exposure that their clients may have in India, the possibility that such entities may have to discharge the tax liability of their clients would impose a very substantial burden.

(ii) A recent amendment to Indian tax laws has extended the period within which the Indian revenue authorities may hold such entities to be representative assesses of their non-resident clients from a period of two years to six years. This further enhances the exposure for such entities in relation to matters which the entities do not regard as justly being their responsibility.

Recommendation

Banking and broking service providers should not be held to be responsible for the tax liability of clients to whom they provide banking and broking services. Such entities have no ability to determine the possible tax liability of their clients and, as such, are in no position to exercise any level of diligence in this regard beyond placing reliance on undertakings provided by their clients and/or advice received from chartered accountants engaged by their clients. Given these

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circumstances, it is EBG’s recommendation that such entities be excluded from the remit of provisions in the Indian tax law under which they could be held to be representative assesses of their clients.

4.3.4 Key tax issues emanating from Budget 2016 proposals

Background

In a bid to project India as a viable investment destination, Budget 2016 contained an array of tax and policy reforms. Although well intended, the relaxation provided vide the Finance Act, 2015 in the tax reforms relating to incentivising offshore fund managers to relocate to India without creating adverse Indian tax consequences for the offshore funds they manage and prospectively addressing the issue of non-applicability of minimum alternate tax (MAT) to foreign institutional investor (FIIs) and FPIs did not really assuage the industry’s apprehensions.

In presenting the Budget 2016, the Indian government kept its commitment to clarify that the MAT provisions are not applicable to foreign companies (including FIIs and FPIs); with retrospective effect i.e. for the period prior to April 1, 2015, if:

(a) The foreign company is a tax resident of a country that has executed a tax treaty with India, and it does not have a PE in India under the applicable tax treaty; or

(b) The foreign company is a resident of a country which does not have a tax treaty with India and where such a foreign company is not required to seek registration in India under any law for the time being in force in relation to companies.

To further rationalize the India-based fund manager regime and address some of the concerns expressed by certain foreign institutional investors, the Budget 2016 has proposed a couple of amendments to the existing conditions:

(a) Extending the concessional tax framework to the funds established or incorporated or registered in a country or a specified territory as notified by the Indian government

(b) The condition that the fund shall not carry on or control and manage any “business in India” or “from India” has been amended. The condition is now restricted to the requirement

that the fund shall not carry on or control or manage any “business in India”.

Subsequent to the budget announcements, the Central Board of Direct Taxes (CBDT) issued new rules for operationalization of the new India-based fund manager regime vide Notificatio No. SO 1101(E) dated March 15, 2016. On the one hand, the rules provide for a safe harbour to comply with the prescribed conditions and more specific guidance on certain conditions; on the other hand, the rules bring the transactions between the eligible funds and the fund manager within the ambit of transfer pricing regulations. As a welcome move, these rules also provide for a pre-approval mechanism under which an offshore fund can seek approval at its option from the CBDT. Once approved, the benefit of the new regime would not be denied unless approval is withdrawn under limited circumstances.

Budget 2016 has also addressed a longstanding request of the NBFC sector, by allowing them to claim a tax deduction of the provision created for bad and doubtful debts (NPA) to the extent of 5% of the NBFC’s total taxable income. Going forward, at the time of actual write-off of a bad debt, NBFCs will be allowed to claim a tax deduction for such bad debt to the extent that it exceeds the credit balance in the provision for NPA account maintained by the NBFCs for tax purposes.

Further, various benefits have been conferred to financial services companies that operate within the International Financial Services Centre (IFSC) in India as well as the investors that invest in securities that are available for investment in the IFSC, such as:

• Exemption from tax on long term capital gains realized on transfer of equity shares and units of equity oriented mutual funds in foreign currency on a recognized stock exchange located in the IFSC even when securities transaction tax (STT) is not paid.

• Applicability of MAT at a concessional rate of 9% (plus surcharge and cess) to a company being a unit operating within the IFSC; provided that such company derives income solely in the form of convertible foreign exchange.

• Exemption from dividend distributed tax on distributions made by a company operating

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within the IFSC and deriving income solely in the form of convertible foreign exchange; in the hands of the company as well as the recipient shareholders.

• Exemption from STT and commodities transaction tax on transactions in equity shares and units of equity oriented mutual funds undertaken in foreign currency on a recognized stock exchange located in the IFSC.

Issues:

(i) The presence of fund managers in India may, in certain scenarios, be viewed as a PE of the offshore fund they manage, thereby exposing the offshore fund to additional tax liability in India. Thus, to encourage the fund managers to shift their base to India and mitigate concerns of adverse tax consequences while making this shift, the Finance Act, 2015 had clarifiedthat management of an eligible offshore fund by an eligible fund manager in India shall not create a business connection of the eligible offshore fund in India, subject to certain prescribed conditions. Further, Budget 2016 proposed a couple of welcome amendments to the existing conditions. However, it will still not benefit any of these categories of foreign financial investors, because some of the conditions are impractical and onerous to comply with. While efforts are being incurred in the right direction to create an effective tax regime for fund managers to manage offshore funds, a few additional changes so as to simplify the regime would have been helpful in incentivizing fund management activity in India.

(ii) The amendment made by Finance Act, 2015 to bring to tax the interest payments that are made by an Indian branch of a foreign bank to its head office/overseas branch offices is likely to adversely impact foreign banks that operate in India as they may land up having to pay tax in India at a rate as high as 40% on the interest that they earn from their Indian branch office, unless they try to seek cover under their respective tax treaties. Separately, the amendment goes against the provisions of the

various tax treaties the Indian government has executed with various foreign governments – containing interest article to the effect that typically require withholding tax on interest payments in a source state where payer and payee are separate entities. The said amendment that was made to the Act, starting April 1, 2015, will only result in additional litigation on the issue.

(iii) Recently, the RBI permitted Indian corporates to issue rupee denominated bonds outside India (also known as masala bonds), as a measure to facilitate Indian corporates to borrow funds from overseas. Investment in rupee denominated bonds would result in the following types of income for an investor:

(a) Interest income on the coupon date from the issuer;

(b) Gains / loss arising on account of redemption of bonds; and

(c) Gains / loss arising on account of transfer / alienation of bonds overseas.

On October 29, 2015, CBDT issued a press release wherein it clarified that withholding tax at the rate of 5%, which is in the nature of final tax, would be applicable on the interest income from offshore rupee denominated bonds; in the same way as it is applicable for offshore dollar denominated bonds. Further, it was decided that capital gains arising on account of appreciation of rupee between the date of Issue and the date of redemption, against the foreign currency in which the investment is made; would be exempt from capital gains tax in India. However, this clarification was provided by way of a press release and thus legislative amendment in this regard was expected in Budget 2016. While the budget proposes to exempt capital gains arising to a non-resident investor on account of appreciation of the rupee, related provisions to make explicitly clear that interest on such bonds qualify for a concessional tax rate of 5% have unfortunately not been proposed for amendment. Separately, the budget does not provide any clarity on whether the benefi

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of availing concessional tax rate of 5% will be extended beyond June 30, 2017.

(iv) It would have been better if the Indian government had permitted NBFCs to offer to tax the interest income they earn on NPAs on cash basis rather than accrual basis. This benefit is already available to banks, financialinstitutions and state financial corporations. In accordance with the directions issued by the RBI, NBFCs also follow prudential norms and, like the aforementioned institutions, are mandatorily required to defer income recognition in respect of their NPAs. Thus, even NBFCs registered with the RBI should be allowed to recognize interest income on NPAs on cash basis in order to avoid unnecessary tax implications for NBFCs.

(v) The steps taken by the Indian government are considerable with respect to promoting financial services companies to operate within the IFSC in India. However, such benefits are still not at par with the existing framework of the other global financial centres in many other countries. India thus needs to take significantsteps to make the tax regime for IFSCs in the country competitive enough to match the framework of the other global financial centres.

(v) Prior to the announcement of Budget 2016, talk of increasing the period of holding for listed shares to qualify as a long term capital asset from one year to two years were doing rounds. Fortunately, the said proposal has not been considered and it is recommended that the said proposal should not be reconsidered in the coming budget as well.

Recommendations

(i) To simplify the conditions prescribed for the Indiabased fund manager regime. It is recommended that as long as the offshore fund conducts all its activities in accordance with the applicable regulations of the home country and adequately compensates the India-based fund manager on an arm’s length basis, the India based fund manager should not be viewed as having a business connection or constituting a PE of the offshore fund in India.

(ii) As regards the amendment to bring interest payments by Indian branches of foreign banks to their head office/overse s branch officeswithin the Indian tax net, it is recommended that this be withdrawn.

(iii) For investment in offshore rupee denominated bonds, absolute clarity is required on taxation in the hands of the non-resident investor by way of an amendment in the Indian tax law. The Indian government should also consider extending the concessional tax regime beyond June 30, 2017.

(iv) The Indian government should give NBFCs the offer to tax the interest income that they earn on NPAs on a cash basis rather than on accrual basis.

(v) In order to bring parity with the global financialcentres, a complete tax holiday should be provided to the units located in the IFSC.

(vi) The period of holding for unlisted shares to qualify as a long term capital asset is proposed to be reduced from three years to two years. While Finance Minister Arun Jaitley mentioned this aspect in his budget speech, the actual amendment is not a part of the Finance Bill, 2016. Hence, it is recommended that the government correct this anomaly before the enactment of the Finance Bill, 2016.

4.3.5 Income Computation & Disclosure Standards (ICDS)

Background

Section 145 of the Income Tax Act’1961 (ITL) provides that the taxable income of a taxpayer falling under the heads “profits and gains of business or profession” (Business) or “income from other sources’ (Other Sources) be computed in accordance with either cash or mercantile system of accounting which is regularly employed by the taxpayer. It further provides that the central government may notify, from time to time, the ICDS to be followed by any class of taxpayers or in respect of any class of income.

The object behind introducing separate ICDS was the perception that ICAI AS provides flexibility of alternative accounting treatments, which makes it possible for a taxpayer to avoid payment of correct taxes by

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choosing a particular system. Therefore, urgent need was felt to standardize one or more of the alternatives in various standards so that income for tax purposes can be computed precisely and objectively.

Since the introduction of this provision in the ITL, the government had notified two standards in 1996 viz., (a.) accounting standard I, relating to disclosure of accounting policies. (b.) accounting standard II, relating to disclosure of prior period and extraordinary items and changes in accounting policies. These standards were largely comparable to the corresponding ICAI AS

The government has now notified 10 ICDS effective from April 1, 2015 for compliance by all taxpayers following mercantile system of accounting for the purposes of computation of income.

Issues:

While ICDS have been broadly framed in accordance with comparable ICAI AS, there are certain deviations/carve outs which will have substantial impact on the taxability of corporates. Though representations have been made to the relevant committee on the suggested changes, it seems these have not been accepted by the committee.

Recommendations

A copy of the representation made to the committee is enclosed as annexure. It is recommended that the central government provide requisite clarificationsand/or amendment to the notified ICDS.

4.3.6 Tax amnesty for subsidiarisation of branches of foreign banks operating in India

Background

In the context of the RBI’s policy with regard to subsidiarisation of branches of foreign banks operating in India, Finance Act 2012 has introduced a special provision in the Income tax law to deal with some issues that need to be addressed in the case of conversion from a branch form of presence for a foreign bank into a WOS form of presence. This is subject to the conversion being undertaken in accordance with the scheme framed by RBI, and the conversion complying with conditions that may be notified by the government. As per this provision:

(i) The capital gains arising to a foreign bank from such conversion shall be exempt from tax in the year of the conversion; and

(ii) The provisions relating to treatment of unabsorbed depreciation, set-off or carry forward of tax losses, tax credits in respect of tax paid and deemed income relating to certain companies and the computation of income in the name of the foreign company and the Indian WOS shall apply with such exceptions, modifications and adaptations as may be specified in the government’s notificatio

Issues:

In November 2013, the RBI released the “Framework for setting up wholly owned subsidiaries in India”. The paper clarifies that the conversion from a branch presence to a subsidiary presence should be implemented through an amalgamation of branches into a wholly owned subsidiary established by the foreign bank in India. The paper also prescribes certain additional conditions that the resulting wholly owned subsidiary should fulfil. On the basis that this paper constitutes the scheme framed by the RBI as referenced in the income tax law, a conversion implemented in accordance with this scheme ought to qualify for tax exemption as provided in the Income tax law. However, the exemption in the income tax law is further conditioned on compliance with conditions that the government may notify. It remains unclear whether the government’s notificatio will simply replicate the conditions contained in the RBI scheme or whether it will include additional conditions which may potentially make the securing of tax neutrality more challenging. Further, issues such as tax credits and carry forward of tax losses must necessarily be free from doubt. But the manner in which the law is presently written suggests that the existing provisions with certain modificationsas may be notified by the government will apply. Greater clarity is urgently required.

A related concern that foreign banks had in relation to the conversion was with regard to the incidence of stamp duty. This has been partially alleviated with the passage of the Banking Laws (Amendment) Act, 2012 in January 2013 pursuant to which the Indian Stamp Act, 1899 has been amended to exempt from stamp duty any instrument for transfer of any property, business or asset (moveable or immovable) in

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connection with a conversion of a foreign bank branch into a wholly owned subsidiary as per the scheme framed by the RBI. However, to the extent that stamp duty may also be attracted under stamp duty laws enacted by different states in India, the exemption provision requires to be incorporated into such state laws as well.

Finally, such a conversion may potentially attract VAT levies and other state or local levies. On the basis that a conversion from a branch to a wholly owned subsidiary should be entirely tax neutral, amendments to such laws is also necessary to ensure that such levies are not attracted upon conversion.

Recommendations

The EBG believes that there is a need for a clear blanket exemption from all taxes to foreign banks that convert from a branch presence to a wholly owned subsidiary. Specificall , it recommends that there should be:

(i) Absolute clarity in the income tax provisions that a conversion from a branch form to a WOS will be free from any income tax liability;

(ii) Absolute clarity that any tax attributes in the branch form, such as tax credits, tax losses, relief in respect of bad debts written off, CENVAT credit, unabsorbed depreciation will become available to the wholly owned subsidiary as if these pertained to the wholly owned subsidiary;

(iii) Certainty that there will be no indirect taxes on the migration from a branch to a WOS including VAT and service tax;

(iv) Certainty that there will be no stamp duty15, cesses, or any other governmental levy (central, state or municipal) on migration of the entire business from a branch to a WOS;

Lastly, foreign banks are likely to incur substantial costs in undertaking this conversion from a branch to a WOS. There should be certainty that all conversion related expenditures that may be incurred should be tax deductible.

5. CONCLUSIONThe EBG believes that the Indian economy is poised for significant growth in the years to come. Financial services provided by banks and their associates will play an important role in facilitating this growth. The EBG looks forward to contributing actively in this process. It is of the view that its recommendations, if implemented, will act as a catalyst in deepening the range of financial products and services available to customers in India, improving access to cost effective financial services, thereby enhancing the competitiveness of Indian businesses, and in furthering the objectives of the government and the RBI of extending the reach of financial services across the economy.

Endnotes)

1. Source: Indian Banks’ Association website - www.iba.org.in

2. Report on Committee on Comprehensive Financial Services for Small Businesses and Low Income Households, 2014

3. Source: Economic Survey on Energy Infrastructure and Communication 2013-2014 (www.indiabudget.nic.in)

4. RBI Circular no DBOD.BP.BC.No.25/08.12.014/2014-15 and DBOD.No.BP.BC.24/21.04.132/2014-15 dated July 15, 2014

5. Source: RBI website – www.rbi.org.in

6. Comprehensive Financial Services for Small Businesses and Low Income Households, January 7, 2014

7. Draft guidelines for licensing of Payment Banks and Small Banks, July 17, 2014

8. RBI/2012-13/138 RPCD. CO. Plan. BC 13/04.09.01/ 2012-13 dated July 20, 2013

9. Within this, not more than 25% should relate to indirect lending

10. Small and Marginal farmers have been defined as, Farmers with landholding of up to 1 hectare are considered as Marginal Farmers. Farmers with a landholding of more than 1 hectare but less than 2 hectares are considered as Small Farmers

11. While there are no specific sub limits prescribed for advances to MSE / small enterprises, any loans to this segment will be counted towards the overall PSL target. However, 60 % of the total MSE advances should be to micro manufacturing enterprises and micro service enterprises. The rationale for introducing the 60 % limit when no specific targets are prescribed for MSE advances is unclear

12. Approach Paper on Automated Data Flow from Banks, November 2010

13. Master Circular DBOD.No.BP.BC. 85 /21.06.200/2013-14 of

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Jan 2014 and subsequent clarification vide DBOD.No.BP.BC.116/21.06.200/2013-14 of June 2014

14. SEBI (Infrastructure Investment Trusts) Regulations, 2014

15. The Banking Laws (Amendment) Act 2012 aims to remove a levy of stamp duty on a conversion of a branch into a WOS

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CHEMICALS &PETROCHEMICALSPosition India to be a competitive chemical producer for domestic and global markets by supporting development of relevant feedstock and chemical infrastructure (e.g. PCPIR), encourage R&D and streamline the tax regime.

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1. INTRODUCTION

Bulk chemicals including petrochemicals: This is the conventional, mature and commoditised segment with differentiation on the basis of economies of scale, access to cheap feedstock volumes and to markets. While basic organic chemicals are expected to grow at 10% by end of FY17, the basic inorganic chemicals are expected to grow at a stable rate of 6-7% CAGR and petrochemicals at a higher CAGR of about 11%.2

Fine and speciality chemicals: This downstream segment comprises technology intensive plants that use base chemicals as feedstock and are characterised by high value and low volume products. These operations require highly trained skill sets and heavy orientation to research and development (R&D) targeting specific consumer end user industries. The growth potential of speciality chemicals is strong and the market size is expected to reach nearly US$44 billion (€38.5) by FY19.4

1.5 Petroleum, Chemicals and Petrochemical Investment Regions (PCPIRs):

A PCPIR is a designated investment region catering to domestic as well as export requirements by providing infrastructure facilities of global standards. PCPIRs were initially approved in the four coastal states of Gujarat, Andhra Pradesh, Odisha and Tamil Nadu and subsequently in Madhya Pradesh. The government has also committed support to proposals from the states of Karnataka and Rajasthan. A total investment of more than INR 150,000 crore ($25 billion/€14 billion) via PPP route is expected to setup these PCPIRs5. The government is now planning to set up petrochemical complexes in all 16 refineries of the country and create downstream and processing industries to

Market Description1

1.1 The Indian chemicals and petrochemicals industry forms an integral part of the commercial landscape in India given that it provides raw materials and intermediates to be used in manufacturing across sectors. India is the third largest producer of chemicals and petrochemicals in Asia and accounts for nearly 3.4% of the global chemicals industry2. The industry contributes about 2.11% of India’s GDP3. The Indian chemical market was estimated at US$139 billion (€122 billion) in 20142 and US$144 billion (€126.5 billion) in 20153. The industry has the potential to reach US$214 billion (€188 billion) by FY19 growing at a compounded annual growth rate (CAGR) of about 9% and in an optimistic scenario, US$234 billion (€205.5 billion) at a growth rate of 11%2.

1.2 The industry produces a wide range of chemical products. Key segments of the industry in terms of market share (in 2014) are bulk chemicals including basic organic and inorganic chemicals (25%), petrochemicals (19%), speciality chemicals (18%), active pharmaceutical ingredients (APIs) (16%) and fertilizers (15%). Biotechnology and agrochemicals accounted for 4% and 3% of the market share, respectively.2

1.3 The industry is well recognised globally for high quality products on a low manufacturing cost base. India is the fourth largest producer of agrochemicals after the US, Japan and China2, and is a predominant exporter to the US, Europe and African countries. Indian dyestuffs are also well received internationally, accounting for about 16% of the world production of dyestuff and dye intermediaries3.

1.4 The key segments of the Indian chemicals and petrochemicals industry can be grouped into the following:

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further add value to such petrochemical complexes6.

1.6 The manufacture of most chemical products is de-licensed (with only certain items being covered under the compulsory licensing list because of their hazardous nature) and entrepreneurs need to submit only the industrial entrepreneurs memorandum to the government’s Department of Industrial Policy & Promotion (DIPP) to start chemical manufacturing. There are no quantitative or other restrictions on the import of chemicals except on a few chemicals which are covered under the obligations of international conventions.

1.7 In the chemicals and petrochemicals industry, 100% foreign direct investment (FDI) is permissible under the automatic route, subject to certain exceptions.

1.8 Increasing urbanisation and per capita disposable income is resulting in a strong growth outlook for several key end user industries. This will positively impact growth in the industry; a sustained growth of 9% CAGR (compound annual growth rate) is projected over the next five years, with further upside potential if appropriately facilitated7.

Recent Developments

1.9 Make in India initiative

Make in India is a government initiative to encourage companies to manufacture their products in India. The programme represents an attitudinal shift in how India relates to investors: not as a permit-issuing authority, but as a true business partner with a focussed target across sectors. It is aimed at enhancing the ease of doing business in India and is expected to attract capital and technological investment.

The initiative is expected to boost several end user industries, thereby propelling domestic demand for high quality chemical products.

India, with its skilled manpower and flourishingdomestic demand, has the right ingredients

to emerge as the global hub for ‘zero defect, zero effect’ chemical manufacturing, fulfil the demand of its domestic market and reduce the dependence on imports of chemicals, provided the government undertakes specifictax, labour and environmental regulatory reforms in a concerted manner to support the industry. Rationalisation of duties on petrochemical products and inputs and addressing inverted duty structures in the last two union budgets are steps in the right direction.

1.10 Rationalisation of duties and goods and services tax (GST)

The Finance Ministry has been making continuous efforts to remove anomalies in the duty structures for the petrochemical sector. In Budget 2015, customs duty on naphtha, ethylene dichloride, vinyl chloride monomer etc. were reduced. Similarly, in Budget 2016, customs duty on acyclic hydrocarbons and cyclic hydrocarbons were rationalised and were reduced on denatured ethyl alcohol and orthoxylene.

GST would be the single largest reform in India’s indirect tax regime. It is expected that introduction of GST would result in increasing GDP of the country by 1-2%, and provide a stimulus to Indian industries. The introduction of GST is widely awaited by the industry as this key reform is likely to streamline compliances, rationalise duty structures, afford greater certainty in taxes and remove existing inefficiencies

1.11 Draft National Chemical Policy

The Planning Commission had in March 2011 constituted a working group on chemicals and petrochemicals that recommended formulating a “National Chemical Policy”. The draft policy is being prepared in a consultative format along with various stakeholders, indicating the various imperatives essential for providing an impetus to growth of the chemical sector in India and identifying action points, especially related to feedstock availability, Health, Safety, Security and Environment (HSSE) and focus on R&D. The

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policy is expected to be announced shortly by the government8.

1.12 Plastic Parks

In 2013, the government proposed to support the setting up of plastic parks for the promotion of downstream plastic processing industries. A scheme for setting up plastic parks, with requisite state-of-the-art infrastructure and enabling common facilities was formulated by the Department of Chemicals and Petrochemicals in order to synergise and consolidate capacities through cluster development. The objectives of the scheme, inter-alia, are to increase competitiveness through R&D led measures, increase investments in the sector and achieve environmentally sustainable growth through innovative methods of waste management, recycling, etc.

Subsequently, the scheme for setting up of need based plastic parks received the government’s approval in March 2015. The government will provide grant funding up to 50% of the project cost, subject to a ceiling of INR 40 crore (€5.2 million) per project. Proposals for setting up plastic parks in Assam, Odisha and Madhya Pradesh have received final approval, while the proposal for Tamil Nadu has been given ‘in principle’ approval. The government has also approved the setting up of six additional plastic parks.

1.13 India as a global speciality chemicals manufacturing hub

Strong governmental support for the establishment of common infrastructure clusters, the existing production of base chemicals as raw materials and the focus on developing specialized intermediate producers creates a robust platform for the fine and speciality chemicals segment, which comprises low volume but high value products, to leverage and enable India to become a global manufacturing hub. There are several other factors facilitating this development:

(i) Availability of a large number of qualified and skilled chemical engineers which constitute

the backbone of this technology oriented segment.

(ii) Robust domestic demand which will continue to be driven by high growth rates in key consumer industries like automotive, construction and pharma and emerging demand across consumer industries for products with higher quality/increased performance (viz. home and personal care).

(iii) Export based growth potential in select segments such as agrochemicals and dyestuffs.

(iv) The government has recognised the immense potential and is focusing efforts on developing R&D capabilities, technical skill training, infrastructure upgradation etc. to support the endeavour to create a global manufacturing hub.

1.14 Focus on Green chemistry and Renewable feedstock

Green chemistry is an area of high focus and priority for some of the largest global players with tremendous effort – and progress – being made to establish green leadership and facilitate a reduction in the carbon footprint. There is increasing emphasis across the world, from governments to consumers and activists, to adopt environment friendly practices and products. Given that the output from the chemicals and petrochemicals sector pervades all kinds of products and uses, there is huge potential for the industry to contribute to green technologies and products supporting green practices and objectives. India should strive to identify and develop its strengths in this area. Replacement of fossil-fuel derived feedstock by plant sourced /bio-based alternatives would support the objective.

Further, the government should focus on promoting compostable plastics which undergo degradation by biological processes and do not leave visible, distinguishable or toxic residue. Adopting such eco-friendly measures would be in line with the prime minister’s Swachh Bharat Abhiyan (Clean India Campaign) announced in 2014.

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1.15 Large and specific demand from the domestic Indian user industries

India is being developed as a cost efficient manufacturing hub across several industrial segments such as automotive and electronics. As a result, there is increasing demand from these industries to develop unique local products and solutions which can cater to both the domestic as well as international markets. In the automotive sector, demand is now created for products and materials that will support the industry’s objectives to be a low cost small car hub. Similarly, the growth in industries like construction (low cost housing projects, green buildings, setting up of smart cities), packaging (driven by the retail boom) and the renewable energy sector is also expected to create a demand for chemical companies to supply relevant products. The country currently imports a large portion of its chemical requirements. Catering to the domestic demand in terms of import substitution and supplying new value added chemicals (specialty and knowledge) presents a huge opportunity for the sector.

European Investment in India

European chemical players are looking at Asian markets as the next growth phase due to the high consumption base. Some large European chemical companies present in India are:

1. BASF2. Solvay – Rhodia3. Clariant4. Akzo Nobel5. Lanxess6. Syngenta7. Bayer Crop Science8. Evonik9. Arkema10. Kemira11. Wacker Chemie12. Croda

2. GENERIC INDUSTRY CHALLENGES

2.1 Infrastructure: Roads, ports, railways, pipeline networks, power, water, pollution control etc. are key factors that central and state authorities should focus on developing. The lack of adequate infrastructure increases the cost of manufacturing and also creates bottlenecks in growth and continuity of operations.

2.2 Feedstock: Primary building blocks such as ethylene, propylene and butenes relevant for the establishment of speciality chemicals products are not accessible in the merchant market as all of these are primarily captively consumed and that too for commodity products (polyethylene, polypropylene, etc.). Hence, currently, most speciality products are imported into India.

2.3 Tax structure: Inverted duty tax structures affect the competitiveness of the industry. The government has attempted to rectify this through several amendments in Budgets 2015 and 2016 by reducing customs duty on ethylene dichloride, vinyl chloride monomer, styrene monomer, denatured ethyl alcohol and orthoxylene etc. However, there is still some work to be done.

The government of Thailand is in talks with the government of India to inter-alia include petrochemicals in the list of goods attracting reduced rate of customs duty under the India-Thailand Free Trade Agreement (FTA)9. While the discussions have not yet concluded, the government should take into account the potential impact of such inclusion on the domestic petrochemical industry.

Moreover, compliance procedures and mechanisms for levy and refunds of cess and duties are quite onerous. It is expected that with the introduction of the long awaited GST, some of these issues will get addressed. Continued dumping of cheap chemicals into India also impacts Indian players, in spite of anti-dumping duty/safeguard duty levied by the government. Procedural bottlenecks in this area should be removed to make it more effective and timely.

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2.4 Health and safety norms: Players in the chemicals and petrochemicals industry have often been lax in adopting established and proven health, safety, security and environment norms. This further impacts public perception linked to the sector and works negatively in terms of attracting requisite talent to work in the industry; it also results in higher risk of industrial accidents.

2.5 Fragmented capacities: Typically, fragmented and dispersed units are not in a position to enjoy economies of scale and face capital constraints due to sub-optimal capacities, which impedes their growth options and further impacts the competitiveness across the value chain.

2.6 Investment in R&D: More resources and finances need to be invested on the R&D front. Besides, individuals entering the industry and institutions providing the training/degrees lack the practical skill sets.

2.7 Skill development: There has been a dearth of talented manpower in the industry. The industry has an additional human resource requirement of 1.72 million by 2022 from the existing employment base of 1.86 million in 201310. Together with the government, the industry needs to take measures to attract, recruit and retain the right talent. To further the Make in India initiative, the government has plans to set up specialized vocational training centres in clusters for the chemicals and petrochemicals industry.

3. KEY ISSUES & RECOMMENDATIONS

Issue/Objective: Developing India as a global hub in speciality chemicals and fulfilling the domesticdemand

3.1 Issue: Inadequate infrastructure

Recommendations

This is a critical issue across industrial segments, not just in the chemicals and petrochemicals industry. While the central and state governments have been

making efforts, it will require time to fill in the gaps given the significant inadequacies. Focused infrastructure development for the industry has been attempted through the setting up of clusters such as PCPIRs and in capacity building of existing identified chemical clusters across India (largely Gujarat and Maharashtra). It is imperative that enabling frameworks are developed for effective infrastructure creation in PCPIRs and chemical clusters by providing specialized infrastructure required for the industry to facilitate co-location of players across the value chain, i.e. feedstock suppliers and downstream players. This could be done by creating a network of specialized and high pressure pipelines and cryogenic storage containers etc. Similarly, centralized effluen treatment units and air separation units in such clusters would help small players. The supporting logistics infrastructure for the industry, namely construction of quality logistics and transportation facilities such as roads, railways, ports and terminals handling chemicals and petrochemicals along with the requisite port based logistics infrastructure, will be critical to ensure overall development. Concerted efforts should be continued by the government and private industry to close infrastructure gaps. Initiatives such as an undersea gas pipeline from Chabahar port in Iran to the Gujarat coast would greatly boost the supply of feedstock. However, a clear road map for development of infrastructure needs to be defined

3.2 Issue: Feedstock availability

Recommendations

Competitive feedstock with relevant brownfiel infrastructure should be made available to the industry. This is critical for local and international companies to invest in India. Chemical companies in India should explore alternate feedstock such as olefins, invest/secure partnerships for facilities in resource rich nations to secure feedstock or form joint ventures/alliances with global players within India to manufacture locally.

The government has addressed some of these concerns in the draft National Chemical Policy and initiated steps in securing feedstock for the industry. These initiatives should be implemented on priority:

1. Investments to be encouraged in areas where sustained feedstock supply is available.

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2. Cluster approach to rationalise the efforts in feedstock allocation with anchor units,

3. Government to government contracts for locking in international feedstock supply.

4. To set up global scale plants for manufacture of base chemicals.

5. Incentives for using bio based raw materials.

3.3 Issue: Alignment of taxes and duties

Recommendations

Rationalisation of taxes is of paramount importance in this sector. Inverted duty structures should be suitably rectified to bring players at par with global players and enhance competitiveness of output from India. Some of these issues have been resolved through amendments in the budget but there is still some work to be done. The government should expedite implementation of GST, which is expected to revamp the indirect tax regime and streamline mechanisms for refunds and compliances. The government should also follow a balanced approach while entering into FTAs so that industry players from signatory countries are mutually benefited

3.4 Issue: Dispersed and uneconomical capacities

Recommendations

The primary objective should be to set up state-of-the-art units with economies of scale so that they are competitive. Units with smaller capacities should be consolidated or ideally upgraded. The consolidation and relocation, if any, should take place in a manner that will shift downstream capacities closer to the anchor plants so that logistics become cost efficientand units are located in proximity to supporting infrastructure. The government could consider incentives to encourage such consolidation.

3.5 Issue: Industry players have been subject to multiple regulations which increases the compliance burden

Recommendations

The government should expedite the simplification of procedural and compliance matters by consolidating/streamlining the myriad acts and rules pertaining to the chemicals and petrochemicals industry.

3.6 Issue: Investments in R&D

Recommendations

It is imperative that R&D spend be increased so that new materials, products and technologies are developed in line with the objectives to position India as a global speciality chemicals hub. The government should also incentivise R&D spend by way of tax breaks, soft loans, subsidies, etc. Currently, R&D spend is in the range of 1% of revenues; this should be increased to 3-5% of revenues. International collaborations with multinational chemical giants can provide an impetus in these efforts. The government can also facilitate indigenous R&D under a PPP model. The National Chemical Laboratory, a constituent laboratory of the Council of Scientific and Industrial Research (CSIR), had earlier set up a NCL Innovation Park to support growth and expansion plans of research and knowledge based business entities. The National Chemical Policy, which is on the anvil, also proposes to set up a National Chemical Development Centre to promote R&D11.

There also needs to be effective implementation of the intellectual property rights framework to protect innovators and facilitate monetization of new materials and discoveries. The draft national IPR policy is expected to be finalized shortly and will give a fillip to R&D efforts.12

3.7 Issue: Human resource development

Recommendations

India has a large manpower pool. In order to create the pool of skill sets required by the industry, investments should be made in technical training infrastructure. It is also critical to attract talent. The training agenda can be developed jointly as a public-private collaboration. The government is also focused on setting up skill development councils or centres as a medium to execute training plans. As an illustration, under the draft

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national chemical policy, the government has plans to set up chemical engineering education centres within leading universities and institutes.

The government has sanctioned 10 more centres under the Central Institute of Plastics Engineering and Technology (CIPET) in different parts of the country; a total of 70 centres will be added in the next three years to increase the number of plastic technicians in India13.

3.8 Issue: HSE (health, safety, environment) and security

Recommendations

Safety management is one of the critical requirements within the sector to prevent disruption of operations and endangering of human lives. There have been initiatives to improve safety through setting up of systems and processes such as the Chemical Plant Safety and Security Rating System which aims to encourage the attainment of zero accidents and to incentivise units to achieve best safety operational measures. Chemicals and petrochemicals industry players must specificall invest and maintain best practices on health, safety, security and environment (HSSE). The government and public bodies must also incentivise units to adhere to safety requirements and abide by global standards. The government plans to including the setting up a National Chemical Safety Centre and a National Bureau of Corrosion Control in the proposed national chemical policy to regulate and prevent corrosion10.

3.9 Issue: Negative perceptions and image linked to the chemicals and petrochemicals industry

Recommendations

The chemicals and petrochemicals sector needs to enhance its public image by creating positive perception through public awareness. Support from the government is needed for this by showcasing the importance of the industry at various public forums. These efforts will also serve well in attracting skilled technical talent to the industry. This is vital for long term growth as well as in conveying the importance of the industry within the national commercial landscape. A roadmap in this direction needs to be put in place.

4. CONCLUSIONThe Indian chemicals and petrochemicals industry is set on a path of significant growth with the support of the government which has prioritised its development on a national scale. The industry holds potential both for domestic and international markets and several opportunities can be identified for collaboration and expansion between European chemical manufacturers in India and the Indian players. The stakeholders and the government will have to work jointly and proactively to realise the potential of the industry.

Endnotes

1 Year 2016 should be read as calendar year 2016, whereas FY16 should be read as financial year 2015-1

2 Source: A report on Chemical Industry – October 2015, FICCI

3 Source: Chemicals – India Brand Equity Foundation – January 2016

4 Source: A report on Chemical Industry – October 2015, FICCI

5 Source: Department of Chemicals and Petrochemicals and secondary research

6 Speech of the Union Minister of Chemicals and Fertilizers, Mr Ananth Kumar, at ‘Indian Chemical Industry: Challenges & opportunities’; organised by The Associated Chambers of Commerce and Industry of India (ASSOCHAM) on December 4, 2015

7 Source: A report on Chemical Industry – October 2015, FICCI

8 Speech of the Union Minister of Chemicals and Fertilizers, Mr Ananth Kumar, at ‘Indian Chemical Industry: Challenges & opportunities’; organised by The Associated Chambers of Commerce and Industry of India (ASSOCHAM) on December 4, 2015

9 Source: Article in livemint.com http://www.livemint.com/Politics/zQK5Ci7enc2zMsc0D0UPIK/India-Thailand-still-disagree-on-FTA-details-Thai-official.htm

10 Source: Press release dated April 9, 2015 by the Ministry of Skill Development and Entrepreneurship

11 Speech of the Union Minister of Chemicals and Fertilizers, Mr Ananth Kumar, at ‘Indian Chemical Industry: Challenges & opportunities’; organised by The Associated Chambers of Commerce and Industry of India (ASSOCHAM) on December 4, 2015

12 Statement by Union Minister of Commerce and Industry, Ms

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Nirmala Sitharaman to the PTI as reported in the Economic Times, October 14, 2015; Source - http://economictimes.indiatimes.com/news/economy/policy/national-ipr-policy-will-soon-go-for-cabinet-approval-nirmala-sitharaman/articleshow/49386064.cms

13 Speech of the Union Minister of Chemicals and Fertilizers, Mr Ananth Kumar, at Indian Chemical Industry: Challenges & opportunities’; an event organised by The Associated Chambers of Commerce and Industry of India (ASSOCHAM) on December 4, 2015

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DEFENCEinvestment-focused defence procurement policy and robust regulatory regime which can leverage the Indian government’s primary objective of equipping the armed forces for promoting “Make in India” in defence production.

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1. INTRODUCTION

Market Description

1.1 Obsolescence and accretion have created a significant demand for equipment, including fighter aircrafts, submarines, main battle tanks, howitzers amongst others, in all the three arms of the Indian defence forces. Accordingly, the Indian government has undertaken a major defence acquisition programme. With a defence budget of €33.5 billion for FY2016-17, it ranks among the top 10 countries in the world in terms of its military expenditure. Overall, India contributes nearly 3% to the world’s defence and aerospace spending of about €1.4 trillion1. In the recent budget for FY2016-17, the government has allocated about 35% (€11.6 billion) of the total defence budget for purchase of capital equipment. However, only about 35% of defence equipment is manufactured in India, mainly by public sector undertakings, the rest being imported.

1.2 During 2011-15, India was the largest importer of defence equipment in the world accounting for 14% of global imports2. Within the second half of year 2015, 28 defence contracts amounting to a total of about €5 billion have

been signed3. Out of these, 18 contracts have been signed with Indian vendors, while 10 have been signed with vendors from US, Sweden, Russia and Israel.

1.3 To facilitate and encourage investment into domestic manufacturing, the Indian government launched the Make in India campaign in 2014. The defence sector is a key area of focus, not just to create a domestic defence manufacturing industrial base but also to achieve the goal of self-reliance in defence production. In the past two years, the government has taken several policy initiatives to lower entry barriers like raising the FDI cap to 49% on the automatic route, improving the ease of doing business in defence manufacturing, relaxing norms of industrial licensing and defence exports, bringing flexibility in offset obligations and providing a level playing field for domestic manufacturing. Both foreign and Indian defence industry have responded with enthusiasm and have expressed their commitment to the Make in India initiative.

Key policy initiatives taken by government

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European Investment in India

1.4 European companies have a legacy of strong

innovative products and platforms with

specialization in land, air and naval systems.

Their annual share of sales to the Indian

Ministry of Defence (MoD) ranges from 20% to

25% of the total defence sales to India during

2011-144. However, given India’s intention of

procuring 36 Rafale jets, announced during

the visit of Prime Minister Narendra Modi to

France in April 2015, this share is bound to

rise. The other European companies currently

supplying military hardware to India are -

supply of AUVs (Autonomous Underwater

Vehicles) in a training configuration by SAAB,

Hawk Advance Jet Trainers by BAE Systems,

trainer aircrafts by Pilatus and in-country

manufacture of defence aero-engines by

Rolls Royce. France is a clear leader with

deals bagged by companies like Thales,

Safran and MBDA. Other countries who have

signed defence contracts with the Indian

MoD are UK, Switzerland, Germany, Italy and

Spain.

1.5 Since the domestic defence industry is at a nascent stage, India is expected to maintain the top spot in arms imports for next few years because of the need of urgent modernisation required by the services. The emerging geopolitical realization combined with sound economic rationale make deeper collaborations between European and Indian defence industries an imperative. A large number of European companies like Airbus, SAAB, BAE Systems, Rolls Royce, Dassault

Aviation and Thales have offered to participate in the Make in India initiative of the government and this could lead to improving the trend of defence equipment sales to India.

2. RECENT DEVELOPMENTS2.1 The central objective of the Make in India

campaign is to boost manufacturing and to generate employment by focussing on 25 sectors, including aerospace and defence.

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The key objectives for the defence sector are to promote self-reliance, indigenisation, achieving economies of scale, developing capabilities for export transfer of technology and domestic R&D. Towards this end, the government has made significant policy changes with respect to the defence industry:

• Amendments to Defence Procurement Procedure (DPP) 2013

• Services, except training and quality assurance services, have been reintroduced as an eligible offset avenue. Services were kept in abeyance in May 2013. Engineering, design and testing as well as software development services have been reinstated with a cap of 20% of the total offset obligation and prescribing of a random audit.

• Foreign defence companies are now not required to indicate the details of Indian offset partners (IOPs) and products at the time of signing of contracts.

• Foreign defence companies have been allowed to change offset partners and offset components while delivering on offset obligation and a standard operating procedure (SOP) has been introduced for processing change of IOPs and products.

• If an Indian firm, including a joint venture between an Indian company and its foreign partner, is bidding for the proposal, the clause relating to offset obligation will not be applicable if the indigenous content in the product is 30% or more (by value). In case the indigenous content in the product is less than 30%, the Indian firm or the joint venture has to ensure that offset obligations are fulfilled to the tune of ‘30% ‘indigenous content percentage’.

• A new DPP 2016 has been announced and offset policy is under finalization, along with rationalization of offset guidelines. These should further strengthen the policy regime to promote defence production in India.

• Exchange rate variation benefit has been extended to the private sector on par with defence public sector undertakings (DPSUs) and OEMs.

• Liberalisation of foreign direct investment (FDI) policy

• The government has allowed FDI in the defence sector up to 49% under the automatic route subject to an industrial license and security clearance. FDI beyond this level will be allowed under the approval route provided the proposal has transfer of critical or cutting edge technology

• Industrial Licensing

• The list of items requiring industrial licenses has been significantly reduced, removing almost all dual use items, and the process to grant defence licenses simplified and speeded up

• Initial validity of defence licenses has been increased from three to 15 years further extendable up to 18 years for existing and future licenses.

• Process of applying for industrial license (IL) and industrial entrepreneur memorandum (IEM) has been made completely online.

• No-objection certificates for exports are now granted online.

• Customs and excise duty exemptions have been withdrawn for all defence purchases, thus, a level playing field has been created for the domestic private companies at par with foreign OEMs.

3. DPP 2016The Ministry of Defence has released the much-awaited Defence Procurement Procedure - 2016 (DPP 2016). The key objective of the policy is to ensure our armed forces get the best equipment they need, procured through a cost-effective and transparent procedure. It also seeks to boost the Make in India initiative in the sector and enhance self-reliance in defence manufacturing. Some of the

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key policy changes that have been notified in the new DPP are:

3.1 Review of single-vendor situations This has been a very sensitive issue that has

grounded a number of programmes. The new DPP has committed that the procurement process will not be derailed now in a single vendor situation by addressing two most common situations in which single bid is received – first, ab-initio single vendor cases and the second where only one bid is received. In addition, it has also addressed two potential situations in the Buy and Make category – the first where all Indian vendors tie up with same foreign vendor and the second, its mirror image where in a Buy and Make category, all foreign vendors indicate a collaboration with same Indian vendor. It has clarified the procedure to be followed in dealing with the above situations so that where necessary, the acquisition can take place.

3.2 Introduction of IDDM categorisation DPP 2016 has introduced a new procurement

category ─ indigenously designed, developed and manufactured (IDDM) with the highest priority. ‘Buy (Indian-IDDM)’ category refers to the procurement of products from an Indian vendor meeting one of the two conditions: products that have been indigenously designed, developed and manufactured with a minimum of 40% indigenous content (IC) on cost basis of the total contract value; or, products having 60% IC on cost basis of the total contract value, which may not have been designed and developed indigenously.

IDDM is a game changer for the future as this would encourage Indian companies to begin design and development within the country, eventually leading to real technology development. However, achieving indigenous content of 60% could be difficult. This threshold can be lowered - Para 14 of Chapter 1 states that the categorisation committee may recommend higher or lower threshold of indigenous content.

3.3 Splitting the Make category In DPP 2016, the Make category has been

split into two parts -- ‘Make I’ category for government-funded projects and ‘Make II’ category for industry-funded projects.

Make I (government funded) involves 90% funding of the development cost by the government. The remaining 10% of the development cost would be reimbursed if RFP for the equipment developed is not issued within 24 months from the date of successful development of prototype. Projects under Make I sub-category, with estimated development costs of less than INR 10 crore (€1.3 million) will be reserved for MSMEs (micro, small and medium enterprises). They will will be opened up for non-MSMEs only if it is not feasible for MSMEs to develop the required prototype. All programmes under the Make I scheme will be eligible for a mobilisation advance of 20% of the estimated development cost, which will be deducted during the course of the development phases.

Make II (industry funded) involves no funding by the government for prototype development. However, if the RFP for the equipment developed is not issued within two years from the successful prototype development, the government will refund 100% development costs to successful developers who were selected through due process. Projects less than an estimated development cost of INR 3 crore (€394,000) will be reserved only for MSMEs and will be opened up for non-MSMEs only if it is not feasible for MSMEs to develop the required prototype.

A dedicated project management unit (PMU) is being constituted at the service headquarters level, and will be headed by a two-star rank officer or equivalent. The PMU head will be responsible for driving all Make projects pertaining to the respective services.

3.4 Changes in Qualitative Requirements (QRs)

In a measure to allow for moving beyond a rigid ‘L1’ approach, future RFPs will have ‘essential’

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as well as ‘desirable’ technical parameters or staff staff qualitative requirements (SQRs). These provisions are likely to allow for improvement in the quality of equipment procured.

The essential parameters are classified under two categories ─ Essential Parameters A (EPA) and Essential Parameters B (EPB). EPA are part of the contemporary equipment available in the market and are tested and validated at the field evaluation trial stage itself. EPB can be developed and achieved by the vendors using available technologies and need to be tested and validated within a specified time frame as stipulated in the contract. The essential parameters will have to be demonstrated at the trial stage and will have to be present in the final product. This will reduce the retraction of RFPs. In fact, it will be helpful if the MoD goes a step forward and institutes a suitable mechanism to address situations such as minor deviations, typographical errors or minor omissions, which do not materially alter the character of the RFP in terms of capability being sought, associated deliverables or have major commercial implications.

The RFPs will also contain enhanced performance parameters to provide for additional capabilities over and above the essential parameters. Vendors who meet them will be provided additional credit score up to 10% while evaluating their product cost. For the purpose of L1 determination, the vendor’s commercial quote would be calculated by reducing the quote to the extent of the credit score percentage. This is a welcome departure from the L1 concept and will encourage both domestic and foreign companies to go the extra mile in product quality.

3.5 Raising the offset threshold DPP 2016 has raised the offset threshold level

to INR 2,000 crore (€263 million) from INR 300 crore (€39.4 million). Foreign OEMs see this as a positive and a logical step. Increase in threshold is beneficial for the industry since management and monitoring by MoD will become more efficient as the number of

programmes decreases. If combined with a directed and outcome-based approach, it will deliver essential technologies and compensate for the reduction in offset opportunities.

3.6 Strategic partnerships A major recommendation of the Dhirendra

Singh Committee was to identify select Indian private sector defence manufacturers as strategic partners. These companies would play central roles in developing complex and strategic systems within the country, or receive technology transferred from foreign suppliers in large defence contracts. A company that has been declared a strategic partner in any one platform, say submarines, will not be chosen as a strategic partner for any other programme, such as aircraft or artillery guns. This is to prevent creation of monopolies. The defence ministry formed a task force headed by former DRDO chief V.K. Atre to recommend the modalities of the strategic partnership model. It divided the sectors eligible for strategic partnerships into two groups. In Group 1 are aircraft, helicopters, aero engines, submarines, warships, guns (including artillery guns) and armoured vehicles, including tanks. In Group 2, the segments are metallic material and alloys, non-metallic material (including composites and polymers) and ammunition. The task force recommended that only aircraft, helicopters, submarines, armoured vehicles and ammunition be considered for strategic partnerships in the initial phase.

The idea of strategic partnerships will be notified later separately, but will be an integral part of DPP 2016, as the methodology for selection of the strategic partners. For ease of implementation of this concept, clear and realistic guidelines for selection are required.

4. KEY ISSUES & RECOMMENDATIONSWhile many issues have already been addressed (to varying degrees), there are some outstanding issues, especially on the fiscal and policy front, which need redressal by the Indian government.

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4.1 Adherence to Mandatory Procurement Timelines

• Whilst the lead time for MoD’s procurements has witnessed improvement over the past few years, it is still considered to be a tedious and lengthy affair and often lacks effective communication with the participants. This leads to delays in achieving procurement milestones.

• Cancellation of tenders mid-way in the procurement cycle adversely affects participants’ business plans and discourages investment too from foreign defence companies.

• Often, no feedback on the progress of the project is provided to the bidders.

• MoD’s preference for competitive bidding, with little or no room for single proprietary tenders, also denies niche products and systems to be bought as there might not be similar products available globally to take part in the competition.

Recommendations

• The government should associate timelines with procurement milestones so that procurements can be made in more time-bound manner. Accountability should be fixedfor exceptional delays.

• MoD may identify and list out specialized technologies or systems that it desires; this would permit it to procure these proprietary products through single vendor tenders.

• MoD should provide feedback on status of individual procurements to develop transparency in the overall procurement process.

4.2 No Cost No Commitment (NCNC) trials

• Another aspect of the complex and long drawn procurement methodology is the requirement for companies participating in the tender process to physically bring their equipment to India for trials at a NCNC basis, wherein the platforms offered undergo extensive live trials in various weather conditions.

• The costs associated with the trials are borne by OEMs and include positioning of dedicated qualified manpower to be stationed at the testing range over the period of trials. This is non-refundable and cannot be included in the pricing of the equipment being sold. Thus, bidders often spend millions of dollars and put in thousands of man hours over a period of many years to comply with RFP requirements, and still end up losing the bid to an inferior system, just because the inferior system costs less.

• NCNC trials serve limited value to MoD in case of proven weapon systems where data supporting the conditions of trials to validate performance can be provided in most cases.

Recommendations

• MoD should consider undertaking fieldevaluation trials (FET) in countries where the equipment is already being used, instead of bringing the platform and the technicians to India. Moreover, for platform level or major system acquisitions, it would be more cost effective to carry out trials in the host country.

• Such trials should be made time bound and the details of the timelines should be shared well in advance with the participants so that they can better estimate costs associated with the trials.

• The government may also consider discontinuing trials on NCNC basis and provide adequate financial compensation to OEMs whose equipment is selected for field trials but finally are not selected for procurement. In this regard, a SCSC (some cost some commitment) approach may be considered.

• For proven weapon systems, where data can validate performance of the weapon systems, the insistence on the requirement for conducting trials may be reviewed. In case the trials for proven weapon systems are continued, the scope of such trials may be reduced to testing only those aspects which may not satisfactorily be validated through the available data.

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4.3 Taxation regime• The tax regime is complicated. While finalizing

bids, OEMs need to consider multiple taxes likely to be applicable through the supply chain such as custom duty, service tax, excise duty, state value added tax (VAT) and entry tax. Such taxes are not entirely creditable or capable of being passed on to MoD, leading to higher bid prices due to cascading effect and distortions in bid pricing due to tax reasons.

• From a direct tax standpoint, whilst royalties/fees for technical services earned by non-residents from notified defence projects entered into with the government of India are exempt from tax in India, similar exemptions are presently not available for defence contracts executed with DPSUs (defence public sector undertakings) acting on behalf of MoD/government of India. Further, notification in the official gazette as required for availing the tax exemption is presently a time consuming process.

• Foreign defence entities desirous of establishing presence in India generally set up a liaison office for identifying opportunities, developing relationships with potential customers and providing administrative support. Indian revenue authorities have been quite aggressive in alleging/assessing such liaison and support offices as permanent establishment (PE) of non-resident OEMs/contractors in India. This has often led to frivolous tax demands and more frequent long-drawn tax disputes.

• Recently, it has also been observed that RFPs are being issued with condition for title transfer in India. Such variation in contracting terms is likely to cause enhanced PE and VAT tax risks/implications for OEMs.

• From an indirect tax standpoint, certain customs duty exemptions in relation to supplies to MoD have been withdrawn. The details of the relevant changes5 vide Budget 2016 along with present indirect taxes applicable to the defence procurements are as under:

• Exemption from full customs duties (basic

duty and countervailing duties) available to the central/state governments on imports of specified goods for defence purposes has been withdrawn.

• Basic customs duty exemption available to contractors of the Government of India, DPSUs or sub contractors of DPSUs on imports of specified goods for defence purposes has also been withdrawn.

• In view of the above, it is clear that the government is looking to provide a level playing field to Indian private companies so as to incentivize domestic value addition and improve cost competitiveness of Indian private companies.

• Services provided to MoD are exempt from service tax only when provided by entities having no business presence in India. Thus, various services such as technical support, trials, maintenance of equipment provided by a domestic service provider attract service tax leading to escalation in project costs. Similarly, import of technology by a joint venture between a domestic manufacture and an offshore technology partner is likely to attract research and development cess in addition to service tax. This acts as a barrier for import of state-of-the-art technology.

• Presently, there is no exemption from levy of state level taxes including central sales tax/VAT/entry tax is provided for the supplies made under a defence project. This also leads to increase in overall cost of the procurements by the MoD and DPSUs.

Recommendations

Direct tax

• Clarity to be provided on availability of tax exemption on royalties/fees for technical services contracts by non-residents (foreign OEMs) with DPSUs. Procedural delay in providing such tax exemption may be looked into.

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• MoD should accept title transfer outside India, as per international commercial terms while keeping the required safeguards to protect defence interests.

• Necessary guidelines should be issued to reduce tax litigation in cases where a PE of the non-resident has been alleged and artificially high attribution of income has been made by the tax authorities. This shall ensure certainty in tax outcome, thereby encouraging investment.

Indirect taxes

• With the withdrawal of existing exemptions, the cost of project would increase significantl . MoD should work with the ministry of financeto reinstate the exemptions and develop sector specific taxation heads which will not only help streamline defence purchases, but also improve costing estimates of products by including taxes. MoD, being the sole buyer of defence products in India, will gain immensely if it can provide tax breaks to the suppliers – as it would directly benefit from the lowered cost of systems that are bought. This would go a long way in creating a stable tax regime and be quite helpful to companies as they would be able to calculate all of their costs for operations and pass on the benefit to the government.

• Broad base customs and excise duty exemptions to cover entire supply chain; all projects, all materials, including equipment, prototypes, consumables, spares etc. should be provided. Supplies by OEMs should be zero-rated from customs and excise duty standpoint, to enable recoupment of procurement side taxes of the OEMs.

• Exemptions to be provided to various defence related supplies/services (as the case may be) under state VAT and entry tax, central sales tax, service tax, excise duty and research and development cess.

• Above exemptions under extant indirect tax regime should be transitioned into the proposed goods and services tax (GST) regime through the appropriate zero-rating

mechanism.

• The concept of deemed export could be brought in for key projects to enable recoupment of customs and excise duties on procurement and supply of raw material by vendors in the supply chain.

4.4 Flexibility required in the offset regime

• Companies within the same group are not allowed to share offset credits with their group companies/subsidiaries.

• There are numerous offset implementation challenges due to the restrictive nature of DPP 2006, DPP 2008 and DPP 2011. While flexibilitywas allowed in DPP 2013 and beyond, older programmes are not grandfathered into new flexible clauses permitting greater offset avenue discharge.

• Due to the limited timeframe provided to fulfiloffset obligations, global OEMs have found lesser reasons to invest in more sustainable, advanced and long term engineering and manufacturing projects within India.

• Though flexibility to change IOP has been allowed, it is still time consuming for OEM offset obligors to shift workshare allocation, in case an IOP is unable to fulfil a workshare obligation, to a more suitable/alternate IOP that may not have been on the original IOP list. This process leads to greater compliance cost and creates a more difficult execution environment for delivery of offset contracts.

• Currently, only Tier-1 sub-vendors on the main platform are permitted to discharge offsets to the extent of their workshare (by value) on behalf of the prime vendor, thereby restricting its scope.

• The offset policy is complex and requires further simplification in the implementation stage as the documents to be submitted to MoD are voluminous, without any scope of e-filing

Recommendations

Group companies or subsidiaries of foreign OEMs

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should be allowed to discharge offset obligations on the behalf of respective OEMs.

Defence offset management wing (DOMW) should be better empowered to take quick decisions.

Flexibility in performance period will enable a more transparent and controlled programme management by the OEM offset obligor. Hence, further extension in the period of performance will encourage more complex collaboration in defence manufacturing and development.

Instead of committing fixed dollar/percentage amounts to IOPs at the time of offset proposal submission, a more flexible approach that permits global OEMs to define offset amounts to be allocated to each IOP over the course of the programme may be adopted. This continuous feedback model will enable greater and more robust IOP engagement and will better benefitIndia’s industry across large, medium and small scale enterprise.

The offset credit mechanism for banking of offset claims should be time bound and efficient and there should be a prescribed time limit for the DoMW for replying to questions.

4.5 MoD’s interface with global OEMs• The defence sector’s strategic importance

requires the ministry to be discreet and limit public interaction; however, MoD is also a customer in the global market with large capital requirements. The ministry and the services presently lack a formalized system of interaction with the industry and this leads to stakeholders having a limited understanding of each other’s requirements and capabilities and ambiguity in policy which affects participation levels of the industry.

Recommendations

• The large-scale modernization of the armed forces being undertaken by India will require a strong and dedicated industry interface mechanism through which sellers can showcase their products and services and approach the relevant authorities as and when required. This can be done through the establishment of an office staffed by MoD and armed forces personnel that can oversee

systems/platform demonstrations and provide replies to any regulatory queries that the industry might have.

4.6 FDI in defence • FDI in defence sector is now allowed up to

49% in automatic route. The current FDI cap is a bottleneck for global OEMs for transfer of technology, something which Indian industry critically requires. Increasing the limit of FDI to allow majority ownership and control will not only bring in the much required capital to operate in this sector, but also technical expertise and proprietary technologies that the Indian industry and armed forces require.

Recommendations

• The government should allow a minimum of 51% FDI in the defence sector without any riders to linkages with ‘state-of-the-art-technology’ so as to enable international defence companies to exercise adequate control over the ventures that these companies are forming with Indian partners, IPR and the product quality. The increase in FDI limit will bring in the capital for establishing new facilities and scaling up current facilities while benefit ing India through large scale job creation.

• The procedures and clearances required for setting up joint ventures/manufacturing units must be streamlined to enable a smooth framework for establishing defence manufacturing facilities. FDI approvals up to 51% should be permitted under automatic route to ensure certainty for long-term plans.

4.7 Introduction of IDDM category• It will be difficult to implement the IDDM

category as many OEMs have moved away from manufacturing systems and components in their factories. They rely on a global supply chain and have limited influe ce in mandating suppliers to localize in a given country unless economics and technical capability justify the investment.

• In the aerospace sector, almost 70% of the raw material is imported as composites and many

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exotic alloys are not made in India and are unlikely in the foreseeable future as the market size does not support the huge investments. Hence, achieving 60% indigenous content is likely to be a challenge, particularly when OEMs are struggling to meet the existing 30%. Having three different levels of IC (40%, 50%, and 60%) increases the complexity of implementation without any significant gai

• Making an IDDM programme number one in the hierarchy may risk delays in acquisition.

Recommendations

• Clarity in execution of IDDM.

• The timing to meet the increased 40-60% indigenous content should be flexible.

• Definition of indigenous content should

include both the cost of raw-material and value addition.

5. CONCLUSIONThe Indian defence industry today is clearly an effective interplay of six key stakeholders – the users, the government, DPSUs, DRDO, foreign OEMs and private Indian industry. Each of these has a definedrole and a clear set of aspirations and expectations. Of the many challenges that shall need to be addressed to give a fillip to this sector, the most critical are the tax reforms and procurement delays. Besides, targeted fiscal incentives shall go a long way in encouraging private investments, both from domestic and foreign industry.

Endnotes

1 World Military Balance 2016, International Institute for Strategic Studies (IISS)

2 Stockholm International Peace Research Institute (SIPRI)

3 Parliament question, Ministry of Defence, 15 March 2016

4 PwC Estimates; Press releases, Rajya Sabha

5 Made effective from 1st March, 2016

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FMCGMeeting demand of the knowledgeable and aspiring customer with improved technology while keeping pace with an ever changing legislative framework.

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1. INTRODUCTION

1.1 Market DescriptionThe FMCG sector is an important sector, contributing about 2.4% to India’s GDP. Despite certain inherent challenges, the Indian retailing landscape is very

dynamic. India’s twin growth engines -- economic liberalization and demographic profile set it apart from other nations and present a convincing business

FAST MOVING CONSUMER GOODS (FMCG)

Source: Dabur, TechSci Research Notes: OTC is over the counter products; ethical are a range of pharma products

Source: Indian Brand Equity Foundation, January 2016

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scenario for global retailers seeking to enter the market.

FMCG is the fourth largest sector in the Indian economy. The FMCG sector in India generated revenues worth US$47.3 billion (€42.55 billion) in 2015. Over 2007-16, the sector is expected to post compound annual growth rate (CAGR) of 11.9% in revenues.

Among the primary sectors, household and personal care is the leading segment, accounting for 50% of the overall market. Healthcare (32%) and food and beverages (18%) comes next in terms of market share. Growing awareness, easier access, and changing lifestyles have been the key growth drivers for the sector. The market reach of the Indian FMCG industry can be summarized as below:

1. The overall FMCG market is expected to touch US$110.4 billion (€99.32 billion) by 2020.

2. The urban segment is the largest contributor to the sector, accounting for around 65% of total revenue and had a market size of around US$20.74 billion (€18.66 billion) in 20151.

3. Semi-urban and rural segments are growing at a rapid pace; they currently account for 35% of revenues.

4. In the last few years, the FMCG market has grown at a faster pace in rural India compared with urban India.

5. FMCG products account for 50% of total rural spending.

2. INDUSTRY TRENDS & MARKET OUTLOOK

The FMCG sector has grown at an annual average of about 11% over the last decade. Online portals are expected to play a key role for companies trying to enter the hinterlands. The internet has contributed in a big way, facilitating a cheaper and more convenient means to increase a company’s reach.

Growing awareness, easier access, and changing lifestyles have been the key growth drivers for the consumer market. The government of India’s policies and regulatory frameworks such as relaxation of license rules and approval of 51% foreign direct investment (FDI) in multi-brand and 100% in single-brand retail are some of the major growth drivers for the consumer market.

Source: Booz & Company, Dabur, AC Nielsen, TechSci Research, Note: F –Forecast

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3. MARKET OPPORTUNITIES

Policy and Regulatory Framework• Industrial license is not required for almost all

food and agro-processing industries, barring certain items such as beer, potable alcohol and wines, cane sugar, and hydrogenated animal fats and oils as well as items reserved for exclusive manufacture in the small-scale sector.

• Further, the lower house of parliament, Lok Sabha, has cleared Aadhaar (Targeted Delivery of Financial and Other Subsidies, Benefits and Services) Bill, 2016. The bill seeks to make use of the Aadhaar number mandatory for availing government subsidies. The Aadhaar bill will plug leakages and ensure prompt receipt of subsidy. This will further boost FMCG consumption by improving the purchasing power of people in rural areas.

• The government recognizes food processing and agro industries as priority sectors (for lending purposes).

• The Food Security Bill would reduce prices of food grains for below poverty line (BPL) households, allowing them to spend resources on other goods and services, including FMCG products. This is expected to trigger higher consumption spends, particularly in rural India, which is an important market for most FMCG companies.

Sectorial opportunities in FMCG IndustryMajor sectorial opportunities for FMCG sector are highlighted below:

• Packaged food - Only about 10-12% of output processed is consumed in packaged form, thus highlighting the huge potential for expansion of this industry. India’s packaged food industry (including snacks and ready-to-eat foods) was approximately US$15 billion (€13 billion). In a recent survey conducted by The Associated Chambers of Commerce of India (ASSOCHAM), it was revealed that 82% of the workforce in some key metros prefer packaged food compared to eating outside food or at roadside eateries.

• Dairy based products – India is the largest milk producer in the world. Since consumption is growing, many foreign companies are coming to India with a variety of dairy products. However, there is scope for growth for other players as value added products form only 15% to 20% of the total dairy production. Considering the higher purchasing power, higher awareness and preference for tertiary processed milk products coupled with low availability, there is an opportunity to grow the spending on this category

• Oral Care - The oral care industry, especially toothpastes, remains under-penetrated in India with penetration rates around 50% 55%. With rise in per capita incomes and awareness of oral hygiene, the growth potential is huge. Lower price and smaller packs are also likely to drive up potential trading.

• Food processing industry - The food processing industry, which accounts for nearly 18% of the FMCG market, is now covered under the government’s Make in India drive. Underlying features of the policy which will directly benefit the industry are

• 42 mega food parks being set up with an allocated investment of INR 98 billion (€1.4 billion Euros). The parks have around 1,200 developed plots with basic infrastructure enabled that entrepreneurs can lease for the setting up of food processing and ancillary units.

• 138 cold chain projects are being set up to develop supply chain infrastructure.

• Personal Care - Penetration of many product categories is still low. Even among those where the penetration is higher, per capita consumption is comparatively low, thereby offering scope for high growth in future. Penetration of products such as hair oil and fairness cream is high in the country, but that of some major products, including cold cream, facewash and men’s facewash is just 10 percent, 9 percent and 0 percent, respectively.

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4. RECENT DEVELOPMENTS1. Consumers have started demanding

customized products specifically tailored to their individual tastes and needs. The trend toward mass-customisation of products is expected to intensify further.

2. Despite economic slowdown, consumers are willing to spend to buy premium goods at higher prices in the space of convenience, health and wellness.

3. Availability of products has become way easier as internet and different channels of sales has made the accessibility of desired product to customers more convenient at required time and place. Online grocery stores and online retail stores like Flipkart, Amazon making the FMCG products more readily available.

5. INDIAN COMPETITIVENESS AND COMPARISON WITH WORLD MARKETS

The following factors can make India a competitive market in global arena:

1. Availability of Raw materials

Because of the diverse agro-climatic conditions in India, there is a large raw material base suitable for food processing industries. India is the largest producer of livestock, milk, sugarcane, coconut, spices and cashew and is the second largest producer of rice, wheat and fruits and vegetables. India also produces caustic soda and soda ash, which are required for the production of soaps and detergents. The availability of these raw materials gives India the geographical advantage.

2. Low cost labour force

Low cost labour gives India a competitive advantage. India’s labour costs consistently rank among the lowest worldwide and are often cited as the country’s principal advantage as a manufacturing base. According to the Bureau of Labour Statistics, average labour compensation (including pay, benefits,social insurance, and taxes) in India’s organized manufacturing sector have only increased marginally in recent years, from USD 0.68 (€0.612) per hour in 1999 to around US$ 1.50 (€1.35) per hour today. When compared with an average compensation of US$3

Source: Emami Investor presentation June 2015, TechSci research

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(Euro 2.70) per hour in China’s manufacturing sector (a 20% year-on-year increase fuelled by an annual 13% rise in China’s minimum wage), India’s labour cost advantage places the country in more direct competition with emerging manufacturing jurisdictions such as the Philippines and Vietnam over now-declining China, Thailand and Malaysia. Many MNC’s have established their plants in India to outsource for domestic and export markets.

3. Demographic DividendIndia’s abundant labour force is English-speaking, young, skilled and cost-efficient. The government has initiated the Self Employment and Talent Utilisation (SETU) scheme to boost young entrepreneurs. It has invested US$163.73 million (€147.29 million) for this scheme.

4. Growing domestic marketAs income levels are rising, there is a clear upwards trend in disposable income. With the rise in disposable incomes, mid-and high-income consumers in urban areas have shifted their purchase trend from essential to premium products. Rapid economic growth provides a large domestic market.

5. Infrastructure Investment plans

The Indian government intends to invest US$1 trillion (Euro 900 billion) in infrastructure by 2017 to lower logistics and supply chain costs. This will help reduce inefficiencies in the supply chain

6. KEY ISSUES FACED BY THE INDIAN FMCG INDUSTRY

1. Impact of ban on non-recyclable, multi-layered plastic material

In 2015, the Ministry of Environment, Forest and Climate Change circulated a draft of the Plastic Waste Management Rules, 2015, for public comments. The draft provided for a stoppage on the use of non-recyclable laminated plastics/metallic pouches, multi-layered plastics in packaging within three year of the rules coming into effect. Despite opposition by the industry, after several rounds of consultations, the ministry notified the revised rules on March 18, 2016.

The following are the salient provisions of the rules:

• They provide for phasing out non-recyclable mult-ilayered plastic within two years. The rules define recycling as “the process of transforming segregated plastic waste into a new product or raw material for producing new products’’. Recoverable plastic waste has been included within the definition of recyclable materials. Hence, only plastic waste which would ultimately make its way to the landfill, as its RRI (recycle and recovery index) is 0, would have to be phased out.

• Rule 6 places a responsibility on the local body to develop and set up infrastructure for segregation, collection, storage, transportation, disposal etc. of plastic waste, either on their own or by engaging agencies or producers. The local body can seek assistance of producers and the system has to be set up in one year from the notification. The rules now recognize recovery as a legitimate part of waste management.

• Rule 9 places an obligation on producers alone to work out modalities for a waste collection system based on extended producers responsibility (EPR), and involving state urban development departments, either individually or collectively, through their own distribution channels or through the local bodies. This has to be done within six months.

• The rules define EPR as “the responsibility of a producer for the environmentally sound management of the product until the end of its life”. The definition of EPR is not very clear. No clarity is available regarding the methodology for discharge of this responsibility - whether financiall , or through awareness generation among consumers or otherwise.

• The primary responsibility for collection of used multi-layered plastic sachets or pouches or packaging is placed on producers, importers and brand owners, who introduce the products into the market. A plan is required to be submitted to state pollution boards within one year of the notification and has to be implemented within two years thereafter.

• Interestingly, FMCG is a small part of the

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overall plastic waste generated. Yet, this responsibility of collection of pouches, sachets or packaging is the only kind of plastic waste considered under Rule 9.

• ‘Form I’ to be used for registration of producers or brand owners is not aligned to the requirements of registration of producers and brand owners. It appears to be more for manufacturers.

Recommendations

The phasing out proposed to be done within two years looks unrealistic and impractical. Multi-layered plastic being the most efficient way of packaging, the focus needs to be on deploying practical solutions of segregation and disposal of plastic waste rather than a complete ban or phasing of multi-layered plastic packaging as proposed. In all developed jurisdictions of Europe and in the USA, there is no ban prescribed for multi-layered plastic packaging. Instead, the focus is on efficient ways of disposal through the principle of EPR.

The central government, by placing a responsibility for waste management on both the local bodies under Rule 6 and for collection on producers and brand owners under Rule 9, has created confusion around the responsibility for overall waste management. The industry needs a clear and uniform set of obligations across India. EPR in itself reflects a positive step towards the industry’s participation in resolving national issues. A plain reading of the rules creates an environment of uncertainty as any local body may place different types of requirements from producers or brand owners. The government must consider a clearly defined, well-thought out and practical EPR mechanism, suited for India, with all affected stakeholders participating in its development. The obligations must be clear, well-defined and evenly spread across all industries, producers and brand owners. It should not be limited to just FMCG.

Further, consumers and waste generators have not been involved in the process at any level. Without the involvement of the consumers, state governments and local authorities, no modalities prepared by the producers and brand owners under EPR can be successfully implemented.

It is suggested that the government of India looks

at alignment between the central, state and local governments to strengthen the overall waste management system in India at the local body level. Under the Swachh Bharat (Clean India) campaign, initiatives should be taken to generate awareness among consumers to ensure that segregation of organic, recyclable and other waste happens at the consumer level itself.

2. Amendments to the Legal Metrology (Packaged Commodities) Rules, 2011 (the PC Rules)

The Ministry of Consumer Affairs, Food and Public Distribution amended the definition of industrial and institutional consumers in the PC Rules vide Notification No. G.S.R. 385(E) dated May 14, 2015 (the Notification). Rule 3 of the PC Rules prescribes that labelling norms (including the obligation to affi a maximum retail price [MRP] by a manufacturer or importer of packaged goods) do not apply to purchases made by an industrial or institutional consumer.

The current amendment aims to expand the definitionof industrial and institutional consumers, allowing such industries and institutions to procure packaged goods from an importer or a wholesale dealer; prior to such amendment, obligation to affix MRP was exempt only when the industrial/institutional consumer directly purchased pre-packaged goods from the manufacturer. This amendment further provides that it is mandatory that all such packages must bear a declaration ‘not for retail sale’.

The aforesaid amendment in the PC Rules can have an impact on the excise duty paid, given that assessment of excise duty depends upon whether the goods are covered under Section 4 (i.e. transaction value) or Section 4A (i.e. MRP based assessment) of the Central Excise Act, 1944. MRP based valuation, for levy of excise duty, is governed by Section 4A of the act. Assessment of excise duty under Section 4A of the act requires that such goods should also be covered under the provisions of the Legal Metrology Act, 2009 (the LM act) on which the MRP is required to be affixed. The MRP based assessment under Section 4A is therefore dependent on applicability of the LM ct vis-à-vis the obligation to affix the MR .

Notification No 21/ 2012 – Customs dated March 17,

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2012 provides that import of pre-packaged goods intended for retail sale, on which retail sale price is required to be affixed under the LM Act or the PC Rules, are exempt from special additional duty (SAD) leviable under Section 3(5) of the Customs Tariff Act, 1975, subject to fulfilment of certain conditions.

In light of the amendment in the PC Rules, pre-packaged goods imported for selling to institutional consumers would not have declared MRP; instead, they will bear the declaration ‘not for retail sale’. Therefore, in respect of such inventory, FMCG companies will not be eligible to avail exemption from SAD in the absence of the MRP based valuation. Though upfront exemption under the Customs Notification may not be available for such goods, refund of SAD (under Notification No 102/ 2007 – Customs dated September 14, 2007) will continue to be available to importer, on fulfilment of the specified procedure

Recommendations

As stated above, the amended definition of industrial/institutional consumer will now cover goods procured, inter alia, from an importer or wholesale dealer. Further, where the company sells to wholesale dealers, who onward supply the same to other industrial/ institutional consumers, it would neither print the MRP nor discharge excise duty on MRP value less abatement; instead, excise duty would be discharged on the transaction value. The legislation is not abundantly clear. Many FMCG companies have not adopted the change but are continuing to discharge excise duty on MRP instead of transaction value in absence of clarity by the Central Board of Excise and Customs (CBEC). CBEC should clarify the changes due to amended definition of institutional/industrial consumer vide a circular.

Further, additional requirement of ‘not for retail sale’ implies that in cases where the food/beverages/pre-packaged goods are not served but are sold by institutional consumers in packaged form (example ready to serve formats), the authorities could allege that such transactions qualify as a retail sale, and that the provisions of the LM Act and the PC Rules ought to apply. Consequently, in case of non-compliance, FMCG companies selling the goods to institutional consumers should not be held liable. A similar clarification should be provided by the CBEC on this issue.

3. Impact of government regulation on advertisements

In 2015, major amendments were proposed to the existing Consumer Protection Act, 1986. A Consumer Protection (Amendment) Bill, 2015 was also introduced. The bill proposes the establishment of a Central Consumer Protection Authority (CCPA). The regulation and adjudication of all advertisements has been included within the scope of the CCPA’s powers and functions. This has brought about a ‘command regulation with discretionary punishment’2 regime, a step backwards from the desired direction, i.e. the development of a ‘regulator enforced self-regulation’ regime, as is the case in most developed jurisdictions.

The following concerns exist with the proposed regulatory system:

• Advertisers and the advertising/media industry have not been included in the regulation mechanism at any level. This set-up will pose challenges for the regulation to stay up to date with the fast-paced developments in this industry and will also greatly increase the cost of regulation and enforcement to the exchequer.

• The vesting of executive and judicial powers in the same authority such as the CCPA is against the principle of separation of powers.

• There is no statutory redressal or appeal process specified against the actions or orders of the CCPA.

• The industry has created several self-regulation codes concerning advertising which provide for honest representation, curb offensive advertisements, prohibit advertisements of harmful products/ situations and promote fair competition. These supplement the provisions of several other legislations dealing with misleading and objectionable advertising and have not been considered in the draft bill. Special legislations such as Food Safety and Standards Act, 2006, Drugs and Cosmetics Act, 1940 and SEBI regulations have enforcement and adjudication mechanisms that are equipped with the infrastructure to do detailed technical analysis for food products, drugs, and cosmetics and evaluate several services such as insurance, banking and

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investments to verify whether or not claims made in advertisements are correct. Therefore, a duplication of functions by the CCPA with respect to these goods and services will not advance the cause of consumer protection. Potential conflicting decisions by the expert forums will only lead to reducing authority of the CCPA or that of consumer disputes redressal agencies.

• The bill envisages that the CCPA shall have regional offices and also exercise its powers at the district levels through the district administration. Advertisements are often published or broadcast nationwide and this may lead to much conflict and confusion if different state CCPAs come to different opinions with respect to the same advertisement. The industry does not support such exercise of judicial powers with potential for contradiction which would severely hinder the ‘ease of doing business’ index.

• The bill is referred to a parliamentary committee to suggest changes after taking feedback from affected stakeholders. The report of the committee is not in public domain and the issues highlighted above remain open.

Recommendations

The government should reconsider including regulation of misleading advertisements from the scope of the CCPA’s powers. A separate exercise should be conducted for determining the best possible way to regulate advertisements in order to balance both consumer protection and unfettered exercise of the freedom granted to commercial speech under Article 19(1)(a) of the Constitution.

Incidentally, the Cable Television Networks Act, 1995 and Regulations thereunder provide for a mechanism for deciding complaints relating to advertisements broadcast on television through an industry self-regulatory organization (SRO), the Advertising Standards Council of India (ASCI). It is recommended that the government expands the scope of the SRO to include broadcast as well as non-broadcast advertisements within the scope of the SRO and help drive its membership.

The role of the redressal agencies/CCPA should be

limited to cases where the complaint has not been suitably dealt with by the SRO, or where there has been a non-compliance of the SRO’s order by any advertiser.

The Department of Consumer Affairs has launched a portal for registering online complaints for Grievances Against Misleading Advertisements (GAMA). National level complaints are forwarded to the concerned regulators, including ASCI. This system can be better leveraged and publicized. Actions taken should also be publicized to increase the faith of the consumers in the SROs.

4. Introduction of concept of ‘outsourced manufacturing unit’ in CENVAT Credit Rules, 2004 in Budget 2016.

With a recent amendment, with effect from April 1, 2016, an input service distributor (ISD) can distribute input service credit to an outsourced manufacturing unit in addition to its own manufacturing units. An outsourced manufacturing unit has been defined to mean either:

• A job worker who is required pay excise duty on the value determined under the provisions of Rule 10A of the Central Excise Valuation (Determination of Price Of Excisable Goods) Rules, 2000, on the goods manufactured for the ISD; or

• A manufacturer who manufactures goods for the ISD, under a contract bearing the brand name of the ISD and is required to pay duty on the value determined under the provisions of Section 4A of the Central Excise Act, 1944 of credit received from each of the ISD and shall use it for payment of duty on goods manufactured for the ISD concerned. The credit of service tax paid on input services, available with an ISD as on March 1, 2016 shall not be distributed to an outsourced manufacturing unit.

The aforesaid amendment has been made to reverse the decision of the tribunal in Sunbell Alloys Co. of India Ltd. vs. Commissioner of Central Excise, Belapur3 wherein the availment of CENVAT credit by a job worker against the ISD invoice issued by the principal manufacturer was denied. The amendment is

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a forward step in extending the benefit to job-workers/manufacturer and ensuring the free flow of credits

Recommendations

This is an important development for FMCG businesses to take note of as CENVAT credit on outsourced manufacturing has not been available till date. The concept of an outsourced manufacturing unit as defined above is not comprehensive enough to cover all arrangements involving outsourced manufacturing. In order to clear doubts, the extent of coverage of the job worker, contract manufacturer as an outsourced manufacturing unit should be explained in detail with the help of illustrations to limit concerns on litigation.

FMCG companies incur substantial expenditure for advertising and brand management of their products. There is no clarity on distribution of CENVAT credit attributable to advertising related expenses as these would constitute a significant portion of the CENVAT credit available with a FMCG company. The government should clear the air over the issue of distribution of credit attributable to advertisement and brand management activities to support adoption of this legal change which is a precursor to a goods and services tax (GST).

5. Issues in enforcement of trademarks for brand protection against rampant sale of fakes, trademark infringements and look-alikes

Trademark infringement and counterfeiting has become a ubiquitous problem and growing at an exponential rate in India taking undue advantage of the consumer and trade. Counterfeit products are a health hazard and against the interest of the consumers. It is not only against the interest of the industry but also the government at large, due to loss of income to the exchequer through unaccounted sales, taxes, etc. of counterfeits. In the light of risks and protection of interests of all stakeholders, it is important to provide the necessary support and infrastructure to intellectual property (IP) right holders to allow them to effectively fight counterfeit products and people involved. Counterfeiting has now become part of a complex and ever evolving organized crime network that requires swift and efficacious actions by the right holders and law enforcement officials on receipt of relevant

information to ensure success of such actions against counterfeiters.

Section 115 (4) of the Trade Marks Act, 1999 (TMA) mandates that an opinion from the trademark registry on the impugned trademark is required before an officer equal to the rank of a deputy superintendent of police takes cognizance and further actions, including search and seizure with respect to offences of applying and selling of goods with false trademarks, i.e. infringement and counterfeiting.

This creates an impediment in taking timely action and allows people ample time to get away. With such a prerequisite for the police, offences under TMA cannot be considered fully cognizable as intended, desired and required by the industry and IP holders.

Opinion from the trademark registry in the above clause takes considerable time due to lack of resources and department priorities. This impedes quick action by trademark proprietors and the police against counterfeiters.

Trademark proprietors are using the judicial or copyright infringement route to take actions due to extreme delay in procuring such opinion for police actions under trademark law. This is not only increasing the burden of the judiciary but also making the section in TMA irrelevant.

Using the copyright infringement route is also not viable because of the requirement of registration documents by law enforcement officials. However, it is important to note that as copyright vests on creation and registration is not compulsory, documents of proprietorship are not available with copyright owners, making it difficult for law enforcement officials to determine the rights and limiting actions against counterfeiters under copyright protection.

Recommendations

Trademarks are intellectual property that reflect the source of origin -- the primary issue in the case of counterfeited products -- whereas copyright pertains to creative protection and complements the trademark law to fight against counterfeiters and infringers. Relying on just copyright rather than trademark also increases the possibility of misuse as copyright infringement is more difficult to identify than trademark infringement due to the creative aspect involved. Therefore, mandating an opinion for action against

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trademark infringement as opposed to copyright infringement being fully cognizable, is discriminatory, irrational and inequitable towards the industry.

In light of the of the time period that has lapsed since the law came into effect and the irrelevance of the same, the government is requested to delete the requirement of an opinion under Section 115(4) of TMA and let right holders as well as law enforcement officials effectively enforce their rights and take appropriate actions against these offenders.

It is also suggested that the central Government consider fast track courts for intellectual property enforcement cases to speed up the adjudication processes,.

6. Issues with labelling of cosmeticsIn June, 2014, the Ministry of Consumer Affairs issued a notification under the Legal Metrology Act to amend the Legal Metrology (Packaged Commodities) Rules 2011 by introducing Rule 6(8) which provides that “every package containing soap, shampoos, toothpastes, and other cosmetics & toiletries shall bear at the top of its principal display panel a red or as the case may be brown dot for 5 products of non-vegetarian origin and a green dot for products of vegetarian origin”. The said issue falls within the scope of the Drugs and Cosmetics Act, 1940 and thereby, beyond the jurisdiction of the Legal Metrology Act, 2009.

In the judgment on Indian Soaps and Toiletries Makers Association v. Ozair Husain and Ors4, the Supreme Court has confirmed that the accurate law under which such a mandate can be provided is the Drugs and Cosmetics Act, 1940.

Further, there are several practical difficulties in complying with such a provision. Cosmetic products are complex and the formulations contain many ingredients. Many of these ingredients are prepared by processes involving multiple steps. Thus, the original chemical identity of the ingredient is lost. These processes are carried out irrespective of whether the material is of plant or animal origin. Consequently, if any of these ingredients are present in a formulation, it is not possible to determine if it is of animal or plant origin.

There are neither technical tests nor any methodology for a manufacturer to confirm whether its source ingredients are vegetarian or non-vegetarian. Each

ingredient for a cosmetic is sourced from various suppliers. Manufacturers would at best have to rely solely on representations made by its various suppliers for the purposes of labelling. It is practically impossible for a manufacturer to actually be aware and comply with the labelling requirements. Further, they would be held responsible for any violation thereof if a product is mis-labelled and there would be no consequences on the suppliers.

In the absence of clear definitions, there is ambiguity in the definition and understanding of animal origin – for instance, honey, wax or silk essence, none of which are defined as being from either animal or vegetarian origin.

The Indian Beauty and Hygiene Association challenged the notification before the Bombay High Court in 2014 and the matter is currently sub judice. The court has directed that no coercive action should be taken for non-compliance of the notification during the pendency of the matter.

Recommendations

The government of India may reconsider its stand considering the significant practical difficulties in implementing the notification and in light of the opinion of the Drug Testing and Advisory Board and the decision of the Supreme Court.

7. Parallel imports and counterfeitsParallel import is a scenario wherein goods are brought in a jurisdiction without the permission of the brand owner (i.e. IP right holder). These goods are not counterfeit goods, but merely unauthorized imports from the brand owner’s perspective.

On account of the lower costs of the parallel importer (as there are no brand management and advertising costs), the products are cheaper. Company authorized retailers oppose this practice as this impacts their competitiveness in the market.

Further, owing to unauthorized imports, there are instances where the consumer experience of a brand may be negatively affected due to variance in product formulations (different countries may have a different product formulation which is suited best for its consumers). In some industries, the authorized resellers may not be able to provide proper after-sales service or replacement.

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Under the TMA, infringements of a registered trade mark under Section 29(1) covers imports or exports of goods. Imports of goods under registered trademarks require consent of registered proprietor of the trade mark before imports. Similar provisions exist under the Indian Copyright Act, 1957, The Patents Act, 1970 and Designs Act, 2000.

However, Circular No. 13/2012 dated May 8, 2012 issued by CBEC states that parallel imports of branded goods are permitted under the TMA. The circular refers to section 30(3)(b) of the TMA without, in any manner, clarifying or interpreting this provision but merely reproducing it. It concludes that TMA permits parallel imports and, on the basis of such conclusion, directs the field formation of the customs authorities across India to follow the circular. In the circular, the nodal authority, the Department of Industrial Policy and Promotion (DIPP), has merely reproduced section 30 of the TMA in its internal advice to Customs.

There is no clarification, express or implied, provided in the circular, that “no consent” of the registered proprietor is required before, or at time of importation of branded products. Under TMA, registration is confined to territory of India only. The registration of a trademark is territorial and not for markets beyond the territory of registration. Under Section 29, inter alia, a mark which is identical with a registered trademark with respect to good for which it is registered, will be a case of infringement of trademark if such identical mark is used by a person other than a registered trade mark proprietor. Under Section 30(3)(b) of TMA, imports are subject to the same restriction. Any use of a registered trademark by any person without the consent of the registered proprietor is treated as infringement. The intent of law cannot be to penalize the domestic infringers and let importers who infringe go free.

Since the issuance of impugned circular, custom authorities at seaports, airports, and inland container depot have stopped examination and inspection of containers that represent carrying imported goods

that are freely importable including branded parallel imported goods. This has prompted traders and importers to import counterfeit goods and there is a surge in sale of counterfeit goods. While the circular seeks to address the parallel imports by issuing directions, it has had the effect of legitimizing counterfeit goods.

Recommendations

Counterfeit goods in the FMCG sector, and more so in the cosmetic industry, have become a major concern. Fake imported products are freely available at throw away prices. Unless custom authorities carry out 100% examination and intimate the right IP holders, this problem cannot be resolved. IP holders are not being called upon to verify suspected branded imported goods. Significant quantity of fake/counterfeit goods are entering the country because right holder consent is not sought anymore.

Therefore, based on the present provisions of the TMA, it is suggested that a further clarification be issued by which the above position is suitably reflected. The CBEC should do the needful at the earliest. It should clarify that consent of the right IP holder in each case of import under TMA will be required.

7. CONCLUSIONSIndia represents a good opportunity for international retailers in single brand retail, cash and carry, and e-commerce, as the country appears to be on the cusp of a strong growth phase over next five years. The tipping point for brick and mortar retail continues to be the opening up of FDI norms in multi-brand retail, a move that is not expected in the near term. India had risen to 15th in the global retail development index behind solid growth in retail sales and strong growth prospects for GDP. GDP is expected to grow at 8% over the next three years, making India the world fastest growing major developing market. Increase in internet penetration and improvement in the physical infrastructure will make India an attractive place for investment.

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Endnotes

1 http://www.ibef.org/industry/fmcg-presentation

2 Responsive Regulation – Transcending the Deregulation Debate by Ayres and Braithwaite (1992, Oxford University Press).

3 2014 (34) STR 597 (Tri. - Mumbai)

4 AIR 2013 SC 1834

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HEALTHCARESupport and contribute to the development of an affordable and effective quality healthcare system for all. Encouraging private enterprise to invest in infrastructure, skill development and healthcare delivery through an ease of doing business environment, strengthened by rational, effective and sustainable business plans.

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1. INTRODUCTION

Market DescriptionThe healthcare sector covers a very wide spectrum of activity, including pharmaceuticals, public and private sector healthcare delivery models and institutions. It also includes a largely import oriented medical equipment sector, public and private training colleges and medical institutions, a growing medical devices industry and multiple models for patient testing spread over diagnostics and lab equipment. In addition, the Indian healthcare system has a unique feature of alternative care options – the homeopathy, Ayurveda and Unani schools of medicine that have evolved over centuries are present at all levels of the healthcare chain. While these are not accurately reported at present, they represent a new focus for delivering relevant, low cost healthcare and are seeing significantinvestments being made. A new thrust area emerging is ‘wellness’ – preventive care – from diagnostic testing and meditation to yoga and other health sustaining activities.

The overall, measureable, Indian healthcare market is estimated at US$100 billion (€87.7 billion) with hospitals and healthcare delivery contributing 65%, followed by pharmaceuticals with 20% and medical devices 8%. The market is expected to see sustained growth with a compound annual growth rate (CAGR) of approximately 17%, crossing US$280 billion (€245.5 billion), by 2020. It currently accounts for 4.5%-5% of GDP, with public healthcare spending at 1%-2% and the balance from the private sector. Global GDP spend on healthcare ranges between 6% in developing nations and 10% in the developed. On key parameters, ratio of doctors and nurses/1,000 patients and number of beds/10,000 population, India lags below the WHO endorsed benchmarks. An additional 1.5 million doctors, 2.4 million nurses and 1.8 million beds are forecast as crucial requirements for effective healthcare delivery.

There is a critical shortfall in the reach of healthcare across the country. An illustration of this is the fact that approximately 75% of all healthcare services reach only 25% of the population. The rest of the population has limited or no access to quality care. While this is

improving, the speed of change is far from adequate due to the lack of skilled professionals and the level of investment required to achieve quality healthcare for all. Over the past 10 years, the government’s GDP spend on healthcare has been 1%. The current goal is to increase this to 2% of GDP. The government is focused on delivering healthcare access to the ‘least served’ segment of the population. As a result, private players have an immense opportunity to grow. The mix between public and private is unlikely to change.

In addition, a severe shortfall in hospital beds has increased the demand for hospitals at all levels, including tertiary care and specialty. The current forecasts are indicative of an investment opportunity of US$25-30 billion (€21.9-26.3 billion). Fundamental demand drivers such as need for more beds, increasing prevalence of lifestyle diseases, increase in disposable income and demand for quality healthcare as well as growing insurance penetration continue to drive the sector while operational drivers, such as the following play a major role in shaping the overall sector landscape in the country.

• Focused healthcare delivery penetration in Tier II and Tier III cities by several major players

• Private sector operational participation to improve the quality of health being delivered in public healthcare institutions.

• Local manufacturing of devices to improve affordability and profitability

• Clarity on medical devices/diagnostic tools regulations to encourage the best to manufacture locally

• Continued focus on research and development

• Indian pharmaceutical players looking to establish a global footprint through cross border acquisitions

The sector is dominated by private enterprises with the private segment accounting for almost 72% of the country’s total healthcare expenditure. The private sector’s share in hospitals and hospital beds is estimated at 74% and 81%, respectively.

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Source: Grant Thornton, LSI Financial services, OECD, Aranca

Most expenses are met by patients ‘out of pocket’. There is no or very limited reimbursement. Private medical insurance, though growing, covers roughly 12% of the population and only ‘in-patient costs.

The Medical Council of India (MCI) currently (2014) fully recognizes 381 medical colleges, which will train 50,078 medical students

Structure of the public healthcare network:

• Primary care: (in rural areas): 22,271 primary healthcare centres and 137,271 sub-centres.

• Secondary care: (healthcare centres in smaller towns and cities): 1,200 PSU (public sector units) hospitals, 4,400 district hospitals, and 2,935 community healthcare centres.

• Tertiary care (hospitals): 117 medical colleges and hospitals.

Private healthcare providers consist of individual practitioners, for profit hospitals and nursing homes, charitable hospitals and diagnostic labs. These are numerous and fragmented with a majority of private hospitals having 200 beds or less. However, the hospital segment is the fastest growing sector as

hospitals increase the number of beds at existing sites or build/buy new units in different locations.

The pharmaceutical industry is one of the key drivers of India’s healthcare system through local manufacturing and exports accounting for about 1.4% of the global pharmaceutical industry in value terms and 10% in volume terms.

• India is expected to be the third largest global generic API (active pharmaceutical ingredient) merchant market by 2016, with a 7.2% market share

• In 2012, drug companies from India filed 49% of the overall drug master filings (DMFs) in the US

• Largest exporter of formulations in terms of volume, with 14% market share and 12th in terms of export value globally

2. KEY DRIVERS FOR HEALTHCARE GROWTH

Population dynamics

• Large population base 1.5 billion by 2050

• Increasing life expectancy at birth, currently 65 and projected to go up to 69 by 2020.

• Geriatric population to double over next 15 years

Increasing capacity to spend

• Literacy rate at 65-70% and estimated at 95% by 2020.

• Huge middle class with buying capacity –300+ mio

• Opening up of reimbursement avenues though still remains predominantly a “pay out of pocket” system

Prevelance of infectious disease

• Fastest growing CVM population

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• AIDS, Oncology and other chronic ailments growing in numbers

• Improved awareness & detection levels

Changing healthcare model

• Major pharma and insurance cos now in India

• Disease specific insurance plans in plac

• Medical tourism growing by 20% YoY

• Corporatisation of hospitals and pharmacies

• Move to more scientific methods of promotio

• New distribution channels

Increased healthcare access

• Current access ~40-50%; govt. committed to take it to 80% in next 15 years

• Improving access and growth rates in rural India

• Hospital market growing rapidly, ~25-30% QoQ

• OTC market projected to grow at 10%

All of these factors come together to present a real need for enhanced/increased healthcare systems and an investment opportunity.

The medical tourism market is valued at US$3 billion (€2.6 billion) and is expected to increase to US$7-8 billion (€6-7 billion) by 2020. With treatment rates in Indian being almost 70-80% less expensive than the US and other developed markets, India is fast emerging as a destination of choice for medical value travellers globally. Additional demand for healthcare delivery is expected to result in significant investment in this segment, enhancing standards of service, quality of equipment and clinical excellence to global benchmark levels.

Foreign Direct Investment (FDI)FDI is permitted up to 100% under the automatic route for the hospital sector in India. Approval from the Foreign Investment Promotion Board (FIPB) is required for foreign investors with prior technical collaborations. Moreover, 100%FDI under the automatic route is also allowed in pharma for greenfield projects and with FIPB approval for brownfield. Since 2015, 100% FDI under automatic route was allowed for medical device companies. However, some arbitrariness continues in

the interpretation of regulations and decision making can be long drawn out.

Budget 2016The budget for FY16 had little to offer in terms of tangible industry level benefits for encouraging and motivating healthcare providers. Focusing largely on addressing the needs of the poorer sections, Budget 2016 saw announcements aimed at the un-served segment of the population – as an example, increased insurance penetration for families living below the poverty line, or in the form of providing generic medicines at affordable prices. In addition, there is emerging focus on public private partnership (PPP) initiatives. The success of these is to be monitored as there are always complexities.

• A key aspect of the budget appears to be the realization that for new schemes to be truly successful in this sector, participation of private players is key. Dialysis is proposed to be provided through private sector participation (under the PPP route), Insurance schemes are also likely to be administered through third party insurance providers and not solely through the government wallet. This approach and plan needs to be strengthened to include more direct initiatives and incentives for increasing healthcare access and coverage.

• Tax exemptions for start-ups may foster healthcare innovation in the medium term. Larger needs for developing infrastructure, encouraging indigenous manufacture of medical devices and equipment, addressing a highly irrational pharmaceutical pricing regime are crucial needs which remain unaddressed for another year in a row. Service tax exemption in case of healthcare delivery and relaxation of FDI norms for medical devices were perhaps the only two radical changes aimed at protecting the industry over the last few years. These need to be taken forward and the processes simplified to motivate international companies to invest.

• A reduction in the weighted deductions for expenditure on scientific research by 25-50% as a proposed phase out measure without a corresponding reduction in the tax rates could

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be viewed by the pharmaceutical industry as a disincentive at this point of time. Scientificresearch should right now be at the forefront for the development of our pharmaceutical sector (with the global patent cliff on the horizon); this phase out is not timed appropriately.

• Clarity on taxation and a true open market approach for international companies seeking to invest is another crucial issue that needs to be addressed.

3. OTHER TRENDS

Healthcare Delivery• Adoption of technology: Significantly low

presence of physicians in rural and semi-urban areas has led to uneven supply of quality healthcare in India. Telemedicine is considered to be one of the solutions to address this and growth of the IT sector in India which plays crucial role in telemedicine has led to emergence of this sector. Tele radiology has emerged rapidly with an increasing number of foreign hospitals active in this space. In addition, hospitals in the private sector have started to offer physician consultation leveraging telemedicine.

• Focus on super specialty: There is a growing emergence of niche and super specialty centres with focus on single areas such as nephrology, cosmetology, oncology, cardiac etc. resulting in shop in shop models becoming a favoured model thereby improving clinical excellence in focus areas and optimizing capital investment. This also gives the opportunity for specialty players to penetrate into tier 2 and tier 3 cities in partnership with an existing hospital. PE/VC (private equity/venture capital) players have also favoured this concept as several investments backing it have been implemented.

• Medical Tourism: Various models are emerging to promote medical tourism in India.

• Government Contracts: Largely individual hospital/state driven effort to reach out to health representatives with the governments

in regions. Typical MoUs with the government guarantee a fee for the hospitals as well as streamlining patient footfalls. These are often slow to take off and bogged down by complexities. Simplification of guidelines and implementation will help build effectiveness.• Facilitators: Facilitators can be individuals or marketing agencies undertaking to source patients from specific corridors and channelizing them to the hospital partner network for a commission.

• Overseas operations and agreements: With hospitals directly making individual efforts to sign agreements with hospitals in foreign countries, whether by way of greenfield/brownfield investments and acquisitions or in the nature of shop in shop operations/ complete operations and maintenance contracts .

• Corporate agreements: With hospitals directly making individual efforts to tie up with corporates (preferably global corporates with offices in India, Africa, GCC [Gulf Cooperation Countries] and other Asian countries) in overseas locations. The nature of the agreement can evolve over a period of time and usually starts with a general health check-up scheme and primarily intends to route complicated surgical treatments to facilities in India.

Generic industry issuesThe sector attracts less than 2% allocation from GDP spend which compares very poorly with other emerging and developed economies. In addition, high customs duty rates effect affordability of ‘best in class’ solutions for the larger population. Duty levels impact both finished products and raw materials. Price controls do not present a real solution to the problem.

Healthcare

• Demand supply gap: There is a highly skewed spread of quality healthcare towards urban areas in terms of beds, doctor quality, facility and equipment. While Tier 1 continues to attract private player participation, investments into semi urban areas needs special policies and a framework to incentivize participation.

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• Rising costs of healthcare: Affordable healthcare currently is available only in the public sector. High customs duty barriers make quality global products expensive and lead to an increase in the overall cost of care. There is need for rationalization of customs duty based on the criticality of the disease being addressed.

• Inability to monetize fully from medical value tourism – limited progress for India as an international health corridor.

Pharmaceuticals and Medical Devices• Ambiguity around price control and frequent

modifications under the NPPS regime deterring pharmaceutical companies from investing heavily in R&D and drug innovations.

• The centre’s decision to ban 344 fixed dose combination (FDC) drugs has impacted more than 400 small and big pharmaceutical companies in Gujarat, which accounts for 30% of India’s pharmaceutical market. The ban covers more than 2,000 brands manufactured by these firms.

• Infrastructure: Inadequate infrastructure in terms of power, sewage, roads and transport. No specific pockets/clusters for development.

• Manpower and technology: Strong need for professionals who are well versed in both medicine and technology. Unsteady supply of skilled workers/outdated labour laws, Vocational training institutes do not include any specific training in medical technology/precision tooling as an example.

• Regulatory mechanism: Changing norms and regulations impact the ability of both national and international companies to develop. This is improving but a lot still needs to be done.

• Investment/access to technology: Limited focus on development activities, no significantcollaborative activities for development of medical technology to address the needs of a populous nation.

• Absence of a comprehensive reimbursement system: No clear reimbursement systems in

place, public intervention currently is minimal and basic

Flavour of the National Health Policy• An expected three-fold increase in the

healthcare budget allocation at US$55 billion (€48.2 billion) under the Twelfth Five Year Plan – share of healthcare to increase from the current low levels of ~1% has been aimed at 2%. Universal health coverage and increased allocation of health insurance premium (including specifically for senior citizens) will pave the way for wider healthcare access. Creation of a new National Health Mission (NHM) for providing effective healthcare to both urban and rural population, with emphasis on states with weak health infrastructure and indicators.

• Encouraging the PPP model

With the private sector having proven its effectiveness in providing healthcare at significantly better quality as compared to public healthcare, the year has seen an increase in the number of projects that are expected to develop using the PPP model. Continued focus is required as this will emerge as the quickest and most reliable mode of taking healthcare pan India.

• Rectifying the Drug Pricing Policy

An irrational drug pricing policy is still under review under the directions of the Supreme Court of India. Clarity of basis, coverage of medicines and therapies and economic sense to service the domestic market (and not just the lucrative export markets) will be clear drivers for provision of medicines.

• Regulation around medical devices and diagnostics

The Medical Devices Bill is yet to see a formal go ahead and needs to be strengthened on various accounts – coverage, classification regulation, de-linking from pharmaceuticals to crease a specific industry segment and provide impetus to local manufacturing where volumes present a real opportunity. An extension of this approach to imports, where local manufacture is not possible, to

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ensure availability of best in class solutions.

As a direct incentive – such as incentives in the form of Income tax exemption for domestic manufactured medical technology products and a marquee announcement for easing FDI norms for medical devices and diagnostic segments requires effective implementation.

4. KEY POLICY REQUIREMENTS

Incentives for deeper penetration of healthcare The hospital industry was incentivized for setting up hospitals in tier 2 and tier 3 cities towards increasing bed capacity. Linkages of such development with the set-up of smart cities, bringing in larger development and private finance institutions to participate can be a key driver for the establishment of required infrastructure.

In order to make healthcare accessible to all, the industry expects the government to take steps towards widening coverage and increasing the penetration of insurance so as to reduce the out of pocket expense burden, which is currently high compared to several other developing countries.

Government recognition of medical value tourism Under the new Narendra Modi-led government, there was, for the very first time, a clear recognition of medical value tourism through the launch of a formal government website which informs overseas patients about details of accreditations, therapies and hospitals which provide relevant treatment. While awareness, empanelment and acceptance of such marketing activities is yet to take better form, we believe this is an excellent effort to recognize the efforts made by private providers to create an international corridor for medical tourism and an excellent avenue for foreign exchange receipts.

5. DEALS LANDSCAPEThe sector has been at the forefront of deal activity in India for several years with large ticket consolidations driven by pharma and big ticket private equity deals happening in the healthcare delivery space. Foreign investors can play significant role in the development of the sector and it is evident from the fact that private equity funds (including venture capital funds) have invested about US$5 billion (€4.3 billion) in the sector since 2011.

Summary of M&A deals – US$ Mn

Type of M&A Values US$ Mn Volume

2013 2014 2015 2013 2014 2015

Domestic 939 3,679 374 22 32 25

Inbound 2,451 691 1,366 13 13 19

Internal Restructuring 185 1,037 - 1 2 -

Outbound 567 267 2,307 10 17 21

Grand Total 4,142 5,675 4,047 46 64 65

Private equity investment 2011 2012 2013 2014 2015

PE Deal values – US$ Mn 281 907 1400 628 1099

PE Deal volumes 19 38 73 49 40

Source: Grant Thornton Dealtracker

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Large hospital groups secured active PE and strategic interest and were closing out on their Series B & Series C funding. Malaysia’s IHH Healthcare acquired a majority stake in Hyderabad-based Ravindranath GE Medical Associates Pvt. Ltd (Global hospitals) for US$200 million (€175 million) and also bought a 51% stake in another Hyderabad-based chain, Continental Hospitals Ltd, for US$45 million (€39.4 million).

Singapore’s state-owned investment firm Temasek Holdings Pte Ltd. also invested in the Naresh Trehan-owned multi-specialty hospital Medanta while Abraaj invested in Care hospitals. Some leading south India based hospital groups have raised funds for their domestic expansion plans. Some notable deals in this space includes India Value Fund’s investment into Cloudnine Hospital and TPG investing in Manipal.

Cross border activity in M&A

In 2015, the total deal value in the sector hit a five-yearhigh. Some notable deals included the largest overseas buyouts by Indian drug makers =- Lupin Ltd. acquired US generic-drug maker Gavis Pharmaceuticals Llc for US$880 million (€771 million). Also Cipla Ltd acquired US-based InvaGen Pharmaceuticals Inc. and Exelan Pharmaceuticals Inc. for US$ 550 million (€482 million). We believe Indian pharma companies are becoming aggressive in their endeavour to become large players

Region wise – US$ Mn 2013 2014 2015

Inbound 2,451 691 1,366

Africa - 132 -

Asia 80 348 370

Australia - 5 5

Europe 505 7 130

North America 1,866 199 861

Outbound 567 267 2,307

Africa 527 10 -

Asia - 40 250

Australia - - 5

Europe 15 56 186

North America 25 159 1,525

South Africa - - 335

South America - 3 5

in the global pharma API space. One of the landmark inbound deals in this space was Mylan’s acquisition of Famy Care business for US$ 750 million (€657.7 million). Apart from this, we also witnessed Indian companies acquiring competition in the local market such as Torrent’s acquisition of Zyg Pharma, Strides acquisition of Medispan’s brands and Emcure’s acquisition of Ranbaxy & Sun Pharma’s products.

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Acquirer Target Announced Value US$ Mn

Type of deal

Lupin Ltd Gavis Pharmaceuticals Llc. and its affiliate Novel Laboratories Inc

880.00 Acquisition

Mylan Inc - Mylan Laboratories Limited

Famy Care Ltd 750.00 Acquisition

Cipla Ltd InvaGen Pharmaceuticals Inc. 500.00 Acquisition

Strides Arcolab Ltd Aspen Pharmacare’s generic pharmaceutical business in Australia

300.00 Acquisition

Aster DM HealthcareSanad hospital 250.00

Increasing Stake to 97%

IHH Healthcare Berhad Group Ravindranath GE Medical Associates Pvt Ltd-Global Hospitals

195.00 Majority Stake

Dr Reddy’s Laboratories Ltd UCB 128.38 Acquisition

Recipharm AB Nitin Lifesciences Ltd 103.00 Majority Stake

Fullerton Healthcare Group RadLink-Asia Pte Ltd- Fortis Healthcare 83.50 Acquisition

Clariant Chemicals India Ltd Vivimed Labs Ltd- Speciality Chemical Products

57.70 Acquisition

Investor Investee Announced Value US$ Mn

Stake

Capital International Mankind Pharma 205.84 11%

Temasek Glenmark Pharmaceuticals Ltd 151.00 4%

TPG CapitalManipal Health Enterprises Private Limited.

150.00 25%

OrbiMed and MAPE Advisory Group

Net-Meds Marketplace Pvt Ltd- Netmeds.com

50.00 N.A.

CDC Group Narayana Hrudayalaya Hospitals 48.00 N.A.

ADV Partners Dr. Agarwal’s Healthcare Ltd 45.00 N.A.

Accel Partners, International Finance Corp, Qualcomm Ventures and Ventureast

HealthVista India Pvt. Ltd- Portea Medical

37.50 N.A.

ChrysCapital GVK Biosciences Pvt Ltd 25.00 10%

Sequoia Capital MedGenome Labs Pvt Ltd 20.00 N.A.

Sequoia Capital La Renon Healthcare Pvt. Ltd 16.00 N.A.

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HOMELAND SECURITYPave way for enhanced participation of international players in this largely unorganized sector to bring international best practices and technology through comprehensive engagement with the policy makers to bring to the fore key regulatory and fiscal challenges which shall require immediate attention frompolicy reforms standpoint in near to medium term.

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Industry Function & Services

The private security industry is critical in maintaining security in India. It is responsible for not only protecting many institutions and critical infrastructure systems, including industry and manufacturing, utilities, transportation and health and educational facilities, but also for protecting intellectual property, sensitive corporate information and individual lives.

Organizations and individuals rely heavily on private security for a wide range of functions, including protecting employees and property, conducting investigations, performing pre-employment screening, providing information technology security among many other functions.

Services of private security providers are used in a wide range of markets, from commercial to residential. Some companies hire their own security personnel, whereas others contract with security firms for these services or use a mix of services—both proprietary and contract staff.

Key sectors that drive services for the private security services industry include:

• Commercial

• Office Spac

• Organized Retail

• Events

• Public Places

• Religious Places …

• Habitat

• Individual Houses

• Row Houses

• Residential Apartments & Colonies

• Multi-storied Colonies

• Townships …

• Industrial

• Manufacturing

• Infrastructure …

• Personal Protection

Demographics

The industry is estimated at INR 400 billion (€5.26 billion) with an expected compound annual growth rate (CAGR) of 20%. The demand for security services is fuelled by an increasing rate of urbanisation, improving foreign investment activity and a growing middle class owning assets they wish to protect. Fear of terrorism and crime has also fuelled this demand.

The private security services industry is one of the largest employers in India with over seven million private security personnel employed across the country. More than 85% of employees come from below poverty line families and rarely have been schooled beyond higher secondary.1

The states that constitute most of the manpower include Bihar, Uttar Pradesh, Rajasthan, Jharkhand, Madhya Pradesh and Assam.

Sector Analysis

Most individuals come in search of employment to urban centres and resort to working as security guards as a last option. But due to rapid urbanization of Tier 2 and 3 category cities, there is growing requirement to provide better manned and electronic security services.

The sector is involved in skill development and employment of backward and economically weaker sections of our society, particularly from the rural and semi-urban areas of the country.

The high growth potential and increase in organized play makes it an attractive market for both international as well as Indian players.

1. INTRODUCTION

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The industry continues to face challenges around low compliance to regulatory norms, competition from small, unorganized players and consequently, margin pressures due to competition and increasing compliance and manpower costs.

Industry TrendsConsidering the growing demand for security services, domestic firms are seeking capital to expand rapidly, while international firms are collaborating and consolidating to gain visible market share.

Technological advancements as in the form of electronic surveillance require a greater need for specialized skills in the segment.

With the use of innovative modus operandi, employers are beginning to understand the need to have competitive and well trained security guards.

The industry is slated to employ over 11.8 million employees by 2022.2

Some major firms in the industry in India are G4S, Peregrine, Securitas, Security and Intelligence Services India (SIS) and Tops.

With the influx of multinational companies in India, expectations of providing expats, employees and facilities with a similar level of security as abroad is growing.

More and more organizations are willing to significantlyinvest in monitoring, guarding, checking, patrolling, surveillance, investigation etc. to secure its business operations.

Industry is slated to become CAPEX (capital expenditure) intensive with regulatory requirements and compliances to be met. Although lack of enforcement allows for slippages, commercial service providers are becoming increasingly aware of the lacunae.

Regulatory & GovernanceCompliance and enforcement of PSARA (Private Security Agencies RegulationAct) is still in infancy. Major multinational and national players follow rules and regulations but a majority of unorganized companies do not.

With armed offences, in both commercial and residential facilities, on rise, there is need for concrete regulations, policies, and directions, on storage and usage of firearms.

State-level governance may be required to infuse private security services with that of police for better governance, patrolling and building trust locally.

2. KEY INDUSTRY ISSUES

Public & Private Sector InvestmentsThere are limited avenues of investments to promote the sector, such as FDI. As policing is a state subject, there are limited areas where private security agencies can be utilized to provide services at the state level.

The government of India has permitted foreign direct investment up to 49% in the security industry and this has attracted big foreign players. But there is lack of clarity on areas where or for what FDI can be utilized.

Multi-country services providers look at India as a high potential market, yet stop investments as seeking partnership is difficult. Ease of doing business in inconsistent at the centre, and even more complex at the state level. States have their own system of providing clearances to set up and operate private security institutions at the state level.

Adopting Best PracticesLeading international service providers bring with them the best in class practices with their multi-country experience. Unfortunately, lack of these practices being available in India means that even the organized sector has to look up to only experienced professionals in the domain for knowledge and not industry certifications in specialized courses.

With investment avoided due to high attrition rate in this industry, there is limited use of technology in imparting training and skills.

International best practices are well documented and available at a cost. Indian companies need to invest in bringing these trainings and best practices to India through professional trainers -- be it in hand-to-hand combat, use of firearms or investigative tools and methodologies. Government needs to regulate this sector better and enforce global best practises.

Training & CollaborationThere is lack of training, more specifically in the case

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of unorganised companies, and lack of collaboration between various niche and mainstream industry players in the area of skill development. It is also not easy for youngsters from rural backgrounds in their early job years to understand urban culture and learn and adapt quickly.

There is a sub-culture in the ecosystem that allows private security guards to be more relaxed than their police counterparts as it is perceived that they can evade responsibility in dire situations.

Employees lack understanding on legal, contractual and financial issues concerning their employers and clients.

EnforcementThe PSARA Act is there but its enforcement in the small, unorganized sector is dismal. It is ineffective at the state level, something which is being realized after the occurrence of profiled media cases and public outrage.

Private security is seen as compliance by the corporate sector to fulfil its obligations towards its employees, while real monitoring of these people assets is rarely questioned.

There are is a lack of both monetary and legal finesand regulations to curb the misuse of the provisions of the act and rules.

Workmen relatedSecurity personnel risk their lives with almost no or inadequate social security and insufficient training. Moreover, they tend to work in extremely poor working conditions. This brings in dissatisfaction amongst employees, leading to attrition and the workforce switching their jobs due to better job opportunities and greener pastures.

3. RECOMMENDATIONS

Foreign Direct InvestmentFDI is one of most direct routes to give a much needed monetary push to the industry, so that capable individuals can be retained and be better trained as well as be provided much better infrastructure and gear. It is recommended that the present limit of FDI should be raised from 49% to 51%, or more for more

influx of money from foreign investors and better control of the Indian counterpart.

FDI will allow for best practices to be made available in India, at par with developed nations. They will make the government rethink its strategy on allowing and partnering with foreign players, thereby making the industry more open and easy to do business with.

A sense of expectation from the industry can be raised by partnering with foreign players; it will allow high-net-worth individuals to have trained private security manpower and also make a medium or small set-up understand the importance and utility of private security just as well as an insurance product.

Foreign investors should be incentivised to establish and operate in India, as it will allow for best practices, technology and knowledge transfer to Indian shores, as well as add monetarily to the GDP of the country.

Larger scale of operations run by large investors also mean that they can push for large scale employment to be conducted, boosting state agendas on employment, wages and working conditions.

Partnering with Skill IndiaThe recently launched National Career Service portal provides an online mechanism to gain training through reputable institutions and further to get assessed and placed. This will allow the youth to search for job opportunities in neighbouring areas rather than travelling to the metros to find employment

Skills development will also allow for trained or ex-servicemen help in understanding city combat, investigations and general hygiene of being a private security personnel. It will allow for this segment of the workforce to become as important as an administration or a finance department in a corporate set-up, where asset (physical and virtual) security is critical.

Private security guards are paid minimum wages as unskilled/semi-skilled category, Private security guards should be viewed as skilled workforce, they get paid under skilled category, which will lead to better talent pool and lower attrition rates.

Regulatory ReformsThe industry has been at the lower end of focus from successive governments in the last decade or so. It is time to converge ‘smart’ and ‘safe’ city

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programmes and for the government to look at private security industry as a trustworthy option to outsource monitoring and detection services.

Regulatory reforms are also required in enforcement of acts and rules, more at the state level to allow for seriousness in non-mainstream players. Financial and legal captions should be placed in delivering services, with a requisite grievance redressal mechanism built by the government to ensure that like the product market, the services industry is also service level based.

The use of firearms by guards during employment with private security agencies is construed as usage of arms for commercial purposes. There is limited clarity on usage of arms for commercial purposes under the current regulatory framework. This needs more clarity for operators to apply for licenses, train manpower and deploy them on a need basis.

Private security agency officers in India are not empowered to carry out activities such as detention. Considering that a significant number of guards in the industry are not adequately trained, it may be

imperative to devise a framework with adequate checks and balances prior to empowering private security agencies to perform non-critical duties.

PSARA was passed by Parliament; however, states have implemented this act as per their requirements based on state-specific guidelines. There is need to centrally control licensing of PSI agencies under one authority i.e. have single window for clearances.

Labour ReformsDespite discharging highly skilled functions such as those of access controls using baggage x-ray machines, guarding critical industrial infrastructure, managing surveillance systems, the present classification of industry labour is unskilled. This needs to be revisited and upgraded to semi-skilled or skilled.

Making the industry labour classification as semi-skilled or skilled will earn better wages, thereby attracting more people to continually stay employed in the industry. This will reduce the current attrition rate of around 40% in semi-skilled and 20% in highly–skilled workforce.

Endnotes

1. Source: Human Resources & Skill Requirements in the Private Security Services Sector, NSDC

2. Source: Human Resources & Skill Requirements in the Private Security Services Sector, NSDC

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ICT & INNOVATIONImprove countrywide access of IT and IT enabled services, encourage policies to enhance India’s competitiveness in R&D operations and offer continuous /increased impetus for manufacture of IT hardware product in India.

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1.

Market DescriptionThe Indian IT and ITeS industry can be divided into four major segments: information technology services, business process management, software products and services, and hardware.

The Indian IT services sector is expected to grow at 11% per annum and triple its current annual revenue to reach US$350 billion (€308 billion) by FY20252. India, the fourth largest base for new businesses in the world and home to over 3,100 technology start-ups, is set to increase its base to 11,500 such start-ups by 20203. Further, India’s internet economy is expected to touch INR 10 trillion (€133 billion) by 2018, accounting for 5% of the country’s gross domestic product (GDP), according to a report by the Boston Consulting Group and Internet and Mobile Association of India. Public cloud services revenue in India is expected to reach US$838 million (€737.4 million) in 2015, growing by 33% year-on-year as per a report by Gartner Inc. India continues to remain the world’s largest sourcing destination for the IT industry accounting for approximately 67% of the US$124-130 billion (€109-114 billion) market. Increased penetration of internet (including in rural areas) and rapid emergence of e-commerce appear to be the main drivers for continued growth of data centre co-location and hosting market in India. The industry has therefore been a net hirer with digital disruptions creating new opportunities.

IT hardware4

During FY 2014-15, the ICT hardware industry registered an overall healthy growth of 24% over the previous financial year in terms of revenue. However, growth in the current financial year FY2015-16 appears less promising with an overall projection of 15% growth for this industry. The biggest driver of this growth has been phablets and smartphones with an expected negative growth for personal computers

1. INTRODUCTION

Information Technology (IT) and Information Technology Enabled Services (ITeS) including Business Process Management (BPM)1

and servers. The server market is expected to de-grow by another 10% in FY 2015-16 due to the growing dependency on cloud based services referred to above.

Telecommunication5

India is currently the world’s second largest telecommunications market and has registered strong growth in the past decade and half. The Indian mobile economy is growing rapidly and will contribute substantially to India’s gross domestic product according to report prepared by GSM Association (GSMA) in collaboration with the Boston Consulting Group (BCG). With the market size driven by strong adoption of data consumption on handheld devices, the total mobile services market revenue in India is expected to touch US$37 billion (€32.5 billion) in 2017. According to a study by GSMA, India is set to become the fourth largest smartphone market by 2020 with broadband services user-base expected to grow to 250 million connections by 2017.

The Indian telecom sector is expected to generate four million direct and indirect jobs over the next fiveyears with employment opportunities expected to be created due to a combination of the government’s efforts to increase penetration in rural areas and the rapid increase in smartphone sales coupled with rising internet usage.

Research and Development (R&D’) and Innovation6

R&D spend continues to be on the rise with focus on building better, faster and smarter products. The overall R&D spend stands at US$577 billion (€507.7 billion) with increased demand for embedded and software content. R&D globalization through in-house R&D centres as a phenomenon appears to be here to stay with locations in emerging economies such as India being the hotspot. Specificall , engineering

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and R&D centres in India deliver US$11.3 billion (€10 billion) worth of services to their parent companies.

RECENT DEVELOPMENTSThe last 12-15 months have seen invigorated efforts in measures by the Indian government to encourage and promote the ICT sector in the country. Some key initiatives include the following:

Digital India

The Digital India programme announced last year is a prodigious initiative of the government that envisions emphasis on e-governance and transformation of India into a digitally empowered society. Initiatives launched under this programme such as Digital Locker System, MyGov.in, eSign, e-Hospital application and Digitize India Platform (DIP) appear to be steps in the right direction that should enhance usage of technology in delivery of a host of services. The estimated impact of Digital India by 2019 would be cross cutting, ranging from wide broadband connectivity, wi-fi in schools and universities and public wi-fi hotspots resulting in generation of significant business and employment opportunities, in the technology, telecom and electronics space.

Start-up India

Start-up India, a flagship programme of the Narendra Modi-led government, is an admirable initiative and has received thumbs up from all stakeholders in the start-up ecosystem. The 19-point action plan announced at the conclave sponsored by the government in January this year contains a three-year income tax holiday, funding assistance by the government indirectly through Securities and Exchange Board of India (SEBI) registered funds, relaxation in various regulations to facilitate ease-of-doing business and promotion of innovation amongst a host of other grand commitments. A missing benefit and a key unanswered ask of this sector is indirect tax benefit such as VAT and service tax exemptions through an increase in threshold of applicability. Last year, over 80,000 jobs were created in the country by start-ups7. Besides, the number of active investors in Indian start-ups had more than doubled last year to 490 from 220 in 20148. This flagship initiative of the government should go a long way in building a strong eco-system for nurturing innovation and technology start-ups that

should then drive sustainable economic growth and generate large scale business opportunities.

Make in India

Make in India is a welcome initiative of the government of India with the objective of increasing the share of manufacturing in the country’s gross domestic product and creating employment across an array of 25 sectors, including electronics and IT-BPM. The ICT sector is hopeful of riding the Make in India wave, capitalizing on attracting tax and duty structure offered for the indigenous manufacture of smartphones, tablet computers and consumer premise equipment (such as modem, router and set top boxes to name a few). As per estimates, domestic demand for IT hardware and electronics is expected to touch US$400 billion (€352 billion) by 2020. At the current rate and base of domestic production, an expected US$320 billion (€281.5 billion) worth of IT hardware and electronics is expected to be imported into India to cater to this burgeoning demand. The success of the Make in India initiative would be to reduce import-dependency and increasing the contribution of local manufacturing towards catering to such demand, a phenomenon that has already taken root in the context of smartphones. The recent budget proposal to disincentivize import of populated printed circuit boards appears to be a step in the right direction for creating an ecosystem of component manufacture through backward integration of processes for creating enhanced value addition during the process of manufacture.

Modified Special Incentive ackage Scheme (MSIPs) and Preferential Market Access (PMA)

To offset disability and attract investments in electronic manufacturing, the MSIPS scheme seeks to provide capital subsidy for setting up units for electronics manufacturing (both greenfield and brownfield) in designated zones. The scheme, which was initially opened for three years till July 27, 2015 and has been given a further lease of life and extended up to July 27, 2020, appears to be a step in the right direction to overall incentivize electronic hardware manufacturing in India.

Ease of business related initiatives

A spate of initiatives to improve Ease of Doing Business are being announced with an emphasis

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on simplification and rationalization of existing rules and absorption of information technology to make governance more efficient and effective. The initiatives include setting up the e-biz portal integrating 20 services offered by the government, series of amendments made to the Companies Act 2015, including a set of changes announced recently (entailing relaxations on maximum number of investment companies, private placement provisions, loans to entities in which a director is interested etc.), relaxations in processes for obtaining various licenses/approvals, relaxations in labour regulations and indirect tax regulations. On the indirect tax front, there has been the much needed relook and revamp of customs processes and procedures for import of goods from associated enterprises; specificall , relaxation of the rigour of scrutiny on zero duty imports as well as import of prototypes for research and innovation are encouraging moves of a government that has well recognized and sought to address the needs of the ICT sector.

While these initiatives of the government are certainly in the right direction and have started showing results, with India’s ranking in World’s Bank’s Doing Business Report 2016 moving up 12 notches to 130 last year, it seems there is still some gap in these initiatives percolating down to the grassroots level -- such that industry starts reaping their benefits to their fullest and truest intended extent.

Net Neutrality Policy

Rules to protect the open internet are under consideration in many jurisdictions around the world. In its report on the subject, the internal committee of the Department of Telecommunications had last year recommended disallowing the controversial zero-rating plans of telecom companies and proposed a ban on throttling any sort of prioritization of Internet traffic. It had also suggested a new law incorporating principles of net neutrality to replace the Indian Telegraph Act. Hitting at the heart of the net neutrality debate, the report had further said that balance was required between ensuring Internet openness and reasonable use of traffic management by telecom companies and Internet service providers for legitimate needs. This attempt of the TRAI to put everything on the Internet on an agnostic platform appears to be a step in the right direction.

Union Budget 2016 announcements

From a tax and regulatory perspective, while Budget 2016 proposals echo the tone of the flagshipprogrammes of the government, they also contain some proposals having an impact on the ICT industry with the following among other key proposals:

• In the backdrop of the government’s fir position to phase out tax incentives, the resetting of the sunset date to March 31, 2020 (for units in a special economic zone to commence activities for the purpose of income tax holiday) while being perceived as an overall welcome move has dashed all hopes of preservation of benefits on an ongoing basis

• Capital expenditure incurred and paid for acquisition of right to use spectrum for telecommunication services being allowed as a deduction in equal annual instalments spread over the period of the period for which the right to use the spectrum remains is force aligned to other similar payments such as license fee paid for operating telecommunication services. Interestingly, even credit under service tax is sought to be allowed in instalments with respect to such rights.

• While the patent box regime (with a tax rate of 10% on gross basis on licensing income for patents developed and registered in India and no deduction for costs and MAT) is a welcome approach to balance the phasing out of weighted deductions for research and development spends in a phased manner, the proposed regime seems to be restrictive in the scope of its coverage of intellectual properties including streams of income. Also, the rate of tax of 10% being on the gross income may not provide significant benefit

• The amendment to Section 80 JJAA of the Income Tax Act, 1961, enabling additional employee related deductions could benefitstart-ups and BPM service providers who have been at the forefront of creating employment at the lower income brackets.

• The introduction of an equalization levy as a mechanism for tax collection on payments made to overseas entities towards online

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advertisements with the threat of the same being extended to other areas (such as cloud computing) is a cause for concern, particularly for start-ups whose nascent spend largely involves such digital advertisement spend.

• Other expected announcements on the direct tax front include (i) country-by-country and master file report introduced in line with the BEPS action plan and to be applicable from financial year 2016-17 and (ii) lower head line tax rate of 25% for manufacturing companies not claiming any tax holidays as well as a lower tax rate of 29% for certain domestic companies with total turnover not exceeding INR 50 million (€660,00). These changes are welcome and are stepping stones to an overall reduction of the headline tax rate of 25% announced by Finance Minister Arun Jaitley last year

• Disappointingly, on the indirect tax front, there has been no specific change except for a reassuring clarification on the manner of taxation of software on a media without any overlap in taxation from a customs/central excise and service tax perspective.

• On the telecommunication front, the declaration of spectrum allocation and transfer as a ‘service’ can be expected to garner additional service tax revenues for the government in the next round of allocation.

2. ISSUES & RECOMMENDATIONS

2.1 Fostering R&D and innovation in India

Issues around IPR protection

While a National IPR Policy is indeed a much needed and welcome move, it is understood that the forthcoming IPR policy seeks government intervention to examine the availability of standard essential patents (SEPs) on fair, reasonable and non-discriminatory (FRAND) terms. It is apprehended that any such intervention, especially with regard to specific licensing terms and price setting, would have a deterrent effect on

the ease of doing business in the country and may hinder the government’s positive initiatives, besides hurting investor sentiment and negatively impacting FDI inflo . The examination of terms and conditions of licenses are best left to private parties in negotiations and adjudications by the respective courts of law of dispute. Besides, such a provision will unnecessarily burden the existing government machinery that may not have the wherewithal to decide such matters. It is notable that FRAND assured SEPs have contributed to the exponential entry and growth of businesses of Indian origin and great consumer demand, besides helping India achieve second position in the world in terms of telecom networks, with substantial increases in rural and urban tele-density. Specificall ,

• Government Intervention in the system will be counter-productive to market driven inter-company licensing regime and deter ‘Ease of Doing Business’.

• The policy statement will not be aligned with the current thinking/ stand taken by the other government bodies.

• Attempts to define FRAND internationally have failed.

Recommendation

• Any government intervention in examining the availability of SEPs on FRAND terms will add another procedural layer towards transfer of technology. This is, in fact, redundant as government department is not expected to deliver the role of judiciary which can best be left to a court of law in case of any potential dispute.

• Given that India has a fairly well developed judicial system, government departments such as DIPP(Department of Industrial Policy and Promotion)/DieTy (Department of Electronics and Information Technology) should not be burdened with any additional responsibility of examining the availability of SEPs on FRAND terms and should ideally be left to the market forces/competition.

Issues around resources (monetary as well as non-monetary)

The Department of Science and Technology (DST)

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and Department of Scientific and Industrial Research (DSIR), the two nodal agencies responsible for promoting science and technology (S&T) initiatives in the country continue to enable projects and opportunities; however, the R&D sector continues to be fraught with several unnerving challenges, a primary one being lack of funding/financing bodies, especially for new ideas and new investors. There is also need for an appropriate legislative framework for incentivizing innovators and commercialization of public funded R&D, where the government, the recipient(s) of funds, the inventor, as well as the public benefit from the protection and commercialization of the IP created. Another focus area is relaxation in VISA norms for movement of technical personnel.

Recommendation

• The Indian government takes positive and focused steps towards increased collaboration among R&D institutes, universities and private sector enterprises and leverage upon their cumulative strengths in funding, designing and implementing various research and innovation programmes.

• For uplifting the growth of innovation in India, the government should also look at providing fiscal and non-fiscal incentives including subsidies with respect to IP created in India to enable creation as well as sustenance of innovation culture in the country. This could include setting up innovation clusters similar to the manufacturing zones being demarcated for MSIPs benefits and in line with international best practices on the subject.

• All regulations with respect to movement of funds as well as resources for R&D and innovation should have specific liberalization norms.

Issues around taxation

An emerging issue under service tax is the threat of a service tax being levied on R&D and testing services even when commissioned by and provided to a customer outside India. This issue particularly plagues product as well as the software development industry which is required to test the product/software under development on related hardware.

Further, while Budget 2016 proposals entails a patent

box regime with a tax rate of 10% on royalty from patents registered and developed in India on a gross basis, the scheme has some limitations; the key ones being the tax rate of 10% on a gross basis that entails a benefit only for companies having profit margins in excess of 30-35% and that the scope of the regime is restricted to patents registered under the Patents Act and only covers income in the nature of royalty. Similar patent box regimes in other countries such UK, China, Netherlands, Belgium, and Switzerland cover larger scope of intellectual properties, larger spectrum of income and better rationalized tax rates.

Recommendation

• A specific clarification be issued confirming the non-taxability including export status for R&D and testing services so as to align the same with repair, reengineering and reconditioning services which are also not taxed when performed in India with respect to products provided by a customer abroad. In fact, there is a stronger case in the context of R&D and testing which is essentially not a service that provides any value addition vis-à-vis goods provided but merely uses goods as a vehicle for testing the parameters and efficiency of the services being provided. This would also align the Indian law with international precedents and practices such as in Europe as well as the UK.

• The following changes be considered in the patent box regime:

• Rationalization of the rate of tax to about 6% to 8% to provide a real incentive to the target players

• Increase the scope of intellectual properties covered

• Increase the scope of income covered from royalty to all forms of income including trading income and capital gains income

Measures to promote ICT hardware sector

Make in India initiative to be extended to all ITA goods and maintained under GST

Budget 2015-16 ushered in an attractive and

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competitive duty regime to encourage domestic manufacturing of mobile phones and tablet computers under the Make in India initiative. A similar package has been extended to consumer premise equipment such as set top boxes, modems, routers etc in March 2016. With exemption on the input side and an option of a concessional excise duty on the output side, domestic manufacturing appears far more attractive as opposed to import of finished goods upon payment of 12.5% customs duty. This, in conjunction with the levy of duty on import of populated PCBs, as well as accessories of mobile phones appears to be aimed at creating a manufacturing eco system involving significant value addition. However, the present schemes do not appear to recognize (i) the increasing penetration of personal computers, particularly in rural areas and education sector (ii) investments already made by manufacturers in this sector (iii) extent of current imports vis-à-vis domestic demand (iv) ever increasing integration of product categories such as laptops and tablets, including the importance of e-readers as an important literacy tool.

Recommendation

The excise duty structure and attendant exemptions recently notified by tablet computers may be extended to all types of ITA goods with additional benefits for the manufacture of parts/components and accessories of these goods in India. Further specific policy initiatives should be thought through with industry consultation to provide investors the required level of confidencethat these benefits shall be maintained in some form or other under GST to ensure that the same are not short lived. These measures could go a long way in attracting investments into this sector.

Harmonization of tax and duty rates for IT and telecom hardware on a pan India basis

With the emergence of new products based on new technologies, multi-functionality in products appears to be the norm rather than the exception. There is therefore the need for specific guidelines on the classification and rate to be applied on such products based on their essential or main functionality. Further, the issue of divergent VAT rates being applied on IT and telecommunication hardware continues to cause diversion of trade causing business decisions to be tax rather than commerce based. Rate arbitrage coupled

with lack of clarity in the classification continues to spew unwarranted litigation. Specificall , there does not appear to be any specific rationale for divergent treatment of parts/accessories from the main product from a tax rate perspective. All of the above is crippling the hardware industry from an ease of business as well as litigation cost perspective on a pan India basis. In this backdrop, a potential increase in the rate of tax on these products under GST is causing additional concerns.

Recommendation

• Central and state governments to implement an amnesty scheme for the past periods to close all classification/ rate related litigation with an assurance of no reopening of any past cases where the issue is purely classificationor rate of duty/tax. This is the need of the hour, particularly in respect of multi-function products as well as cases of accessories being taxed at a rate higher than the main product. This shall also ensure that sufficient finality is brought to bear in such matters ahead of GST implementation.

• Upon introduction of GST, a uniform merit rate of GST may be applied on a consistent list of IT and telecom products, including their parts and accessories across all central and state GST laws to ensure there is uniformity in taxation on a pan India basis across central and state GST laws.

Other hardware related recommendations

There is need for the following long standing issues to be addressed as well to overall encourage the hardware industry:

• Increase in the rate depreciation across tax laws (including under the Foreign Trade Policy and CENVAT Credit Rules, 2004) to align the rate prescribed to period of technological obsolescence.

• Increase in the rate of abatement where excise duty is required to be paid based on the retail sale price of the product in recognition of increasing distribution, logistics and post-sale taxes and duties.

• Deemed export status for local supply of

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information technology hardware under the ITA list.

• Dispensation of way bills, entry permits and taxes on entry of goods with a view to encouraging free interstate trade and movement of goods. The recent trend of special levies on goods ordered via online portals at the stage of delivery in the destination state is a particular cause for serious concern and needs immediate redressal through an appropriate directive being issued by the centre to state governments.

Measures to promote IT services sector

Clarity in the taxation of intangibles and emerging technologies

The dual taxation of electronic supplies including intangibles appears to be on the rise. Coupled with this is the lack of clarity in the tax treatment of emerging digital instruments such as cloud offerings, e-vouchers, e-wallets etc.

Recommendation

• There should be a specific clarification from the Department of Revenue as regards the characterization of these instruments as goods, services or actionable claims/money.

• It should be ensured that there is no dual taxation of the same under central and state tax laws variously as goods and as services.

Benefits for service exporters

The scheme of refund of unutilized CENVAT (central value added tax) credit while being popular amongst exporters has been far from successful for exporters of services, particularly those in the IT and ITeS sector. The recent scheme of sanction of 80% refund within five working days while being conceptually a step in the right direction has been difficult to implement for most companies in the light of the conditions, particularly the format of documentation/certificationprescribed.

There is urgent need for a robust and upfront service tax exemption/refund/rebate scheme to replace or at least supplement the existing scheme.

Recommendation

• A process similar to the scheme of upfront service tax exemption be prescribed for SEZ (special economic zone) developers and units may be replicated for STPI (Software Technology Parks of India)/EOU (export oriented units).

• Alternatively, a simplified service tax drawback scheme may be notified to streamline and expedite the process of issuance of export incentives to service exporters.

• Additionally, exporters may be allowed to discharge import of service liability from the CENVAT account to address the issue of accumulating credits.

Liberalization of the credit scheme

A real value added tax or GST hinges on businesses being rid of taxes, particularly transaction taxes. However, businesses in India, including exporters, continue to incur several tax costs on account of a restrictive CENVAT credit scheme.

Recommendation

• All existing credit restrictions, except those relating to non-business/personal use of employees, be dispensed with under the current law and the same continued under GST.

Overall infrastructure development in the country

A key driver, including key performance indicator, of any economy is its infrastructure. In this backdrop, the overall civil as well as technological infrastructure development in the country has not been commensurate with the development of technology. While enterprises/businesses are growing, infrastructure needs in terms of basic building blocks, including regulatory parameters, have not reached the same level. This area requires significant amount of focus and initiatives. For instance, traffic management, consistent power supply, environment pollution (air, water and soil) and quality of roads/highways are perennial problems which directly and indirectly contribute to the efficiency as well as performance of the ICT sector.

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Recommendation

• Apart from allocating sufficient funds for infrastructure developments/growth, a proper implementation agency be established to ensure that funds are utilized in an efficientway and progress on specific projects continuously monitored.

Need for futuristic laws

Many of the country’s current laws have not kept pace with advances in technology. A case in point is VAT/ sales tax laws not recognizing the concept of digital demarcation of warehousing space to accommodate registration of multiple sellers within a single warehouse. There is therefore need for a relook at all laws that hamper growth drivers to ensure that laws enable rather than disable the conduct of business.

It is therefore recommended that:

• There is need for a futuristic and liberal GST law for the taxation of goods and services. It is hoped that a GST model law be rolled out to

enable industry to prepare for a smooth and early transition into GST.

3. CONCLUSIONIndia, both as a growing domestic market and expanding export hub for information technology and innovation activities, needs to address the issues articulated above to ensure sustained growth and success. Overall, significant progress in the development of ICT sector, including infrastructure, is called for. In the absence thereof, European businesses would find it increasingly difficult to bring in fresh investments in these sectors into India. With India implementing its plan of phasing out all tax holidays, there are fears that the country set to lose the global battle for attracting new investments to other emerging economies. A sector specific plan may have to be carved out to ensure that India continues to be a preferred investment destination and to make Indian ICT exports competitive in the international arena.

Endnotes

1. ht tp:/ /www.nasscom.in/robust-growth- indian- i tbpm-industry http://indiainbusiness.nic.in/newdesign/index.php?param=industryservices_landing/395/3

2. As per NASSCOM

3. Report by NASSCOM and Zinnov Management Consulting Private Limited

4. MAIT and IMRB Annual ITOPS performance report of ICT industry for the FY 2014-15

5. http://www.ibef.org/industry/telecommunications.aspx

6. http://zinnov.com/indias-rd-globalization-and-services-market-set-to-double-by-2020-to-38-billion/

7. As per data supplied by IT industry body Nasscom

8. As per data supplied by IT industry body Nasscom

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LOGISTICSTo create a logistics industry in India comprising both domestic and international operators, that will deliver cost effectiveness that is at the least equal to India’s principal competitors and thereby to ensure the success of the make in India strategy.

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1. INTRODUCTION

This document is the third attempt in the series of summaries of issues that face European logistics providers serving India. The objective of the document is to provide an agenda for discussion between the European logistics industry and the various Indian stakeholders in government, regulatory, statutory bodies, infrastructure providers and so on. These discussions should aim to develop collaborative solutions to the issues identified

The paper is reduced in content as compared to previous editions which had proved too voluminous. The object is simply to list the main issues as a prelude to engagement with government. Thus, for each section, key issues for discussions are listed. The background has changed. There is clear recognition by government at a senior level of the importance of logistics to the health of the economy and to the success of the programmes that are designed to improve its performance. Delivery though remains a problem, and issues remain in the key areas of competitiveness and ease of doing business. Generally, the logistics industry is not able to deliver the level of service that is required. For as long as these issues remain, Indian manufacturing will remain uncompetitive. As previously, the paper does not seek to provide answers. These will only come through comprehensive, open engagement between industry and institutional stakeholders.

A number of sections have been deleted, a brief section on railways has been added.

2. COMMON THEMES, MAIN RECOMMENDATIONS

There are a number of common themes across all sectors. These are summarized below. It is believed that unless these principles can be adopted, progress is likely to be slow at best.

2.1 The present practice of relying upon detailed regulation of every process and enterprise to achieve policy ends has to cease. Policy makers need to accept the principle of regulation by market forces. This includes all pricing activities by infrastructure operators.

2.2 It follows therefore that infrastructure must be created in sufficient quantity to allow the functioning of an effective market. This means that users must have real choice between modes and between suppliers in one mode. This probably means that there has to be an effective planning process to provide infrastructure in advance of anticipated demand.

2.3 It has to be acknowledged by policy makers that the logistics industry is interlinked across

all modes. No one mode or hub can operate in isolation and those solutions that do not recognize these essential features of the industry will deliver sub-optional solutions.

2.4 The logistics industry is now an essential element within the manufacturing industry. A competitive and effective manufacturing industry will not emerge unless it is supported by effective logistics.

2.5 The organization of government ministers must recognize the interlinked nature of all logistics sectors and the essential links to manufacturing. The present structure of separate ministries operating without coordination will not deliver effective solutions.

2.6 It must be recognized that ‘infrastructure’ is as much a matter of the legislative infrastructure as it is about the provision of physical infrastructure. The processes, procedures and values governing the operation of

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infrastructure may be the difference between effective and inefficient infrastructure, and can drive capacity enhancement.

2.7 The legislative structure governing the logistics industry contains several outdated regulations that are inappropriate to modern transport methods. These have to be updated and / or removed altogether.

2.8 As far as possible, all elements of the logistics industry should be privatized.

2.9 Such legislation as may be necessary has to be applied uniformly across the country. The practice of allowing significant local variations on a theme that should be common is a significant impediment to an effective logistics industry.

2.10 The role of customs and its interaction with the logistics industry needs fundamental review to make it a trade facilitator rather than an inhibiter which it is now.

2.11 Across all modes, economies of scale are a paramount consideration, Logistics planning must recognize this.

2.12 India must develop transport hubs, particularly in the container shipping and air transport sectors. Such hubs have to have the appropriate legislative infrastructure as well as the physical infrastructure.

2.13 The rules governing the interaction between government and infrastructure operators, the so-called PPP (public private partnership) model needs review to reduce the balance of risk and reward which is currently significantlyskewed in favour of the government.

2.14 The planning process is over centralized and does not enable coordinated industry input and participation in implementation which itself must allow greater flexibilit .

2.15 There are serious skills shortages across the sector.

2.16 Implement goods and services tax (GST) uniformly across the country to facilitate national Inland distribution networks.

2.17 Safety must be enhanced across the sector. At present, this falls short in terms of regulation and management attention. It

is unfortunate that transport is delivered at such human cost.

3. ROAD TRANSPORT• The standard and extent of roads capable

of supporting road freight transport remains poor.

• There remains a multiplicity of toll taxes which add delays, cost and unpredictability.

• State taxes and their application differ widely geographically and across commodities.

• Truck permit regimes differ between states which prevents the development of effective national distribution.

• There is no formal training of drivers and attendants.

• Safety standards are low and there are very few organized training programmes.

• International best practices of route optimization and freight management through the use of multiple trailers for single horse (i.e. tractor) are prevented in India due to archaic interpretations of the Motor Vehicles Act. Further, the interpretations of this act as it applies to allowing for multiple trailer single horse (MTSH) type operations differ from state to state depending on the interpretation of the specific state’s Regional Transport Office(RTO).A nationwide circular to all RTOs to allow separate registration of tractors and trailers is recommended. Develop well definedlaws that differentiate between the legal obligation of the tractor owner and the trailer owner while goods are in transit. These laws should be national in scope and not left to the interpretation of RTOs or individual states.

• Multiplicity of regulations applicable to truck movement in India coupled with random inspections on the road by different agencies responsible for implementing these regulations lead to multiple stoppages. Such stoppages, including those at checkpoints and entry-points, could add up to as much as 10 to 14 hours per day for trucks in transit. It is suggested that tax related check-posts are done away with in the post GST regime

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and replaced with risk-management based flying squads for random inspections. The registration of information for intra-state movement is done through an automated system. All stops made by flying squads would have to be registered by the officials,and physical inspections if any, be undertaken on camera. All RTO inspections should also be made on-camera and all stoppages registered online by officers and made s.t. RTI Act.

• Road weight legislation has to be enforced nationally.

• Above all, implement GST to facilitate the development of proper national distribution networks to replace the patchwork of regional structures.

4. AIR FREIGHT TRANSPORT• There is urgent need to implement

comprehensive e-governance systems across the industry, supported by a robust EDI (electronic data interchange) customs system with adequate back-ups.

• Implementations of cargo community system at all airports and terminals capable of working without manual intervention.

• Landing and navigation charges remain high thus adding to India’s high logistics costs.

• Sea-air, road-air freight development has been extremely limited.

• 24x7 availability of key officials

• Best practice sharing between airports need to be adopted.

• Royalties and service tax on all airport services is making air freight unnecessarily expensive.

• The processes for part shipment of imports is a major issue and amendment processes take days.

• Excess and over-carried cargo is an integral part of the business but, the process of regularisation is too slow.

• Allow establishment of cargo ‘villages’ to allow build-up and handling of ULDs (unit load devices) and pallets as per international practice.

5. CONTAINER SHIPPING • The development of port user community

systems in all ports to serve all users and stakeholders is essential. These exist in almost every port in competitive markets and greatly facilitate the handling of transactions.

• The current rail pricing structure for containers remains an impediment. Railways must be able to compete effectively and reverse the disastrous transfer of cargo to road.

• The movement of containers across state boundaries must be liberalized in all respects particularly tax, where, a uniform GST is essential. Without this, inland markets cannot develop and compete properly.

• The current arrangement of interstate check-points needs to be done away with.

• Port productivity and connectivity still needs improvement.

• The cabotage issue remains unresolved despite recent initiatives.

6. PORTS AND TERMINAL SERVICES

• The paucity of inland connectivity for many ports remain an issue.

• Dedicated freight corridor networks with attendant double stacking need swift expansion.

• The cabotage issue needs resolution.

• Port connectivity systems are needed in all ports.

• Leave pricing to market forces not regulation.

• Uniform application of customs rules both across ports and inland facilities.

• Ports to move nationally to landlord and concessionaire arrangements under equitable PPP structures.

7. EXPRESS LOGISTICS• Ensuring appropriate space is set aside for

dedicated and exclusive express handling facility for express operators in the airport

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premises with city and airside access for express operators with own aircraft. Such space needs to take into consideration the unique needs of express, and thus be located next to aircraft parking and transit bays. Additional features required by express operators, especially if India is to develop an express logistics regional hub, are:

• Self-ground handling for express companies with own aircraft.

• Customs is encouraged to give custodianship to express operators. Custodianship for express operator is essential for seamless operations leading to speed and security of operations.

• Simplification of trans-shipment procedures.

• Allowing export commercial shipments to use courier by

• integrating an export module in the courier EDI currently jointly being developed in PPP mode by Express Industry Council of India (EICI) and CBEC and

• in the interim customs can issue a circular clarifying the carriage of commercial exports up to Rs.25, 000 (€377) on the existing courier shipping bill.

8. TRADE FACILITATION• The logistics industry appreciates the recent

initiatives towards developing an effective single-window and a single-common online declaration for customs and all allied agencies. It looks forward to further systemic reforms that would ensure zero downtime of the customs EDI and a paperless system that accepts scanned electronic copies of all documents required for clearance with digital signature.

In addition, some other expectations of the logistics sector include:

• Inclusion of a wide category of entities [ACP-, AEOs (authorised economic operators), star trading houses, and large manufacturers) for the benefit of deferred duty payment (DDP) scheme announced by Finance Minister Arun Jaitley in his budget speech. Limiting this to just AEO and ACP category (even a reformed AEO category) would be self-defeating, and become a tool in the hands of a few ‘AEO’ freight forwarders to develop their business. The obvious implications for rent-seeking and favours that would perpetuate the AEO programme would defeat the entire purpose of transparency. India’s large manufacturers who are responsible members of global supply chains should be allowed to have this facility as a matter of course, whether or not they get AEO status or not

• Delays happen at assessment level where the counter signature of the assistant/deputy commissioner (AC/DC) is required due to assessable value being greater then INR 1 lakh (€1,325). This delay is again due to the shortage of officers and the multiple tasks expected to be done by the AC/DC. It has been industry’s long standing demand that the limits be re-definedin light of the fact that the purchasing power value of INR 1 lakh has declined substantially from the time this limit was first promulgated. The AC/DC signature requirement should be applicable only to shipments with assessable value greater than Rs.5 lakh (€6,626).

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OIL & GASEnable evolution of a progressive and transparent regulatory framework which can facilitate enhanced Public-Private partnership in the sector by providing a stable policy regime and level playing field to private investors

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MARKET DESCRIPTION

1.1 With a gross domestic product (GDP) of US$2.18 trillion (€1.91 trillion) in 20151, the Indian economy is the third largest in the world in terms of purchasing power parity.2

It is amongst the fastest growing major economies in the world with GDP growth rate for FY2016 estimated at 7.6% and targeted growth for FY2017 at 7-7.75%.3 The energy sector is expected to play a vital role in further improving/sustaining this growth momentum.

1.2 India continues to be the fourth largest energy consumer (after the United States, China and Japan) accounting for more than 4% of the total global energy consumption.4 It has the fifth largest power generation portfolio worldwide with total installed capacity of 271.722 gigawatt (GW) as on March 31, 2015.5 Increasing economic growth, coupled with growing urbanization, and a wider consumer base that needs access to energy is likely to push the India’s energy demand even further.

1.3 While India’s energy demand has increased to 637 million tonnes of oil equivalent (Mtoe)6, due to its high population of 1.27 billion7, the per capita consumption of energy is much lower than the world average. The demand for primary energy is anticipated to increase threefold by 2035 to 1,516 Mtoe from 563 Mtoe in 2012.8

1.4 India’s primary energy basket is skewed towards fossil fuels, coal being the main source of energy. Though the country’s energy requirements in the short run shall continue to be met predominantly by coal and oil, dependence on renewable sources of energy and nuclear power is expected to increase in the long run. India committed at the 2015

UN Climate Change Conference to raising the share of non-fossil fuel based power to 40% by 2030.

1.5 Over the next two decades, energy challenges will be fundamental to India’s growth potential. In order to achieve this, energy supplies will require an exponential rise from the current levels.

1.6 In the energy space, the oil and gas industry is an important pillar and ranks amongst India’s six core industries. This industry is one of the highest contributor to the exchequer – by way of taxes, duties, levies, lease, license fee, royalty, cess and profit petroleum. The sector contributes about 35.5% to primary energy consumption.

1.7 India is the third largest importer of crude oil in the world9; net oil imports constituted over 78.6% of India’s total domestic oil consumption in FY15. The domestic annual production of crude oil has been at around 37-38 million metric tonnes (MMT). Crude oil production during 2014-15 was 37.461 MMT, whereas during April-December 2015, domestic production of crude oil was 27.9 MMT (0.8% lower than production during the corresponding period of 2014-15)10. India has the potential to meet a higher share of demand from domestic production with total reserves of 763.476 MMT of crude oil as on April 1, 2015.11

1.8 Natural gas constituted about 7.1% of the energy mix during 2014. The maximum use of natural gas is in the fertilizers industry (32.56%) followed by power generation (31.02%) and domestic fuel (8.60%). Industry wise off-take of natural gas shows that natural gas has been used both for energy (59.42%) and non-energy (40.58%) purposes.12

1. INTRODUCTION

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1.9 India increasingly relies on imported liquefiednatural gas (LNG); it was the fourth largest LNG importer in 2014 and accounted for 5.7% of the global imports. Further, LNG regasification facility in India is likely increase to 32.5 MMTPA (MMT per annum) by 2017-18 from a current level of 22 MMTPA.

Domestic production of natural gas during 2014-15 was 33.656 billion cubic metre (BCM); during the period April-December 2015, gas production was 24.7 BCM (2.8% lower than production during corresponding period of 2014-15)10. India has total reserves of 1488.73 BCM of natural gas as on April 1, 201513 which can aid growing demand of natural gas from various sectors.

1.10 In 2014-15, domestic production of petroleum products marginally increased to 220.74 MMT from 220.31 MMT during 2013-14. Total domestic production (provisional) during 2015-16 (till January 2016) is 190.25 MMT. Further, total domestic consumption of petroleum products during 2014-15 was 165.52 MMT and about 166 MMT during 2015-16 (till February, 2016).14

1.11 While India is one of the largest importers of crude oil, it is also a major exporter of petroleum products. However, Indian exports have been on a declining trend recently, largely due to tepid global demand and volatile global currency markets. Export of petroleum products declined from 67.86 MMT during 2013-14 to 63.93 MMT during 2014-15. During 2015-16 (till January 2016), export of petroleum products further reduced to 49.4 MMT. Total export of petroleum products (in value terms) declined from US$60.66 billion (€53.16 billion) in 2013-14 to US$47.27 billion (€41.43 billion) in 2014-15.15

1.12 India’s economic growth is closely connected to energy demand. The need for oil and gas is projected to grow further, providing vast opportunities for investment. To meet this demand, the government has adopted various policies, including allowing 100% foreign direct investment (FDI) in many segments such as natural gas, petroleum products,

pipelines and refineries. This move, along with various others, has made the oil and gas sector in India a more viable place to invest in. Today, India’s oil and gas sector attracts both domestic and foreign investment, as seen by the presence of Indian and foreign companies such as Reliance Industries Ltd (RIL), Essar, BP, Shell, BG and Cairn. The cumulative foreign investment in the petroleum and natural gas sector between April 2000 and January 2015 stood at US$6.64 billion (€5.81 billion).16

DEVELOPMENTS IN THE SECTOR

Exploration and Production (E&P) – a brief history

1.13 Being a natural resource, the ownership and management of petroleum vests with the government. The sedimentary basins of India, on-land and offshore up to the 200 meters isobath, have an aerial extent of about 1.79 million sq km. In the deep waters beyond the 200 meters isobath, the sedimentary area has been estimated to be about 1.35 million sq km. The total works out to 3.14 million sq km.

1.14 Till the 1990s, E&P activities were dominated by two state-owned companies viz Oil and Natural Gas Corporation (ONGC) and Oil India Limited (OIL). With the aim of encouraging private participation and stepping up investment in E&P, the government formulated the New Exploration Licensing Policy (NELP) in 1999 along with the Directorate General of Hydrocarbons (DGH). The government also permitted 100% FDI (under automatic route) in E&P activities under NELP regime. As on June 2014, under NELP era, investment of US$14.25 billion (€12.49 billion) and US$9.42 billion (€8.25 billion) has been made towards exploration and development operations, respectively.

1.15 The first round of bids was invited in 1999, with DGH as a nodal agency for NELP implementation. Since then, nine rounds of bidding have taken place, and more than 300 exploration blocks (deep-water/shallow water/on-land) have been offered to private participants. Production sharing contracts

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(PSC) under the NELP regime permit the contractors 100% cost recovery from sale of oil and gas before sharing profit with the government; the cost recovery model provides an incentive to investors, especially in deep sea exploration activities, as it guarantees recovery of all sunk costs which is key to attracting oil majors with proprietary technology.

1.16 To incentivize new investments, the ministry of finance had introduced a seven-year tax holiday under provisions of the Income Tax Act, 1961 (IT Act) for E&P operators engaged in commercial production of mineral oil and natural gas. However, in Budget 2016, as a part of the government’s overall plan to reduce headline corporate tax rate from 30% to 25%, it is proposed to phase out this tax holiday for E&P operators in cases where commercial production commences on or after April 1, 2017.

1.17 To encourage participation from foreign oil field service contractors and ensure world class technology is brought to the Indian E&P sector, the IT Act provides for concessional tax regime for non-resident oil field service providers; eligible contractors are exonerated from the requirement of maintaining books of account to avoid undue hardship and costs.

1.18 With respect to pricing of gas, the Cabinet Committee of Economic Affairs (CCEA) approved a gas pricing policy in October 2014. The gas price was linked to US Henry Hub, UK NBP, Canadian Alberta hub and Russian domestic prices. However, the price derived on the basis of the notified formula is not an ‘arms-length’ price; 70% weightage has been accorded to gas prices in gas exporting countries /markets having a gas surplus, which is different from the Indian domestic gas scenario. CCEA also gave in-principle approval for a premium on price charged for gas to be produced from new discoveries from deep water, ultra-deep water and high pressure-high temperature areas.

1.19 Till date, 254 PSCs have been signed by the government in the nine NELP licensing rounds. However, commercial production could start in only three blocks and major gas discoveries have been mired in litigation and controversies.

Recent Developments

1.20 Hydrocarbon Exploration & Licensing Policy (HELP)

• To stimulate new exploration activity for oil, gas and other hydrocarbons, the union cabinet approved a new Hydrocarbon Exploration & Licensing Policy (HELP) in March 2016. As part of this change, the government proposed to make a policy shift from the extant production sharing contract (PSC) model, based on pre-tax investment multiple (PTIM) and cost recovery, to revenue sharing contract (RSC) model for licensing of hydrocarbon acreages. Under the new regime, the government will not be concerned with cost incurred by the explorer, and will instead receive a share of the gross revenues from the sale of oil, gas etc.

• Contracts will be based on ‘biddable revenue sharing’ wherein bidders would quote revenue share in their bids, forming a key parameter for selection of the winning bid. The bidder giving highest net present value of revenue share to the government, as per transparent methodology, would be preferred under such a parameter. As a step towards the RSC regime, the government launched a pilot in October 2015 wherein 69 idle oil and gas fields are proposed to be auctioned under the RSC model.

Other important features of HELP are as follows:

• Uniform licensing system is to be ushered in covering exploration and production of all hydrocarbons, i.e. oil, gas, coal bed methane etc. under a single license and policy framework.

• Open acreage licensing policy (OALP) will be implemented whereby a bidder can also apply to the government seeking exploration of

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any block, thereby not restricting exploration activity only to blocks put on tender by the government.

• Concessional royalty regime will be implemented for deep water and ultra-deep water areas; no royalty payable for the firstseven years and thereafter, a concessional royalty rate of 5% for deep water areas and 2% for ultra-deep water areas. For shallow water areas, royalty will be reduced from 10% to 7.5%.

• The contractor will have pricing and marketing freedom for domestically produced gas on arm’s length basis. The government’s share would be calculated based on the higher of prevailing international crude price or actual price.

The policy shift to RSC regime with a uniform licensing system and OALP is in line with recommendations put forward by EBG in last year’s edition.

1.21 Marketing and pricing freedom for new gas production from deep water, ultra-deep water and high pressure-high temperature areas

Finance Minister Arun Jaitley in his budget speech for 2016 has proposed to incentivize gas production from deep water, ultra-deep water and high pressure-high temperature areas, which are presently not being exploited on account of high costs and risks. The CCEA has recently approved a new policy wherein marketing freedom, including pricing freedom, will be given to the producer for all discoveries which are yet to commence commercial production as on January 1, 2016, and for all future discoveries in such difficult areas.

However, such pricing freedom would be subject to a ceiling price on the basis of landed price of alternative fuels. The ceiling price shall be calculated as the lowest of landed price of imported fuel oil, weighted average of import landed price of substitute fuels (namely coal, fuel oil and naphtha) or landed price of imported LNG.

The grant of marketing and pricing freedom for new gas production from difficult areas is

in line with recommendation put forward by EBG in last year’s edition.

1.22 Extension to PSCs for small, medium sized and discovered fields due to expire

In March 2016, the government rolled out the policy decision for granting extension to PSCs for small and medium sized discovered fields due to expire from year 2018 onwards, by a period of 10 years, or economic life of fields, whichever is earlier. The government will be entitled to a 10% higher share in profitpetroleum than the share calculated using normal provisions of the PSC during the extended period. Royalty and cess would be payable at prevailing rates and not at concessional rates stipulated in the PSC.

1.23 Oil for food scheme

To meet the country’s growing energy requirements, the government is considering a unique ‘oil for food’ scheme with oil rich countries involving possible swap of oil with food. Oil rich nations could invest/store oil in strategic oil storages in India with a right of first use on two-thirds of such oil remaining with India. In return, India could help to resolve food security problems by exporting food items to such nations. Talks have been initiated with the United Arab Emirates (UAE) in this regard.

The government in Budget 2016 has also proposed an exemption from income earned by foreign companies on account of storage of crude oil in a facility in India and sale of crude oil therefrom to any person resident in India, subject to satisfaction of prescribed conditions. This incentive is likely to encourage national and foreign oil companies to store their crude oil in India or build up strategic oil reserves; lending, as a result, price stability in oil prices.

1.24 Rationalization of oil industry development cess on domestic production of crude oil

In Budget 2016, the government has proposed to revise the Oil Industry Development Cess on production of crude from a flat rate of INR 4,500 (€59) per MT to 20% ad valorem. The

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proposed revision seeks to align the cess with falling international crude oil prices.

1.25 Re-alignment/rationalisation of indirect taxes/exemptions

The government has proposed to re-align/rationalise indirect taxes /exemptions in Budget 2016. The key proposals are as follows:

• Re-alignment of exemption from levy of basic customs duty (BCD) and countervailing duty (CVD) on import of equipment required for undertaking petroleum exploration under various licenses such as pre-NELP contracts, NELP contracts, Marginal Fields Policy and Coal Bed Methane Policy. The exemption is proposed to be unified under a single entry with unified set of conditions and list of goods. The scope of exemption is also proposed to be extended to all petroleum exploration licenses issued or renewed after April 1, 1998.

• Exemption from excise duty on capital goods and spares thereof, raw materials, handling equipment and consumables on clearance to a ship repair unit, for repair of ocean going vessels. ‘Ocean going vessels’ has been defined to include tugs, dredgers, oil rigs, drilling ships and jack up-rigs amongst other identifiedequipment.

• Rationalisation of BCD on import of all variety of coal, lignite and peat with rates being brought to 2.5% across varieties. This rate has been rationalised at 5% for certain other products such as coke and semi-coke of ‘coal, lignite and peat’.

Mid-stream and downstream (refining andmarketing)

1.26 The sector was opened up for FDI under automatic route in 2006.17 In relation to petroleum refining, in case of public sector undertakings (PSU), FDI up to 49% has been permitted18 under the automatic route, subject to not involving any divestment or dilution of domestic equity in existing PSUs.

FDI in petroleum and natural gas sector reached US$1.07 billion (€937 million) in 2014-15. However, FDI inflows have declined considerably since then accounting for US$48.69 million (€42.67 million) during the period April-November, 2015.19

1.27 FDI in marketing of transport fuels (petrol, diesel and aviation fuel) is also permitted20 subject to an investment of INR 20 billion (€296 million) in E&P, refining, pipelines or terminals.

The government is also working on a policy framework to grant marketing rights for CNG as transportation fuel to private firms; it is proposed to lower the threshold investment limit to INR 5 billion (€67.5 million) as against INR 20 billion (€263 million) (required for retail fuel stations) in the draft proposal.

1.28 In line with scaling demand for petroleum products, India’s refining capacity has also been scaled up. Total refining capacity in India increased from 187.4 MMTs (as on April 1, 2011) to 215.1 MMTs (up to February 2015), making it the second largest refiner in Asia after China. State-owned companies own and operate 60% of the refineries while the private sector owns and operates the remaining 40%. At present, India has 21 refineries

Petroleum demand, product-mix and progressive stringent quality norms are reinventing the refining sector. From a product slate perspective, refineries in India are designed to produce large quantities of middle distillates viz high-speed diesel (HSD), aviation turbine fuel (ATF) and ultra clean fuels that provide opportunities for reaping higher margins. Robust demand in Asia has led to new trade and opportunities for refiners in India.

1.29 India’s domestic petroleum product marketing is dominated by state-owned companies viz IOL, Bharat Petroleum, Hindustan Petroleum etc. Over the years, significant marketing infrastructure has been established in the country spanning product pipelines, retail outlets, terminals, depots and other marketing/ distribution networks.

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Presently, the retail outlet network is over 40,000.

1.30 The administered price mechanism for petroleum products was dismantled in 2002. In June 2010, petrol prices, both at the refinerygate and at the retail level, were made market determined though the government continued to exercise control to an extent. As diesel prices were deregulated with effect from October 2014, the government’s price control over the retail selling price of sensitive petroleum products is now limited to public distribution system (PDS) kerosene and domestic LPG.

With respect to subsidy on domestic LPG, the government has launched a direct benefittransfer (DBT) scheme instead of subsidizing cylinder prices. Also, a pilot project has been initiated for DBT scheme on kerosene subsidy.

1.31 In case of natural gas, the government has enacted a natural gas pipeline policy to promote competition. Moreover, the erstwhile Planning Commission proposed a roadmap to meet the demand for energy through safe, clean and convenient forms of energy at the least cost in a technically efficient,economically viable and environmentally sustainable manner in its report, Integrated Energy Policy, 2006.

1.32 In 2006, the Petroleum and Natural Gas Regulatory Board (PNGRB) was constituted

under the Petroleum and Natural Gas Regulatory Board Act, 2006 to provide regulatory oversight to the midstream and downstream sector comprising refining,processing, storage, transportation, distribution, marketing and sale of petroleum, petroleum products and natural gas. PNGRB endeavours to create a vibrant energy market to facilitate growth by encouraging investments into basic infrastructure and protecting consumer interests through promoting fair trade practices and competition amongst the entities.

1.33 Over next few years, India will accelerate to becoming a natural gas based economy, propelled with the discovery and development of offshore gas fields, and the expansion of the LNG terminals on the western and southern coast of India. Natural gas is already powering gas-fired turbines for power generation and feedstock for the fertilizer industry. Increased emphasis on clean and efficient energy has also given thrust to the demand for natural gas. India’s gas market is embarking on the next phase of accelerated growth, mainly driven by the reform initiatives across the gas value chain. By end of 2015, the demand for gas is estimated to increase to 381 million metric standard cubic metres per day (MMSCMD).

Sector 2009-10 2010-11 2011-12 2012-13 2013-14 2014-15

Power 67 88 150 185 212 234

Fertilizer 44 50 58 68 68 68

CGD 11 14 18 23 29 37

Pet-chem/ Rfnry 24 25 26 27 28 29

Sponge Iron 4 4 4 4 4 4

Total 147 179 253 306 341 381

Sector-wise estimates of demand for natural gas (in MMSCMD)

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The stage is gradually being set for piped natural gas to replace LPG as a fuel for households and for the development of CNG as a preferred fuel over petrol and HSD for city transportation. Over the next few years, it is estimated that city gas distribution networks could require investment of close to €39 billion. Further, an additional 15,000 km of gas pipeline will be developed using appropriate PPP models.

1.34 Moreover, the commerce and industry ministry permitted setting up of 16 bio gas-based and three coal-bed methane-based natural gas filling plants to encourage use of alternative fuel in the country.21 As per the ministry’s estimates, many such technologies could help energy intensity of India’s GDP growth by up to 1% per year.

1.35 IT Act provides for an investment linked deduction of 100% of capital expenditure incurred on laying and operating a cross country natural gas or crude or petroleum oil pipeline network for distribution including storage facilities, being an integral part of such network. Such a deduction is available in the year of commencement/incurrence of expenditure, as the case may be. This provision was introduced to give impetus for investments in gas pipeline infrastructure.

1.36 In Budget 2016, the government has proposed to increase excise duty rate on ATF from 8% to 14% except for ATF supplied to scheduled commuter airlines operating under the regional connectivity scheme. Also, it is proposed that the supply of gas through a pipeline would be deemed to be ‘inter-state supply’ for the purpose of Central Sales Tax Act, 1956 (CST Act) if the gas is transported from one state and taken out in another.

2. GENERIC INDUSTRY ISSUES2.1 The burden of under-recoveries on PDS

kerosene and domestic LPG is shared between the government and state-owned upstream companies. While the government compensates state-owned oil companies for

selling sensitive petroleum products below the international price, a similar compensation mechanism is not extended to private oil companies, thereby distorting the competitive environment.

2.2 Levy of minimum alternate tax (MAT) under the IT Act is a dampener for the industry as the obligation to pay MAT arises based on book profits even in the absence of taxable profits given the ability of the tax payer to set off unabsorbed tax losses.

3. KEY ISSUES AND RECOMMENDATIONS

3.1 Under recovery/high operating losses of private-run oil companies

Several private oil companies, including European companies, have invested heavily in marketing infrastructure. While state-owned oil companies are compensated for the under recoveries by the government by way of compensation and subsidy, there is no similar benefit extended to private companies

Recommendation

The government should provide a level-playing field to private oil companies by way of extending calibrated subsidies /compensation to recoup under-recovery of such private oil companies.

3.2 Taxation of oil-field contractors

Under the IT Act, non-resident oil field service contractors are eligible for a deemed basis of taxation (i.e. 10% of gross revenues is deemed as taxable income for the relevant financialyear). The deemed regime of taxation does away with the requirement of maintaining books of accounts and certain related tax compliances.

However, the tax authorities are deviating from the established positions and denying applicability of deemed basis of taxation to most categories of oilfield services other than drilling activities, leading to ambiguity and needless litigation.

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Recommendation

Whilst the Supreme Court of India in the case of ONGC22 has upheld applicability of section 44BB of the IT Act to all activities which are in relation to E&P activities, the government should resolve the dispute by clarifying the scope of deemed regime of taxation by way of a legislative amendment/administrative clarification to avoid litigation

3.3 Rationalization of MAT rate

The current MAT rate of ~ 20% on ‘book profits’acts as a significant deterrent in the overall investment decision-making for high-risk and capital intensive upstream operations. It is recommended that the government consider a moderate rate of MAT for E&P operations, considering the long gestation period of the industry.

3.4 Introduce investment-linked incentive under the IT Act

Vide Finance Bill 2016, the government has announced phasing out tax holiday provisions, including the one for upstream operations under Section 80-IB(9) of the IT Act. At the same time, the Finance Bill 2016 has proposed to extend investment-linked incentive in the form of 100% deduction of capital expenditure to businesses in the nature of developing and/or operating and maintaining infrastructure facility such as including roads, highway projects, water supply /treatment projects, port /airport projects, etc. under section 35AD of the IT Act.

The above investment linked tax deduction has not been proposed in respect of development costs incurred by E&P businesses, even though drilling and exploration costs are allowed to be deducted under Section 42 of the IT Act.

It is imperative to provide adequate fiscalincentive for stimulating private investments in the oil and gas industry. Towards this endeavour, the government may consider extending investment-linked incentive for all capital investments in E&P activities.

Recommendation

In view of the strategic importance of the sector, it is recommended that E&P projects should also be included within the ‘infrastructure facility’ eligible for investment-linked deduction in respect of development costs incurred in E&P operations.

3.5 Need for rationalization of indirect taxes

Consistent with the Make in India theme, the government should consider rolling out specific policy directions, including tax incentives, for dedicated manufacturing zones and clusters focused on oilfield services

Currently, services provided to specifiedinfrastructure projects are exempt from service tax. There is need to treat E&P at par with infrastructure projects; thus, service tax on services provided for E&P activities ought to be exempted or zero-rated. Further, licenses granted by the government for exploration of oil and gas should be clarified to not constitute a ‘service’. This is because exploration licenses granted by the government arise out of discharging a statutory function provided under the Oilfields (Regulation and Development) Act, 1948 rather than undertaking an activity for a consideration and thereby qualify as a ‘service’.

The government should provide for customs duty exemption for parts and raw materials imported for manufacture of goods to be supplied in connection with onshore E&P activities akin to those available for offshore operations.

Also, inclusion of natural gas /RLNG/ATF in the list of ‘declared goods’ under Section 14 of the CST Act would ensure that VAT rate on natural gas /RLNG /ATF is subject to a ceiling rate like coal and crude oil.

3.6 Goods and Services Tax (GST)

GST proposed to be introduced soon in the country would be the largest tax reform in the indirect tax regime subsuming various centre and state level taxes on goods and services. Identified oil and gas commodities such as motor spirit, HSD, ATF and natural gas are

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proposed to be kept out of GST initially. This would lead to increased input tax for this sector on account of GST laden input goods and services as well as capital equipment and dealing with two tax regimes simultaneously.

Recommendation

The government should provide for adequate provisions in law to allow credit of GST paid on inputs, services and capital goods so as to avoid cascading of taxes.

3.7 Ambiguity in contractual terms

Several private oil companies, including European companies, have invested in India’s E&P sector. While bidding for blocks, many promises are made by the government; however, these are differently interpreted by the government at different phases of investment. As a significant amount of capital is invested in the E&P sector, any ambiguity on contractual terms is detrimental to investor sentiment.

Recommendation

In order to promote broad based participation in bidding for E&P assets and overall investment climate, the government should review model contract documents to ensure that terms of bidding/contracts are unambiguous and appropriately understood by contractors at the tender stage itself.

3.8 Absence of single agency for multiple approvals

Multiple nodal agencies for approval/clearances such as environmental clearance, naval clearances etc. invariably cause delayed turnaround of projects and result in cost-overruns.

Recommendation

The government should make provisions for granting mandatory clearances at the pre-tender stage with a view to avoiding hardships for contractors post award of the contract/PSC. In this regard, the government has acted proactively and 56 blocks under the 10th round of NELP are proposed to be offered with all

necessary statutory clearances having been pre-obtained.

3.9 Lack of encouragement to use new /improved technologies

Use of knowledge-based technology is crucial for the growth of the oil and gas sector and the energy industry at large. However, these technologies are relatively newer and yet to find acceptance in the Indian context. Also, the development of LNG, floating storage and regasification unit (FSRU) and pipeline infrastructure requires high expertise during project execution and equipment selection. It is imperative, therefore, that the use of improvised knowledge based technologies is encouraged by means of recognizing the enhanced weightage of such technology and expertise in implementation of newer technologies as a mandatory bid qualifying criteria.

Recommendation

To fulfil the rapid and ever increasing demand for energy, there is growing requirement for innovative technology, use of cost-effective superior material that has a long life and vendors with experience in energy efficienttechnology.

Lack of acceptance by authorities for adopting technological advanced products acts as an impediment towards the development of this sector.

There is need to create a separate arm aimed at technology development under each energy authority that would assist in establishing industry standards, similar to KYC norms, for adopting advanced technological capabilities.

4. CONCLUSION The investment climate would be positive if

the private sector feels investment would be safe and free of disputes on a long-term basis. On the other hand, the government would feel comfortable relaxing rules and regulations if corporates could demonstrate the highest standards of efficiency in various deals.

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The government appears to have taken the first step in this direction by introducing a host of new policy measures to overhaul the regulatory landscape, particularly for upstream industry. The above steps also appear to support the Indian government initiatives viz

‘ease of doing business’ and Make in India. It is hoped that these policy measures, in combination with the ongoing reforms of the oil and gas sector being pursued by the government, yield desired visible results in the medium to long term.

Endnotes

1. International Monetary Fund data - http://www.imf.org/external/ pubs/ft/weo/2015/02/w e o d a t a / w e o r e p t . a s p x ? s y = 2 0 1 5 & e y = 2 0 1 5 & scsm=1&ssd=1&sort=country&ds=.&br=1&pr1.x=91&pr1.y=18&c=534&s=NGDPD%2CNGDPDPC%2CPPPGDP% 2CPPPPC&grp=0&a

2. World Bank Data - http://articles.economictimes.indiatimes.com/ 2014-04-30/news/49523310_1_capita-income-third-largest-economy-world-gdp

3. Chapter- State of the Economy: An Overview in Economic Survey 2015-16

4. BP Statistical Review of World Energy - June 2015

5. Source - http://www.makeinindia.com/sector/renewable-energy

6. Oil & Gas – India Brand Equity Foundation report, January 2016

7. As on July 11, 2015 reported by National Population Stabilisation Fund (NPSF), an autonomous body under the Union Health Ministry

8. Energy Statistics 2015 - Ministry of Statistics and Programme Implementation available at http://mospi.nic.in/Mospi_New/upload/Energy_stats_2015_26mar15.pdf

9. India Energy Outlook 2015, World Energy Outlook Special Report, International Energy Agency

10. Chapter – Industrial, Corporate and Infrastructure Performance in Economic Survey 2015-16

11. Indian Petroleum and Natural Gas Statistics 2014-15, Ministry of Petroleum and Natural Gas

12. Energy Statistics 2015 - Ministry of Statistics and Programme Implementation available at http://mospi.nic.in/Mospi_New/upload/Energy_stats_2015_26mar15.pdf

13. Indian Petroleum and Natural Gas Statistics 2014-15, Ministry of Petroleum and Natural Gas

14. Source: Petroleum Planning and Analysis Cell, Ministry of Petroleum and Natural Gas

15. Source: Petroleum Planning and Analysis Cell, Ministry of Petroleum and Natural Gas

16. Fact sheet on FDI (From April, 2000 to December, 2015) by Department of Industrial Policy and Promotion available at http://dipp.nic.in/English/Publications/FDI_Statistics/2015/FDI_FactSheet_OctoberNovemberDecember2015.pdf

17. Press Note no 4 (2006 Series) dated February 10, 2006

18. Press Note 6 (2013 series) dated August 22, 2013

19. Chapter – Industrial, Corporate and Infrastructure Performance in Economic Survey 2015-16

20. Resolution dated March 8, 2002 by Ministry Of Petroleum & Natural Gas published in the Official Gazette of Indi

21. S o u r c e : h t t p : / / e c o n o m i c t i m e s . i n d i a t i m e s .c o m / a r t i c l e s h o w / 4 6 7 1 8 7 0 2 . c m s ? u t m _source=contentof interest&utm_medium=text&utm_campaign=cppst

22. Oil & Natural Gas Corporation Ltd. vs Commissioner of Income-tax [(2015) 376 ITR 306 (SC)]

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POWERContribute policy (regulatory and fiscal)related thought leadership towards the government’s endeavor of achieving ‘energy security’ by developing sustainable, high growth and low-carbon emission based economic models and evolving technology-intensive renewable sources of energy.

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1. INTRODUCTION

Market Description1.1 Electricity is one of the critical infrastructure

pillars for the socio-economic development of any country. The electricity supply in India will need an exponential rise from the present levels to support the growth momentum of the country. The Indian power sector is expected to add to its total installed capacity, nearly 88.5 gigawatt (GW) during the period 2012-17 and 86.4 GW during 2017-20221. The sector has already added about 74.53 GW (84.19% of the target addition during 2012-17 as of January 2016) to the existing installed capacity2. FY15 saw the highest ever increase of 26.5 GW in generation capacity—compared to an average 19 GW over previous five years 3

1.2 India is the third largest producer of electricity in the world (after China and the United States)4. The generation during the year 2014-15 was 1048.67 billion units (BU) and nearly 1011 BU in the year 2015-16 (up to February 2016)5. The size of short-term market for electricity in India was 98.99 billion units during the year 2014-156.

India’s electricity consumption increased from 881,562 gigawatt hour (GWh) in the year 2013-14 to 938,823 GWh in the year 2014-15, an increase of around 6.5%. However, due to India’s high population base and deficit in installed capacity and generation, per capita consumption of electricity was around 1,010 kilowatt hour during the year 2014-15, one of the lowest in the world.7

1.3 The power sector has also been one of the key sectors attracting substantial foreign direct investments (FDI). The sector received US$650 million (€585 million) in the year 2015-16 (up to December 2015). Cumulative FDI inflows since 2000 up to December 2015 have been around US$10.25 billion (€9.23 billion Euros, 3.69% of total FDI inflows) 8 Although

the power sector is not a major contributor to the exchequer by way of taxes, this industry is a major employment generator both in the public and private sector, directly and indirectly.

1.4 The government had revised its targets for installed renewable energy capacity to 175 GW by 2022, comprising 100 GW from solar, 60 GW from wind, 10 GW from biomass and 5 GW from small hydro power. The installed capacity in FY16 (as on January 31, 2016) has reached 5.2 GW from solar power, 25.18 GW from wind power, 4.76 GW from bio-power and 4.18 GW from small hydro power9.

1.5 Nuclear power for civilian use is well established in India and has been a priority since independence. The Indian nuclear programme for production of power has been an indigenous effort. It is strategically important to develop core capabilities in critical areas to reduce vulnerabilities to external pressures. India is the only country in the world that has accorded high priority to the use of all three main fissionable materials, U-235, plutonium and U-233 in order to meet the challenge of reaching independence through deployment of domestic nuclear resource.

Generation1.6 India’s installed generation capacity stands

at 288.665 GW as of February 2016. Thermal based power plants account for 69.76% of the total installed generation capacity. Of this, coal based generation capacity accounts for 60.92%, gas 8.49% and oil 0.34%. Hydro based generation accounts for 14.79% and nuclear for 2% of the total installed generation capacity. Other renewable energy sources account for 13.45% of the total installed generation capacity. Approximately, 40% of the installed capacity is owned by the private

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sector and balance 60% by central and state government utilities.10

1.7 Electricity generation by utilities in India exceeded the target of 1023 BU to achieve 1048.67 BU during the year 2014-15, registering a year on year growth of 8.4%. During the year 2015-16 (up to December 2015), electricity generation reached 829.85 BU, at a growth rate of 4.4%. Out of the aforesaid, thermal generation has the major share of 694.83 BU. The share of hydroelectric generation is 102.15 BU, nuclear generation 27.75 BU and import from Bhutan 5.12 BU.11

1.8 Demand for electricity was 1,068,923 million units (MU) during the year 2014-15; during the year 2015-16 (up to February 2016) it was 1,017,954 MU. Availability during 2014-15 was 1,030,785 and 995,981 MU during 2015-16 (up to February 2016. Whilst the deficit has decreased from 3.6% in 2014-15 to 2.2% in 2015-16, supply needs to increase further and at a greater pace to match growing demand from economic growth, increasing urbanization and rural electrification

Peak demand for power has increased from 141,160 megawatt (MW) during the year 2014-15 to 148,463 MW during 2015-16; peak deficit was estimated at 3.2% in the year 2015-16.12

Transmission and distribution1.9 India’s capacity of transmission system of

220 kilovolt (KV) and above voltage levels as on February 29, 2016 was 339,158 circuit kilometre (ckm) of transmission lines. Further, as on the same date, the total transmission capacity of inter-regional links is 57,450 MW, which is expected to be increased to 68,050 MW by the end of FY17.13 Almost 100% of transmission facility and 87% of distribution facility in India is owned by the public sector. In order to enable greater private participation, in recent years, a number of transmission projects in different regions have been awarded to private bidders under a specifiedscheme. Also, privatization of distribution is being attempted by way of sale of government

owned distribution licensees and through the appointment of private distribution franchisees in select states.

Recent Developments1.10 Regulatory institutions have made significant

developments in the Indian power sector. Rationalization of tariff, opening up of market for private participation, distribution franchisees, captive coal block allotment, power exchanges are among developments which have resulted in re-emergence of the sector.

1.11 In November 2015, the government formulated and launched the Ujwal DISCOM Assurance Yojana (UDAY) to improve health and performance of the state electricity distribution companies (DISCOMs). UDAY seeks to turnaround the financial and operational condition of DISCOMs and provide a sustainable solution to the problem of accumulating losses and debt overhang.

The scheme envisages improvement of their operational efficiencies by compulsory smart metering, upgradation of transformers etc. and reduction of cost of power through increased supply of cheaper domestic coal. The scheme also aims at reduction in interest cost and enforcement of financial discipline through alignment with state finances. Under the UDAY scheme, states shall take over 75% of DISCOM debt as on September 30, 2015 over two years, 50% in 2015-16 and 25% in 2016-17, thereby reducing the interest cost on debt taken over by states to nearly 9% from 15%. This debt taken over by states will not be included while calculating fiscal deficit of respective states in financial years 2015-16 and 2016-17.

Presently, the UDAY scheme has nearly covered 90% of the total DISCOM debt of around INR 4.3 trillion (€57.33 billion), in terms of in-principle approvals and state cabinet approvals; nine states have signed on to the scheme14.

1.12 The government has initiated the ‘Power for All’ scheme with the objective of providing 24x7

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power across the country by 2019. The joint initiative of the central and state governments aims to provide uninterrupted and continuous power supply to all households, industry, commercial businesses, public needs, any other electricity consuming entity and adequate power to agriculture farm holdings. Presently, 18 states have signed up for the scheme15.

1.13 Further, the government has taken the following major initiatives to achieve its objective to making available ‘24x7 Power for all’:

• Deendayal Upadhyaya Gram Jyoti Yojana (DDUGJY): The government launched the DDUGJY scheme in July 2015 enabling power sector reforms in the rural areas. The scheme envisages electrificationof all villages, metering of unmetered connections and separation of feeders and improvement of sub-transmission and distribution network. In his budget speech for 2016, Finance Minister Arun Jaitley committed to 100% village electrification by May 1, 2018.

• Integrated Power Development Scheme (IPDS): The scheme was launched by the government in December 2014. It envisages strengthening of sub-transmission and distribution network in urban areas, metering of distribution transformers/feeders/consumers in urban areas and IT enablement of the distribution sector as well as strengthening of the distribution network.

• Budget 2016 has proposed an allocation of INR 85 billion (€1.1 billion) for DDUGJY and IPDS schemes.

• National LED Programme: The government launched the National LED Programme in 100 cities in January 2015 with the aim of promoting use of the most efficient lighting technology at affordable rates. The programme comprises (a) Domestic Efficient Lighting Programme (DELP) aiming to replace 77 crore incandescent light bulbs with LED bulbs by providing them to domestic consumers at concessional rates; the government has already distributed over 8 crore LED bulbs16 (b) Street Lighting National

Programme (SLNP) aiming to replace 3.5 crore conventional streetlights with energy efficient LED streetlights by March 2019. The scheme is expected to result in considerable energy savings and lower greenhouse gas emissions.

• North Eastern Region Power System Improvement Project (NERPSIP): The government approved NERPSIP for strengthening intra-state transmission and distribution system in the north eastern states through enhancement in access of consumers to grid connected power supply.

1.14 The union cabinet recently approved the National Tariff Policy, 2016 making comprehensive amendments to the National Tariff Policy, 2006. Significant changes have been proposed with respect to renewable energy, including higher renewable power obligation (RPO) from solar energy, provisions for renewable generation obligation (RGO) and development of transmission projects through competitive bidding process. Further, the revised cross-subsidy surcharge formula should help encourage open access to a large extent.

1.15 The government has approved the establishment of the National Smart Grid Mission (NSGM) in the power sector to plan and monitor implementation of policies and programmes related to smart grid activities in India.

1.16 The proposed amendments to the Electricity Act 2003 vide the revised Electricity Amendment Bill will usher in much needed reforms in the power sector and will also promote competition, efficiency in operations and improvement in quality of supply of electricity in the country resulting in capacity addition.

1.17 There have been several developments in the renewable energy space as well. India has launched the International Solar Alliance (ISA), a coalition of 121 solar resource-rich countries, to address energy needs and common concerns. It has also initiated several programmes, including implementation of

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grid-connected solar rooftop systems over a period of five years up to FY20 under the National Solar Mission (NSM), setting up of 25 solar parks and ultra mega solar power projects with an aggregate capacity of 20 GW in the next five years, approval of 56 solar city projects and the viability gap funding scheme for setting up solar power projects by offering project developers capital cost support17.

1.18 A comprehensive revised framework for External Commercial Borrowings 18(ECB) was announced by the Reserve Bank of India (RBI) vide Circular 32 dated November 30, 2015. The RBI has allowed infrastructure companies (including power companies) to access long-term foreign currency denominated ECB with maturity of 10 years (Track II) and Indian rupee-denominated ECB with average maturity of three to five years (Track III). This enables Indian power companies to access international markets for raising long term capital.

1.19 In the budget speech for 2016, the government stated the need to diversify sources of power generation for long term stability. In this regard, the government is drawing up a comprehensive plan for the next 15-20 years, to augment investment in nuclear power generation. A budgetary allocation up to INR 3,000 crore (€394.7 million) per annum along with public sector investments will be leveraged to facilitate required investment for this purpose.

1.20 In Finance Bill, 2016, the government has proposed to extend the benefits of additional depreciation under section 32(1)(iia) of the Income-tax Act, 1961 to assessees engaged in the business of transmission of power. Benefit of 20% additional depreciation would be available to assessees engaged in the business of generation, distribution or transmission of power in respect of cost of new plant or machinery acquired and installed during the previous year.

1.21 Currently, undertakings engaged in generation or generation and distribution of power or transmission/distribution of power by laying

new transmission or distribution lines (including substantial renovation/ modernization) are entitled to a 10-year tax holiday if they begin stipulated activities on or before March 31, 2017. While a tax holiday is available to an undertaking for the aforementioned businesses, such an undertaking is liable to pay minimum alternate tax (MAT) at 18.5% (plus applicable surcharge and cess) on ‘book profits’ during the tax holiday period. Power projects are typically funded through a mix of debt and equity. Equity being the most common funding source, the distribution of profits emerging from the business is liable to dividend distribution tax at the effective rate of 20.357%.

In Budget 2016, the government rolled out the roadmap for phasing out tax incentives as a part of its overall plan to reduce the headline corporate tax rate from 30% to 25%. The sunset date of March 31, 2017 for commencement of activities to claim tax holiday under section 80-IA of the IT Act has not been extended further. Therefore, the eligible undertakings shall be entitled to tax holiday under section 80-IA of the IT Act only if such undertakings begin to generate power on or before March 31, 2017.

1.22 On the indirect taxes front, Budget 2016 largely focused on rationalization and re-alignment of incentives rather than granting new ones for boosting the power sector. Wind and hydropower projects are still left unattended in the budget announcements and continue to lag behind their solar power counterparts in terms of indirect tax incentives. Further, the following proposals were made in Budget 2016:

• Clean energy cess has been renamed Clean Environment Cess and the rate stands increased from INR 200 per metric tonne to INR 400 (€2.6) per metric tonne. This increase will make the use of coal as a fuel an expensive alternative and would help the government to fund its initiatives for a clean India. Service tax has been introduced on ocean freight and this is likely to increase the cost of importation of coal.

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• Rationalization of basic customs duty (BCD) on import of all variety of coal, lignite and peat with rates being brought to 2.5% across varieties. This rate has been rationalised at 5% for certain other products such as coke and semi-coke of ‘coal, lignite and peat’.

• Excise duty exemption presently available to ‘solar lanterns’ to be extended to ‘solar lamps’.

• Solar tempered glass or solar tempered (anti-reflective coated) glass used in manufacture of solar cells/panels/modules would now attract a concessional rate of BCD of 5% as against the present rate of 10%. Further, BCD on industrial solar water heater has been increased from 7.5% to 10%.

1.23 The government has also proposed to introduce a Krishi Kalyan cess of 0.5% on all or some taxable services to be effective from June 1, 2016. However, in the absence of any output liability for payment of the Krishi Kalyan cess, the cess paid on the input leg would result in increased cost for power companies. Additionally, in the union budget presented for the year 2015, the government had proposed to levy a cess called Swachh Bharat (Clean India) (SBC) on all or some taxable services. The government has notified November 15, 2015 as the effective date for the imposition of SBC. The rate of cess has been specifiedat 0.5%.

1.24 As a result of these two cesses, the effective rate of service tax would increase to 15%. This will have a dampening impact on upcoming power projects with increase in cost on procurement of essential services such as erection, commissioning or installation services, commercial or industrial construction services, works contract/EPC (engineering, procurement and construction) services, mining of mineral services, consulting and engineering services, procurement services and O&M (operation and maintenance) services.

2. GENERIC INDUSTRY ISSUES2.1 Although various significant steps have

already been taken in this direction, there are several areas such as management of cross subsidies, cross subsidy surcharges, open access, global transmission tariff, commercial revival of state electricity boards and proper management of grids where more thrust may be needed.

2.2 Also, historically, this sector has faced a number of challenges relating to project execution, fuel security issues, financing, etc. Equipment shortage has been a critical cause for missing the targets in the past. Shortages have been primarily on account of both supply of core components of boiler, turbines, generators (BTG), as well as balance of plants (BoP). Besides, there has been shortage of supply in construction equipment as well.

2.3 Challenges for power institutions like political interference and structure of institutions, particularly lack of unbundling, lack of corporate governance, power theft and inability of distribution companies to collect revenues also add burden on the power sector.

2.4 Financing power projects is presently a challenge for developers given the high financial stakes involved. As a result, this sector continues to be affected by way of shortfalls – both in generation and transmission capacity.

The Indian power sector is highly leveraged – as high as 70-80% -- and continues to struggle for funds. As mentioned earlier, financingpower projects is perennially constrained for developers given the long-gestation period of projects and the high financial stakes involved. Given the high exposure of banks in this sector and the sectoral cap on lending by domestic financial institutions, financingpower projects has been an impediment. Indian power companies have been exploring opportunities of borrowing overseas funds for their projects.

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3. KEY ISSUES AND RECOMMENDATIONS

3.1 Procurement of power from renewable sources through competitive bidding

Tariff Policy 2016 provides that states shall endeavour to procure power from renewable energy sources through competitive bidding (except in case of ‘waste to energy’ plants) in order to keep the tariff low. In the process of lowering tariffs, the prices quoted under competitive bidding are sometimes not sustainable and hence not bankable. Also, the award process through competitive bidding is uncertain and time consuming.

Recommendation

Keeping in mind the government’s ambitious targets of renewable energy installed capacity by 2022, it is recommended that renewable energy projects be awarded on feed-in-tariff mechanism based on cost of generation instead of competitive bidding. Feed-in-tariff will offer price certainty and award long-term contracts to power generators which would accelerate investments in renewable energy resources.

3.2 Implementation of new technologies

While CO2 emissions are unavoidable when using coal-fired power generation for electricity due to its nature as a fossil fuel, it is imperative to use and adopt new environmentally sensitive technologies in India that will lead to maximum efficiency and reduce emission of harmful gases and toxics, including mercury emissions. India has committed to reducing its carbon emissions at the UN Climate Change Conference held in Paris in 2015 as a part of its Intended Nationally Determined Contributions (INDC) goals. The Ministry of Environment, Forest and Climate Change has introduced clear guidelines into the law on allowable emission standards for sulphur oxide/nitrogen oxide/mercury from coal fired utilities. The guidelines provide for specific measurable emissions norms for all super-critical and sub-critical power plants going into generation from 2017 onwards, in line with MATS (mercury and air toxic standards) in

the US and norms being promulgated in China. For all fossil fuel burning electricity generating plants, incentives are provided to encourage use of emission capturing equipment and processes, including use of activated carbon to reduce mercury and other toxic emissions.

European companies are well equipped to provide cutting edge know-how to electricity generation businesses in India to meet this critical objective.

Recommendation

Innovative new technologies such as super-critical, ultra-supercritical, and even solar-thermal in the thermal power sector and high concrete dams, special tunnels, tidal power and offshore wind power projects in the renewable sector have demonstrated high efficiencies worldwide. Their proper implementation is vital in achieving the maximum efficiency from the project.

3.3 Rationalization of MAT rateThe current MAT rate of ~ 20% on ‘book profits’ acts as a significant deterrent in the overall investment decision-making for high-risk and capital intensive operations. It is recommended that the government may consider a moderate rate of MAT for power generation businesses to incentivize power generation in the country.

3.4 Introduce investment-linked incentive under the IT Act

The government has not sought to extend the sunset date of March 31, 2017 for commencement of activities to claim a tax holiday under section 80-IA of the IT Act available to eligible undertakings in the power sector. Further, vide Finance Bill 2016, the government has announced the roadmap for phase-out of incentives available under the IT Act; accelerated depreciation available to power businesses at the rate of 80% in respect of certain block of assets is proposed to be restricted to 40% with effect from April 1, 2017.

At the same time, Finance Bill 2016 has proposed to extend investment-linked incentive, in the form of 100% deduction of capital expenditure, to businesses in the nature of developing and /or operating and maintaining an infrastructure facility, including roads,

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highway projects, water supply/treatment projects, port/airport projects, etc. under Section 35AD of the IT Act. However, such investment linked deduction has not been proposed in respect of capital costs incurred by power businesses.

It is imperative to provide for adequate fiscal incentive so as to stimulate private investments in the power industry. Towards this endeavour, the government may consider extending investment-linked incentive for all capital investments by power businesses.

Recommendations

In view of the government’s target of Power for All by 2019, it is recommended that accelerated depreciation rate of 80% be continued for specified block of assets. Alternatively, the government may consider including power operations within the definition of ‘infrastructure facility’ eligible for investment-linked deduction in respect of capital costs incurred under Section 35AD of the IT Act.

3.5 Role of recognized technical expert is not adequately emphasized in optimizing project costs

Need for knowledge based technology and new technologies mentioned above are most crucial for the growth of the Indian power sector. However, these technologies are comparatively new to be adopted in Indian scenario, and require high expertise during project execution and equipment selection.

A consultant with global experience brings in proven expertise to the project and is loaded with decades of experience to guide the developer on various options for state of the art, energy efficient and reliable technology. Our public purchase guidelines need to be moderated to encourage and incentivize best practices and top of the line know how.

Recommendations

The role of consultants should be properly positioned as the ‘think-tank’ as they play an important role in optimizing cost of the project. So far, the contribution of a quality technical consultant with global experience is not being recognized by the government /developer.

The government should select consultants based on technical expertise and international experience and

on the basis of contribution to the ‘net value add’ to the project.

3.6 Need for adequate fiscalincentives for encouraging financing of power project

The government has announced significant capacity addition in the power sector, especially in the area of renewable space (175 GW). One key challenge for the sector, however, shall be to achieve required financingof new projects. Whilst the Indian power sector is highly leveraged, project developers continue to explore opportunities of borrowing overseas funds. Requirement of tax withholding leads to increase in cost of borrowing and thereby the cost of project.

Separately, European companies continue to be one of the key suppliers of equipment, technology, and erection, commissioning or installation service, commercial or industrial construction services, works contract/EPC services, consulting engineering services procurement services, O&M services, etc. Under the extant law, there is no specific exemption under service tax for power projects and/or EPC and related activities. Given that power projects do not have a service tax liability on the output side, levy of service tax on the above input services is to be borne by project owner, thereby increasing the overall project cost.

Recommendations

• Provide for lower tax withholding rate in respect of interest payments on rupee denominated bonds floated overseas (hereinafter referred to as masala bonds) by Indian borrower company/body corporate and subscribed to by non-resident lenders.

The RBI, vide Circular No 17 dated September 29, 2015, has permitted any corporate/body corporate (including Real Estate Investment Trusts and Infrastructure Investment Trusts) to issue masala bonds, to be subscribed by eligible non-resident investors. Subsequently, vide press release dated October 29, 2015, CBDT clarified the applicability of concessional tax rate of 5% on rupee denominated bonds for non-residents. However, in the recently introduced Finance Bill 2016, no provision

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enabling the applicability of lower withholding tax rate of 5% on interest payments was proposed. It is therefore recommended that appropriate enabling provisions be legislated in the IT Act to permit lower tax withholding rate in respect of interest payment on masala bonds.

• Ensuring that incidence of indirect taxes flows

seamlessly across the value chain by creating a mechanism which allows a refund of all non-creditable indirect taxes in the hands of the power project owner, particularly to mitigate the cascading effect of indirect taxes for project owner in the absence of indirect tax liability on output side, i.e. sale/supply of electricity.

Endnotes

1. Source: http://www.makeinindia.com/sector/thermal-power

2. Executive Summary - Power Sector, January 2016 – Central Electricity Authority (CEA), Ministry of Power

3. Chapter – Powering “One India” in the Economic Survey 2015-16

4. BP Statistical Review of World Energy, June 2015 - Electricity

5. Source: Power Sector at a Glance ALL INDIA available at website of Ministry of Power (http://powermin.nic.in/power-sector-glance-all-india)

6. Report on Short-term Power Market in India: 2014-15, Central Electricity Regulatory Commission

7. Growth of Electricity sector in India from 1947-2015, CEA, Ministry of Power – April 2015

8. Fact sheet on FDI (From April 2000 to December 2015) by Department of Industrial Policy and Promotion available at http://dipp.nic.in/English/Publications/FDI_Statistics/2015/FDI_FactSheet_OctoberNovemberDecember2015.pdf

9. Source: Data available at website of Ministry of New and Renewable Energy

10. Source: Power Sector at a Glance ALL INDIA available at website of Ministry of Power (http://powermin.nic.in/power-sector-glance-all-india)

11. Chapter – Industrial, Corporate and Infrastructure Performance in the Economic Survey 2015-16

12. Source: Power Sector at a Glance ALL INDIA available at website of Ministry of Power (http://powermin.nic.in/power-sector-glance-all-india); data for 2015-16 is provisional up to February 2016

13. Source: Overview of Transmission, website of Ministry of Power (http://powermin.nic.in/overview-1)

14. Source: http://www.livemint.com/Politics /7pKwAJCjhMZjqqLZxidSDN/ UDAY-is-a-game-changer-Piyush-Goyal.html

15. Source: Ministry of Power (http://powermin.nic.in/Power-All)

16. As on March 21, 2016; Source: http://www.delp.in/

17. Chapter – Industrial, Corporate and Infrastructure Performance in the Economic Survey 2015-16

18. AP (DIR Series) Circular No 32 dated November 30, 2015

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REAL ESTATEGrant the sector infrastructure status, provide for single window clearances, reduce delays in according approvals along with other structural changes towards clear title and higher FSI.

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1.1 Market DescriptionThe Indian economy has shown green shoots of recovery in the last few quarters, boosting investor sentiments. With the government’s continued focus on initiatives such as Make in India, Digital India, Smart Cities and continued efforts to improve the Ease of Doing Business in India, the economy is set to witness an increase in investments and growth in the near term. Budget 2016 has proposals to further strengthen the path of economic recovery, with increased investments of €32 billion (INR2,310 billion) in roads, highways, railways, ports and airports.

The country’s real estate industry has grown at more than 8% since FY12; however, the growth rates have slowed down significantly in the last few years — growth rates of 4.4% in FY15 and 3.7% in FY16 — due to weakening of both domestic and global growth1. Although the office segment recorded high leasing — at 38 million square feet (msf) — in 2015, residential continues to witness high inventory.2 The industry is reeling with multiple challenges. Some of the major factors plaguing the sectors are higher finance cost, increase in unsold inventory, increasing cost of raw material, reduction in margin pressure, and strict regulatory environment. The prices in various cities are resilient; however, prices have dropped in select cities. The Indian real estate market is progressing well in the recovery mode and the long term fundamentals look promising.

With the recent announcements of DDT being removed on REITs in the FY16 budget, several REITs/ InVITs are expected to be listed in near term which shall provide much needed liquidity to the sector. With several big ticket schemes such as Housing for All and Smart Cities, along with positive measures on easing FDI norms for construction, reforms in affordable housing, the sector is witnessing growth opportunities.

The Real Estate Regulation and Development Bill has been passed in Parliament, and the government is expected to drive further reforms and regulations,

including GST, speedier project approvals and liberalized FSI norms. With a 3.5% fiscal target, RBI has headroom to lower the interest rates, which would benefit the housing industry directly by triggering recovery and fuelling growth.

In FY16 (April to October), construction (infrastructure activities and townships, housing, built-up infrastructure and construction-development projects) received higher FDI equity inflows of €1.04 billion (US$1.15 billion) as compared to €1.5 billion (US$1.64 billion) in FY15. As a major initiative, the government relaxed FDI policy by removing minimum area and capital requirements3. Although the majority of the investment is currently,in the form of debt, renewed optimism in the international investor community regarding India is expected to further increase FDI equity inflows in the next few years.

1.2 Rising UrbanizationAccording to the 2011 census, 377 million people in India reside in urban areas (31 out of every 100 people in the country).4 As the economy, India’s urban centres will continue to grow and develop. By 2040, an estimated 40% of the country’s population is expected to live in urban areas.5 This massive urbanization would create huge demand for housing and also for other segments of real estate. Moreover, India has a working population (aged 15 to 64 years) of more than 750 million (65% of the population), which is expected to create demand for housing and retail in the coming years.

1.3 Policy support and measures: The government of India and the Reserve Bank of India have come out with several policies and measures to support the demand of real estate.

1. The RBI reduced the statutory liquidity ratio (SLR) by 0.50% to 21.50% in February 2015 and further eased the policy repo rate during

1. INTRODUCTION

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the year to 6.75%, in all making a substantial cut of 125 basis points (bps) between January and September 2015.

2. The government has significantly relaxed the FDI policy for construction development sector.

3. The risk weight for individual housing loans of up to €104,250 (INR 7.5 million) has been reduced from 50% to 35% for banks and housing finan e companies. Further, the loan-to-value ratio has been increased to 90% for loans up to €41,700 (INR 3.0 million).

4. The FY16 Budget has proposed exemption from DDT on distributions made by a special purpose vehicle (SPV) to business trusts, i.e., REITs and InvITs.

5. In the FY16 Budget, the finance minister has proposed 100% deduction of profits for an assessee engaged in developing and building affordable housing projects, subject to certain conditions.

6. The budget also provides for service tax exemption for civil work related to the rehabilitation of existing slum dwellers using land as a resource through private participation. It also has exemptions for low cost houses up to a carpet area of 60 sq. m. under the affordable housing project Housing for All (Urban) Mission/Pradhan Mantri Awas Yojana (PMAY) or any housing scheme of a state government.

1.4 Services sector robust while manufacturing moving ahead:

The services sector has been a major and vital driving force in the economy in the last decade. It has been instrumental in driving India through the turbulent years of economic crisis. According to advance estimates, the services sector recorded 9.2% growth in FY16, which is marginally lower than the FY15 growth but still robust. As per the economic survey, the manufacturing sector has grown by 9.5% in FY16 (advance estimates)6 ; with the government’s focus on Make in India, demand for real estate is expected to increase.

1.5 Government initiatives in improving urban infrastructure:

The quality of urban infrastructure defines a city as well as enables the demand of real estate in the city. Realizing the importance of urban infrastructure, the previous government had initiated the €5.3 billion (INR 380 billion) JNNURM (Jawaharlal Nehru National Urban Renewal Mission) scheme, which focused on upgrading India’s urban centres through a reform-driven, fast track, planned development for identifiedcities. The current government has laid impetus on improving urban infrastructure and committed an investment of €55.6 billion (INR 4,000 billion) under the Atal Mission for Rejuvenation and Urban Transformation (AMRUT), Smart City Mission and for the construction of 20 million houses for urban poor under PMAY (Urban)7.

2. RECENT DEVELOPMENTS

2.1 Liberalisation of Foreign Direct Investment Policy for construction development

Investor friendly FDI policy for construction and development sector in India can induce significantinflows of foreign capital to achieve higher growth and activity levels in the construction development sector and further support stimulate and sustain other interlinked sectors.

To encourage the development of smart cities and in line with its socio objective of Housing for All by 2022, the government of India has relaxed selected norms of the FDI policy for construction development8:

• Conditions with respect to development of minimum area and minimum capitalization have been removed.

• Each phase of FDI-funded construction development project will be considered as a separate project.

• The investor can exit the project on completion of the project or after development of trunk infrastructure, i.e., roads, water supply, street lighting, drainage and sewerage.

• A foreign investor is permitted to exit and repatriate foreign investment before

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completion of project under automatic route, provided a lock-in period of three years in respect of each tranche of foreign investment has been completed. Such lock-in is not applicable to hotel and tourist resorts, hospitals, special economic zone, educational institutions, old age homes and investment by NRIs.

• Transfer of stake from one non-resident investor to another non-resident, in case of no repatriation of funds, has been permitted under automatic route. However, repatriation before completion of trunk infrastructure is permitted provided a lock-in period of 3 years has been completed.

• The Indian investee company can sell only developed plots. Developed plots shall mean plots where trunk infrastructure has been made available.

• Investor’s responsibility for obtaining all regulatory permission by the investor has been dropped and only the Indian investee company has been held responsible. The condition of development of 50% of project within 5 years from the date of commencement has also been waived.

• 100% FDI under automatic route is permitted in completed projects for operation and management of townships, malls/shopping complexes and business centres as long as they do not get into the realm of the real estate business. Subsequent transfer of shares of investee company from residents to non-residents is also permitted. However, a lock-in period of three years is applicable to such investments. Also, transfer of immovable property is not permissible during this period of three years for investment in completed projects; and

• It has been clarified that leasing of property shall not qualify as real estate business.

The aforesaid changes made by the government should provide an impetus to foreign investments in the sector. This will also improve liquidity, since these relaxations will cover more projects and will provide developers an alternate source of financing

2.2 Real Estate Regulation and Development Bill

The Bill has been passed by both the houses and is waiting for the president’s assent. Although it seems to be applicable on both new projects and under-construction projects, more clarification is needed9. It is valid for projects of size more than 500 sq. m. or project with more than eight apartments. The Bill also covers commercial projects. Its major focus is on protection of the rights of the buyers along with making the industry more transparent. Key features of the Bill are as follows10:

• It provides for setting up of an apex body to regulate real estate activity in the country. Each state would have its own real estate regulator within one year.

• Builders have to deposit 70% of the amount collected from buyers in an escrow account, which can only be used for the earmarked project. In case of delays in project completion, builders have to pay the same interest rate as buyers do in case of delays in their payments.

• Approvals from local authorities and registration with the regulator disclosing project information would be mandatory for launching projects.

• The Bill also provides for arranging insurance of land title, which should benefit both the developer and the buyer.

• Any changes to the original plan can be done only after written consent from at least two-thirds of the buyers.

• In case of disputes, the regulatory authorities have to dispose of complaints in 60 days.

• In case of violations of the orders of the tribunal, the Bill provides for monetary penalties as well as imprisonment of buyers, promoters and real estate agents.

Currently, the Bill does not talk about delay of approvals by multiple authorities. However, it is expected to improve transparency and accountability in the industry and provide much-needed confidenceto buyers and investors. The Bill should transform the industry and make it an attractive asset class for both domestic and foreign investors.

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2.3 Funds entering stressed assets in real estate

With the RBI pushing state-owned banks to reduce exposure to stressed or restructured debts, several domestic and foreign funds are eyeing this space. Deals are already happening in several other industries such as renewables, road, power and retail, and with slowdown in sales in real estate, several developers are under stress and even at the brink of defaulting payments. These may provide opportunity for specific funds looking for stressed assets in the realty space/ as well as non banking finance companies (NBFCs)

2.4 Affordable housingThe government has placed strong emphasis on affordable housing in India. It has announced its vision of Housing for all by 2022, which would mark 75 years of India’s independence. According to the Ministry of Housing and Urban Poverty Alleviation (MHUPA), the housing shortage in urban India has been estimated at 18.78 million. The shortage is heavily skewed towards economically weaker sections (EWS) and lower income categories11. Continuing the reforms and measures from the last budget, this year’s budget has addressed the affordability issue through a number of policy initiatives:

• Affordable housing has been planned to be a part of core infrastructure of the smart cities, especially for the poor.

• The budget has provided additional deduction of interest under section 80EE from €1,390 (INR 100,000) to €2,085 (INR 150,000) with the following primary conditions:

• The loan has to be sanctioned for the period April 1, 2016 to March 31, 2017.

• The loan should not exceed €48,650 (INR 3.5 million) and the value of the house should not exceed €69,500 (INR 5.0 million).

• This deduction should be over and above the limit of €2,780 (INR 200,000) provided for a self-occupied property under Section 24 of the Act.

• To incentivize affordable housing and to meet the larger objective of Housing for all

by 2022, the finance minister has proposed 100% deduction of profits of an assessee engaged in developing and building affordable housing projects, subject to certain conditions. This is expected to improve the margins of developers as well as attract domestic and foreign investment due to increase in IRR. Some primary conditions are as follows:

• The project should be approved by March 31, 2019.

The project should be completed within three years of the date of approval.

• Commercial establishments in the project should not exceed 3% of the aggregate built-up area.

• The upper limit of the size of the units is 30 and 60 sq. m. for metros (within cities or within 25 km of the municipal limits) and non-metros, respectively.

• The minimum size of the plot should be 1,000 sq. ft. and 2,000 sq. ft. for metros and non-metros, respectively

With sales of premium and upper scale housing slowing, several reputed developers have entered the mid-income and affordable housing segment. The relaxations in the budget should help attract developers into this segment.

2.5 REIT The Securities and Exchange Board of India (SEBI) approved the setting up of REITs in India in August 2014. As per SEBI regulations, REITs should have a minimum investment of €69.5 million (INR 5.0 billion)12; minimum 80% of the value of REIT assets should be invested in completed and rent-generating properties, and the remaining 20% of value of REIT assets can be invested in other specified assets. An REIT has to distribute at least 90% of net distributable cash flowsto unit holders on at least a half-yearly basis. REITs have been restricted from investing in vacant land, agricultural land or mortgages, as well as in other REITs. However, they may invest in mortgage-backed securities. REITs would have a direct implication on the funding of real estate projects, and developer/corporates would get an alternate funding avenue.

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REITs have been given a pass through status for tax purposes and taxation of various parties in a REIT is as follows:

Sponsor

• Capital gains at the time of exchange of shares in SPV with units of business trust to be exempt. Deferral of MAT at the time of exchange of shares in SPV with units of business trust. MAT to be applicable only at the time of disposal of units by sponsor. Cost of acquisition of such units for calculating gains for purposes of MAT shall be cost of shares in SPV.

• Capital gains at the time of exchange of rental assets or interest in a Limited Liability Partnership with units of business trust subject to capital gains tax

• Future sale of units by sponsor – exempt under section 10(38) in case of long-term capital gains and subject to concessional capital gains tax rate of 15% under section 111A for short term capital gains where units are sold on stock exchange and STT is paid

SPV

• Distribution of dividend to trust - exempt from dividend distribution tax (DDT) subject to the following conditions:

• The business trust owns 100% share capital of the SPV or holds all the share capital of the SPV except what is required to be held by other entity as part of any direction of any government or specificrequirement of any law or which is held by government or government bodies;

• The exemption of DDT shall be only in respect of dividends paid out of current income after the date when business trust acquires the desired shareholding in SPV. The dividends paid out of the accumulated or current profits up to this date as mentioned above shall be liable for DDT

• Interest paid to trust – allowed as deduction. No taxes to be withheld

REIT

• Income of trust

• Dividend and interest received by trust from SPV – exempt

• Capital gains on disposal of assets - taxable in the hands of REITs (tax rate of 20% plus surcharge plus cess) for long term capital gains with indexation benefitand maximum marginal rate for short term capital gains)

• Income from rental assets owned directly – exempt. No withholding tax on rent paid to REITs

• Any other income – taxable at maximum marginal rate

• Interest component of income distributed by trust to the unit holders would attract withholding tax at 5%/10% for non-resident and resident unit holders respectively. Dividend and capital gains component of income distributed by REITs to the unit holders will be exempt in the hands of the unit holders.

• REITs to file return of income

Unit holders

• Interest income received by non-resident unit holders taxable at 5% concessional rate and at applicable rates for resident holders

• Rental income distributed by the REIT to unit holders shall be taxed in the hands of unit holders. Such rental income distributed would attract withholding tax at rates in force (i.e. 40%) for non-resident unit holders and 10% for resident unit holders.

• Capital gains on sale of listed units of REITs on the exchange to attract levy of security transaction tax at par with that of listed equity shares. Long term capital gains (where units held for more than 36 months) would be exempt and short term capital gains would be taxable at 15%. Where sale of units is off the exchange LTCG (long term capital gains) taxable at 20% and STCG (short term capital gains tax) at applicable rates.

• MAT applicable on capital gains on sale of REIT units.

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2.6 REITs by public sector banks/ public sector enterprises may be a possibility

With the government’s announcement of removal of DDT at the SPV level, several developers are planning to go the REIT way. There is a possibility of banks opting for REITs as well, with the RBI allowing banks to revalue their real estate assets and treating the revaluation reserve as tier-1 capital. State-owned banks own vast commercial real estate for their officesand branches. These assets can be revalued and swapped into a REIT (sponsored and controlled by the bank) and the asset leased back to the bank. The high quality of the assets and well-regulated tenants can be a plus point for investors13. In addition, the financeminister indicated in his Budget 2016 speech that they will encourage public sector enterprises (PSE) to divest non core assets such as land; hence, PSE could look at REITs as a vehicle for achieving such objectives.

2.7 FDI in retailThe introduction of FDI in multi-brand retail and liberalization of the norms relating to single brand retail over the past one year has encouraged foreign retail players to accelerate their entry strategy and would create considerable demand for retail space and boost mall development in the country. This may even create huge employment and in turn create demand for housing14. The demand would also firm the rentals going forward and bring down the vacancy rates in existing malls15.

2.8 Boost to start-ups may impact office segment

FY17 Budget has provided an encouragement for start-ups, by offering 100% tax rebate on their firstthree years’ profits. Some of these start-ups could be significant tenants for office space, as has been the case in the technology and ecommerce space in the past few years. This would also compel developers to build small offices, provide for small offices in mixed-use developments or arrange for sharing of office 16.

2.9 Demand for new asset class The Indian real estate growth story until 2000

had largely been focused around the residential, commercial and industrial segments. Since then, developers have been exploring several new asset classes, such as affordable housing, student housing, holiday homes, senior living, amusement parks, education hubs and logistics hubs, depending on opportunities in the market. The affordable housing and senior housing segments cater to the specific segments of residential customers, based on their income and age, respectively. The medical city or Medicity concept is a more recent phenomenon which is gaining visibility on the back of extensive budgetary focus on health and family welfare by state governments. Some of these new developments could even boost the economy of nearby areas by offering employment17.

2.10 Hospitality on potential growth trajectory

The hotel industry has shown moderate performance in the last few quarters. It has reported a marginal decline on several parameters such as occupancy levels and average room rental; nevertheless, with economic recovery serving as a catalyst for the revival of the country’s hospitality industry, the resurgence of business and leisure travel is expected. As of March 2015, the number of hotel rooms in India stood at 112,284, with 49,000 upcoming rooms18. Developers, particularly in South India, are developing hotels, several of which are part of their residential and office properties or upcoming mixed-use projects.

According to World Travel and Tourism Council, by 2020, the hospitality sector in the country will require 180,000 additional rooms at an investment of €19.4 billion (US$25.5 billion) and approximately 211,000 people to operate them. Based on the success of the visa-on-arrival initiative introduced last year to travellers of 43 countries, the government has proposed to increase the number of countries to 150 in stages19.

Improving affordability and increased affinity for leisure travel are driving domestic tourism in India. Domestic travel spending is expected to have grown by 7.0% in 2015 to €80.6 billion (INR 5,737.5 billion), and is expected to grow by 7.2% per annum to €160.9 billion (INR 11,448.7 billion) in 202520. Over the last few years, international hotel chains have increased

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their presence in the country to tap its rapidly growing hospitality industry.

2.11 Real estate moving from bank-based financing to market-basedfinancing

India’s real estate transaction landscape has reported an increase in investments made by private equity (PE) funds, pension funds (PFs) and sovereign wealth funds (SWFs); however, the majority of it was in the form of debt. PE funds and NBFCs are becoming major sources of debt refinancing during the current condition of lower sales and poor cash flow due to a large inventory. Developers are looking to refinance their debts with the hope that the market will recover in the near to medium term. As per market reports, PE investments in Indian real estate increased 33% to more than €1.8 billion (US$2 billion) in 2015. Of the total PE deals in 2015, structured debt deals (debt transactions organized in a manner that offers assured returns to investors) constituted approximately 50%. These deals offer 15% to 17% guaranteed returns to investors21. Majority of the domestic PE funds (94%) took the route of structured debt deals in 2015, compared with only 18% of the foreign PE investment.

With relaxed FDI norms, the majority of the real estate stock is now accessible to foreign investors. PE investments are expected to further increase in the coming years due to the government’s focus on improving basic infrastructure. According to Economic Survey FY16, the industry saw a total investment of approximately €9.1 billion (US$10 billion) in 2015 by domestic and foreign investors via structured deals and non-convertible debentures (NCD).

In the recent past, platform-level transactions in real estate have also increased, creating a win-win situation for developers and investors. With improved yields in commercial real estate at approximately 10.5% and Indian REIT regime taking shape, PFs/SWFs are partnering with developers, operators and managers to create a platform of office space assets. These funds are now directly investing in real estate instead of investing in third-party fund and are hence being in a better position to exercise control over projects22.

3. GENERIC INDUSTRY ISSUES3.1 Shortage of skilled manpower: The

construction Industry is facing acute labour shortage across the country. There is a shortage of approximately 30% labour on any day as per CREDAI (Confederation of Real Estate Developers Association of India). This has triggered a sharp increase in the wages of skilled and semi-skilled workers. Non-availability of labour has also delayed projects throughout the country.23

Recommendation

To meet the growing demand of workers in the construction sector, private companies along with the government should set up skill training institutes across the country. Various training programmes should be conducted by industry bodies. Companies, too, have to contribute towards training their own hired workforce and setting aside a fixed amount from their profits for training and development. Some leading companies have taken the initiative of setting up such training centres; however, this would prove to be an inadequate measure to serve the massive demand for manpower needed to fuel economic growth. The adoption of the latest technology could also help mitigate the labour shortage risk, as the latest technology runs on lower labour requirement.

3.2 Absence of latest technology in construction: The technology being used by a majority of real estate developers is quite old and labour intensive. Looking at the shortage of labour, rising construction cost and delays in projects, latest technology is the need of the hour. Although a handful of developers are adopting latest technology such as prefabrication, this is restricted to certain phases of the project.

Recommendation

Streamlining process of the entire lifecycle of the project and applying latest available technology not only in construction phase but also in design, project management, marketing

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and customer service. The integration of several services in real estate business will go a long way in delivering services in a timely manner at much lower costs.

Best Practices

Several developers in India are adopting prefabrication technology to build high quality walls and slabs. This saves time and cost in comparison to conventional construction. New shuttering technology is being used which helps complete slabs in a record seven-eight days.24 Apart from the construction stage, some developers are adopting ERP (enterprise resource planning) in various activities, including design, engineering, purchase and payments.25

3.3 Funding constraints: Banking institutions have cut down on their lending to the real estate sector. In 2015, RBI eased the policy repo rate to 6.75%; however; interest rates are still too high for the sector to rebound26. Real estate is still struggling to get industry/infrastructure status which would make possible easier access to low cost institutional funds.27 RBI’s move to allow ECB for affordable housing and exempting long-term bonds raised for funding affordable housing from mandatory regulatory norms such as CRR and SLR will bring in liquidity. However, these steps would benefit only one segment of real estate.

Recommendation

To solve the liquidity crunch, real estate sector and especially integrated townships should be given infrastructure status. This is expected to facilitate access to low-cost institutional funds and simultaneously permit the sector to leverage long-term funds. Infrastructure status may even allow insurance companies to invest in housing sector.

4. KEY ISSUES, CHALLENGES & RECOMMENDATIONS

Although there are several drivers and growth

opportunities in the Indian real estate sector, there are some impediments to the sector’s growth, mostly in the regulatory space. A growing economy and favourable demographics, including a large young population, are the two strongest growth drivers of the Indian real estate market. If India wishes to stay ahead in the economic race, there is strong need to improve primarily the regulatory environment to facilitate real estate development.

4.1 Taxation

Tax Recommendations for REITs

Although the government has provided several concessions and a robust tax regime for REITs/ InvITs (business trusts), the following consequential changes would really provide a further fillip to the launch of REITs in India:

a. Exemption from capital gains on transfer should be extended to transfer of assets or interest in a fir

Under the current tax regime for business trusts, exemption from capital gains tax and deferral of MAT has been provided in case of transfer of shares of SPV to the business yrust in consideration for units. However, a similar exemption (from capital gains tax) and deferral (from MAT) has not been provided where units are received in consideration for transfer of interest in a LLP or for transfer of an asset directly to the business trust. Given that SEBI regulations permit all three formats, the current taxation regime creates a disparity and incentivizes the SPV format in comparison to a LLP format or direct asset ownership format. In order to remove the existing disparity and make REIT/InvIT an attractive proposition to all categories of potential sponsors, we humbly request that an exemption (from capital gains tax) and deferral (from MAT) should be extended to situations where:

• Assets are transferred to a business trusts in exchange of units; and

• Interest in a LLP is transferred to a business trusts in exchange of units.

b. Period of holding of units of a business trust

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Units of a business trust should be accorded the same treatment provided for listed equity shares; accordingly, the period of holding of units in a business trust to qualify as a long-term capital asset should be 12 months and not 36 months akin to listed equity shares.

c. Allocation of expenses of business trust

Based on the provisions introduced, there is no clarity on deductibility of expenses in the hands of the business trust. Expenses incurred by the business trust would include manager fee, trust fee, administrative expenses, and interest paid on borrowings.

Based on the proposed tax regime, distribution of income to unit holders is proposed to be taxed in the proportion in which income is earned by the business trust. Accordingly, it is imperative that appropriate rules and forms be introduced prescribing method of allocation of expenses of trust on distribution to unit holders.

d. Standard deduction in cases where the REIT directly owns the asset and distributes rental income to unit holders

As per the existing tax regime, where the REIT directly owns the asset and receives rental income, such rental income is exempt from tax in the hands of the REIT but is taxable in the hands of the unit holders. Under Indian tax laws, if a person were to receive rental income, there is a standard deduction of 30% of such rental income which is available while calculating the taxable rental income.

Given that the rental income is exempt in the hands of the REIT, such standard deduction is not available to the REIT. Therefore, such standard deduction should be permitted in the hands of the investor.

4.2 Challenges faced in acquiring land

Historically, land acquisition has been a major challenge in large real estate and infrastructure projects. Even after acquisition, there have been cases of litigations, which bother developers during and after execution of projects. With a view to making the

process fair and transparent, the government enacted The Right to Fair Compensation and Transparency in Land Acquisition, Rehabilitation and Resettlement Act, 2013 (LARR). This act will primarily affect public and PPP projects. Private developers are free to buy land at prices agreed to in private negotiations; however, they have to provide R&R (relief and rehabilitation) benefitsif more than 50 acres of land are bought in urban area and 100 acres in rural area. Moreover, certain conditions in the R&R package such as reservation of 20% of the developed land for landowners as part of their rehabilitation entitlement can make the projects unviable. Additionally, a subsistence allowance for 12 months and an annuity for 20 years are difficult to implement and can impact the project’s internal rate of return (IRR), thus making the project unprofitablein the long run.28 This will have enhanced effect in urban areas where the cost of land is very high. Due to R&R conditions, developers may even shy away from increased developments and lose out on the advantage of economy of scale, which could eventually increase the price tag of the property. The current government has brought in amendments in the LARR Act through an Ordinance in December 2014 with an aim to kick-start development. There are few amendments, which will benefit the real estate secto .

a. Private hospitals, private educational institutions and private hotels are to be included in the definition of public purpose and will be exempted from social impact studies29.

b. Consent of 70%–80% owners and social impact study shall not be required in case of land acquisition for five purposes -- defence and defence production, rural infrastructure, including electrification, housing for poor, including affordable housing, industrial corridors and infrastructure projects, including projects taken up under the PPP mode. This will speed up infrastructure projects and will have a positive effect on the real estate sector.

c. On the return of unused land, the amendment nullifies the five-year limit and specifies that the land will be returned if it is unused for the period specified for the project. This will provide relief to large township projects along with major infrastructure projects, which are stuck in legal hurdles.

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Recommendation

Although LARR promises fair and timely compensation to land owners, it may lead to notional increase in land prices. The amendments through the ordinance will have a positive impact on the industry; however, they are now pending before a joint committee. Even if the consent clause and social impact study are ruled out, R&R clauses could put pressure on the margins of the project and may need to be further moderated.

4.3 Unclear land titleAccording to ministry estimates, thousands of hectares are lying idle in many states due to improper land titles that are mired in family disputes, litigation and without proper registration. The large number of unclear land titles in India is a deterrent to attracting FDI in real estate. Although there is 100% FDI in real estate through automatic route, many foreign investors are wary of investing in land and properties due to unclear land titles. Unclear title is also a major reason in litigation and delays in real estate projects.30 The central government has directed state governments to set up a mechanism to have clear land titles and land records and has also made it part of the mandatory reforms to avail central funds under JNNURM. However, not all states have started work on the ground.

As per the Economic Survey FY15, The National Land Record Modernization Programme has been revamped under the Digital India Initiative to modernize land records. It will be implemented as a central sector scheme with effect from April 1, 2016. The revamped programme will build an integrated land information management system. The provision made in this year’s budget for digitization of land records will improve transparency, thereby boosting the confidence of property buyers and investors. It will also expedite the process of land acquisition, thereby checking delivery delays and cost escalations31.

Recommendation

Land survey and mapping to be done for all parcels of land in the country. Various technologies such as satellite imagery, aerial photography, electronic total stations (ETS) and global positioning systems (GPS)

may be used. This would help the authorities issue conclusive titles to the land parcels. Some states have already initiated the process of land mapping. All the details of land title and records should be made available online. 32

Best practices

• Singapore: The information on land titles/records is accessible to the public via the Housing Development Board or Urban Redevelopment Authority (URA) websites.

• China: The Ministry of Land and Resources has a system where land records may be accessed online.

• UAE: The Land Department provides many online services. These services include inquiring about procedures and monthly and daily trades, issuing maps, evaluating lands, issuing ownership certificat s in lieu of lost one and registering land sales.

4.4 Delay in approvals of projectThe approval process for real estate projects in India involves dozens of state and central government departments. To develop a real estate project, more than 50 consents33 are required from the government bodies. This takes approximately two years. The complex and time consuming process is a primary reasons for the delay of projects across cities. Moreover, most projects are announced before all legal, regulatory and statutory clearances are in place, resulting in road blocks throughout the project cycle.

Recommendation

Early completion of the projects is possible by simplifying the tedious and complex process of approvals. Instead of more than 50 approvals at different departments, there should be a single window clearance facility in all states.

Best practices

Singapore

• Single window clearance through URA.

• The electronic development application (EDA) allows the submission of development

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applications (DAs) electronically to URA for approval.

• There are a range of e-services for guidance such as SMS notification on approval of plan

• CORENET e-Submission system (eSS) is an internet based system that allows an individual to submit building project-related applications to regulatory authorities such as the Building and Construction Authority (BCA), URA and the Land Transport Authority (LTA) for approval.

4.5 Lower FSI challenge in optimizing land use

Most Indian cities currently have FSI of less than two and state governments have been reluctant to increase the limits. There have been revisions recently by some states but the revisions are still low to meet the demand of rapid urbanization and to enable vertical development. In February 2015, the BrihanMumbai Municipal Corporation proposed a variable FSI ranging from 2.5 to 8.0 as part of its draft development plan for 2014–2034. This is an important development and will spur growth if applied along with development of infrastructure34.

Recommendation

FSI to be revised as per the business potential and population concentration of areas within the city to enable vertical development and even lower the high prices of properties prevalent in Indian cities. The Planning Commission has recommended vertical growth of Indian cities by selectively providing additional FSI beyond the permitted index at an extra charge of at least 50% of the area rate. However, increasing the FSI to a higher level has to be accompanied with better infrastructure considering the extra load on services such water, sewage and electricity.

Best practices

Some of the best planned cities in the world have high FSI, such as Shanghai-13.1, New York and Manhattan-15. The high rises in these cities have sufficient Infrastructure to complement the high rises and higher density of population.35

4.6 Title insurancesWhile insurance of buildings has been compulsory since 2001 as per state governments’ bylaws, title Insurance has not been taken seriously. In the absence of title insurance, a property’s current owner is at high risk of claims originating from various quarters: previous owners, their heirs, old liens etc. Title insurance ensures that the current property owner is safe from past claims and from the expense incurred in legal proceeding. While title insurance does not correct any title faults and past claims, it helps cover litigation cost to mitigate further loss in the case of property transactions where the sanctity of the title comes into question. While many companies are willing to tap this huge potential sector, the challenges are the lack of digitalized records, pricing, risk management issues, right applications to issue and manage the insurance policies etc. Insurance companies will not be able to move any further, before the land record system and procedures are in place36. The Real Estate Regulation and Development Bill provides for arranging insurance of land title, which will benefi both developers and buyers. It would pave the way for structured title insurance for all new real estate projects in the country.

Recommendation

In India, this concept can work wonders, leading to a surge in the real estate market and high customer acceptance due to insurance cover. As per the latest survey on realty sector by Ernst & Young, there is urgent need for transparent process and regulation in Indian land title laws. Despite the growing interest in investing in India, what really stops the West is the lack of title insurance.

A robust and sturdy mechanism including internal databases, applications and technology coupled with a human resource pool which is familiar with the legal and regulatory aspects of the landscapes. Government records and systems would only be reference points and inputs; using this, insurance companies will have to perform an underwriting procedure before they can insure titles. Title insurance in these sectors would bring confidence for venture capitalists and other investors as a majority of the capital raised in these sectors go into property and machinery.

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Best practices

Title insurance was introduced in the United States and is now available in many other countries, such as United Kingdom, Mexico, Canada and throughout Europe.

Title insurance is prominent in the US, owing to the many loopholes in land record laws. Fidelity National Financial and First American Corporation are amongst the largest companies in the US providing title insurance.

The American Land Title Association (ALTA) is a national trade association representing the title insurance industry. Founded in 1907, ALTA also focuses on a property’s abstract of title, which ties the history of the title to a particular piece of real estate. The organization seeks to improve industry oversight and to protect consumers. ALTA does not issue title insurance; it provides standardized policy and endorsement forms that most title insurers issue.

4.7 Different building regulations across states

In India, building regulations are different for each state and even for cities in the state. Although a National Building Code (NBC) is in place, it is not mandatory for states to follow it strictly. These regulations are primarily governed by the local municipal corporation and development authority. It is quite challenging for a local developer to work within a new set of guidelines and seek dozens of approvals while taking up the same project in some other state. A foreign developer and investor find it even more challenging to work in India where

several clearances have to be taken from different authorities and different regulations need to be followed in different regions of the country.

Recommendation

There should be a clear well defined document stating clear rules and procedures to be followed for each state, thereby making single window of approvals and procedures to be followed on state level basis. There should be complete transparency in terms of guidelines and processes, which in turn should be made simpler for investors and developers to follow.

4.8 Flexibility in the Development Control Rights

Development control rights (DCR) such as FSI, ground coverage limits and permissible heights are governed by local bodies. In some cities like Mumbai, these rights are quite inadequate and rigid in consideration to the growing urbanization. The safety aspect, along with the infrastructure supporting the real estate development, should be considered. Currently, looking at the lag of some of the regulations such as FSI in comparison to the international cities leads to frequent changes to DCR.

Recommendation

There is a need of appropriate DCR which should not be changed frequently. There needs to be a structure in terms of revisions of the rights to maintain its sanctity. Strict procedures and policies should be applicable which permits revisions only after a certain span of time.

Endnotes

1 “Economic Survey FY16,” Ministry of Finance Website, http://indiabudget.nic.in/, accessed on 25 March 2016.

2 “Improvement in real estate may be harbinger of economic turnaround, Hindustan Times, 24 March 2016, via Factiva, Copyright 2016. HT Media Limited

3 “Economic Survey FY16,” Ministry of Finance Website, http://indiabudget.nic.in/, accessed on 25 March 2016.

4 “Provisional Population Totals,” Census of India website, www.censusindia.gov.in/2011-prov-results/paper2/data_files/indiapaper2_at_a_glance.pdf, accessed on 18 December 2012.

5 “Realty in changing times,” EY thought leadership report, November 2012.

6 “Economic Survey FY16,” Ministry of Finance Website, http://indiabudget.nic.in/, accessed on 25 March 2016.

7 “PIB press release,” http://pib.nic.in/newsite/PrintRelease.aspx?relid=134001, accessed on 25 March 2016.

8 “Press Information Bureau Government of India Ministry of Commerce & Industry,” http://pib.nic.in/newsite/PrintRelease.aspx?relid=112475, accessed on 18 march 2015 and Press note 12 issued on 24th November 2015

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9 “Real estate regulation and development bill,” ICRA, March 2016, via ThomsonOne.

10 “How the real estate regulatory bill 2013 impacts investors,” The Economic Times, 22 March 2016, via Factiva, (c) 2016 The Times of India Group.

11 “Report of the technical group on Estimation of urban housing shortage,” MHUPA website, http://mhupa.gov.in/ministry/housing/HOUSINGSHORTAGE-REPT.pdf

12 “India Regulator Approves REIT Rules; Trusts Will Be Given Tax Pass-Through Status,” The Wall Street Journal Online, 10 August 2014, via Factiva, © 2014 Dow Jones & Company

13 “The REIT way for recapitalizing Indian banks,” Mint, 7 March 2016, via Factiva, Copyright 2016. HT Media Limited.

14 “FDI in multi-brand retail to boost mall space demand: Realtors,” Press Trust of India, 14 September 2012, via Factiva, © 2012. The Press Trust of India Limited.

15 “FDI in multi-brand retail: Foreign players worried over mandatory $100-mn investment in first 3 years,” The Economic Times, 28 September 2012, via Factiva, (c) 2012 The Times of India Group.

16 “Budget 2016: First-time home buyers in tier-III & tier-II cities to benefit, says JLL India,” The Economic Times, 1 March 2016, via Factiva, (c) 2016 The Times of India Group

17 “Building new dimensions for real estate growth, September 2013, EY Thought leadership report.

18 “Infotech-fuelled hotel boom in South India,” HospitalityBiz, 19 March 2016, via Factiva, © 2016. Saffron Synergies Pvt Ltd

19 “Union Budget 2015-16, http://indiabudget.nic.in/ub2015-16/bh/bh1.pdf, accessed on 18 March 2015, Union Budget 2016-17, http://indiabudget.nic.in/ub2015-16/bs/bs.pdf, accessed on 28 March 2016

20 “Travel & tourism, economic impact 2015: India,” World Travel and Tourism Council website, https://www.wttc.org/-/media/files/reports/economic%20impact%20research/countries%202015/india2015.pdf , accessed 28 March 2016.

21 “Foreign private equity investments in real estate jump 33% to $2.22 bn,” National News Agency Lebanon, 12 March 2016, via Factiva © 2016 NNA Lebanon

22 “New age funding for real estate: Real estate - making India,” EY Thought Leadership report, November 2014.

23 “Construction sector facing 10 mn workers shortage: Credai,” Realty Plus, 7 July 2010, via Factiva, © 2010 Adsert Web Solutions Pvt. Ltd.

24 “Real estate developers lean on technology to cut construction costs,” The Economic Times, 6 October 2012, (c) 2012 The Times of India Group. All rights reserved.

25 “Realty cos seek byte, log on to ERP to plug wastages,” The Economic Times, 20 March 2006, via Factiva, (c) 2006 The Times of India Group

26 “ Ratios and rates,” RBI website, https://rbidocs.rbi.org.in/rdocs/Wss/PDFs/5TABB1EA1B904147C7889F72DB411DAC15.PDF, accessed on 24 March 2016.

27 “India real estate funds lose sheen,” Hindustan Times, 14 December 2012, via Factiva, © 2012. HT Media Limited. All rights reserved.

28 “India real estate,” J.P. Morgan, 23 August 2012, via Thomson One;

29 “Changes in Land Acquisition Act hailed, The Hindu, 30 December 2014, via Factiva, (c) 2014 Kasturi & Sons Ltd

30 “Computerise land records, states told, The Times of India, 14 March 2007, via Factiva, (c) 2007 The Times of India Group

31 “National: Setting Path for Realty Reforms,” The DayAfter, 16 March 2016, via Factiva, © 2016 The DayAfter

32 “Rs 1500-cr project to give you clear land titles, updated maps, Mumbai Mirror, 13 November 2011, via Factiva, © 2011. Bennett, Coleman & Co., Ltd.

33 “India: REAL ESTATE project hampers industry growth as needs to take 57 different approvals,” Mena report, 10 September 2012, via Factiva, © 2012 Al Bawaba.

34 “Sky is the limit for Mumbai; FSI norms set to be relaxed,” Hindustan Times, 17 February 2015, via Factiva, © 2015. HT Media Limited

35 “Higher FSI not enough, better infra a must: Builders,” Business Standard, 9 April 2012, via factiva, (c) 2012 Business Standard Ltd.

36 http://www.deccanherald.com/content/162596/why-title-insurance-matters.html; http://www.projectsmonitor.com/REALEST/title-insurance-is-a-virgin-sector-in-india-owing-to-the-current-land-record-system

Note: For conversion of currency to report in Euro following rates have been considered

1US$ = 0.9063

1INR = 0.0139

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RETAILPromote fair competition by allowing increased access to international goods and brands that benefits the Indian public throughcost optimization – relax FDI policy, align sourcing norms with business realities, grant ‘industry status’ to retail sector and improve ease of doing business through single window procedures.

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1. INTRODUCTION

Market Description

1.1 India’s retail sector, comprising organized and unorganized retail, has emerged as a dynamic and fast growing sector over the last decade. From a history of traditional/unorganized retailing, the sector is moving swiftly towards organized retailing. Large international and domestic players are attempting to continuously increase their India presence.

The sector is poised to grow at a CAGR (compound annual growth rate) of 11% by 20201 (from 7%) with the market size expected to touch US$1 trillion (€877 million) by 2020 (from US$600 billion [€526 billion] in 2015). This growth is driven by factors like increase in purchasing power of consumers, urbanization, nuclear families and attitudinal shifts.2 The sector is the third largest employment generator after agriculture and construction, and adds considerable momentum to India’s GDP.3

1.2 E-commerce, as a retail channel, has seen phenomenal growth over the last few years. While organized retail is expected to grow at a CAGR of 32% by 2020, online retail/e-tailing is expected to grow at a staggering 63%, albeit over a low base.4

1.3 Direct selling is also an area of increasing focus. Modern direct selling in India kick-started in 1980s. The direct selling market has the potential to touch INR 645 billion (€8.4 billion) by 2025 (from INR 79 billion [€1 billion] in 2015), and is the fastest growing non-store retail format. Though a relatively new format in India, direct selling has provided self-employment opportunities to more than

fiv million people in less than two decades. The industry has also significantly contributed to the growth and development of SMEs and allied services like transportation, distribution/logistics etc.

Regulatory framework

1.4 The sector is governed by multiple legislations at the central and state levels, and also by sector-specific regulatory bodies. These include state-wise shops and establishments acts, labour laws, legal metrology act, sector-specific labelling regulations, foreign direct investment (FDI) policy, IT and telecommunication laws, payment and settlement related laws, etc. Some background is provided below in respect of these.

• The enactment of shops and establishments act is a state subject and hence different states have different legislations relating to shops and establishments (referred as ‘state acts’). The state acts regulate the conditions of work of employees/workers in shops and commercial establishments.

• The legal metrology law5 seeks to establish standards of weights and measures, regulate trade in weights, and other goods which are sold or distributed by weight, measure or number. It is also used as a measure to ensure consumer protection by making the originator of goods (manufacturer/packer/importer) accountable for such goods.

• The sector-specific labelling regulations are used as a measure to provide needed information and/or to ensure the health and safety of consumers. These regulations are required to protect customers and

RETAIL SECTOR IN INDIA

Objective: India has an important position in global retail rankings. While strong growth fundamentals with increased urbanisation and consumerism offer immense scope for expansion, trade challenges need to be addressed. This paper provides a brief overview of the retail sector in India, key investor challenges and recommendations.

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businesses from unfair competition from false representations of product content, origin and quality.

• India’s FDI policy in retail identifies two broad categories within retail – single-brand retail trading (SBRT) and multi-brand retail trading (MBRT). The fear of hurting small kirana stores or unorganized sector is what had caused the previous governments to remain closed over liberalisation of FDI in retail over the years. As a result, India’s FDI policy on retail had been tightly regulated in the past.

Recent developments

The government has taken a number of steps to liberalise the organized retail sector. Some of the key ones are listed below:

1.5 Relaxation in FDI regulations in retail: A number of relaxations have been made in this respect. Key ones include relaxation of sourcing requirement in case of SBRT to be reckoned annually from date of opening of the first store, relaxation of sourcing requirement subject to government approval in case of ‘state of art’ and ‘cutting edge’ technology, SBRT and wholesale activities permitted to be carried out in a single entity subject to procedural compliances, SBRT entities now permitted to sell through e-commerce channel and 100% FDI permitted in duty free shops under the automatic route.

1.6 Proposal to roll out the Model Shops and Establishments Act: Finance Minister Arun Jaitley announced6 the roll out of the Model Shops and Establishments Act to bring uniformity in regulatory provisions. This will help in reducing complexity, and help manage operational challenges currently faced by retailers owing to different state acts with differing standards.

1.7 Committee to consider separate legislation for direct selling: An inter-ministerial committee has been formed to consider the requirement of separate legislation for direct selling/multi-level marketing, and to examine the factors/features that distinguish these from Pyramid, Money Circulation Schemes.

1.8 Other developments:

• Select states like Maharashtra and Andhra Pradesh have rolled out (draft) retail policies to streamline the regulations relating to retail sector.

• Many states like Karnataka, Maharashtra, Telangana and Delhi have exempted shops and commercial establishments from weekly closure requirement.

• Select states like Rajasthan and Kerala have rolled out guidelines to bring definitional and operational clarity on direct sales.

• The government has notified conditions in relation to marketplace model of e-commerce with specific restrictions on inventory based models in B2C (business to consumer) arrangements [Press Note No. 3 (2016 Series)].

European investment in India

1.9 Pursuant to liberalisation of FDI in SBRT, many European companies are increasing their presence in the Indian retail market. Further, the long ongoing discussion between India and the European Commission on an India-European Union (EU) Free Trade Agreement (FTA) called the EU-India Bilateral Trade and Investment Agreement (BTIA) is yet to be concluded. The conclusion of these talks could bring significant trade benefits to both parties.

2. KEY ISSUES AND RECOMMENDATIONS

2.1 FDI in SBRT(a) While 100% FDI is permitted in SBRT, all

proposals above 49% still require government approval, which is a lengthy process. A joint venture proposition in single brand business does not go down well with either partner i.e. the non-resident brand owner and the Indian joint venture partner. It is therefore recommended that 100% foreign investment should be permitted in SBRT under automatic

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route to facilitate ease of doing business in SBRT.

(b) Despite relaxation in sourcing norms, the requirement continues to present an obstacle to entry into India. This is due to challenges in the supply chain as retailers, even after opening of stores, have to progressively train domestic suppliers on technical standards and quality making domestic sourcing challenging. This is particularly difficult where supply in India does not meet the requirements/benchmarks of the brand owner. It is therefore recommended that 30% sourcing requirement should be further relaxed to be applicable only after a particular period (say after five years) from opening of the first store.

(c) The mandatory 30% sourcing requirement for retailing in India should not be applicable to multinational groups that operate in India under a composite business model such as sourcing from India for global markets, besides undertaking retailing in India. This is for the reason that by sourcing for global markets, these groups already support the government’s Make in India initiative in a significant way. A relaxation to this effect would ease expansion plans for such businesses in India besides providing significant fillip to the government’s flagship initiative. In order to ensure commensurate sourcing from the Indian market, a suitable threshold for sourcing from India for all markets (India and non-India) may be provided which is linked to the turnover from retail sales of such a group in India.

(d) Foreign investment in SBRT is confine only to a brand owner or an authorised brand licensee. In order to promote greater investment in the sector, it is recommended that the sector be opened to financia investors, including private equity funds and venture capitalists, and hence this requirement be done away with to promote FDI in Indian brands.

(e) SBRT players are permitted to market sub-brands in Indian stores subject to the condition that the umbrella brand clearly appears

alongside the ‘sub-brand’. This requirement is unlike in any other country and necessitates development of separate branding elements that are otherwise not made, resulting in increased costs, inconsistency and inefficienc . It is therefore recommended that the requirement of mentioning the umbrella brand alongside be removed.

2.2 FDI in MBRT(a) FDI in MBRT requires a minimum FDI of

US$100 million (€87.7 million) out of which US$50 million should be in back-end infrastructure as defined in the policy within a span of three years. In this regard, the following is noted and recommended.

• The high minimum capitalisation would facilitate only large investments. It is therefore recommended that minimum investment limit be reduced or waived to also allow medium and small investors.

• The entity engaged in MBRT would have to make fresh investment in back-end infrastructure.7 This fresh investment requirement impacts multinational groups that had earlier invested in India and set-up back-end infrastructure for efficient distribution of goods to small retailers and other business users. It is therefore recommended that such multinational groups be allowed to integrate back-end infrastructure for wholesale trading with MBRT.

(b) FDI in MBRT is subject to approval from state governments and to any additional conditions that may be imposed by them. This makes the process cumbersome for an investor since it has to engage in individual negotiations with multiple state governments. Also, differences in conditions prove to be materially disruptive for the business, leading to inefficiencies. It is therefore recommended that the requirement of state government approval be done away with.

(c) Recommendations as outlined above for relaxation of sourcing norms in SBRT should also be extended to MBRT.

(d) The government should come out with a clear

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action plan for FDI in multi-brand retail to remove uncertainties in the sector.

2.3 FDI in e-commerce(a) The recent clarificatory guidelines in relation

to e-commerce businesses seem to have a negative effect on market driven pricing and business practices, hence sub-serving consumer interest. Therefore, FDI policy progression towards B2C e-commerce should be delineated from physical retail and implemented in a phased and gradual manner. In the first phase, 49% FDI in B2C e-commerce should be permitted under the automatic route, and a higher FDI may be made subject to a case specific approval

2.4 Issues in relation to labelling requirements and recommendations

(a) Multiple regulations: Labelling compliance requirements flow from multiple regulations issued by different sector-specific regulators.8 While every industry may have its own information needs, the existence of multiple regulators with diverse regulatory powers increases complexity in the regulatory space. It is therefore recommended that labelling rules be defined in one place under one regulation (which could act as a model law) for all goods/items. This would help in simplifying regulations, bringing efficiencies and cross pollinating best practices.

(b) Permanent versus temporary labelling: The statutory requirement of permanent and non-detachable label is a matter of significantconcern. The products, in order to comply with Indian labelling regulations, are required to be manufactured for sale in India only. This proposition is not economically feasible as businesses manufacture products in many locations as per requirements and changing the supply chain for a single market on stand-alone basis is a costly affair. Further, stringent requirements also have the potential of non-compliance, particularly for foreign retailers, invoking penalties/fines. It is therefore

recommended that this requirement be relaxed with specified conditions. Also, when a label falls off/is damaged, re-labelling should be permitted in the store itself.

(c) Excessive requirement for declarations: Excessive requirements under the regulations puts undue burden on stakeholders and consequently increases costs, which would ultimately be borne by consumers. For example, in case of imported goods, a product label must include importer information like date of import, name and address of importer, etc. This information may not be available with the manufacturer before or during the manufacturing process (since manufacture happens globally for different markets). Further, in many instances, products or their parts are produced in different countries and then combined in countries other than where the final product would ultimately be sold. Under these supply chains, the destination market for each product is not pre-defined and stock is kept at various regional distribution centres and pulled on demand by markets. Compliance costs with such requirements is substantially high if shipments are required to arrive at the port of entry with labels that must include information that is not available at manufacture or is subject to change. Therefore, an objective-based impact assessment exercise should be undertaken on labelling regulations so that onerous statutory requirements can be done away with.

(d) Removal of maximum retail price (MRP): MRP rules add to the cost of a product and complicate logical routines leading to a higher price for the customer. In SBRT, this requirement is redundant since the retailer produces, prices and sells the product itself and hence there is no pricing differentiation. Also, putting MRP poses a challenge in the global supply chain since displaying prices in foreign currencies is not permitted in some countries like Indonesia. Moreover, at the point of production, the final sales price may not be accurately determined as price is determined at the country level. This requirement therefore disrupts an ideal supply

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chain, with a need to re-label products that are bound for India. Hence, the requirement of putting MRP on the product should be done away with, and an advanced pricing system, in line with international best practices, should be implemented.

(e) Excise duty on packing and labelling activities: These are common activities in retail businesses since goods need to be packed and repacked for transportation and delivery. The applicability of excise duty at each such event is onerous and it is recommended that an exemption or safe harbour is provided under excise laws to restrict applicability of excise duty in such circumstances. Early implementation of GST should help address this issue.

(f) Declaration requirements under Indian legal metrology laws should be aligned with globally accepted labelling standards to mitigate problems arising on account of labelling requirements.

2.5 Generic issues and recommendations

(a) Policy induced barriers: Organised retail is managed by the Ministry of Commerce and Industry and the Ministry of Consumer Affairs; while the former administers retail policy, the latter regulates retailing in terms of licensing and approvals. The sector is subject to loose regulation due to multiple ministries/regulators. The development of the retail sector can take place at a faster pace if a comprehensive regulation is enacted. It is therefore recommended that central and state level consolidation of trade act must be envisaged by a single trade policy so that multiple acts and legislation can be unifiedand provisions to address violations and grievances can be made. All trade related acts should be a part of the trade policy.

(b) Lack of industry status to retail: Due to lack of industry status, the retail sector faces difficulties in procuring organized financin and fiscal incentives. The government should grant industry status to the sector with a

clear articulated policy framework. Further, attempts must be made to ensure that there should be a single, nation wide retail sector policy.

(c) Poor supply chain infrastructure: Lack of storage and transport logistics often leads to wastage. Lack of cold chain infrastructure hampers development of food retail. Further, low internet penetration in rural areas is an obstructing factor for online retail industry. Thus, poor quality and irregular supply of infrastructure and intermediate services act as a major impediment for retail sector in India. There is therefore need for growing allied infrastructure in the country.

(d) Real estate concerns: Escalating real estate prices and rentals in large cities severely impacts profitability of retail companies. Further, lacking sophisticated retail planning is another major challenge since it is difficultto find suitable properties in central locations for retail, primarily due to fragmented private holdings, infrequent auctioning of large government owned vacant lands and litigation disputes between owners. It is therefore recommended that zoning laws be introduced to create ‘property banks’ suitable for the retail sector. Commercial zones could be split into retail with low floor space index (FSI) having high ground coverage and office, hotels with high FSI having low ground coverage. Excess FSI could be transferred to nearby plots for office, hotels and other adjacent components. Big box developments should be allowed in areas with lower FSI. This would help in reducing rental costs due to ‘clustering’ of supply and benefit consumers due to lower travel costs.

(e) Ease of doing business: A major impediment for new entrants is coping with procedures associated with starting and carrying on a business in India. According to the World Bank Doing Business 2016 Report, starting a business in India requires 29 days to get many licenses and statutory approvals.9 Though the government has taken various initiatives, it is recommended that a single window clearance for all licenses and approvals be introduced

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for retailers to ease and accelerate the pace for doing business in India.

(f) Inflexible labour laws: Indian labour laws leave no room for free contracting and hiring contract workers seasonally to meet additional demand. Further, there are restrictions on women working beyond 8 p.m. (though a few states have relaxed this restriction). This discourages businesses from having women managers since daily store closing formalities need to be completed by the store manager. Rules in line with the BPO sector need to be framed to bring in consumer focus without exploiting labour. Women employees should be permitted to work beyond the stipulated work hours if safeguard measures have been adopted by organisations. Also, restrictions on part-time workers/employees should be removed. This can create employment opportunities and simulate creation of a part-time work force, in line with international best practices. Finally, employees should be allowed the flexibility of working in shifts best suited to their personal needs. This will ensure balance in their personal life and work.

(g) VAT on e-tailers: Various state governments are intending to levy VAT on sale made through online portals if the warehousing is undertaken in a particular state by e-tailers. This raises challenges for these businesses since it would create duplicity in tax payment and compliances, both at the end of the seller and also the marketplace. These aspects should be clarified and dual imposition be removed.

(h) Multiplicity of taxes and resultant cascading effects: There is multiplicity of indirect taxes in the retail sector – those imposed by the centre such as customs duty (levied on import of goods), excise duty, service tax, and those imposed by state governments such as VAT,

CST and octroi/ local body tax. These have a cascading effect with limited or no credits and tend to complicate the system. A unifiedGST that subsumes all or most of these levies should be implemented without any delay.

3. CONCLUSION3.1 Retail businesses have evolved dramatically

with start-up retail companies dotting the landscape -- from food service, health and beauty and apparel to electronics, furniture and footwear. With most retailers in India today being in the midst of implementing their multi-channel approach, increasing the geographical footprint has taken on a whole new meaning. At the same time, definingbusiness success and profitability in this fast changing environment remains a challenge for companies.

3.2 The recent relaxations on FDI in retail provides an interesting dynamic to the Indian landscape. Several large international groups/companies (including European companies) are contemplating investing in India to leverage the strong demand potential of one of the largest consumer market. Currently, a host of large retail chains are undergoing market assessment studies to set up their operations in India. However, due to teething issues in the regulatory framework and operating space, foreign investors tailor their business models and strategies accordingly.

3.3 The Indian government therefore must play a key role to develop and evolve the regulatory space for the retail sector. There is also need for the government to facilitate and address teething issues through policy/regulatory interventions and infrastructure support. We look forward to early implementation of the recommendations proposed in the position paper.

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Endnotes

1 “Building retail businesses for tomorrow today”, by PwC and Retailers Association of India

2 “Retail 2020: Retrospect, Reinvent, Rewrite” by the Boston Consulting Group and the Retailers Association of India

3 Article titled “Retail Sector feels let down by the Finance Minister Arun Jaitley”, can be accessed at http://www.merinews.com/article/retail-sector-feels-let-down-by-the-finance-minister-arun-jaitley/15914411.shtml, last visited on March 15, 2016

4 “Building retail businesses for tomorrow today”, by PwC and Retailers Association of India

5 The Legal Metrology Act, 2009 read with the Legal Metrology (Packed Commodities) Rules, 2011

6 Budget Speech, Union Budget 2016-17, available at http://indiabudget.nic.in/ub2016-17/bs/bs.pdf, last visited on March 15, 2016

7 Clarification on queries of prospective investors/ stakeholders on FDI Policy for Multi-Brand Retail Trading (Circular No. 1 of 2013), available at http://dipp.nic.in/English/News/MBRT_Clarification_06June2013.pd , last visited on March 15, 2016

8 Such as in case of packages containing food articles, provisions of the Prevention of Food Adulteration Act, 1954 applies; in case of packages containing seeds, provisions of Seeds Act, 1966 applies. Also, there is a Legal Metrology Act, 2009 which also covers labelling requirements in case of pre-packed commodities.

9 “Doing Business 2016 – Measuring Regulatory Quality and Efficiency”, available at http://www.doingbusiness.org/~/media/GIAWB/Doing%20Business/Documents/Annual-Reports/English/DB16-Full-Report.pdf, last visited on March 15, 2016

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TELECOMMUNICATIONSEvolve stable telecom policies and a regulatory framework which is consistent and predictable and helps attract long term investments.

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1. INTRODUCTION

unprecedented growth of the Indian telecom sector can be attributed to the wireless segment, which accounts for more than 98% of the total subscriber base as of December 2015.

In the last one-and-a-half decades, tele-density has increased from 3.58% in 2001 to 82% in January 2016. Urban tele-density stands at 152% and rural tele-density at 50%. Most new users are largely expected from the country’s rural heartland. The total telephone subscriber base has risen from 76 million in 2004 to 1036 million subscribers in December 2015; with over 600 million urban subscribers and 436 million rural subscribers. As stated earlier, wireless subscriptions constitute the major part at about 1011 million (580 million urban and the rest 431 million in rural areas). In the broadband segment, the total subscriber base in the country was 120 million as of December 2015, most of which is in urban areas.

Government initiatives have led to large commitments of investments from all leading developed nations. The Indian telecom sector continues to attract investment from global telecom giants. The telecom sector received investments worth US$18.1 billion (€15.8 billion) in the period from April 2000 to December 2015, accounting for about 6.5% of the cumulative foreign direct investment (FDI) equity inflows to the country. India’s foreign exchange reserves have surged by US$2.5 billion (€2.1 billion) to touch an all- time high of US$355.9 billion (€312 billion) in March 2016, as per Reserve Bank of India (RBI).

2. REVIEW OF YEAR 2015 FOR TELECOM SECTOR

For the telecom sector, the year 2015 was indeed a historic year. Though there were highs as well as lows, the highs outscored the lows on almost all counts.

According to the World Bank, India is now the world’s fastest growing economy. It is well-positioned to weather global volatility and set for modest acceleration in growth in the coming years. India’s economic growth is expected to be 7.5% in 2015-16, accelerating to 7.8% by 2016-17 and 7.9% by 2017-18. The year 2015 was a landmark one as it was the first complete year in office for the Narendra Modi-led government. With the new government in place, the Indian telecom industry is witnessing a revival period and empowering one billion connections. The change in government has brought renewed hope and expectations for the industry with ambitious GDP growth targets of 7.5-8%, focus on tackling inflation and facilitating a digital economy for the country. The government has started making rapid strides on various programmes for strengthening India’s position on the global map with a view to boosting all round economic growth and spreading the benefits of the growth across all sectors of the economy. These include programmes such as Digital India, Skill India, Jan Dhan Yojana (JDY), Jan Aadhaar Mobile (JAM), Start-up India, Smart Cities and Make in India. The prime minister himself led the thrust on improving the overall image of the country overseas and committed personally to improving the ease of doing business with India.

The year 2015 was significant as it marked the completion of two decades since the first mobile network’s launch in India. Also, the year witnessed a series of events including the launch of Digital India, launch of 4G networks, spectrum auctions and introduction of spectrum sharing and trading, among others. The Indian telecom accounts for about 14% of total global subscribers. The phenomenal growth of the telecom sector has made it a significant contributor to the country’s GDP. The contribution of the communication sector to GDP has increased from 0.7% in 1980-81 to 6.1% in 2014-15. The sector contributes directly to about 2.2 million jobs and indirectly to another two million jobs. The

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Positive Developments

1 Launch of Digital India

2 Launch of 4G networks

3 Spectrum Auctions in March 2015

4 Policies on spectrum sharing and spectrum trading

5 Government’s tower initiatives by way of permitting the use of government property for the installation of towers

6 Government going out of its way to extend helping hand to the industry by way of creating awareness of the absence of any harmful effects on human health of mobile tower radiation

7 Initiation of harmonization process in various spectrum bands

8 Improvement in ease of doing business in India -going up by 13 notches

9 Growing speed of e-commerce and use of m-commerce

10 Rapid rise in mobile apps/OTTs

11 Government and regulators proactive policy on releasing recommendation on the forthcoming spectrum auction

12 Announcement of 100 Smart Cities

13 Announcement of the M2M roadmap for India

14 Increased focus on IoT

15 Increased focus on the build out of Bharat Net

16 Availability of really low-cost consumer devices viz. 3G & also 4G handsets

17 Increased focus on Design in India, Make in India and Start-up India

18 Mergers and consolidation beginning to happen as a result of allowing of spectrum sharing and trading, thereby reducing the number of operators in the market

19 Introduction of Aadhaar Bill in the union budget and approval in both houses of Parliament

20 Telecom Commission nod to entry of virtual network operators

21 Sharing of active infrastructure among service providers on mutual basis is permitted

22 Draft Indian Telegraph Right of Way Rules, 2016

While there was overall a sense of positive optimism and cheer all around the industry due to several long

pending policy decisions coming through, there was also cause for some concern in a few areas.

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On the regulatory front, ease of doing business and investments (FDI), there were some significant positive achievements. Many proactive and positive steps have been taken by the regulator to step up the pace of regulation. Ease of doing business has also improved significantly with investor friendly policies, investor friendly and pro-development oriented climate being ushered in by the government. Investments in the form of FDI have increased significantly in the telecom sector, particularly in the first two quarters of this year when FDI in India was higher than the BRICS countries. From the formation of new government in May 2014 to June 2015, the telecom sector attracted an FDI of about INR 11,000 crores (€1.44 billon). Due to stiff competition resulting in low tariffs (lowest in the world) and the multi-fold increase in spectrum prices, the financial health of the telecom industry has remained a major concern. The industry is reeling under a debt burden of INR 350,000 crore (€46 billion) at the end of 2015.

3. TRENDS AND OPPORTUNITIES OF TELECOM SECTOR

a. Broadband

Although National Telecom Policy (NTP) 2012 had ‘broadband on demand’ as one of the main objectives, progress on this has been quite inadequate in the three years that have elapsed since then. Against a target of achieving 175 million BB (broadband) connections by 2017, we have achieved only 120 million as of December 2015 and

this too with the current download speed of 512 kbps which is way below the norms in comparable countries. According to the State of Broadband report 2015 by the UN, India’s broadband penetration ranking has fallen to 155 from 113.

With Digital India (all nine pillars rest fairly and squarely on broadband/ICT) starting to take shape, the current scenario of broadband adoption is set to change sharply and all technologies, whether fixed, mobile, satellite, Wi-Fi, cable etc. have a powerful role to play in enabling the reach of broadband to all. With the demographic dividend of a high, vibrant young and working population and the launch of great programmes like Digital India, Make in India and Start-Up India, all of which will demand broadband, the supply side of potential increased broadband penetration has to match up. The significant increased offtake of mobile broadband (3G) in smaller towns is testimony to this effect. Two of the foremost challenges to increased broadband growth have been, and continue to be, inadequate spectrum and difficulties in rolling out the essential infrastructure of optic fibreand tower installations.

It is encouraging that the government has recently announced a series of steps to make available government properties for installing towers. As regards the second biggest challenge of inadequate spectrum, some progress has been made through the last auction and also through the announcement of spectrum sharing and trading. The biggest

Issues of Concern

1 Regulatory announcement to charge penalty for mobile call drops

2 Arbitrary decisions/orders of the state governments/municipalities/local bodies which have created barriers for the rollout of towers on grounds of right of way (ROW)

3 Dis-allowance of differential data pricing

4 Service tax on spectrum assignment

5 Service tax on spectrum usage charges and license fee amount

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ever spectrum auction of over 2000 MHz spectrum across seven or eight bands is also scheduled for mid-2016. Harmonization of 1800 MHz spectrum is another challenge and the Department of Telecommunications (DoT) is working on it.

A third key factor is increased public awareness and ability to use broadband services. The Telecom Regulatory Authority of India (TRAI) has rightly stressed a focused approach to content, applications, skills and affordable access such as shared use model. Regional/local content development would need to be strongly incentivized.

Government initiatives would play a very crucial role in enabling many of the above. Possibly the biggest challenge in the Indian scenario would be to achieve a harmonized and concerted approach not only between the various ministries and departments in the centre but, even more importantly, between the centre and various state governments.

b. National Optic Fibre Network (NOFN)/Bharat Net

The National Optic Fibre Network (NOFN) Project was launched to reach 250,000 gram panchayats (GP) to facilitate broadband connectivity all over the country as part of the Digital India Mission. Its goals were to reach 50,000 GPs by March 2016, another 100,000 by March 2017 and the remaining 100,000 by December 2017. It is understood that 37,000 GPs were connected by December 2015. This project is being implemented by three public sector undertakings (PSUs), namely Bharat Sanchar Nigam (BSNL), Rail Tel of Ministry of Railways and the Power Grid Corporation of Power India Limited (PTCIL). A major part of the funding is provided from the Universal Service Obligation (USOF) of the government and ‘GPON’ technology equipment has been deployed in the access part. State governments have also agreed to contribute by signing up to not levy any right of way charges (ROW). Bandwidth from 20-100 Mbps is planned along with non-discriminatory access to all categories of service providers.

A review committee sought to enlarge the scope to reach all 620,000 villages of the country and recommended altering the architecture as well as the network configuration This was re-christened Bharat Net. However, in view of differing suggestions, the matter was referred to TRAI. TRAI issued recommendations in February 2016 and the same are being examined by the government. There is all-round acceptance that the measures suggested by TRAI would give Project Bharat Net a big boost and help achieve ‘Broadband India’ most expeditiously. The key to the success of these new recommendations would be the TRAI recommended BOOT model with involvement of the private sector for deployment and operations. However, it was felt by the industry that the ownership/funding should remain predominantly with the government. Such an ownership structure is essential to ensure open, non-discriminatory access to all operators.

TRAI has rightly stressed that RoW must be provided free of cost by all the states to the executing agency. This is an absolutely essential requirement for the success of this project. Many recommendations of TRAI are in complete congruence with stakeholders’ suggestions, such as:

i. Concessionaire period of operation/agreement should be kept 25 years, co-terminus with the life of the optical fibre. This would give the operator sufficient incentive to recover the costs sunk into the project. Also extension of the lease/agreement period for a further period in blocks of 10/20/30 years, subject to mutual agreement.

ii. Involvement of government (centre/state) as equity partner in the consortium as it will help in getting faster government clearances, resolve the risk of monopolistic behaviour while also automatically solving the risks associated with windfall profits.

iii. Flexibility in terms of route for laying optical fibre, choice of construction, topology and technology to be allowed to the bidder/executing agency.

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iv. Selection of bidder based on the minimum viability gap funding (VGF) sought and to align the service area as the LSA or the state/circle itself.

v. Incentives to the private operators for early achievements against pre-defined milestones.

vi. Inbuilt measures to ensure access is provided to all service providers in a non-discriminatory and transparent manner.

vii. Regulation of wholesale pricing by TRAI to safeguard against anti-competitive behaviour and to ensure affordability.

viii. Liberal eligibility criteria to allow maximum participation of bidders.

ix. The government of India is also understood to have set up a review committee to enlarge the scope of the Bharat Net project to reach all the 620,000 villages. The final decision of the government in this regard is awaited as regards revision of technical configuration and cost of the project is concerned.

c. Spectrum Auctions Spectrum is the very lifeblood of the telecom

sector. It is, as ruled by the Supreme Court of India in 1995, a ‘public property’ and the government is merely its custodian or caretaker. The process of commercial auctions is being seen and being used by the government as reasonable, open and transparent method of efficiently allocating this scarce’ public resource’ to the eligible licensed service providers (interested parties) for providing telecommunication services.

The last round of spectrum auction was conducted by the government in March 2015. The result of the auction with different quantum of spectrum for the 22 licensed regions is summarized below:

S. No. Band Quantum

1 800MHz 108.75MHz

2 900MHz 177.80 MHz

3 1800 MHz 99.20 MHz

S. No. Band Quantum

4 2100 MHz 85.00 MHz (limited to 5MHz each in 17 Tele-com Circles)

Source: DoT

The auction ended on March 25, 2015 through a fiercely contested sale, which lasted 115 rounds, spread over 19 days. The auction value rose as high as INR 1,09,874 crore (€14.4 billion).

The next round of spectrum auction is scheduled in mid-2016. This is expected to be a big bang auction increasing the supply of spectrum by nearly 60%. TRAI has proposed to put 2090 MHz of spectrum in 700, 800, 900, 1800, 2100, 2300 and 2500 MHz band. Proposed break-up of the same is given below:

Spectrum for 2016 Auction

S. No. Band Quantum (in MHz)

1 700 MHz 770

2 800 MHz 23.75

3 900 MHz 9.8

4 1800 MHz

21

5 2100 MHz

345

6 2300 MHz

320

7 2500 MHz

600

Total 2089.55

Source: TRAI

It is hoped that as mentioned earlier, suitability of 700 MHz frequency band for rural broadband would be preserved by the government. It would greatly help Digital India if the pricing of 700 MHz band were to be kept at an affordable low level; by doing so, the government would achieve the goal of early

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penetration of broadband in rural areas of the country.

d. Make in India Scheme The new government has initiated certain

flagship projects to give the economy a major boost. One of them is the Make in India initiative. It stems from the basic premise that the country needs to galvanize its dormant manufacturing sector to have all-inclusive economic and financial progress. This, Prime Minister Modi believes, will also create additional jobs, provide opportunities for the private sector and also lead to fresh investments by way of FDI. Moreover, it will lead to new skills being developed, and availability of world class products for local consumption at highly competitive prices. The government is taking several bold measures to bolster the Make in India scheme that aims to make India a world class manufacturing hub. To help promote and kick-start local manufacturing, Budget 2016 has proposed cuts in customs duty on several items, particularly on parts/components that will make it cheaper for Indian companies to import parts/components, needed for manufacturing the product. Domestic production shall get a big boost from the government as a result. Further, roll out of GST, hopefully, from June 1, 2016, is expected to boost investor confidence as well as the manufacturing of telecom products. The growth of domestic manufacturing units is expected to revive and benefit from specificsteps, such as customs and excise duties rejig, reduction in customs duty on inputs and parts, greater access to credit, focus on improving skills and broader impetus on ease of doing business and infrastructure, all of which are currently being examined by the government.

As a part of the ongoing initiative to give a special fillip to the local manufacturing industry, over a dozen national investment and manufacturing zones have been identified. Procedures and processes to set up manufacturing units in these areas are being simplified. Moreover, a Technology Acquisition and Investment Fund

has been established by the government to create a ‘patent pool’, which would also be able to purchase IPRs located overseas. Six corporate have already sent their ‘expression of interest’.

Towards the objective of global integration, the government is intensifying efforts to bring about a breakthrough in the field of telecom equipment design and manufacturing, not only for the domestic market but also for exports. The present scenario of free flow of information worldwide may help in considerably overcoming the challenges of matching global competitiveness in the manufacturing sector and to develop the appropriate Indian technology, products, skill and talent for this purpose.

The Make in India initiative has a significantrole to play in the Digital India plan. In the process of digitally empowering all its citizens, the government is focused on laying the critical digital infrastructure across the country to connect all citizens. It is raising domestic contribution in this project through the Make in India efforts and this is gaining significantmomentum. The government believes that Make in India and the digital transformation drive would ensure that the overall national import bill for import of telecom and electronic equipment can be drastically reduced from its anticipated rise to US$400 billion (€350 billion) from the current levels of US$100 billion (€87.6 billion) so that India can meet domestic demand as well as export surpluses in future.

India imports electronic equipment worth around US$ 100 billion (€87.6 billion); this is estimated to go up to US$400 (€350 billion) billion by 2020.

e. Skill India The government has also launched a Skill

India mission. The National Skill Development Mission was approved by the union cabinet on July 1, 2015, and officially launched by the prime minister on July 15, 2015, on the occasion of World Youth Skills Day. The Mission has been developed to create

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convergence across sectors and states in terms of skill training activities. Further, to achieve the vision of Skilled India, the National Skill Development Mission will not only consolidate and coordinate skilling efforts, but also expedite decision making across sectors to achieve skilling at scale with speed and standards. It will be implemented through a streamlined institutional mechanism driven by the Ministry of Skill Development and Entrepreneurship (MSDE).

f. Ease of Doing Business in India As per a recent (2016) report of the World

Bank, India has been ranked 130 out of 189 countries in overall ease of doing business. The ranking has improved by four notches as compared to 2015. The government has set a target of upgrading India to among the top 50 nations over the next two to three years.

In the last few years, the government announced several steps to improve ease of doing business, including de-licensing the manufacture of many defence products and introduction of the e-Biz project for single window clearance. The emphasis of the Department of Industrial Policy and Promotion (DIPP) has been on simplification of existing rules and introduction of Information technology to make performance more efficient, effective, simpler and user friendly. The Commerce and Industry ministry has taken several measures and has proposed a further series of steps, including drastically reducing the time for registration of business to one day (from the existing average of 27 days), single registration of all labour laws and a cut in the number of taxes towards this objective.

The government wishes to do away with cumbersome clearances before starting a business in the country, replace/rationalize the multiple prior permission needed for starting a business, with a fair and transparent regulatory mechanism. The idea is to let entrepreneurs start manufacturing firstthrough self-certification and let approvals and clearances come later. At the same time, the

government, along with various departments, is in consultation to remove barriers and simplify cumbersome/time consuming procedures related to approvals and clearance mechanism for business activities.

DoT needs to review, cut delays and simplify existing procedures for government approvals and clearances such as wireless planning and coordination wing and telecom engineering centre for industry related proposals. Online handling of requests/proposals needs to be considered by the government. While having the essential rules and regulations in place, the government may like to consider, more importantly, the necessity to have a good system of quick and predictable clearances so that small and start-up businesses do not feel harassed.

g. Net Neutrality, OTT Services and Internet Governance

The definition of net neutrality is still to be decided in the Indian context. The government has recently asked the regulator (TRAI) to give its views/recommendations on net neutrality. TRAI is expected to shortly start the consultation process in this regard. The subject has arisen not directly but in connection with over-the-top (OTT) services. Access providers feel adversely impacted in respect of their voice and SMS revenues due to competing OTT services being offered free of cost to the consumer. While OTT players are not subjected to any taxes and levies, security compliance requirements, legal interception, KYC (know your customer), QoS (quality of service) etc., access service providers are burdened with all these functions, thereby leading to a lack of level playing field. Several OTT communications services have acquired significant dominance in the Indian market – for example Whatsapp now has more than 70 million users in India. Existing access service providers (mobile services) in the country have made several representations both to TRAI and DoT to help correct this anomaly in service conditions.

One key constituent in net neutrality is

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differential pricing and zero rating policies which have been deployed extensively in developing economies to jumpstart the local economy into high connectivity equilibrium. Zero rating is now an acknowledged pricing tool and its potential to increase internet connectivity quickly and at low/zero cost is well established. Zero rating programmes are effective means of bridging the digital divide; in the case of zero rating, social welfare increases because benefits are directly passed on to consumers and not to commercial entities as is the case of paid search.

In this context, TRAI in March 2015 released a consultation paper on OTT services and the need for regulation. The paper received an unprecedented number of responses from stakeholders, with a huge online community backed by consumer associations pleading for status quo and no regulation on OTT services. Parallel to the TRAI consultations, in May 2015, a DoT committee, headed by a senior ranked official came out with an independent report on net neutrality. This report only reiterated the government’s commitment of upholding the principles of net neutrality and ensuring that all have an equal right to access the Internet in a fair and non-discriminatory manner. While doing so, the committee also recommended non-blocking, non-throttling and non-prioritization of traffic over the network as the core principles of net neutrality. After a few months, in December 2015, TRAI came up with a new consultation paper on one of the aspects of net neutrality -- differential pricing for data services. This paper received a historic response running into several millions. After a consultation process that included open house discussion with all stakeholders, TRAI decided to disallow differential pricing for data services on February 1, 2016.

India had last year expressed favouring a neutral internet through its Minister of Communications and IT Ravi Shankar Prasad. For India, net neutrality is very important; for the governance model as well as the regulation for OTT services, a broad framework would be worked out in consultation with stakeholders.

The Minister said in March 2016 in Morocco that we instinctively value the Internet to be open, plural and inclusive and that access should be without discrimination. He had suggested a bigger role for governments, perhaps in the context of rising cyber threats. He, however, clarified that multi-stakeholders approach to internet governance is a significant change from the stand of the previous governments which had advocated a multilateral approach.

On internet governance, the announcement of the US moving out of IANA (Internet Assigned Numbers Authority) has been welcomed by the Indian government. Minister Prasad, while welcoming the move, has promised that India shall play an increasingly important role in the new governance structure of the Internet Corporation for Assigned Numbers and Names (ICANN). ICANN is also working towards developing a more inclusive model and cleared the use of non–Latin languages; consequently, India launched its dot bharat domain in the Devanagri script last year.

EBG would deliberate on the subject and supplement the views of its members with examples taken from European countries, including best practices besides the Indian experiences and concerns. The approach would need be balanced, consumer friendly and also take care of industry’s key requirements regarding fair competition and level playing field to the extent feasible.

h. Enterprise Market Fuelled by the convergence of social,

mobile, cloud, and big data and growing demand for anytime, anywhere access to information, technology is disrupting all areas of the business enterprise market. Cloud and mobility will give cost efficienc , reach and cost optimization in the future. The marketplace in India has been very mobile, attracting fast growth of the enterprise market in the country.

i. Smart Cities Smart Cities, in the most basic terms, are urban

settlements that exploit technology to offer

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more structured and hospitable conditions for residents including services. In short, a Smart City is one that uses information technology to solve urban problems. There is accordingly need for cities to get smart to enable large scale urbanization and to find new ways, supported by technology, to manage the complexities, increase efficienc , reduce costs and improve quality of life. Information and communication technology forms the backbone of Smart Cities and is the main tool to address common problems like congestion, waste of energy, facilitating the set up of a centralized control system to provide real-time inputs on availability of water, electricity, public transport, healthcare and education as well as intelligent communication tools for managing and enabling a faster response to emergencies.

As defined in the government of India guidelines, (Ref: smartcities.gov.in /writereaddata/SmartCityGuidelines), a Smart City is an urban region that is highly advanced in terms of the overall infrastructure, sustainable real estate, communications and market viability. It is a city where information technology is the principal infrastructure and the basis for providing essential services to residents. There are many technological platforms involved, including but not limited to automated sensor networks and data centres.

According to the government guidelines, the core infrastructure in a smart city would include:

1 Adequate water supply

2 Assured electricity supply

3 Sanitation, including solid waste management

4 Efficient urban mobility and publictransport

5 Affordable housing, especially for the poor

6 Robust IT connectivity and digitalization

7 Good governance, especially e-governance and citizen participation

8 Sustainable environment

9 Safety and security of citizens, particularly women, children and the elderly

10 Health and education

The government has decided to develop a programme of 100 Smart Cities in the country. It has allocated a budget of approx. US$80 million (€70.1 million) per city over a period of five years. A detailed transparent criteria had been laid down for selecting, preparing the model plan and for selection of the most eligible cities which have the potential to transform into Smart Cities. Based on the criteria provided, each state government (of all the 29 states and union territories) was asked to come up with a list of potential cities which could be turned into Smart Cities. After consolidating the list of potential cities received, the Ministry of Urban Development (MOUD) came up with a list of 98 cities. Subsequently, the central government recently announced the first list of 20 cities which have become eligible to receive the first tranche of investment towards their development into Smart Cities.

The list of 20 smart cities is as follows:

1 Bhubaneswar, Odisha

2 Pune, Maharashtra

3 Jaipur, Rajasthan

4 Surat, Gujarat

5 Kochi, Kerala

6 Ahmedabad, Gujarat

7 Jabalpur, Madhya Pradesh

8 Visakhapatnam, Andhra Pradesh

9 Solapur, Maharashtra

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10 Davangere, Karnataka

11 Indore, Madhya Pradesh

12 New Delhi Municipal Corporation

13 Coimbatore, Tamil Nadu

14 Kakinada, Andhra Pradesh

15 Belagavi, Karnataka

16 Udaipur, Rajasthan

17 Guwahati, Assam

18 Chennai, Tamil Nadu

19 Ludhiana, Punjab

20 Bhopal, Madhya Pradesh

The government has tweaked the method of selecting the next list of 40 Smart Cities by allowing 23 states that got left out in the firstround to compete on a fast-track mode as against the earlier plan that the rest 77 cities go in together. The 23 states and union territories which were not represented would take part in the fast-track competition by submitting upgraded Smart City proposals of one top ranked city in each state and union territory.

Phase Three shall comprise the remaining 54 cities that get to participate in the next round of the Smart City Challenge Competition. This change in methodology of selection will give two more opportunities in the next few months for more cities to be selected from other states and union territories.

j. Social Media India has become the third largest smartphone

market in the world. As per industry estimates, smartphone penetration in India will increase from 15% in FY14 to 55% in FY2020. The growth in the usage of smartphone is driven by young population and the availability of affordable handsets and content that has generated a huge upsurge in data services. Ericsson estimates that the monthly mobile

data traffic per active smartphone is expected to increase from 1 GB in 2014 to 4.5 GB by 2020. Free Wi-Fi services in public spaces are now being implemented in several cities and several tourist locations across the country. Several free Wi- Fi zones/pockets/hot spots have started emerging in several cities in the country. However, TRAI’s recent regulation of taking explicit consent for data activation through 1925 may hamper new data subscription as well as the data traffic in India. This means that data service on the cellular mobile telephone connection of a consumer cannot be activated/deactivated without his/her explicit consent.

k. Virtual Network Operators (VNOs) The Telecom Commission, the apex decision

making body of the government of India, in March 2016 approved a new category of unified license called virtual network operators (VNOs). Mobile VNOs basically buy the bandwidth and talk time in wholesale from telecom operators which own the spectrum and infrastructure. Instead of building hugely capex-intensive telecom networks, they can simply pay and partner an existing mobile network operator. These virtual operators can then sell the usual telecom services (voice calls, data packs etc.) to the consumers under their own brand.

The proposal is currently under approval by the telecom minister after which new unifiedlicenses are expected to be issued and implemented within few weeks. EBG shall deliberate on this subject and offer its views after considering all its aspects following the issue of the official government notificatio

l. 100% FDI in e-commerce The recent decision of the government to

allow 100% FDI in the e-commerce sector is another step towards reforms. E-commerce has caught the imagination of a young breed of start-ups and a new class of consumers who are ever willing to try out new technology-driven platforms for shopping using the convenience of their mobile phones, iPads

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etc. As the brick and mortar business grapples with demand slowdown, online frontrunners are logging in double-digit growth with gross sales running into several billion dollars. Till now, most were raising millions and billions of dollars of foreign funding through circuitous routes.

To give the entire start-up industry a big boost, the government has streamlined the process for infusion of 100% FDI into this industry through automatic route in online trading. While the move is generally welcome, the guidelines still need to be ironed out as it still imposes some restrictions.

4. KEY ISSUES AND RECOMMENDATIONS

a. Policies and Regulations

The telecom sector is witnessing improvement in growth. However, heavy debt burden continues on the telecom companies (estimated at INR 350,000 crore (€46 billion) as on FY15), mainly due to auction outflows.The present government, which appears to be committed to development, has been reviewing economic policies to reignite economic growth, ensuring that the benefitsare more widely shared within India with inclusive growth and is set on a stable policy framework. The government seems to be seized of the fact that stability, consistency and predictability in telecom policies as well as regulations is vital for investor confidencefor long term and sustained huge investments, which are necessarily needed for accelerating the rapid growth of the telecom sector in the country, especially in the emerging areas of broadband and data services. There is, however, need to ensure a fair regulatory environment in competition. A level playing field amongst equally placed players, adoption of a light touch regulatory approach for emerging new technologies/applications are some of the cornerstones of the new policy and regulatory regime.

b. Spectrum Reforms Due to legacy issues, most frequency

bands needed for commercial usage for the consumers in the country have been typically in the custody of government agencies viz. defence, space and others, thereby largely restricting/limiting the adequate availability of spectrum for commercial use of the rapidly growing mobile services (2G, 3G, 4G, etc.) While normal international practice has been to provide for an average of around at least about 100 MHz, in India, even after almost 20 years and umpteen policy interventions, the average quantity of spectrum held by the operators has only reached around 18 MHz.

Telcos need urgent availability of additional contiguous spectrum for mobile services, especially for broadband deployment and penetration. The operators have usually been handicapped by having inadequate quantum of spectrum and that too in a fragmented form. Several steps have been taken by the government now as well as in the past but the problem still remains. For upcoming auctions in mid-2016, it is believed that the government is working at a feverish pitch to harmonize the ultra-important 1800 MHz band. Once done, this will help in release of contiguous chunks of 5 MHz (minimum) to the operators for use. This band is considered as one of the most useful and cost-effective bands for mobile broadband. Further, it is understood that the government has set up a committee to enable release of further spectrum in the commercial bands from other government agencies viz. defence.

Based on the findings of the high powered steering committee, TRAI issued guidelines for active network sharing. These guidelines focus on sharing of spectrum by two licensees in a LSA (local service area) using a common radio access Network (RAN in 2G and UTRAN in 3G networks). The government has approved norms for such spectrum sharing as well as spectrum trading. It would be appreciated if the government could define a roadmap for spectrum availability for current services 2G, 3G as well as emerging technological trends

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(4G, 5G)/futuristic applications, including a roadmap for auction of 700 MHz frequency band (698-806 MHz). A carefully designed roadmap for 700 MHz would help facilitate planning by the vendors for timely availability of devices at affordable prices -- the 700 MHz band is especially suited for broadband penetration in rural areas of the country. Possibility of implementing dynamic spectrum allocation may be examined by the government for optimum utilization of spectrum, as best as feasible. It may be prudent to continue to adopt globally/internationally harmonized frequency bands enabling India to leverage economies of scale and offer affordable services to the consumers. The government may like to consider introduction of spectrum audit in order to ensure optimum utilization of available spectrum.

Further, there is need to simplify spectrum auction structuring. The pricing of 700 MHz frequency band needs to be kept at an affordable low level as the band is being put to auction for the first time and affordability and accessibility of broadband services will suffer if the band is unreasonably priced.

The Telecom Commission has recently reduced spectrum usage charges from 5% to 3% for the spectrum to be auctioned in the next round of auction in FY17, after due verification. The formal notification is awaited

c. Call Drops TRAI issued a Regulation on Call Drops in

October 2015. After a detailed consultative process and elaborate discussions with all the different stakeholders, TRAI issued a regulation to penalize Telecom Service Providers (TSPs) only for the call drop problem. The regulation mandated TSPs to compensate customers for dropped calls within their networks. As per the regulation, TRAI asked operators to credit Re.1/- for each call drop subject to a maximum of three call drops per day within four hours of the occurrence of call drop.

Operators have explained to the authorities that there are multiple reasons for call drops,

all of which cannot be attributed to them. While the operators have made significan investments to improve the network and quality of service, they have asked the regulator and the government to withdraw the notification to impose penalty as there are multiple stakeholders involved and it is not fair to penalize the operator alone. The regulation was subsequently challenged in court and is currently being heard in the Supreme Court.

d. Market Consolidation India has the largest number of operators/

service providers - as many as eight-nine per service area with the global average being three-four. The telcos holding market share above 10% are Bharti, Vodafone, Idea, and Reliance (RCoM). Post announcement and notification of the spectrum sharing and trading norms, the sector has started to see mergers and acquisitions (M&A) being announced. The larger operators are also consolidating their respective spectrum holding as a result.

M&A norms/guidelines need to be made simpler and should encourage consolidation. The industry believes that some of the present provisions are detrimental, like payment of market price by the service provider to the government for the acquired spectrum.

e. Infrastructure Rollouts The prime minister’s 10-point agenda for

India’s turnaround includes infrastructure and investment reforms as a key item. To achieve the same, the government needs to extend ‘infrastructure status’ to the industry. This would include making available assured grid power at industrial rates on priority, tax holidays and preferential debt interest/instruments. This would bring the telecom sector at par with other infra sectors like power for expeditious rollouts of telecom networks at reasonable costs and make it affordable for the Indian consumer as well help address environmental concerns and CO2 emissions. At present, ROW charges are very high and vary widely in different States/Municipalities. Recently, DoT

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has issued draft Indian Telegraph Right of Way Rules, 2016.

States need to be aligned with DoT guidelines with regard to tower installations. There is need to adopt a pragmatic approach for encouraging green technologies and renewable energy resources. The Universal Service Obigation (USO) fund could appropriately incentivize and/or subsidize service providers resorting to green renewable energy solutions in their networks. Further, there is need to ensure availability of 24x7 grid power as service providers have to otherwise resort to diesel based power back-ups which add significantlyto high operative costs.

f. Machine to Machine (M2M) Communications/Internet of Things (IoT)

It is expected that future ICT developments will mainly ride on machine to machine (M2M) and Internet of Things (IoT). It is estimated that India will have 24.6 million active cellular M2M connections, the ninth highest in the world. M2M/IoT services in India will be driven by differentiated service offerings, cloud based offerings, operational efficiency and cost savings, government mandates and regulatory compliances, standardization requirement, network coverage and availability of high speed data services.

In India, digital infrastructure will bridge the gap arising from lack of physical infrastructure. There is huge scope in the areas of health, education, financial inclusion, power management, transportation logistics, car automation, portable electronics, etc. On M2M/IoT, DoT issued a roadmap in May 2015. The policy and regulatory guidelines under consideration on some of the key issues pertaining to M2M included:

• Registration of M2M service provider with DoT

• KYC Norms for M2M services

• International Roaming

• Making available connectivity anytime, anywhere

• SIM related other Issues

• Data security Issues

• Location and connectivity guidelines

• Health/safety regulations and environmental guidelines

The above mentioned guidelines were prepared under the aegis of the consultative committee. Implementation of the above guidelines into a policy and regulatory framework will be carried out by various departments under DoT.

g. Cloud Technology and Services Technological advances, high-speed internet

connectivity and the ever-decreasing cost of storage will lead to proliferation of cloud services. For Digital India, Smart Cities and M2M/IoT to succeed and grow, these would necessarily have to deploy the latest ‘Cloud’ technologies and other related services. There are several cloud based services available, but these cannot be offered to the customers due to regulatory challenges, such as

i. Cloud based audio conferencing (where the audio conferencing bridge may not be in India): whereby all enterprise customers can use a single audio conference bridge world over. This single bridge too could be managed by the operator in the cloud.

ii. Cloud service – multi-tenant contact centre solution: wherein multiple OSPs can share their infrastructure. Each OSP need not have his own telecom infrastructure and the single large platform can be developed in the country or outside for all OSPs with logical partition to ensure security and other related concerns.

iii. Microsoft Lync, Cisco UnifiedCommunication (Full blown solution): wherein the UC can be located anywhere in the world and not required in each office or each country, thereby giving the customer better solution and effective price and better control over his traffic etc

The government may like to consider earliest the feasible policy or guidelines/framework for cloud technologies through consultation

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route. The government may like to consider policy and regulation aspects to be in line with the latest technology Cloud/IoT and consumer requirements, ensuring a level playing fieldand fair play.

h. Mobile Devices As per a FICCI-EY report, Mobile Handhelds

and Handset, the mobile market in India is expected to cross 300 million devices in 2015. Approximately 83% of the demand is expected to be met through imports. The smartphone segment has been growing at a rapid pace in India. During 2014–2015, this segment in value terms had been estimated at nearly 75% of the total handset industry (26% by volume). In 2014–2015, the demand for smartphones was estimated at 70 million units compared to 32 million units in 2013–2014, i.e., a growth of 118% in 2014-2015 compared to the previous year. In value terms, the segment grew to INR 56,000 crore (€7.3 billion) in 2014–2015 and had a whopping growth of 90% in 2014-2015 compared to the previous fiscal yea .

i. Standardization Telecommunications Standards Development

Society India (TSDSI) aims at developing and promoting India-specific requirements, standardizing solutions for meeting these requirements and contributing these to international standards. It also targets contribution to global standardization in the field of telecommunications, maintaining the technical standards and other deliverables of the organization, safeguarding the related IPR, helping create manufacturing expertise in the country and providing leadership to the other developing countries (such as in South Asia, South East Asia, Africa, Middle East, etc.) in terms of their telecommunications-related standardization needs.

Collaboration with the Global Standards Development Organization is now happening at the level of the Global Standards Collaboration (GSC) initiative, where TSDSI is now a full member. The industry is also happy to note that TSDSI has taken up important

areas of technical work such as M2M, energy efficienc , 5G and security to name a few. TSDSI is now fully operational, an active technical organization having its own IPR policy.

The European Telecommunications Standards Institute (ETSI) and TSDSI have a cooperation agreement as well as a ‘partnership instrument’ project supporting EU-India ICT cooperation, under which stakeholders were successful in identifying 5G, intelligent transport systems (with M2M), and NFV/SDN as priority topics. The second partnership instrument project (expected later in 2016) shall provide dedicated support to cooperation in these fields. TSDSI has also joined the OneM2M Partnership Project and is working on India specific contributions.

The Department of Telecom, including the Telecom Engineering Centre (TEC), should continue its support and sanctificationin making TSDSI a well-established and recognized standards development organization from India and continue its momentum and work through tabling local requirements at global platform, promote relevant locally developed standards and contribute to its global harmonization.

TSDSI may like to develop country specificstandards where suitable international standards, including country specificapplications and futuristic technologies, are lacking. It can take these locally developed standards on global forums, get them acknowledged for harmonization through adoption and implement available international standards for telecom system products to avail smooth inter-connectivity, interoperability and economies of scale, wherever applicable.

j. EMF Radiations and Health During the year, both the government and

TRAI came out strongly with statements of assurance to the public and the Parliament that there need be no concern as regards EMF (electromagnetic field) emission from mobile towers. They have repeatedly assured that the

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Indian limit followed for emissions is extremely stringent as compared to the global norms. With this in place, every location – school, hospital, residential area etc -- is equally safe for installation of towers.

There have also been several landmark judgements. The High Courts of Madras, Gujarat, Kerala, Allahabad, Rajasthan and Himachal Pradesh have, in several judgements over the past four years, upheld that there are no harmful health effects due to radiation from cell towers.

EBG feels that the current momentum of creation of awareness of the correct facts regarding EMF emissions may be continued and intensified

k. Domestic Manufacturing In the past one year, there has been significant

government focus on flagship programmes viz. Digital India, Make in India and Start-up India. It has set up specific programme monitoring cells under nodal ministries viz. DoT and DeiTY (Department of Electronics and Information Technology) for Digital India and DIPP for Make in India and Start-up India. Significant changes in the business environment are being enabled by the government by way of policy changes, duty relaxations for raw materials, etc. to help facilitate new businesses/ventures.

The National Manufacturing Policy, which is now under the umbrella vision programme of Make in India and Design in India, focuses on 25 sectors, including IT, electronics and renewable energy1 . It addresses the areas of regulation, infrastructure, skill development, technology, funding, environment, exit mechanism and pertinent issues, and also projects that the ICT sector would grow at 12% per year in the medium term. A well-regulated and stable financial environment has been put in place; this would be conducive to domestic as well as foreign investments.

The government is taking several bold measures and initiating incentives to bolster the Make in India scheme – an ambition to

make India a world class manufacturing hub. There is need to encourage and establish progressive indigenous manufacturing of telecom products in the country as initiated by the scheme. Instead of widening the differential gap in tariffs, the government may like to consider alternative modes to support domestic manufacturing, such as early build-up of the strong base of component manufacturing as well as local ecosystem and some tax holidays for a specified period. The high finished duty differential between import and domestic products tends to encourage grey market/increased smuggling activities. There is also need to incentivize service providers, instead of making it mandatory to implement indigenously manufactured products in their networks, wherever suitable.

l. Multiple levies and taxes The telecom industry pays 8% of adjusted

gross revenues (AGR) as licensing fees, about 5% spectrum usage charge and 15% service tax. Moreover, states levy additional taxes such as octroi, VAT, stamp duty, entry tax and levies on the towers, which aggregate to 30% of the revenues earned by telecom companies as compared to about 5% in other Asia-Pacific (APAC) countries. The levies are also charged on non-telecom related revenues of the service providers. This makes Indian telecom one of the highly taxed industries in comparison to other Asian countries. There is need to rationalize and bring down the taxes and levies in the sector to encourage rapid growth of the telecom sector and delivery of telecom services at reduced prices to the Indian masses. There is also urgent need to rationalize the present rate of universal service obligation (USO) contribution which is presently 5% of AGR (as per TRAI’s recommendations it should be 3%). Industry also expects that the present framework of adjusted gross revenue model may also be reviewed since it does not address the issue of double levies on the same service/product.

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Retrospective tax amendments changes in tax laws foster a sense of ‘uncertainty’ in the business which dampens enthusiasm for investment and M&A activity. The new government has assured that retrospective changes in tax will not be introduced in order to improve business confidence of investors. To make any industry the preferred destination for investors, the government must ensure a stable environment with simpler and transparent regulations, ease of doing business, robust infrastructure, single window clearances etc.

It is worth noting that the anomalies of different tax regimes levied by the states, especially VAT would get resolved, hopefully, on the introduction of a pan-India uniform goods and services tax (GST) from June 1, 2016.

The introduction of 10% basic customs duty on certain telecom products for manufacturing in SEZs has placed units in these zones at a relative disadvantage against those in the FTAs. However, when the country is embarking on a Make in India mission, any form of domestic manufacturing ought to be encouraged.

m. Service tax on assigned spectrum, LF and SUC

The recent union budget has proposed that service tax would be applicable on spectrum assignment and its subsequent transfer. Moreover, service tax would also be applicable on license fee and spectrum usage charges payable on AGR. The industry believes that such additional indirect taxes have direct impact on the affordability of telecommunication services and financialhealth of the sector; therefore, it may be reviewed immediately.

n. Draft rules on RoW

DoT recently published draft rules on RoW. It is a positive step from the government towards ease of doing business and should be finalized

o. In-country mandatory testing/certificatio

The extension was granted upon request until April 1, 2017. However, EBG intends to take up the issue of requesting for adequate time to be given for preparation and also to permit acceptance test reports and certification from internationally accredited organizations to avoid unnecessary delays and procedural bottlenecks.

5. CONTRIBUTION BY EU TO TELECOM SECTOR

The European Union (EU) as a bloc of 28 countries with a common trade policy is by far India’s largest trading partner. EU companies contribute to the growth of many sectors in India; for example, through investments, manufacturing, research and development and a source of advanced and clean technologies. Trade between India and the EU - which is roughly balanced - stood at US$101.5 billion (€89 billion) in fiscal year 2014 (2013-2014) and US$57.25 billion (€50.2 billion) between April and October during the financial year 2014-2015. European companies have also made major investment in the Indian telecommunication market. They have boosted employment in the country, besides creating many high value jobs, for instance, engineering and research and development. They have also helped many other companies become part of global value chains, and actively contributed to the realization of India’s telecommunication vision and targets.

To obtain greater access to the market for services and products between India and EU, there is greater need for the faster progress and closure of the Broad-based Trade & Investment Agreement (BTIA) between the two sides. The two sides are cooperating to boost the investment climate amidst a global economic climate of falling demand and competitive currency devaluations. A free trade agreement (FTA) is on the anvil which would be beneficial to both. This also includes the issue of market access for Indian services in the EU. The issue of ‘data security’ for Indian services in the IT and ITES sectors is also on the agenda.

The present government has revived the lapsed Public Procurement Bill (2012) and initiated the consultation

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process with the stakeholders for review of existing provisions of the Bill. The European Commission (EC) has welcomed this initiative of the government and believes that it is a significant step in the setting up of a modern, efficient and transparent harmonized public procurement system in India. Their comments are under preparation.

Improving public procurement rules, PMA (preferential market access) should be introduced on the lines of the net–zero policy for electronic imports. Global vendors who have made investments and have created manufacturing facilities in India should be PMA compliant based on net exports commitment of manufactured goods from India, instead of being PMA compliant for every product to be manufactured in India, which is not practicable due to lack of scale.

Telecom Network Security & Indian Test Labs: The government plans to set up accredited security testing labs in India which shall be solely authorized to certify all imported telecom equipment as being fitfor use in the domestic network. However, this might impact business conditions for global companies due to possible delay in testing every equipment and RED channel customs category for all telecom and IT products.

The government may consider maintaining status-quo of self–certification by OEMs and accept global test lab certific tions and OEMs’ test reports instead of Indian lab testing. This would also align the standards for testing towards 3GPP global standards. Products test certificates submission may be limited to once per major HW/SW (hardware/software) release rather than batch testing.

Ensuring intellectual property rights and effective protection and enforcement: India has made rather limited progress in the IPR field, such as patents and copyright. The Department of Industrial Policy and Promotion (DIPP) recently issued a consultation paper on Standard Essential Patents and their availability on FRAND (fair, reasonable and non-discriminatory) terms. The committee intends to respond in a very substantive way.

One of the significant achievements of the EBG-TSC group has been to highlight the gross anomaly in policy implementation that is hampering the maintenance of mission critical communication infrastructure in the country and development of new technologies. In

fact, by permitting free import of used equipment and modules/components for the purpose of repair and research, the government stands to gain significantlyby way of new jobs created, creation of new skills and savings due to availability of local expertise.

EBG-TSC has taken up the issue with the apex ministry-DIPP and has apprised them about the need to coordinate the activities with other ministries to bring about an amicable resolution to the issue, which has impacted the business of established network equipment vendors who run the backbone of the communication networks in the country and have set up unique R&D centres for new products and technologies. It is expected that DIPP shall take up the issue with the concerned ministries viz. Ministry of Environment & Forests (MOEF), DeiTY and DoT, the latter two departments falling under the Ministry of Communications and IT.

6. ACHIEVEMENTS OF THE EBG TELECOM SECTOR COMMITTEE

The European Business Group of India has focused on fostering a business environment that is conducive to growth of telecom sector. Continuous advocacy and liasoning have successfully resulted in favourable decisions by the regulator/government, thereby boosting investment sentiments. Request for big bang auction has been largely met. It has been decided for the first time to put multiple bands to auction in mid-2016 (700 MHz, 800 MHz, 900 MHz, 1800 MHz, 2100 MHz, 2300 MHz and 2500 MHz.

The activities of the EBG Telecom Sector Committee have increased significantly and is witnessing increased levels of motivation and a lot of vibrant participation by its members. Going forward, the intention of the Committee is to actively participate in all government and TRAI consultations with written submissions. The Committee is also examining the outcome of Budget 2016 w.r.t enhanced applicability of service tax provisions on spectrum assignments made in the past, on license fees, deferment of Cenvat (central value added tax), credit etc. and is expected to take up the matter appropriately with the government. Besides, TRAI finalized its recommendations for definition and interpretation of AGR for license fee

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and SUC (spectrum usage charge) payments by operators. These have long been contentious issues and are highly disputed. The government’s decisions are awaited.

7. CONCLUSION The present government has initiated several measures and programmes to propel the economic growth of the country and is focused to set up an environment of stability, consistency, and predictability in telecom policies as well as regulation, for enabling long term and sustained investments in the telecom sector in the country. If growth in the last decade was driven by growth in subscribers, the coming decade will be growth driven by innovation. Catalysts for this will be policy and regulatory stability, customer centricity and content. The potential for rapid growth

of telecom sector in the country is high due to the

announcement of programmes like Digital India, Make

in India, Design in India, Start-up India etc. All of this,

including the predictable and long term policy and

regulatory announcements in this sector coupled with

technological changes viz. big data, cloud, analytics

and mobility together may lead to higher efficiencies

and revenues with delivery of affordable connectivity

and digital empowerment for all the citizens.

We expect 2016 to be another landmark year in terms

of bringing broadband services to Indian subscribers

coupled with possible consolidation in the sector in

view of encouraging revised policies of M&A, coupled

with spectrum sharing and trading norms as released

by the government. We will progress towards the

goals of Digital India, ease of doing business and

widespread launch of 4G services.

Endnotes

1. Source: http://www.makeinindia.com/policy/national-manufacturing

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