Good intentions, unintended consequences: The cost of regulation
Free markets thrive on competition, innovation and commercial freedom. Regulation, on the other hand, is essential to protect consumers, prevent the misuse of market power and build trust. The challenge begins when intervention goes beyond correcting market failures and starts altering the economic incentives that make businesses viable. For investors, regulation is not merely a compliance matter; it can fundamentally change the earnings potential, valuation and long-term attractiveness of an entire industry.
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India’s insurance sector offers a recent illustration. In September, insurance stocks came under pressure following proposed regulatory changes by IRDAI concerning commissions and distribution practices. The intention is understandable: curb mis-selling, improve transparency, reduce distribution costs and ultimately deliver better value to policyholders. However, for insurers and intermediaries, distribution economics are central to profitability. A sudden change in these economics can affect earnings visibility, business expansion and investor sentiment. What the regulator sees as consumer protection, the market initially interprets as an earnings risk.
Both perspectives can be valid.
Not all regulation, however, creates a conflict between business interests and consumer welfare. The government’s decision to cap trade margins on non-scheduled anti-cancer medicines is an example of intervention aimed at improving affordability and access to essential treatment. Similarly, the RBI’s regulatory framework for the UPI ecosystem has helped create trust, interoperability and scale in India’s digital payments revolution. In both cases, regulation has played an enabling role by addressing market frictions and improving consumer outcomes.
The problem arises when the immediate objective of intervention overshadows its longer-term economic consequences.
Consider India’s agricultural export restrictions. Measures such as export bans and duties have often been introduced to protect domestic availability and contain food inflation. While such decisions may offer short-term relief to consumers, they can leave farmers with fewer opportunities to realise international prices. They also create uncertainty for exporters who invest in storage, logistics and processing capacity. If export policies change unpredictably, businesses become reluctant to commit long-term capital. Ultimately, the country risks weakening the very supply chains it needs to become a reliable global agricultural supplier.
The telecom sector provides another lesson. The prolonged Adjusted Gross Revenue (AGR) dispute demonstrated how the interpretation of regulatory and revenue-sharing obligations can create substantial financial liabilities for operators. In an industry requiring continuous investment in spectrum, networks and technology, regulatory uncertainty can compound existing financial stress. The consequences extend beyond company balance sheets to competition, capital expenditure and the quality of services available to consumers.
India’s retrospective taxation disputes with foreign investors, including Vodafone and Cairn, exposed a different dimension of the problem: policy predictability. The subsequent withdrawal of certain retrospective tax demands was an important recognition that investor confidence depends not only on the tax burden but also on certainty about the rules. Capital is mobile, and investors evaluate not just the opportunity to earn returns but also the stability of the institutional environment in which they operate.
This is particularly relevant for India’s ambition to attract long-term domestic and foreign capital. FPIs assess regulatory developments as part of the country-risk equation, while domestic investors evaluate their implications for corporate earnings, valuations and competitive positioning. A single announcement can trigger sharp repricing in an industry, even before its full economic impact becomes visible.
The larger concern is not regulation itself, but regulatory unpredictability. Businesses can adapt to higher compliance costs, tighter standards and even lower margins when the rules are transparent and introduced with adequate transition periods. What they struggle to price is the possibility that established business economics could change abruptly.
A sound regulatory framework must therefore follow three principles: proportionality, predictability and consultation. Intervention should address a clearly identified market failure without unnecessarily distorting competition. Policy changes should provide adequate notice and transition periods. Most importantly, regulators should engage with businesses and investors to understand the commercial consequences before implementation.
India needs strong regulators, but it also needs strong, investible businesses. Consumer protection and commercial viability are not competing objectives; in a sustainable market economy, they must reinforce each other.
Regulation should set the rules of the game, ensure a level playing field and protect participants from unfair practices. It should not predetermine who wins, rewrite the economics of an industry without due consideration or discourage the very investment that drives economic growth.
Good regulation builds confidence. Poorly calibrated regulation creates uncertainty. And uncertainty, unlike compliance costs, is a price that investors are often unwilling to pay.
(The author, Jimeet Modi is the Founder & CEO of SAMCO Group)
(Disclaimer: Recommendations, suggestions, views and opinions given by the experts are their own. These do not represent the views of The Economic Times)
