Closed for business

If Indian companies prefer to invest abroad,why should foreign firms choose India?

Written by Gareth Price | Published: May 14, 2012 3:39:46 am

If Indian companies prefer to invest abroad,why should foreign firms choose India?

The decision by the finance minister,Pranab Mukherjee,to defer the implementation of the General Anti-Avoidance Rules is a rare piece of good news for potential investors in India,presuming that the year’s grace is used to clarify the rules. However,India’s economy is suffering from global economic woes. Risk aversion has led the currency to decline,and this aversion has not been helped by a string of policy decisions. If India follows through on plans to demand retrospective taxation from Vodafone,more foreign investors are likely to be wary of committing themselves to India,raising the possibility of continued,and accelerated,currency depreciation.

S&P’s decision to downgrade India reflects the fact that longstanding economic impediments,notably its fiscal deficit,are coming back into view. While India’s economy was growing strongly,the slow pace of economic reform and over-spending (or under-taxing) was just an opportunity cost. But two factors have changed. First,India’s economic growth (though still high by international standards) is slowing. Second,the global economy remains precarious and India’s economy is not as insulated as in the past. The implied claim made last month by Chief Economic Adviser Kaushik Basu,that coalition politics constrains the government’s ability to initiate major economic reforms hardly seems radical,nor does the suggestion that a single party government would be better placed to undertake more expeditious economic reform. The storm created by his remarks reveals more about the political scene in Delhi than about the future trajectory and pace of India’s economic policy.

However,the primary concern of many international observers is in the pace of reform in relation to foreign investment. Is India slowly but steadily opening up to foreign investment? On this front it is hard to claim that progress is fast,and the treatment of a number of larger investments hardly implies India is open for (international) business.

These two sides of economic reform are not unconnected. India records constant current-account (and fiscal account) deficits. One means of plugging the gap is foreign investment. FDI flows into India are holding up: after receiving just under $20 billion in 2010-11,a significant increase is expected in 2011-12. This needs to be put in context. First,almost two-fifths of foreign investment is from Mauritius,a debatable proportion of which involves round-tripping — Indian investors moving monies out and then reinvesting via the tax haven. Second,while FDI inflows may be rising,in comparison with other countries India could do much better. Third,even now India’s FDI inflows are skewed by a few big-ticket purchases. Fourth,the preference of large Indian firms to invest overseas rather than in India raises difficult questions. If those companies that know India best prefer to invest internationally,why should foreign firms choose to invest in India?

For years now,the narrative has been that India is gradually but irreversibly opening up to foreign investment. This is supported by the increase in foreign investment,but challenged by the government’s clear inability,in the face of political opposition,to allow investment in protected sectors. There is little domestic agreement that foreign investment per se is a good thing. While there is a desire for access to new technologies and working practices foreign firms can offer,this is tempered by a negative reaction to the repatriation of profits.

That economic reform would be expedited in the event of a single party government is undeniable. But if recent state election results are any guide,that is an unlikely outcome,with a more unwieldy coalition the more likely result. And while most of India’s smaller parties have shown themselves to be pragmatic at state level,there are fears that their populist rhetoric may translate into a more dirigiste policy at the national level.

Few parties openly support economic reform. The reforms that have taken place have been by administrative decree,which reinforces the view that economic reform lacks legitimacy,and is in some way against the interests of the “common man”. So,international observers conclude that if there is to be another swathe of economic reform,it will stem from a crisis,rather than a position of strength. India has been insulated from economic crises because of its relatively closed economy,but much of its recent growth has come from the sectors that interact with the wider global economy.

The series of corruption scandals could provide an opportunity for economic liberalisation. Some steps taken by the government could recalibrate the way India works. But internationally,as in India,these incremental steps are overshadowed by the perception that the reform process has stalled.

The writer is senior research fellow,Asia Programme at Chatham House,London

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