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The investment imperative

Simply allowing FDI will not be enough. A stable and predictable policy regime is essential

Written by Chandrajit Banerjee |
July 9, 2013 5:38:35 am

Simply allowing FDI will not be enough. A stable and predictable policy regime is essential

India’s external position has been deteriorating for some time,manifesting itself in the current account deficit (CAD),which increased from a negligible 0.3 per cent of GDP in 2004-05 to 4.8 per cent in 2012-13. While capital inflows have been mostly adequate to finance the deficit,this has had a lot to do with global liquidity being strong. With the tide of liquidity expected to turn as the US Federal Reserve plans to reduce liquidity injections,financing the deficit may become more of a problem. The rupee plunged sharply as indications of a recovery in the US prompted the Fed to announce an eventual withdrawal of the stimulus. Foreign portfolio investors pulled out a record $7.5 billion from the Indian equity and debt markets in June.

This means much greater efforts are now required to attract capital inflows. Without the surge in liquidity that lifts all markets,global investors would be selective in choosing economies performing well. For India,it will be critical to

contain the CAD and to attract inflows.

There has been some good news,with recently released data showing the CAD contracted sharply from 6.5 per cent in Q3 of FY13 to 3.6 per cent in the last quarter. For FY13 as a whole,the deficit at 4.8 per cent was less than the anticipated 5 per cent. However,with the export scenario remaining bleak,it is uncertain whether there will be any improvement in FY14. Further,there has been a serious build-up in India’s external debt,with a significant amount of $172 billion to be repaid over the next year. Capital inflows would need to cover this outflow,as well as a CAD of about $80 billion.

What can we do to ensure capital inflows remain adequate? The recent action allowing power companies to pass on the price of imported coal,setting up an independent coal regulator,clearing projects on a fast-track basis and revising gas prices signal to investors the period of “policy paralysis” is probably ending. The government has also indicated its intention to raise FDI limits in sectors where it continues to be restricted below 100 per cent. This,along with simplification in the approval process and clarity in procedural issues,can go a long way in making India an attractive destination for FDI.

It needs to be emphasised that simply allowing FDI will not be enough to attract investment. Recent amendments to policies and tax structures,some retrospective,have detracted greatly from investor confidence and are somewhat responsible for the slowdown in FDI inflows. A stable and predictable policy regime is essential to attract continuous investment flows. The environment for doing business in India is challenging for overseas companies. This is apparent in sectors where the FDI limit has recently been raised,such as multi-brand and single-brand retail,but investors continue to face lack of clarity on the conditions imposed.

Ultimately,India needs to contain its CAD at a more sustainable level of 2.0-2.5 per cent. This is possible only if we ensure competitiveness for our goods and services,so that our imports are contained and exports boosted. The rupee depreciation should help to an extent by making goods produced in India cheaper than imported goods. However,the government needs to ensure the handicaps suffered by Indian producers vis-à-vis competitors abroad do not offset the advantage offered by the change in relative prices.

The disadvantages include weaker infrastructure,high cost of power,stringent labour laws and lack of a comprehensive indirect tax structure. Lack of clarity in regulations and overlap of Central and state regulations are also a source of difficulty. Particularly in the manufacturing sector,India has not been able to establish itself as a global player,despite advantages such as a large labour force and a large domestic market. In this respect,the CII would like to see a bigger push for implementing the new manufacturing policy,which envisages manufacturing zones where many of the disadvantages will be overcome.

Another area where action is required is rising gold imports. While some measures have been taken,we need to address the lack of alternative savings instruments perceived to be safe in the long term. To veer people away from gold purchases,the RBI should take steps to increase financial savings in the economy,which have gone down to 8 per cent of GDP in 2011-12 as against 11.6 per cent in 2007-08.

Finally,if there is still a problem in financing the deficit,the government should be ready to issue long-term sovereign bonds or sovereign-guaranteed bonds to raise dollars from overseas investors. Such a move could increase India’s debt and interest liability,but hopefully the economic situation would have improved by the time of repayment. With the government currently implementing many economic reforms,investor perception of India would be turning positive and this may be a good time to issue such bonds.

The writer is director general,CII

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