Glimmers of hope? Prospects for economic reform in India

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Glimmers of hope? Prospects for economic reform in India

It seems difficult to believe that only a few short years ago, newspaper headlines around the world were proclaiming that India was ‘shining’. At that time, with growth rates hovering near ten percent and international businesses clamouring to enter the market, India’s economy indeed appeared to be in an enviable position. Today, the same headlines tell a very different story: growth has slumped to five percent, its lowest in over a decade; foreign direct investment has plunged; and the government of Prime Minister Manmohan Singh seems unwilling or unable to reverse the downward trend. The drop in foreign investment in particular has been tied to fortunes of the governing Congress Party, which enacted a series of populist measures in the wake of its victory in India’s 2009 general elections. Many of those measures have ultimately had the effect of discouraging foreign business. Coupled with the government’s woeful inability to contain a series of high-profile corruption scandals – that have exposed several western companies to regulatory scrutiny – investment into India today is a much less appealing prospect than it was several years ago. Given this backdrop, investors were delighted to hear India’s finance minister announce a series of economic reforms in September 2012 which promised to create an ‘easier and friendlier’ landscape for foreign investment. Finally, it seemed the Congress-led government was planning to take action to boost economic growth, and, as a key to doing so, to pursue structural economic reforms to make the Indian landscape friendlier for international business. But why did global businesses – so keen to enter the Indian market just a few years ago – decide the challenges outweighed the opportunities in the first place? And more importantly, how likely is it that the reforms the government has been touting will convince sceptical investors to return? Background to the crisis Among the cornerstones of the Congress agenda in 2009 were a clutch of protectionist policies which have complicated the efforts of multinationals seeking to enter the market in sectors as diverse as IT, pharmaceuticals, and solar power. Walmart and Tesco have complained that their bids to enter India were stymied by laws limiting their ability to buy controlling shares in Indian businesses or set up independent outlets. Pharmaceutical companies such as Pfizer complained that the government either revoked or denied them the ability to patent the products they manufactured in India. Foreign IT businesses have bemoaned the government’s policy of guaranteeing the purchase of goods produced by local suppliers, thus limiting competition. Beleaguered foreign investors had another shock in March 2012 when the government proposed tax legislation allowing Indian authorities to claim taxes retroactively from international companies. Vodafone was the first to feel the sting of the new legislation: following a legal battle that dragged on for months, a January 2013 Supreme Court ruling seemed to put the telecommunications company in the clear, backing its claim that it owed no tax on capital gains made by the previous owners of an Indian subsidiary it acquired several years earlier. Then, in May, the government brushed aside the Supreme Court’s decision, amended the law to allow retrospective taxation and thrust Vodafone’s tax liability of over $2 billion back on the table. Far from providing clarity about the rules, the episode served to highlight how India’s complex and shifting tax system presents another potential challenge for global businesses. A third factor discouraging investment has been the series of headline-hitting corruption scandals involving the government. In February 2012, the Supreme Court rescinded over 200 government-issued 2G spectrum telecommunications licences following a high-profile investigation which found that the licences had been handed out not through a competitive bidding system, but simply to companies favoured by the then-telecommunications minister. Months later, the Indian press reported that other government ministers had similarly handed out no-bid contracts in the highly lucrative coal sector without going through a bidding process. These scandals have showed no signs of abating. Most recently, in March 2013, Italian prosecutors and the Indian Central Bureau of Investigation, an anti-corruption watchdog, opened an investigation into the former head of the Indian Air Force, alleging that he and his family accepted bribes to ensure that an Italian defence contractor, Finmeccanica SpA, won a deal to sell helicopters to the Indian armed forces. The impact of corrupt government officials on the business environment is clear. Anheuser-Busch InBev NV recently announced that its Indian subsidiary has come under scrutiny from the US regulators for allegedly paying bribes to Indian government officials in breach of the Foreign Corrupt Practices Act. Such tales are not isolated examples: last year, Bean Inc, a Walmart joint venture company, announced that it too was under investigation for possible violations of the FCPA in India. Ready for real reform? These episodes sent a clear message to foreign businesses: the difficulties of doing business in India are beginning to outweigh the benefits of its large and growing market. But as the economy remained adrift in late 2012, the government finally seemed to wake up to the need to get the economy moving again. Led by the newly appointed finance minister, Palaniappan Chidambaram, the government has now proposed the most sweeping economic reform in over a decade, headlined by legislation allowing international retailers to buy up to 51 percent of local multi-brand companies – a clear bid to draw back global business. Since then, it has put forward a string of measures aimed at shoring up investor confidence, including lowering the cap on investment by insurance companies, allowing foreign ownership in local airlines, and proposing initiatives to liberalise pricing for coal and natural gas. But if this sudden change of attitude in New Delhi seems too good to be true, that’s because it is. While certainly a step in the right direction, the measures proposed do nothing to address the systemic hurdles that have long hampered the operations of foreign businesses in India. Why, for example, has there been no mention whatsoever of turning back the tax policy that has trapped not only Vodafone but also the Indian subsidiaries of Shell and Nokia in prolonged legal battles? In interview after interview in the international press, business leaders have criticised the seemingly unpredictable and punitive tax system – but the government seems deaf to their concerns. Built upon the sprawling edifices of mandatory permits and clearances, Indian labour laws present a regulatory nightmare for investors. So do archaic land purchasing laws, which leave multi-billion dollar projects languishing for years while businesses attempt to purchase one tract of land or open one factory – and make local officials well aware of the benefits of speeding up the process by demanding bribes. In the face of such entrenched problems, the government’s silence on reforms to land or labour laws is bewildering. When foreign investors first began flooding the Indian market in the 1990s and 2000s, they had little sense of the landscape that awaited them. As India’s economy continued to grow, offering ever better opportunities, many investors were willing to navigate a difficult environment. What is now clear is that as the good times have come to an end, the government will need to do more than offer reforms that appear merely token in the face of these long-term challenges. Certainly, the impression we have formed in the course of working with clients entering India has been that their levels of interest have been consistently high. However, these are now paired with a growing awareness that among the myriad difficulties of operating in the country, is the need to understand fully the corruption environment that the government has taken few steps to address to date. More changes ahead The good news is that stronger and more substantive reforms could be on the agenda, linked to upcoming general elections in 2014. Political analysts seem convinced that the Congress Party, hampered by its economic record, is set to either lose or suffer heavy losses. The opposition Bharatiya Janata Party (BJP), perhaps signalling its intent to confront the Congress Party on economic issues, seems set to nominate Gujarat Chief Minister Narendra Modi as its prime ministerial candidate. Modi has a strong record of economic reform and is widely credited with putting in place policies that have spurred job creation and industrial growth, even attracting American manufacturers Ford and General Motors to set up shop in his state. The BJP’s message to voters seems to be: ‘elect us, and we’ll get the economy going again’. Perhaps the best news to come out of India in a long time is that there is now a general consensus that economic reform is desperately needed. And while what has been proposed thus far is a long way from where it needs to be, perhaps it should be viewed as simply a starting point – not definitive enough, not comprehensive enough, but a signal that with some political will, India could shine again. By Nyresa Cama Research Associate, Business Intelligence, London   Image:PA
Published: 17th May 2013