Financial Daily from THE HINDU group of publications
Friday, Dec 13, 2002
Foreign Direct Investment
Turning the FDI tide
S. D. Naik
THE need to attract a much higher level of foreign direct investment (FDI) has now assumed new urgency in the context of achieving the 8 per cent average annual GDP growth rate in the Tenth Plan. Most economists, policy-makers and industry leaders are understandably sceptical about achieving this target, given the perceptible slowdown in investment, particularly in agriculture and industry. The targeted growth rate is predicated upon the agriculture sector growing at 4 per cent per annum and industry at 11 per cent.
In a poll conducted on the theme at the recently concluded "India Economic Summit 2002 8 per cent growth for 20 years. How?", a majority of business leaders (as many as 59 per cent) forecast a 6 per cent annual growth over the next five years and 37 per cent expect the growth to be a mere 5 per cent. Only 4 per cent of the respondents were optimistic of achieving 8 per cent growth rate. And 94 per cent of the respondents felt that India cannot overtake China's competitive edge by 2007.
Unfortunately, both the Prime Minister and the Finance Minister abstained from this year's World Economic Forum (WEF), thus missing an opportunity to articulate the Government's policy on economic reforms and FDI. The absence of all the senior ministers in this year's summit is perhaps a reflection of the serious differences within the Government over the strategic sale of public sector undertakings and the reform process.
No wonder, the Infosys' Chief Mentor, Mr N. R. Narayana Murthy, was prompted to observe at the WEF summit that the country would be left far behind in the FDI race and economic development unless the reform process gathered momentum. He urged the Prime Minister to "take decisions as if there is going to be no tomorrow." And the former Finance Minister, Mr. P Chidambaram, stressed the need to free FDI from ideological and election pulls. He deplored that no Prime Minister has thus far put the full weight of authority to attract more FDI.
Experts, time and again, have stressed that FDI is important not only to bridge the big gap between domestic savings and the desired level of investment to step up the growth rate of the economy but also to bring in modern technologies and provide better access to markets and efficient management practices. It is well-recognised that export-oriented FDI is an important means of expanding manufactured exports for developing countries, as it helps improve the quality and competitiveness of manufacturing industries. In the 1970s and 1980s, FDI played a crucial role in the rapid exports growth achieved by East Asia's newly industrialised economies (NIEs). And more recently, South-East Asia comprising Malaysia, Indonesia, Thailand and China has successfully replaced the East Asian NIEs Hong Kong, Korea, Taiwan and Singapore as the most important FDI destination.
While in most countries the share of transnational corporations (TNCs) in exports is in double-digits, ranging from 15 per cent for Taiwan and Korea to 50 per cent in China, TNC affiliates account for a mere 3 per cent of India's exports. While one may attribute this to the lure of the large domestic market, it cannot be the only explanation because the same could be said of China too. However, China has been able to push up TNC share in exports from 17 per cent in 1991 to 50 per cent in 2001. Multinationals have poured in more than $400 billion into China over the past decade as compared to a mere $20 billion into India.
China's success can be attributed to its pro-active FDI policy, which includes the development of special economic zones (SEZs). As UNCTAD's World Investment Report, 2002 says, the degree of success of a host country in attracting and upgrading export-oriented FDI depends critically on its ability to develop domestic capabilities. To benefit fully from export-oriented FDI, it suggests that the host countries need to encourage linkages between foreign affiliates and local suppliers. According to the WIR, "Simply opening up the economy is no longer enough. There is a need to develop attractive configuration of locational advantages."
Commenting on Unctad's annual WIR, noted Harvard economist, Mr Jeffrey Sachs, says that "the fact that India trails China so much in attracting FDI is a matter of significant policy concern for India, because India is missing a lot of markets and a lot of capital investment that should be going there and losing it to China."
According to him, regulatory shortcomings, the Enron debacle, tardy privatisation of public sector undertakings, and free electricity to a large number of customers are some of the reasons for poor FDI flows into India.
The policy-makers seem to have recognised the importance as well as the potential of attracting FDI for improving infrastructure, modernising industry, raising productivity levels in manufacturing and making exports competitive in world markets. However, despite all the measures announced over the past decade, the actual FDI inflows have remained insignificant vis-à-vis China and the other NIEs.
The reasons are not far to seek. The country has been liberalising its FDI policy in small doses, in relation to the changing business environment. In a globalising world, there is intense competition among countries to maximise FDI inflows. The degree of success of a host country depends critically on its ability to create a favourable business environment for foreign investors, by providing better infrastructure and a hassle-free policy regime. In other words, what India needs is a pro-active policy if it wants to attract more FDI.
Unfortunately, the infrastructure, be it power, ports, roads or civil aviation, continues to be pathetic. There is considerable improvement in telecom services, but not in rural areas though. Economic reforms face frequent roadblocks and prolonged periods of suspension. Even where approvals are granted, the bloated bureaucracy hampers implementation. Consequently, only about 25 per cent of FDI approvals translate into investments. The number of casualties with respect to approved proposals is quite high. Withdrawals, even after setting up of joint ventures, are not uncommon.
In a damning indictment on the prevailing business environment, Mr Paul O'Neill who was in the country as the US Treasury Secretary (he has since resigned) recently to attend the Conference of Finance Ministers of Group-20 countries, said that honest businessmen and investors are shying away from India because of widespread corruption and bribery. "India should reduce trade barriers, improve governance and economic freedom to enhance foreign direct investment and productivity."
According to Mr O'Neill, India's English language skills and democracy should make it a preferred destination for investors over China. However, while US investments in China have gone up from $1.25 billion in 1997 to $1.6 billion in 2000, those to India have declined from $737 million to $336 million over the same period. "No one wants to spend time and capital fighting a system that is unfriendly to success and fears competition."
Similar views have been expressed by some of the renowned international institutions too. The World Bank's World Business Environment Survey, for instance, finds that in India managements spend as much as 16 per cent of their time dealing with government officials. Areas that have been identified as particularly in need of reform include curbing corruption, improving the effective implementation of government policies and infrastructure.
Last year, McKinsey, in its report "Achieving a quantum leap in India's foreign direct investment" (prepared for the American Chamber of Commerce in India), had stated that India has the potential to attract $100 billion FDI in the next five years, at the rate of $20 billion a year, enhancing thereby the country's GDP growth rate to over 8 per cent per annum. The report also states that in such a scenario, the country would also see over one million jobs being created every year. The report suggests removal of sector-specific barriers, relaxation in foreign ownership restrictions and reduction of red tape, which alone would attract $43 billion FDI. Further, another $49 billion FDI could come through the privatisation programmes.
Recently, the N. K. Singh-led Steering Committee on Foreign Direct Investment recommended raising FDI caps in a host of sectors and an overhauling of strategy. However, it favours only 49 per cent foreign equity in some sectors and is, surprisingly, opposed to FDI in the retail sector in view of the likely impact on employment potential.
Yet again, the policy-makers appear excessively cautious, as if foreign investors are queuing up to invest in India.
If the past is any indicator, merely raising the FDI cap or expanding the list of industries under automatic approval will not open the FDI floodgates. More important is the removal of procedural hurdles, setting up a transparent mechanism and a proper legal framework.
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