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Business Commentary/Bibek Debroy

Why FDI will rise in India in future, not now

I have in front of me a report on FDI (foreign direct investment) Confidence Index, brought out by A T Kearney. This is based on a survey conducted between September and December 1998 among CEOs and CFOs of the world's largest 1000 firms, collectively accounting for more than 70 per cent of global FDI flows.

So what do investment preferences of these decision-makers reveal for the next three years? India is seventh on the list, after the United States, Brazil, China, the United Kingdom, Germany and Poland.

This is after Pokhran, but before Jayalalitha, although one must point out that India's rank has dropped from fifth in the June 1998 survey. Scores are calculated on a 0-3 scale and India has a score of 1.14. Not bad, considering that Brazil and China have 1.38.

What explains India's unexpectedly high ranking? In part, the answer lies in a reversal in sentiment away from Russia, Indonesia, Brazil, South Korea, China, Japan, Malaysia, Thailand, Mexico and Argentina.

Consider the ten most important variables considered by these decision-makers -- market size, political stability, GDP (gross domestic product) growth, regulatory environment, profit repatriation, macro-economic stability, GDP size, quality of business infrastructure, competitor presence and cost/quality of labour.

Barring market size and GDP size, one would probably not award India a high rank on any of the other eight criteria. But the vaunted market size of 300 million middle class consumers is probably the key, although several producers of consumer goods have discovered that the 300 million middle-class market does not exist.

A description based on income can be completely misleading, since many of these income earners are in rural areas. The moment one begins to use criteria like ownership of consumer durables to gauge potential sales of other consumer durables, the figure drops to something like 30 million. However, the perception about market size is an enduring one and this makes India the second most sought after FDI destination in Asia, after China.

There is also a sectoral classification and sectors are divided into light manufacturing, heavy manufacturing, telecom and utilities and financial services. In both light and heavy manufacturing, market size is the most important consideration, while the regulatory environment is the most important consideration in telecom and utilities, and political stability is the most important consideration in financial services. It is thus not surprising that India figures prominently among light and heavy manufacturing firms and is also ranked second (after Brazil) in telecom and utilities.

Quite understandably, India is not in the big league in financial services. But all this is about potential FDI inflows, which can be as high as $ 10 billion a year. The actual inflows are nowhere near the potential. So India has a wonderful future, but not much of a present.

Before one makes the hackneyed India-China comparison, one must make a couple of points. First, the Indian FDI figure is not quite comparable to the Chinese one because of accounting differences. In a project with 45 per cent foreign equity participation, the Chinese accounting system will count the entire amount as FDI inflow, while the Indian system will count only 45 per cent.

Second, if one compares the first eight years after reforms (1978 or 1979 onwards for China and 1991 onwards for India), India does not compare all that unfavourably, even on inflows. The great takeoff in China was in the second half of the 1980s and there is of course no evidence yet that India will be able to replicate that performance.

Why does India want FDI? Regardless of political colour, the following arguments will be cited:

First, FDI permits a gap between the domestic savings rate and the domestic investment rate.

Second, FDI helps to bridge the foreign exchange gap and non-debt creating capital inflows are preferable to debt creating capital inflows.

Third, technology upgradation can take place through joint ventures and marketing networks of foreign firms can be accessed.

Fourth, FDI can be an engine of export growth, as has happened in southeast Asia.

Fifth, most of trade flows are intra-industry trade and intra- firm trade and, therefore, one cannot have an export strategy independent of an FDI strategy.

Almost everyone will agree on these five arguments. There is yet a sixth argument, perhaps the most important, but on which there is less unanimity.

This is the consumer angle.

The consumer benefits from any competition and the colour of the competition does not matter. If FDI brings in competition, that represents welfare gains for the domestic consumer, although there may be welfare losses for inefficient domestic producers.

Having accepted the desirability of FDI, you will find people begin to disagree. Typically, a conversation with the average citizen flows along the following lines.

First, he (or she) will argue that most FDI has come into the consumer goods sector (this is factually wrong).

Second, he will argue that we need FDI in computer chips, not in potato chips, even if you argue that potato chips provide more employment. If you argue that these are private resources, not public resources on whose allocation we might justifiably be interested, he will not be convinced.

Third, he genuinely believes that a distinction between consumer goods and non-consumer goods can operationally be drawn.

Fourth, he does not accept that majority foreign equity participation is necessary.

Fifth, he believes that mergers and acquisitions and conversion of joint ventures into 100 per cent foreign equity concerns is bad, even if the domestic Indian company makes a sizeable amount of money in the process of selling out.

Sixth, he believes that making money is bad, especially if the money is made by foreigners.

Seventh, profits and dividends will be repatriated and that is inherently bad. What does India gain from this repatriation?

Eighth, foreign companies indulge in restrictive and unfair business practices. Everyone has heard of transfer pricing.

Whether I personally agree with these arguments is beside the point. (I don't, barring the argument about a competition policy.) But throughout the length and breadth of India, you will hear these arguments advanced.

We want FDI, but on our terms. In any case, what is all this brouhaha about FDI? FDI will not account for more than five per cent of total investments.

India will have to be built by Indians. Besides, if the benchmark is India before 1991, we have done a lot, haven't we? (The benchmark is never what other countries in the world are doing.)

Because people genuinely believe in such arguments, policies become restrictive. Take the automatic approval route, which is a joke because procedures are so horrendous. Not more than 10 per cent of FDI approvals and inflows take place through the automatic approval route.

That leaves the Foreign Investment Promotion Board, which is also so concerned with the above issues that decisions become non-transparent and ad hoc. If we gave up the Planning Commission mindset of knowing what is best for the country and trying to control and influence it, perhaps FDI inflows might improve.

But that is not likely to happen in a hurry. Therefore, India will always remain an FDI destination with a great deal of potential in the future, but nothing very much happening in the present.

Bibek Debroy

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