24 July 2015

India needs a total reset


Earlier this year, India’s finance minister used the occasion of his budget to declare a truce. There would be no more multi-billion tax raids on big foreign companies in India. Investors could rest easy: the days of ‘tax terrorism’ were over. One month later, the London-listed Cairn Energy opened a brown envelope to find that the Indian authorities were demanding $3.2 billion in extra tax.

Cairn had just joined countless other investors who have learned that India’s economy is schizophrenic. It will extend one hand as a friend, and the other as an enemy. If India is to get anywhere near its massive potential, it needs treatment.

And India’s potential matters. Not only for the almost one-fifth of the world’s population that lives there, and not only for the stability of the world’s biggest democracy. It also matters for the prosperity of the rest of the world, something to which India should be a vital contributor.

On the face of it India looks good. It emerged from the financial crisis in better shape than most other large emerging economies. Growth has been better than the rest of South Asia and markedly above the emerging economy average. Currency, inflation and stock market values are all looking encouraging. India doesn’t do Chinese-style boom and bust cycles; historically it’s style has been cautious, steady growth – what the economist Raj Krishna once characterised as ‘the Hindu rate of growth’. The mood has been upbeat since since the election of a new government with a reformist programme designed to make India more open to the inward investment and technology it badly needs.

And that investment should be a no-brainer. India is bursting with manufacturing and marketing and IT skills, and speaks English. That makes it all the more striking that the recent record of large scale foreign investment in India is disastrous. In the last five years Barclays and RBS have abandoned their attempts to build retail banking networks in India. Berkshire Hathaway gave up trying to sell insurance. WalMart sold its share in a national retail network, and last year French retailer Carrefour followed Walmart through the exit door. POSCO of South Korea abandoned a plan to spend $5.3 billion on a steel plant; Luxembourg-based ArcelorMittal cancelled a $12 billion plant – and that is far from being the complete list. Many large company investors who have stayed will tell you, informally, that they are struggling.

The official Indian reading of this is that global not Indian conditions are at fault. That is not borne out by total investment figures, as tracked annually by UNCTAD. Last year China became the world’s biggest recipient of foreign direct investment with $232 billion flowing into mainland China and Hong Kong. India, with a similar population, attracted a small fraction of that ($34 billion).

The reason that the world’s companies do not invest more in India is that it is one of the most difficult large economies to operate in. According to the World Bank it is ranked 132 out of 185 economies in terms of ease of doing business. There are more restrictions on foreign equity ownership than in China, Russia or Brazil. On the ease of starting a business, dealing with permits and enforcing contracts through the courts, India is ranked amongst the worst in the world.

But there is India, and then there is India. Nothing shows the contradiction between functioning India and fossilized India more vividly than a few days spent in the country’s higher courts.

Let’s fly first to the High Court in Mumbai, set in the Bladerunner-like decay of the business city’s downtown. Barristers in moth-eaten black gowns and nineteenth century white neckties shuffle in and out, carrying docketed files that bulge like sacks of rice, arguing the latest piece of procedure in a case that might have been started decades ago. Bring a new action today, and if you are lucky your grandchild might see it settled.

But India does not have to be like that. Two thousand kilometres away in the Commercial Court in Kolkata you will see very different India at work. The Court is frenetic: business disputes involving anything from large commercial contracts to the sale of a faulty laptop are heard at the same rate as a market stall turns over fresh produce, and most are required to be settled one way or the other within six months.

Bureaucracy, legal delay and corruption are part of the Indian fabric. The newsflow from India over the last year or so has often touched on corruption, and that usually means the corrupt issue of commercial licences, such as the $40 billion worth of mobile spectrum licences issued in 2008 and cancelled two years later, or last year’s cancellation of over 200 commercial mining licences. Yet for most companies corruption is not a very pressing concern. If you ask large companies operating in India about their experience of corruption, most will say that routine dishonesty has greatly diminished, except at the very bottom and the very top of the system.

What matters more is delay: India is in the bottom 0.5% of all countries when it comes to the complexity of dealing with permissions to do business. The ‘Licence Raj’ – a system of of overlapping and contradicting regulations that was bequeathed to India by the British and which makes three-dimensional chess look easy – is alive and unfortunately well.

For companies uncertainty is often the biggest cost of doing business. And for the business that wants to make things and create employment, the Indian environment offers uncertainty squared. The official Indian approach to negotiating business deals is to play tough, then settle, and then to change the rules and play tough all over again. For example, when Ikea finally won agreement to open its stores the champagne was barely popped when Indian regulators sprang a new rule on the Swedish company: no food to be sold. The enormous tax bills that have surprised Cairn, Shell, Vodafone and others are also the result of retroactive rule changes.

This kind of regulatory arbitrage is deep in the Indian mindset. It’s the kind of thing that may be standard practice in the world of entrepreneurs, but is counter-productive in the world of regulators and policymakers. The recently-elected prime minister Narendra Modi came to office on a promise of an India that was more open to business (and stock market prices and investment have both risen on the back of that promise). Businesses are already beginning to wonder where that reform is to be found.

India’s problem is that while everyone agrees that reform of rules and regulations would be a good thing, that is the easy part. What is actually needed is a change of mindset. And there is no accepted therapy to achieve that transformation.

Richard Walker is a journalist and communications advisor to financial companies.