The 2016 budget will be vital for India. Its success in attracting capital will singularly determine whether the programme of the Narendra Modi government from Make in India to Start-Up India has a chance to transform India. Without capital these initiatives run the risk of getting consigned to the dustbin of history as mere marketing events. Luckily for India, a confluence of global and domestic circumstances have opened up opportunities to attract capital. This will be the litmus test for the finance minister as he rises in Parliament a few weeks from now.
Capital is the fuel without which economic growth is impossible. India’s single-biggest challenge in the last two decades has been the inability to attract significant levels of capital, especially long-term equity, in the form of foreign direct investment (FDI). Whilst internal generation of capital is an option, ingrained attitudes towards gold and equity mean this may take time to come into the mainstream. Hence, attracting global FDI in the medium term remains the only viable option for accelerated economic growth.
In the last year India has benefited from favourable events — a clean government with a majority in Delhi, a strong prime minister and a sizable drop in oil and commodity prices. This drop has given a fiscal stimulus to India while making commodity-exporting nations such as Brazil and Russia unattractive. Combined with the turmoil in the Chinese economy means India has virtually no competition among the large countries of the world. With the developed world flush with liquidity but struggling for growth, India’s ability to attract capital provides a huge opportunity.
The key question is: What do FDI and long-term equity investors seek? Investors seek fair, consistent and predictable treatment for their investments. It’s no surprise then that the US, with its rational investor regime, has consistently attracted the largest FDI while most emerging markets continue to languish. Unfortunately India has consistently assumed, somewhat erroneously, that investors are solely attracted to size of the opportunity and potential. Complacency and a sense of entitlement have time and again killed India’s ambitions.
Opportunities compete for capital and not the other way around. This means if India has to attract capital it must deliver superior returns to global benchmarks. That can only happen when India works to provide world-class products and services which are good for the world, not just for India. The large Indian market already allows large economies of scale. It has done it in IT services and with right polices can repeat the success in other sectors. It is therefore vital that Indian companies innovate and the government provides them an enabling environment where they can generate world class products and services and offer world-class returns.
It is equally vital that for the special sectors the government tailors policies and tax structures so that capital can earn world-class returns. An example is the US, where exploitation of natural resources and home-ownership were the sectors that policymakers focused on. As a result, the US has had a consistent tax-free status for Master Limited Partnerships (MLPs) and Real Estate Investment Trusts (REITs) to attract investors. The shale gas boom is eventually a result of consistent US policy to attract capital for exploiting natural resources.
In contrast, India’s announcement of Infrastructure and Real Estate Trusts have failed to attract capital as they are subject to dividend taxes (unlike US MLPs and REITs). Let’s not have half-hearted attempts. If we need to attract capital then let us do so unashamedly. Let us offers tax breaks, incentives, protection, i.e., everything that our competition is offering at better terms. We have to compete in attracting capital so let’s be the best at the game. There is nothing wrong in this and does not go against domestic industry. Done right it could have a multiplier effect on domestic business.
From housing to hospitals, India needs capital in sectors that involve the government. The Indian government is no longer perceived to be credible by investors. To regain the credibility, it will have to walk the talk. We should seek this out by investing alongside external investors at the same terms without any preference or enhanced securities. A sovereign fund which intelligently leverages India’s domestic savings and foreign reserves could not be more appropriate at this point. This will be the greatest demonstration of India’s belief in its economic projects. It will also overcome global fears that the Indian government cannot be expected to behave rationally and fairly when it deals with other people’s capital.
Finally, it is clear that the FDI investor will not take a currency risk on India. So let’s try to stop deluding ourselves by offering sophisticated arguments why investors must learn to write their own risks. Investors must underwrite their commercial risks but the principal ought to be currency insulated. After all, the FDI investor brought in the US dollars and converted them into Indian rupees for a long term at a fixed rate! I suggest we guarantee that he can convert this amount back at the same, or a pre-set rate. Let us believe in the future strength of the rupee, through enhanced capital flows, and remove currency volatility from the investor equation. This one act alone could open a deluge of FDI into India.
These are bold suggestions. However, greatness requires taking big risks. The window that has opened for India may shut down as the world adjusts itself to the new economic reality.
Shaurya Doval is director, India Foundation, and managing director, Zeus Caps.
The views expressed are personal.