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Don't blame the eurozone

India's faulty regulatory apparatus is discouraging foreign investment inflows. N Chandra Mohan writes.

india Updated: May 30, 2012 23:27 IST
N Chandra Mohan

Top government officials can't resist blaming the woes of the Indian economy — slackening investments, slower growth, a wobbly rupee, among others — on the ongoing turmoil in eurozone economies like Greece. At the risk of sounding like a "nattering nabob of negativism", to borrow an expression of Prime Minister Manmohan Singh, nothing could be further from the truth. These problems stem from policy uncertainty, if not paralysis; from a government that has abandoned its reform agenda.

The country has a booming $1.7 trillion economy that has integrated with the global economy and attracted $247 billion of foreign direct investments (FDI) since 2000. It is the world's second fastest growing economy, with GDP growth averaging 8.2% per annum over the last six years. But thanks to policy inaction, slower growth due to declining investments has kicked in since last year. FDI inflows in particular have been sharply declining to $32.9 billion in 2010-11 when compared to $41.8 billion in 2008-09.

Not only have FDI inflows slowed down, outflows due to repatriation of investments have also gone up to $10.7 billion in 2011, according to Nomura Research. The reasons include delays in the approval of big-ticket investment proposals; pursuit of 'environment-sensitive' policies in denying forest clearances for projects in steel and mining and delays in land acquisition. Investors have also been concerned by the threat of retrospective taxation, especially for offshore mergers and acquisitions (M&As).

A comparison of actual FDI vis-a-vis the potential level determined on the basis of macroeconomic factors showed that "actual FDI which has generally tracked the potential level till 2009-10, fell short of its potential by about 25% during 2010-11… this large divergence between actual and potential was partly on account of rise in policy uncertainty", according to a recent Reserve Bank of India (RBI) study on 'Foreign Direct Investment Flows to India'.

The retrospective amendment to income tax laws in the Union budget for 2012-13 is the latest source of uncertainty that could dampen overseas acquisitions of assets here. The government's defence is that India is not a tax haven for FDI. But the reality is otherwise. For example, 10-year tax holidays have been introduced in the tax law precisely to attract foreign investment, and this has worked very well. It was certainly successful in attracting a lot of investment in telecom that is the poster child of reforms.

A lot of 'foreign investment' into India is, in fact, money laundered out of the country and is now being routed back through tax havens like Mauritius. In fact, as much as 39% of the FDI that has come into the country between 2000 and February 2012 comes from Mauritius. This route has not been plugged to this day. It is open to the Indian government to amend its tax treaty with Mauritius, or indeed terminate it. Such a drastic step was taken by Indonesia that was unhappy with the use of the Mauritius route by foreign investors.

But the Indian government, no doubt for its own strategic reasons, has not taken such a step, including the fact that there has been considerable resistance to change from Mauritius itself. Besides Mauritius, FDI to the country comes from other tax havens like the Cayman Islands, British Virginia, Bermuda, Virgin Islands, Malta, Bahamas, Isle of Man among others — all of which amount to less than half of India's FDI flows of $247 billion from 2000 to February 2012. So much for the tax haven argument!

The upshot is that prospective investors are bound to rethink their exposure just when the Indian economy needs more FDI to build roads, ports and airports of $500 billion over the next 10 years. The government must get its act together and clear the decks for an acceleration in FDI inflows. Doubtless, some foreign investors will continue to invest in India but multi-national companies cannot be expected to do business here in an uncertain policy environment. Investment is an act of faith. Reforms must be taken to restore it.

While the policy regime has become more liberal, there is still some distance to cover in streamlining procedures; removing sectoral caps in insurance, retail trade and the financial sector. More FDI will not flow in unless the hassle-component of the regulatory apparatus is reduced. India must compete aggressively for investments to restore the shine to its growth story. Blaming it all on the eurozone economies is a recipe for further inaction.

N Chandra Mohan is an economics and business commentator. The views expressed by the author are personal.