India's Awakening - From Far Eastern Economic Review
(Economies - India's economic reforms and new business-friendly legislation have foreign investors licking their lips. The new government is launching an ambitious assault on the remnants of the old command economy and promising greater competition, leading some experts to predict India could be Asia's next economic miracle.)
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India's Awakening
Government stokes the interest of foreign investors with reforms and business-friendly legislation
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By Sadanand Dhume in New Delhi, Hyderabad and Bangalore
Issue cover-dated January 20, 2000
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Although HSBC Holdings has had a presence in India for a century and a half, there's no time like the present. After decades of waiting to expand its modest branch network, the global banking giant recently won approval to open in three new cities. In addition, its distinctive red bow-tie logo will soon appear on a new asset-management company, a bonds dealership and a nonbanking finance firm. "We've never had a better chance," enthuses Zarir Cama, the bank's country head who has spent most of his 32-year career with HSBC in India. "I am very optimistic."
That sums up the mood of many foreign and domestic investors in India since a business-friendly government led by the Bharatiya Janata Party, or BJP, won a solid majority in October's parliamentary elections and pledged to triple foreign investment and launch an ambitious assault on the remnants of India's decades-old command economy. The government quickly removed onerous foreign-exchange controls and whipped legislation through parliament that opens up the insurance sector to private investors, including foreigners. Additional measures to encourage competition and foreign investment in banking and industry will follow shortly, the government promises.
The foreign business community has responded with enthusiasm. HSBC, the world's third-largest banking group, will invest $14 million in the country in coming months. Swiss-Swedish construction giant ABB and U.S. energy company Enron plan to build power plants in India, expanding operations in the country. Geneva-based Zurich Financial Services, which saw its insurance operations in India nationalized in 1972, is considering a return. In December, the annual India Economic Summit in New Delhi organized by the World Economic Forum saw a record turnout.
Both domestic and foreign investors are more optimistic about the near-term business outlook than they were a year earlier, says the Confederation of Indian Industry, which conducted a survey in October just after the election. The reasons for the rosy mood: The economy is coming out of a two-year recession, and investors say the new government's policies will ignite record-setting growth. "India could be the next Asian economic miracle," says Prasenjit Basu, chief economist for Southern Asia at Credit Suisse First Boston in Singapore. "We're looking at an average growth rate of 7.5% over the next five years."
Finance Minister Yashwant Sinha says he hopes to attract $10 billion in foreign direct investment each year, more than triple the annual average of the past decade. Nor is the momentum coming solely from New Delhi. A clutch of reformist states in western and southern India have pioneered investor-friendly policies over the past few years, with spectacular results (see story on page 39). Competition among these states to attract new business projects has given economic reform a life of its own.
Of course, India's many investment obstacles won't be eradicated overnight. Bureaucratic red tape, shoddy infrastructure and a runaway fiscal deficit that has driven up the cost of capital all have the potential to spoil the party. Moreover, bright growth projections for the country as a whole disguise the fact that while some states are embracing free markets and globalization, others remain mired in petty caste politics and protectionism. The six states of Delhi, Maharashtra, Karnataka, Tamil Nadu, Gujarat and Andhra Pradesh have cornered most of the $18 billion in foreign direct investment that has flowed into India since 1991. Largely left out are the four states known as the Hindi heartland--Bihar, Madhya Pradesh, Rajasthan and Uttar Pradesh--which are home to nearly a third of India's 1 billion people. The challenge for Delhi is to ensure that the economic reforms take hold even in the poorest states, so that they don't remain a drag on national growth and threaten the hard-won consensus for liberalization.
It is the prospect of stability after three elections in as many years that bolsters investors' confidence. Last October's polls gave the BJP and its allies a comfortable majority in the lower house of parliament, meaning the government can no longer be held hostage by small members of its 24-party coalition. Some key parties supporting the government spearheaded the state-level economic reforms, including Andhra Pradesh's TDP and Tamil Nadu's DMK.
Even the main opposition Congress Party broadly supports the reforms. In December it joined the ruling coalition in approving an end to the state monopoly in insurance--a measure that was hotly debated for six years and came to be considered a litmus test of the government's commitment to reform. That move prompted Zurich Financial Services to think seriously about returning to India this year by entering into a joint venture with a local firm, says Robert Sulzer, Zurich Financial's regional manager for North Asia and India. "The spirit of India has definitely changed and we hope that they can carry this through," Sulzer says. He adds that the company is considering investing as much as $12 million, but will wait to see what detailed regulations follow on the heels of the legislation.
Arun Seth, managing director of British Telecom in India, was impressed when, within two days of taking office, the BJP government implemented a longstanding industry demand:It separated the Department of Telecoms' commercial operations from its policymaking and regulatory functions, thus creating a more level playing field. The government expects to win parliamentary approval soon for replacing high licensing fees with a more business-friendly system of revenue sharing between companies and the government. "I have never seen this much change in this little time," Seth says. "There's greater urgency and more political will than ever before." He says BT is considering investments in mobile telephony, long-distance calling and the Internet.
In recent weeks, parliament also has eased restrictions on most current-account transactions, and lifted a requirement that some foreign companies earn through exports any foreign exchange they wanted to repatriate as dividends. It passed legislation that protects international trademarks and allows trading in derivatives. The government is preparing to send parliament further legislation that would outlaw monopolies and bring Indian patent law up to global standards. The government also has promised to open more sectors to foreign investment, allow foreign law firms to open offices in India, reduce import barriers and press ahead with longstanding plans to reduce state ownership of banks and other enterprises. Currently, about a quarter of India's economy is state-owned.
One reason so many policymakers now accept economic reform is the dramatic growth of India's software industry. As a new economic sector, it is relatively free of state involvement and is flourishing. More important, it proved to protectionist politicians that Indian companies can face global competition and win. It also showed foreign investors India has a wealth of entrepreneurial talent.
"The success of software has made fund managers sit up and notice India," says Suresh Rajpal, founder and chief executive officer of eCapital Solutions, a software start-up. "They are beginning to look at other sectors of the economy as well." Rajpal wasn't always bullish. In 1997, as head of Hewlett-Packard's India operations, he told the REVIEW he was concerned about the government's slowness to reform, and said poor logistics caused HP to decide against putting a printer factory in India. Now, he says:"Things have clearly changed for the better."
Much of the current enthusiasm is based on projections of India's market size once its economy takes off and incomes rise. Philip Spender, president and managing director of Ford India, expects India's passenger-car market to double to about 1 million cars a year over the next decade. "Then you're beginning to knock on the door of becoming a major market. India looks very attractive," he says. In the first eight months of the current financial year, passenger-car sales rose 53% from a year earlier to 400,000 units. Ford has invested about half a billion dollars in India over the past three years, including designing a sporty new model, the Ikon, targeted at the growing population of young professionals.
Obstacles still loom large. Stephen Howes, senior economist at the World Bank in New Delhi, says the combined central and state fiscal deficit is hovering at about 9% of gross domestic product, helping keep interest rates high. "Growth won't take off unless you solve the fiscal crisis," says Howes. The central government was aiming to get its portion of the deficit down to 4% of GDP for the year that ends March 31, but the actual figure is expected to be 5.5%, according to SGAsia Securities.
India's bureaucracy also retains its ability to effortlessly choke economic growth. On December 9, Cogentrix of the U.S. and China Light & Power of Hong Kong withdrew from a $1.3 billion project to build a power plant in the southern state of Karnataka, citing inordinate delays in government clearances and multiple lawsuits over the environmental impact that dragged on for four years. But the government's swift response showed a new willingness to battle for investment funds: It offered the project financial guarantees, prompting the companies to say they would reconsider.
However, investors would all like the government to pay greater attention to implementing, not merely announcing, business-friendly policies. "There's a massive amount of regulation and control built into the Indian economy," says Alan Rosling, chairman of the Jardine Matheson group in India. "What India really needs is a deregulation drive and for the government to start working faster."
The single most important move the government could make to encourage more foreign investment would be to create a one-stop shop for project approvals, as countries such as Malaysia have done. Senior government officials in India say turf consciousness among the various ministries remains too strong at the moment for that to happen. Instead, reformers are nibbling at the edges of the often daunting licensing process by expanding the list of sectors in which foreign investment is automatically approved. Foreigners also are being allowed to own bigger stakes in Indian projects: As of January, the ceiling for foreign investment in pharmaceutical firms rose to 74% from 51%.
The government also needs to take steps to bring the new reformist programme to India's poorest states. While strong investment inflows and expanding industries powered a 7.4% average annual growth rate in the western state of Maharashtra from 1991 to 1997, Bihar's economy actually shrank by an average of 0.7% a year, according to the World Bank.
"India's more prosperous states are growing at rates that make them look more and more like East Asian tigers," says Joydeep Mukherji, a New York-based India analyst at Standard and Poor's. "The trouble is, some others are stagnating like sub-Saharan Africa." P. Chidambaram, a former finance minister of India, blames backward-looking politicians in the less-developed states. "A different breed of political people must come up," he says.
There are signs that the Hindi states are starting to awaken to the challenge. Uttar Pradesh, for example, took the first steps toward the privatization of power by establishing an independent regulator. Kirit Parikh, a Bombay-based economist at the Indira Gandhi Institute for Development Research, says that in just four years Andhra Pradesh went from being among India's laggards to a leader, largely because of the reformist policies of its chief minister, Chandrababu Naidu. Says Parikh: "If Andhra Pradesh can do it, then why can't Uttar Pradesh and Bihar?"
India might look to its neighbours in East Asia and ask itself the same question. If the government continues lifting obstacles that have kept capital out, India can finally join the ranks of the Asian tiger economies.
(Source:Far Eastern Economic Review) |
