India's long, uncomfortable history with FDI

27th September 2012 by The Harried House Hunter

In an excellent paper, two academics, RamMohan Yallapragada, from the University of Louisiana and Madhu Paruchuri, from Tennessee State University provide some fascinating background to the current efforts of the Indian government to push through FDI (foreign direct investment) against massive resistance from India’s left wing political parties. As the authors note, from the outset of independence on August 15th 1947 India embraced an economic policy known as “a Socialist Pattern of Society“, predicated on central planning and “tight government regulations, permits and controls.” Like so much optimistic socialist planning this policy wound up in virtual bankruptcy after four decades of tight government control and massive government mismanagement.

“The ever increasing state controls were carried on to such a point where, after nearly four decades of governmental intervention, the nation had become virtually bankrupt in almost every sphere – economic, political and commercial.”

By the early 1990s it was clear that a change of course was the only way forward and under Prime Minister Narasimha Rao the government began to liberalize the Indian economy little by little. FDI started trickling in. By way of comparison, China, under Deng Xiaoping had begun introducing something akin to modest amounts of free market reform in the 1980s as a way out of a similarly ruinous and failed socialist economy. However, comparisons of FDI flows between India and China do not flatter India. In 1990, at the dawn of Rao’s reforms, FDI into India stood at an extremely modest US$162 million and it took until 1998 for FDI flows to pass the $3 billion mark. China hit $3.4 billion in 1990 and by 1998 was seeing FDI of $45 billion. Over that same period, the authors point out, China received $208 billion in FDI to India’s $11 billion, yet the Indian market has as much to offer. As India’s rapid and highly successful ramp up over the last decade of its capabilities as a site for offshoring IT and financial processes demonstrates, the country has tremendous potential to compete in global markets. Unfortunately, the country’s socialist history has left it with a legacy that allows almost any market liberalising move to be branded as “anti-people”, to the advantage of this or that political grouping, creating road blocks to economic progress at every turn.

There is a real paradox about the relative positions of China and India on FDI, the authors emphasize:

The comparative FDI picture presents a paradox in global investment. India and China started liberalizing their economies about the same time. India is the world’s largest democracy, with its administration operating under rule of law, and with a very stable and long established judiciary system. Contrarily, China has been and still is an authoritarian communist country, a far cry from the democratic society that India is… Most of the developed countries are democracies with capitalist market economics… global FDI is rushing to China… bypassing India, which by all standards should have been a natural choice for foreign investors. Obviously, something is seriously wrong in India’s approach to attracting FDI.”

The sources of the problem are not hard to find. The authors sum them up as follows:

“Some of the major impediments for India’s poor performance in the area of FDI are: political instability, poor infrastructure, confusing tax and tariff policies, Draconian labor laws, well entrenched corruption and governmental regulations.”

That is a frightening handful of failings to lay before any potential investor, and the biggest whammy in the list is probably the first one, which goes to political risk. As the authors note:

“Indian politics is cacophonous and fractious, playing itself out in one of the most socially heterogeneous societies in the world with sharp social inequities, a corrupt and inefficient bureaucracy, and poor accountability of politicians (Kapur and Ramamurti, 2001). Adding to these problems is the political instability at the central government arising out of the multiplicity of regional political parties and the need to form shaky coalition governments.”

It is hard to imagine any potential investor reading that and thinking, “So what?”. If there is one thing business hates above all else, it is political risk. Politics is a realm where anything can happen and probably will, as far as business is concerned. The problems with the eurozone are, in essence, purely political, as are the solutions, which is why the Eurozone crisis looks set to run for a decade or so yet. India’s “cacophonous” politics look set to run for a good deal longer than a mere decade – which looks like inhibiting what should be strong FDI flows into the dim and distant future.

Further reading on emerging economies:

This blog post was originally published on QFinance by Anthony Harrington.

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1 thought on “India's long, uncomfortable history with FDI”

  1. Anno Domini says:

    You could say many of the same things about the US and many European countries — to a lesser degree of course — but that hasn’t stopped them from progressing. This line of argument conflates political stability with earnings stability when the two can be very different.

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