{"id":2217,"date":"2013-09-10T12:40:31","date_gmt":"2013-09-10T07:10:31","guid":{"rendered":"http:\/\/teekhapan.wordpress.com\/?p=2217"},"modified":"2013-09-10T12:40:31","modified_gmt":"2013-09-10T07:10:31","slug":"the-great-indian-fdi-conundrum","status":"publish","type":"post","link":"https:\/\/vivekkaul.com\/2013\/09\/10\/the-great-indian-fdi-conundrum\/","title":{"rendered":"The Great Indian FDI conundrum"},"content":{"rendered":"

\"ghemawat<\/a><\/p>\n

Our politicians think our problems come from being connected with the world, but the reality is we are too little connected to the world, says Pankaj Ghemawat.<\/span><\/span><\/span><\/p>\n

Vivek Kaul<\/span><\/span><\/span><\/strong><\/p>\n

The United Progressive Alliance government is fond of telling us that India\u2019s weakening macroeconomic indicators \u2013 a falling rupee, a declining stock market, rising bond yields \u2013 are the result of being tied to a weak global economy and factors external to India. But if you were to ask Pankaj Ghemawat, Anselmo Rubiralta Professor of Global Strategy at IESE Business School in Barcelona, Spain, India is not exactly as globally connected as we think it is.
Ghemawat has constructed a broad index of international integration, the\u00a0DHL Global Connectedness Index,<\/i>\u00a0which was first released in November 2011. The 2012 version of this index was released last year and it shows India closer to the bottom. \u201cThis index extends beyond trade to incorporate capital, information and people flows as well, and covers 140 countries that account for 95% of the world’s population and 99% of its GDP,\u201d says Ghemawat.
India ranks 119 out of 140 countries on the depth of its global connectedness. \u201cWhen it comes to trade intensity, India still ranks in the bottom 25% in the sample. As far as capital connectedness is concerned, it is closer to the median,\u201d says Ghemawat.
Capital connectedness is calculated from measures of foreign direct investment (FDI) and foreign portfolio equity investment into the stock market of the concerned country. India’s decent performance on capital connectedness is primarily on account of the huge money that has come into the Indian stock market from abroad in the last decade and big outward FDI flows in the form of overseas acquisitions by Indian corporates.
If one looks at just inward FDI, the performance is dismal. As Ghemawat puts it, \u201cIn terms of inward FDI stock (i.e. foreign companies having built or bought businesses in India) expressed as a percentage of GDP, India comes in the bottom 10%.\u201d
FDI flows into India have also fallen in three out of the last four years. For 2012-13, FDI fell by 21% to $36.9 billion, government data show. The United Nations Conference on Trade and Development (UNCTAD), in a recent release, said that FDI inflows to India declined by 29% to $26 billion in 2012.
The government has, faced with an unsustainable current account deficit (CAD), has been trying to encourage FDI into the country to firm up the rupee against the dollar. Last year in September, the government opened up FDI in multi-brand retailing with the rider that each state can decide whether it wants companies like Wal-Mart to set up shop within its borders.
But since then not a single dollar has come into the sector. \u201cOne reason for foreign money not coming in is that investors are not sure whether the policy will continue as and when a new government comes in. Also, letting states set their own rules on such an international economic policy matter is basically unheard of elsewhere,\u201d said Ghemawat. Towards the middle of July 2013,\u00a0the government relaxed FDI norms in 12 sectors,\u00a0including telecom, insurance, asset reconstruction, petroleum refining, stock exchanges and so on.\u00a0
Ghemawat\u00a0feels that there is a lot that India can learn from China on this front. China started opening up its retail sector to FDI in 1992, initially with various restrictions, but ultimately allowing 100% FDI in 2004. This benefited them with foreign players bringing in new management practices along with supporting technology and investment capital. And we shouldn\u2019t forget the complementarity for foreign retailers between sourcing from China (contributing to China\u2019s export boom) and selling there.
Ghemawat argues that much of the fear about FDI in retail is exaggerated, because even with full liberalisation, foreign retailers would hardly come to dominate the Indian market. \u201cRetail is a very local business, where an intimate understanding of customers, real estate markets, and so on, is essential to success.\u201d He cites a recent estimate that 40 foreign players account for only about 20% of organised retail in China, to suggest that foreign and domestic retail could thrive side-by-side in India.
\u201cForeign retailers don\u2019t always win out against domestic rivals,\u201d he adds. \u201cElectronics retailers Best Buy from the US and Media Markt from Germany both shut down their stores in China in the last few years. They just couldn\u2019t compete with local rivals Gome and Suning, which had greater domestic scale and business models more attuned to the Chinese market. Home Depot also exited China in 2012. But Chinese consumers gained anyway – competition against foreign retailers spurred locals to improve customer service, one of their weak points.\u201d
Coming back to data from the Indian market, Ghemawat notes an interesting factoid from the 2013\u00a0Economist<\/i>\u00a0Corporate Network Asia. The nominal GDP of India grew by 12.6% in 2012. In comparison, the sales of MNCs (mainly Western) in India grew by only 6.3%, only half as fast as the GDP. \u201cWhile this could be viewed as positive regarding Indian firms, a difference of such a big magnitude is probably reflective of a lack of openness,\u201d said Ghemawat.
There are multiple reasons for India\u2019s poor showing on these indicators India regularly figures in the bottom tier of countries in terms of the extent to which its policies promote trade. In the World Economic Forum’s 2012 Global Enabling Trade Index, India figures in the bottom tier. On the market access parameters, in particular, it figures third from last in a list of 132 countries. Ghemawat also cites the OECD’s FDI restrictiveness index which he has inverted into the FDI Friendliness Index. \u201cIndia again figures in the bottom 10% of 50 countries in terms of the extent to which it encourages FDI.\u201d No amount of ministerial cajoling of potential foreign investors is likely to outweigh the impact of such protectionist policies.
These indicators, of course, translate into low productivity and lack of infrastructure required to carry out a profitable business. \u201cThe Global Competitiveness Report tells us all we need to know about India’s poor infrastructure and low productivity,\u201d says Ghemawat. \u201cIndia currently ranks 59th<\/sup>\u00a0on the list (out of 144 countries). It has fallen 10 places since peaking at the 49th<\/sup>\u00a0spot in 2009. Once ahead of Brazil and South Korea it is now 10 places behind them. China is 30 places ahead of India,\u201d he adds.
When it comes to the supply of transport, energy and ICT (information, communications technology) infrastructure, India is 84th<\/sup>\u00a0on the list. This lack of infrastructure is the single biggest hindrance to doing business in India, feels Ghemawat. And this has kept foreign investors away from the country. Also given India’s weak health and basic education infrastructure (where it is 101st<\/sup>\u00a0on the list), India remains low on productivity, which is an important factor for any foreign investor looking to make an investment. And as if all this was not enough it is worth remembering that it is not easy to start any business in India. Every year the World Bank puts out a ranking which measures the Ease of Doing Business across countries. In the 2013 ranking, India came in at rank 132 on the list \u2013 the same as in 2012. When it comes to starting a new business In
\ndia is 173rd on the list. Hence, foreign investors have an option of starting their business in a much easier way in many other countries. Given this, why should they be hurrying to India?
The spate of recent scams also has not helped the way India is viewed abroad. There is significant evidence to show that corruption hampers trade. Says Ghemawat: \u201cAccording to one study, an increase in corruption levels from that of Singapore to that of Mexico has the same negative effect on inward foreign investment as raising the tax rate by over 50 percentage points.” India stood at 94th<\/sup>\u00a0position in Transparency International’s 2012 Corruption Perception Index. \u201cGiven this, tackling corruption has to be a priority,\u201d adds Ghemawat.
The moral of the story is that although India is much more open than it used to be 20 years ago, there is a lot that still needs to be done. And this is important because there is a clear connect between the global connectedness of a country and measures of prosperity. As Ghemawat puts it, \u201cThere is a strong positive correlation across countries between the depth of a country\u2019s global connectedness and measures of its prosperity, such as its GDP per capita and its ranking on the UN\u2019s Human Development Index. To be sure, correlation is not the same as causation, but statistical analysis indicates that after controlling for initial income levels, countries with deeper global connectedness have tended to grow faster than less-connected countries.\u201d
The point is further buttressed by one look at the list of countries that are on the top of 2012 DHL Global Connectedness Index created by Ghemawat. These countries are the Netherlands, Singapore, Luxembourg, Ireland, Switzerland, the United Kingdom, Belgium, Sweden, Denmark, and Germany. In the recent past some of these countries have been caught up in the aftermath of the financial crisis, but it\u2019s important not to let recent growth rates overshadow measures of current prosperity, on which all of these countries far surpass India.
Ghemawat gives the example of the Indian information technology sector. \u201cAsk this simple question to yourself: Would Indian IT companies have been as globally competitive if we had protected them from international competition?\u201d The answer of course is no. But that is the case with the business services sector. There is a huge protective moat around it. This, despite the fact that the sector has a huge potential to create jobs.\u201d
And he backs his argument with numbers. \u201cAlthough some services (like haircuts) will always be delivered locally,\u00a0liberalizing trade in services alone could boost global GDP by at least 1.5%.\u201d In India’s case, opening up business services is even more important given that we don’t trade much with our neighbours due to various reasons. \u201cFor example, Indian trade with Pakistan, according to one study, is only 2 to 4% of what it might be under friendlier circumstances. The rest of India\u2019s neighbours are relatively small and poor, presenting limited opportunities compared with, for example, the benefits China realised by tying into Japanese and Korean production networks. It is neither exaggerated nor xenophobic to say that one of India\u2019s key structural problems is that it is located in a difficult neighbourhood,\u201d says Ghemawat.
Countries tend to trade the most with their neighbours.\u00a0 Ghemawat explains, \u201call else being equal, if you cut the distance between a pair of countries in half, their trade volume will go up almost 200%.\u00a0 Add a common border, and trade rises another 60%.\u00a0 That\u2019s why more trade happens within world regions than across them, and the US\u2019s top export destinations are Canada and Mexico.\u201d
In India’s case, at least over the short-to-medium term, trading primarily with neighbours won\u2019t be workable (though Ghemawat does urge India to take the lead on regional integration in South Asia). Hence, he feels that\u00a0some business services can be outsourced over greater distances than many categories of merchandise are traded, since physical shipment of products is not required.\u00a0
One exception he notes is how, recently, China became India’s biggest trading partner, overtaking the United States. But Ghemawat feels that caution is in order. \u201cIndia runs a huge trade deficit with China and exports mainly primary products there: Cotton, copper and iron ore account for nearly one-half of the total. Given the limited progress the US has made in rebalancing its trade with China, it\u2019s hard to see what India might accomplish within any reasonable timeframe,\u201d he says. Trade deficit is the difference between imports and exports.
Ghemawat also feels that India has a lot to gain by encouraging trade within states. \u201cI have been trying unsuccessfully for years to get hold of data on trade between Indian states,\u201d he says. \u201cIndia has a lot to gain by encouraging and increasing trade between states. As the former Chairman of Suzuki once put it to me, what India needs is not external trade liberalisation but internal trade liberalisation.\u00a0And I heard Ratan Tata say something similar about the need for more integration and fewer barriers within India.\u00a0For a large country, the potential gains from internal trade are typically much larger than those from international trade,\u201d Ghemawat concludes.\u00a0<\/span><\/span><\/span><\/p>\n

The interview originally appeared in the Forbes India magazine\u00a0<\/a>in the edition dated Sep 20, 2013<\/span><\/span><\/span><\/p>\n

 <\/p>\n","protected":false},"excerpt":{"rendered":"

Our politicians think our problems come from being connected with the world, but the reality is we are too little connected to the world, says Pankaj Ghemawat. Vivek Kaul The United Progressive Alliance government is fond of telling us that India\u2019s weakening macroeconomic indicators \u2013 a falling rupee, a declining stock market, rising bond yields … <\/p>\n

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