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Published by Asad Mazhar
Foreign Direct Investment
Foreign Direct Investment

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Published by: Asad Mazhar on Oct 29, 2010
Copyright:Attribution Non-commercial


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India and China not only survived the financial crisis — over the course of the financialcrisis their economies grew. This is the perfect time for India to attract much needed non-debt creating capital flows through foreign direct investment (FDI). The Indian Budgetfor 2010-11 has rightly proposed to simplify the FDI regime, maintaining FDI flows particularly by recognizing ownership and control issues and liberalizing the pricing and payment system for technology transfers, trademarks, and brand name and royalty payments. More importantly, the budget shows an intention to introduce user-friendlyregulations and guidelines for FDI.But while India is macro-economically well placed to attract FDI inflows, merelyshowing an intention to introduce user-friendly regulations without addressing the coreregulatory, institutional and policy issues affecting FDI may not be enough to attract thehuge amounts of FDI the country needs. Economic surveys in last few years confirm timeand again the need for concrete reforms to improve the Indian investment and businessclimate. While the 2009 ‘Doing Business’ survey prepared by the World Bank showedthat India’s indicators have gotten better, India still lags behind China overall. China beats India in crucial indicators such as: registering property, trading across borders,enforcing contracts and closing business (see the table below). In this context, thesuggestion in the budget for simplified, user-friendly regulations and guidelines would beuseful — provided that after the budget institutions are designed to enforce commercialcontracts, in order to reassure investors. In fact, it was expected that the budget would notonly demonstrate an intention to simplify FDI rules and regulations, but also propose a proper framework of action for achieving this.India’s high trade and transaction costs are mainly due to the country’s lack of qualityinfrastructure. This lack of infrastructure discourages resource-seeking and export-oriented FDI to use India as their base as they do with China. China’s unmatched averagegrowth rate of 10 per cent for more than a decade is due to consistent improvements in physical infrastructure. The 2010-11 Budget does focus on infrastructure development,allocating substantial general funds, which constitutes 46 per cent of the total planallocation, and doubling plan allocation to power sector and improved allocation for renewable energy in particular. Moreover, some of the budget’s announcements—like
allocating coal blocks for captive mining and a proposal to set up a Coal RegulatoryAuthority to ensure greater transparency—are welcome steps.The public sector cannot cover the USD150 billion per annum required for themaintenance and creation of infrastructure. India invests around 5 to 6 per cent of GDPon infrastructure whereas China invests 14.4 per cent of GDP. The gap betweeninfrastructure investments in China and India is widening not only as share of GDP, butalso in absolute levels given that India’s GDP is only one third that of China. Hence, the private sector must participate substantially in infrastructure development in India. Oneway of improving the environment for infrastructure development is through public- private partnerships. These require a more stable and secure policy framework; particularly ensuring the protection of property rights and consistency in pricing andsubsidy policies. Infrastructure projects need maximum clearances and approvals thatsometimes run into innumerable disputes. Therefore, there should be an institutionalmechanism for speedy dispute resolution. The politically acceptable cost-recovery based pricing is a must for attracting private investment into the infrastructure sector.Infrastructure projects are capital intensive. A special federal investment law should beformulated to consolidate the many sets of State laws, rules and regulations covering theinfrastructure sector. Infrastructure also needs stable financing. Because of this the Rs20,000 income tax exemption for investment on infrastructure bonds is a welcome step.But the government could do more by allowing financial intermediaries to invest inreasonably rated infrastructure projects and by giving a guarantee to use pension funds,insurance and FII’s to invest in infrastructure projects.The Budget 2010 intends to simplify and introduce user-friendly regulations andguidelines for FDI but these are mostly at the central government level. However, actualimplementation of projects will take place at the state level. Bureaucratic hassles, mainlyat the state level, are obstacles to the realization of FDI. Some of the major issues relatedto project implementation such as land acquisition, land use change, power connection, building plan approval are at the state level This division of political responsibilitycreates a delay in implementation. Therefore, a concerted effort is required for better co-ordination between the central and state governments on this issue. An institutionalmechanism may be set up for getting clearances of FDI projects from both central andstate governments within a stipulated time.Another way of attracting FDI is by following the Chinese special economic zone (SEZ)model. This is large with state of the art infrastructure facilities and proper infrastructureconnectivity to the market. To attract FDI SEZs in India should be designed as China’sare, with proper infrastructure connectivity to domestic and external markets. If necessary, the private sector should be encouraged to set up private airports and ports toservice the SEZs through automatic routes and 100 per cent FDI equity. Since it’s hard toconnect different kinds of transportation infrastructure in India, SEZs should beestablished in the coastal regions like in China to make transportation easier. The Budget2010-11 should have addressed some of these measures to attract FDI much needed bythe economy.

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