IvEy ‘906M82 INDIA’S FAILURE TO ATTRACT FDI" Daniele Cecteux prepared thie e360 under the eupenision of Professor David Conklin cally to provide material fr class dscussion. The authrs donot intend fo lutral ether effective or effective handing of @ manager situation. The authors may hhavecsguised certain names and other identifying Information fo protect confidentaty {ney Management Sences pron any for of reproduction, storage or transmittal without is writen permission. Reproduction of this meter! not covered uncer auorzaton by any reproduction rights organization. To order copies or request permission 12 reproduce materials, contact vey Publshing, hoy Manegoment Soniees, 20 Flehard Wey Schoo! of Bushess, The Univesity Of Wester Ontario, Landon, Ontae, Caneds, NA 347; phone (18) 6612208; fox (519) 6613882; ema cases@Ney.uvoce. Copyright © 2008, ey Management Services ‘ Version: (A) 2008-08-24, INTRODUCTION In the early years of the 21st century, many/nalysts compared China’s outstanding economic success with India’s relatively slow economic progréss. Businesses ‘considering alternative location sites for new investments were overwhelmingly choosing China rather than India. In analysing India’s failure to attract foreign direct investment (FDI), Morgan Stanley focused on a series of factors that it believed explained India’s competitive weakness, To a major degree, these failure factors were the result of bad public policies, fiom fiscal deficits and the tax system through restrictive labor laws and poor infrastructure. As a result of these factors, Morgan Stanley eniphasized that: India’s share in.global FDI remains poor at less than 1 per cent compared with China’s share of 12 per cent. Indeed, China has received a cumulative inflow of USS480 billion since 1990 ecmipared with US$33.1 billion in India, India’s FDI inflows pale even when compared (with other emerging markets. For instance, Mexico receives about USS10 billion compared with FDI inflows of USS4 [billion]-S billion a year in India” McKinsey and Company concluded that excessive and inappropriate goverment regulations and government ownership underlay India’s failure to achieve growth rates as high as China’s, and emphasized the need for India to improve: A decade ago, India and China had roughly the same GDP [gross domestic product] per capita, But at USS440, India’s current GDP per capita is now only half that of China's, Further, India’s GDP is growing at a mere six per cent a year, compared to China’s 10 per ‘cent. India’s working-age population, however, is expanding ever faster. Unless GDP {This case has been wten on the basis of published sources only. Consequently, the interpretation and perspectives [presented in this case are not necessarily those ofthe Government of Inia or any ofits employees. ‘Morgan Stanley Equly Research, India and China: A Speci Economie Anolysis: New Tigers of Asia, Morgen Staley, ‘New York, July 26, 2004, p. 19, document is aoried for educator revi use ony by RAMANNA SHETTY, lance Business Schoo! Banglore unt Sep 2021, Copying or goss an ins 7 9 als anintingement of copght Tis Permissions @hbspharvard edu or 617723 7260a oe —— «at eloser to 10 per cent a year, India could face unemployment a high as 16 pe grows 3 cent by 2010. ‘The World Bank developed a set of investment climate indicators that measured the extent and e a of f tor busi nature of teal impediments tothe decisions and activities of private sector businesses. It pointed toa seria Shortcomings in India: of Deficiencies in India’s investment climate pose cttical constrains on: private sector investment and performance, particularly industrial competitiveness «In regulation and corruption subcategories, for example, or tax and administration, one finds vast differences between India and China. The World Bank's Doing Business database shows, on the one hand, that in China, the average time taken to secure the necessary clearances fora startup, o to complete the bankruptcy procedure, is much smaller than in India, Also, Indian labor laws allow firms far Jess latitude with their employees than the labor code does in China, Brazil, Mexico, or the Russian Federation! 2 ‘Yet, by 2006, all was not entirely bleak in India’s environment of business, There were certain issues ‘here Indi had considerable advantages. Morgan Stanley pointed to India’s financial system as relatively Successful, with effective risk assessment, adequate “capitalization and manageable levels of now, performing loans. Meanwhile, India had created world-class software sector and had become a major Gestinaion for the outsourcing of service activities. Morgan’Stanley emphasized India’s, suocess in improving its major public institutions, and other analysts predicted that India's rule of law and democratic brocesses would provide compelitive advantages:over China, particularly in entrepreneurship, innovation and high-technology. In a 2006 Financial Times aticle, Yasheng Huang discussed this optimistic view: a In an article published’in 2003 called“Can India Overtake China?” Tarun Khanna of Harvard Business School and {argued that India’s domestic corporate sector — strengthened by the country’s rule of law, its democratic processes and relatively healthy financial system — was a Source’of substantial competitive advantage over China. At that fime, the notion that India might be more competitive than China was greeted with wide derision, ‘Two years laters!India appears to have permanently broken out of its leisurely “Hindu rate of growth’) — an annual gross domestic product increase of about 2 to 3 per cent — and its performance is beginning to approach the east Asian level? MORGAN STANLEY'S ANALYSIS (NEW TIGERS OF ASIA, JULY 2004)* Morgan Stanley. pointed to the following six factors that it believed explained India’s competitive weakness: ‘+ Labor cost, productivity and availability Capital cost, productivity and availability ‘nla: The Growth Imperative, McKinsey & Compa 36 2001, pt ae a rulactungFeenes and Prva Setar Development Unt, South Ase Regen, The ‘Uindia Investment Climate end Menufacturing, World Ben : November 2004, pp. bi ney sien ata (esrong uur, Whol Guna Could eam dw’ Sow ood Gut Fse” Ean! Ties Jay 24,208 0 Tiere of Asia, Morgen Stale. © Morgan Stanley Equity Research, India and China: A Special Economic Analysis: New Tigers of Asia, New York, July 26,2004, p. 19. ™ a eutrized for educa eve use only by RAMANA SHETTY, lance Busnes: Sete! 1 a geet Shoe Banglore il Sep 202, Coping posta evan use oly oor Ys document or educa A Ssirathbepnervaré.eu "617723 7200, iSBo6M082 Direct and indirect tax structure Infrastructure costs and access Quality and sustainability ofthe financial system Progress of the overall institutional framework Labor Cost, Productivity and Availability India had failed relative to other countries, such as China, to provide basic education to its population. Both, primary and secondary school parameters indicated India’s weakness. On the other hand, post-secondary education was well-developed for the relatively small proportion ofthe population who were able to participate. This extensive tertiary educational system created a large pool. of skilled labor, especially engineers. Another significant factor related to labor Jaws that impétded business decisions: In comparison, India’s labor laws seem restrictive. Indeed, the World Economic Forum's global competitiveness report (2003-04) ranks India 96th out of 102 countries on hiring and firing policies compared with a 26th ranking for China. Currently, any factory ‘employing more than 100 people needs to go through a rigorous approval-seeking process not enly for closing down but also for fing employees. Recent attempts to relax labor Jaws have met with stiff opposition from trade tn & } < Capital Cost, Productivity and Availability India had a relatively low savings rate.of f per cent of GDP, and the FDI inflow was less than 1 per cent of GDP. This investment flow wvas not adequate‘to support grow rates as high as those of China or other Asian countries. Morgan Stanley pointed {9 the govermment’s fiscal position as a serious cause of this low savings rate. The fiscal deficit Was substantial for both capital and current expenditures. Morgan Stanley used what it termied'the incremental capital output ratio (ICOR) as @ proxy for capital efficiency. This index‘indicated the amount of capital required to produce one additional unit of output India’s ICOR was significantly higher than that of other Asian countries, suggesting that capital was not used as efficiently in India as elsewhere. fr é , Direct and indleoct Tax Structure India’€-Vety-high indirect taxes added to the costs of manufactured products, and were a major reason for relatively higher prices than in China. Morgan Stanley referred to a study by the Confederation of Indian Industries and. McKinsey that concluded that Chinese manufactured products were 28 to 33 per cent cheaper than India’s. Taxes were a major contributor to this cost differential. (india's tax code was extremely complex with many exemptions, which resulted in low tax collections. {India also had poor compliance with its tax laws, As a result, the high fiscal deficit stood as an obstacle 10 Pte redtiction of the high tax rates. Overall, the tax system needed basic reforms. ” Morgan Stanley Equity Research, India and China: A Special Economic Anlrs's: New Tigers of Asia, Morgan Stanley, “New York, July 26, 2004, p. 23. “This documents aoe recat rave ue ony by RAVANNA SHETTY, Allnce Buses Schoo Barger tl Sop 202. Coping or posta en tinge ot coprgh, Pormesons@haephanerteds or. 70370002B06Moa2 pep icture Costs and Access i ee jes suffered from a lack of consistent and high-quality asit times more on its physical infrastructure than Inia A i ia as in.China. For a i ‘ructure facilities in India as in sly not expect the same kind of infrast ially electricity, estes fam nemaonal ecmpaiivenss depended upon Key infarcts nods ere aly lati, transportation and telecom, In India, the ost of infastructure services was 50 to 100 pet een! higher than inchina A major bottleneck for many firms was the shortage of electricity; freq ee continual business interruptions. Morgan Stanley estimated that 20 per ie he elecucity war distributed to farmers at almost a negligible charge; a further 40 per dent was Tos distribution. % Stanley concluded that Indian comp Mfestureseviees, China was investing ei China’s highway network was seven times larger than India’s:'1.4 million kilometers versus 200,000 Kilometers India’s ports were inefficient, and the cost of cargo movements was significantly higher then the global average. Yel as noted above, the government faced revenue ‘deficits, which limited potential investment in physical infrastructure that would be necessary for businesses in India to achieve international competitiveness, Quality and Sustainability of the Financial System "> ‘ “Gy India’s financial system was relatively successful comparéd with other countries in Asia, India’s banks had effective risk assessment, adequate capitalization and manageable levels of non-performing loans, Competition existed in the financial sector, providing busfesses with the opportunity to raise debt. capital, x 1ecess in the service outsourci ing sector, M ' overall economic success would require seven basie charac organ Stanley concluded that India’s ges: Develop human capital Augment savings rate through fiscal reforms Increase in capital accumulation through FDI and privatization Kick-start investments in infrastructure Reform tax structure oaAShp 0 York Jay Soy Research, India and China & Special Economie Analisis: New Tigers of Asia, ‘Now York, July 26, 2008, p. 38 stAsia, Morgan Stanley, ance Business School Bangalore unl Sep 2021. Copying or Permissons@nospheraréedu or 617.765 9006 2 Coens eta on eeprent aPage 5. ee eee eee 6. Improve labor flexibility 7. Decentralize? q - é and China: In 2006, Morgan Stanley issued what it termed Part Two of ts special economic analysis, India and. Chine, ‘New Tigers of Asia. While supporting Morgan Stanley’s earlier conclusions, this report focused on several Significant issues, recommending the following three major publie policy changes: 1. Introduce legislation that allows the implementation process for infrastructure projects to cut through the current maze of regulations and to acquire land quickly. sana tite 2. Set up several special economic zones along the coast ini areas without Ta disputes. ; ; mas the 3._ Sell state-owned assets to jump-start a 100 billion-dollar infrastructure Progra ‘core of India’s modernization.'® Morgan Stanley devoted individual sections of its 2006 report to each of the following. Infrastructure Deficiencies India’s infrastructure remained inefficient and high ‘S6st., Ongoing fiscal deficits prevented the necessary investments in infrastructure. The government bufeaucracy seemed unable to develop and supervise large tially lower than infrastructure operating costs, because politicians responded to electoral pressures/‘Thegovernment had failed to include private-sector investors in infrastructure development. Nevertheless, Morgan Stanley noted that the government was making a fresh start. ‘The Largest Fiscal Deficit among tho World's Major Economies Morgan Stanley pointed to the combined central government and state government deficits of nearly 8 per cent of GDP. State govérnments in particular were blamed for becoming less careful in regard to achieving, a fiscal balance. AboutS0\per cent of the overall deficit was due to state deficits. In addition, both the central and state govemments.had incurred rising “off-budget” obligations, including the debts of various state infrastructure agencies as well as pensions owed to civil servants. Morgan Stanley pointed both to a weaker political ‘environment in which politicians were pressured to increase non-development expenditures and to weak tax compliance, ‘Outmoded Labor Laws In spite of extensive discussions concerning India’s archaic labor laws, the political will in India to reform these laws was still lacking. Overall, Morgan Stanley continued to present a very negative picture for foreign investors: # Morgan Stanley Equity Research, india and Chine: A i yew York, July 26, 2004, pp. 43-44. eae organ Stney Equi Resear India and China: A Special ali ‘Stanley, New York, June 2006, p. 12 ne om rs of Asia, Part Il, Morgan jal Economiethe hurdles We cific FD) Many of entrepreneurs rather than. spe facilities throughout the and long delays in legal thi MCKINSEY’S ANALYSIS (INDI. The McKinsey Globs u project to assess the economic faced by foreign inves val Institute, in collaboration 9B06M082 se suffered by domestic 1 business environment Ye infrastructure \d procedures me as tho: ¢ general 1s are inadequal cratic controls ‘an ink FDI i 1 regulations. country, Tg proceedings in India ii ‘The matt jd labor laws, bureau 0 OWTH IMPERATIVE, 2001) dia office, undertook ointed to many of the 1a faced the following IA: THE GR° with MeKinsey’s In performance of India. Although the assessment pi ‘same issues 0S ‘those noted by Morgan Stanley, barriers to growth: 1. Regulations governing products and markets 2. Land market distortions 3, Government-owned businesses 4. Regulations Governing Products and Markets % McKinsey estimated that regulations governinigiprodue 2.3 percentage points each year. Merely to remgve substantially. The assessment pointed to India’s “McKinsey concluded that, Indi {and markets reduced India’s GDP growth rates by thege regulations would raise India’s growth rate iberalized automotive industry as an example of the success that India’s businesses Gould achievézif‘the regulations constraining their decisions and actions were removed. McKinsey pointed to fivefeatures that made India’s regulations very damaging to the competitiveness and productivity, of India’s businesses. Rican: Many regulations were inequitable"Regulations did not treat all busines sses the same. In particular, regulations protecléd incumbent firms from new entrants. In the telecom sector, for example, new entrants had to pay-expensive fees for new licenses, although the incumbents did not face these fees. ‘New entrants he cceis-the networks of incumbents, but their access fees were set at very high levels. McKinsey concluded that regulations were not only inequitable, but they were also ill- conceived, and they damaged the public good rather than enhancing it Uneven enforcement. Regulations were not applied equally to all businesses, and so profitability was affected by the.ability of firms to avoid regulatory costs, McKinsey pointed to tax avoidance as an exanipleyasiwell as different prices paid for public utilities. At the-time of the McKinsey study, some 830 products were reserved for small-scale businesses. These products (could be manufactured only by firms that were smaller than ified si seo e a specified size. regulations “which covered a wide varity of products, inchuding clothing and textiles, impeded the achievement of economies of scale, At the same time, import restricti 7 : 7 restric inefficient firms to survive, mp a the economy as a whole, creating inefficient sectors that could have bene! technology, managerial practices and capital that foreign investors coul Morgan Stanley Equity Research, ‘Stanley, New York, June 2006, p. 52. fs document Is authorized fr educator rovow use en by RAMANNA SHETTY, Allance Business School Ba Pamiainneinen nena oe Sana Unt Se India prohibited foreign direct investment in many sectors of the econom: ions enabled these small and y. This prohibition damaged fited greatly from the modern id have provided. Once again, India and China: A Special Ec Analysis: New Tiger a, Pert ll, Morgan 3° 2021. Copying oF postion en inannsent =f —~Page 7 9B06M082 Paget 8 28 re b India’s politicians were motivated by the desire to protect incumbent firms that might be destroyed by more efficient foreign investment. license fr : ‘na license from Licensing in many sectors. Investors wishing to create a new business had to first obtain a Hretec the government. Goverment officials often refused such licenses in order to protect ine Licenses that were granted might not be given to the most efficient potential entrants: 2. Land Market Distortions. ints McKinsey estimated that land market distortions reduced India’s GDP growth rate by 1 Pere by tiating each year. These distortions impeded business plans in regard to investments: Furtetbicees Ut available land, these restrictions drove land prices to be the highest among_all Asian nations, average incomes, McKinsey pointed to three kinds of land market distortions: «Unclear ownership, As much as 90 per cent of the land in India. was subject to Tegal chspiict So ownership. Resolution of such disputes required many years of judicial procedures: meee (1 difficult to purchase land with a clear title. McKinsey recommended that basic a 5 ‘ownership had to be reformed, and the process for dispute resolution had to be aia inet med + Counter-productive taxation, McKinsey argued that India’s entire tax system had fo be. Hon Property taxes were too low, tax collection was ineffective and user charges for public willties heavily subsidized. This situation impeded the expansion of public infrastructure. Furthermore, business decisions were distorted by the tax system and collection procedures. + Inflexible zoning, rent and tenancy laws. These. tegulations limi ited ‘the transfer of land for new purposes, Because of rent controls and protected tenancies, buildings could not be torn down and Teplaced, and there was no financial incentive for the owners to renovate. These laws further restricted ‘the potential for new entrants in many businesses. 3. Government-owned Businesses McKinsey calculated thatgovernment-controlled businesses accounted for around 43 per cent of India’s capital stock, and the labor and capital productivity levels of these entities were well below those in the Private sector. State-owned companies that experienced losses could survive in spite of inefficiencies by relying on government subsidies. McKinsey estimated that this low productivity in government-controlled businesses reduced India’s GDP growth by 0.7 percentage points each year. 4, Labor Laws and Infrastructure McKinsey estimated that India’s labor laws and poor transportation infrastructure reduced India’s annual GDP growth by 0.5 percentage points. Overall, McKinsey strongly advocated regulatory reform and privatizatic i i z privatization as essential st achievement ofa better business investment climate and more rapid economic growth, oe WORLD BANK INVESTMENT CLIMATE INDICATORS: Exhibit 1 presents World Bank inves tment climate indi fia, Chis Organ hr Eee tment climate indicators in 2005 for each of India, China and the eration and Development (OECD) average. These 12 indicators were ‘This documents auborzed fo educator review use ony by RAMANNA SH copying IETTY lance Business School Bangaloe unt Sep 202, or Perissons@hisphavarsedyor617. 7007600 Dost Is an intingemen of copya SB06NM0a2 a ST EMNED, developed by the World Bank to reflect the environment of business in countries throughout the world. On the basis of these 12 indicators, India’s environment of business was still extremely poor, Except:for the Gsclosure index, India fll far behind the OECD averages. On most of the indicators, India also fell behind Shirt, India did have an indicator of legal rights that was substantially better than that of China, although Stil lower than the OECD average. In most of the categories, the enviroriment of business in India posited to be considerably worse than both the environment of business in China and the OECD average. a ft¥s and cost to start a business were substantially higher, employment was considerably more rigid, the ime to resister property was longer and the cost higher. The time 10 enforce a contact was longer, and [Rg, cost was higher. The time to go through insolvency was much longer and the recovery rate was much rst a _— of the World Bank’s investment climate indicators, India in 2005 was still not ractive for FDI. 2 APOLITICAL PHILOSOPHY OF AUTARKY AND GOVERNMENT INTERVENTION little role to play. ist philosophy, | offeconomic It Affinity with the Communi ‘West, led to an acceptance to maintain independence from the ‘Union — linkages that were ine € age, disregarding financial and political polum for providing permissions and approvals. Because of the widespread politcal philosophy.in favor of government intervention in the economy, India found it difficult to move oe fee cnlerprise market economy. While India followed a socialist development path, some private enterprise ‘was allowed, but only under a complex system of regulations and restrictions (People ‘in, India had lived under a caste system in which social status, ‘employment prospects depended upon the specific caste into which each person was bor. In recent years, f affirmative action programs sought to guarantee @ stipulated percentage of civil service jobs and college é “Places for the deprived castes that had suffered discrimination, In 2006, the governnient proposed to implement another affirmative action program that would reserve an extra 27 per cent of places in India’s oolleges for a variety of lower classes. This program would raise the percentage of places that were allocated on the basis of caste and class, rather than on the basis of merit, to 49.5 per cent. Widespread educational opportunities and aed for educator view use only by RAMANNA SHETTY, liance Business Senco Bangalore unl Sep 2021. Copying or postin an ingen coy ‘This document utnoze reaver 1 A risreeheephavarseaso 87 TESTPage 9 sett protests erupt. i before ean ap India in response to this proposal. Clearly, India still had a long distance to traverse ari # opportunity could be achieved. The implications of the caste system and of attempts 10 Trtalige ce ced Significant for economie development and enrepreneuship. The 2006 Beonomist igence Unit (EIU) Report discussed this ongoing challenge: f Z Z There is indeed evidence that itis not discrimination in tertiary education that holds back ‘the lower classes, but rather the poor quantity and quality of primary’and secondary education, which fails to produce enough qualified students who can later. gain ‘entry to university ‘The debate about reservation has been around since indepéndence, but critics of the government allege that the timing of the proposal is politigally, motivated. . Congress is competing with and has lately lost support to parties that promote the special interests of the backward classes. Its proposal may therefore bevaimed at atracting votes ‘fom those who stand to benefit. However, the-plan remains a highly risky political gamble that could backfire. There is a historical precedent. In 1990 the government's attempt to extend the scope of reservation for. the backward classes triggered massive protests in colleges across the country, when students jmmolated themselves in protest. It ‘was the ultimate cause for the resignation of the then prime minister, ‘Vishwanath Pratap Singh. It also led to a formidable movement againstjob reservations for backward classes." ‘The composition of India’s people, ideologies andtinterests posed unique problems for leadership. More ‘than 650 dialects were spoken; there were 18, official languages and nut wus religions. The 28 states and ‘seven union territories each iad constitutional rights and responsibilities separate from the federal government. This panoply of interest groups resulted in a multiplicity of political parties. ‘After the 1998. Election, in order to gain majority control/6f the government, the Bharatiya Janata Party (BIP, literally Indian People’s Party) had to join25 other parties to form a coalition. ‘The 2004 election also fesilted in a coalition government, termed the United Progressive Alliance (UPA), “The Congress Party, which had been among the biggest supporters of economic reforms, was the leading ‘member of the new codltion. The Left Front, of which the strongest faction was the Communist Party, was the Congress Party’s key coalition partner. a: } In describing the. contrastsin political philosophy between India and China, Martin Wolf emphasized that India fried to minimize any social dislocation, ad India’s politicians sought to protect special interests. Chind's Jeadérs, on the other hand, focused on economic development and were prepared to accept any social transformation that was necessary: ___. China his accepted both growth and social transformation. India weleomes growth but £2 Rxries to minimise social dislocation. The Chinese state sees development as both its goal “and the foundation of legitimacy. Indian politicians see the representation of organised __Anterests as their goal and the foundation of their legitimacy. Chinese politics are = developmental, while India’s remain predominantly clientelist.° ky, 2 Economist intetigence Unit, EIU Country Report Indie, June 2006, pp. 16-17. (7 Martin Wolt, “india and Chine Part 1: On the Move: Asia's Giants Take Different Rc Ui ‘Economic Greatness,” Financial Times, February 23, 2005, p. 13. rent Rvses in Pur of ‘Tis document utorizd for educate rvew use only by RAMANNA SHETTY, Alance Business Scheel Banglore und Sep 2021. Copying ox posting i an nin Permissions@nbsphervard.eds of 17.763 7060 Bement of copySB06M0R2 age 0 ‘THE BEGINNING OF LIBERALIZATION REFORMS — e crisis /As the Value of its Liberalization reforms began in 1991. India was suffering in & foreign ce neta Fund (IMF) for currency was falling, India tumed to the World Bank and e i erat aly india aréed to a set foreign currency loans, These institutions stated that they would len¢ adie Ts tie reduction of of liberalization reforms. Known as the Washington Consensus, these reforms reat Tie et import tariffs and quotas, the removal of foreign investment restric on a eal such government-owned enterprises. The Washington Consensus was based on the opini i “the loans and avoid reforms would India be able to achieve the economic growth necessary to repay the future similar crises, An initial set of reforms was called the New Industrial Policy. After,1991, Tndia shifted slowly towards a greater reliance on the free enterprise market. ‘The number of indastries teserved for the public ies reduced; in theory, private sector firms could now compete with government-owned businesses in these industries. The New Industrial Policy promised that majority foreign-equity, even up to 100 per cent, would be permitted in some industries. In 35 industries, foreign investment up to 51 per cent would be cligible for automatic approval. Foreign exchange controls were relaxed to some degree. Foreign exchange would be available for a number of purposes, sich as payment of royalties, lump sum fees, dividends and business development abroad. The New Industrial Policy also introduced some measures aimed at delicensing and deregulation. The requirément of obtaining an industrial license in order to build Certain industries of strategic, social or environmental @ manufacturing activity was now limited to: r hase.dndustrial inputs were removed, allowing freer concen. Licensing requirements in order to pul ‘access to capital goods, raw materials, sparé'parts, components and other items. js Le ‘Until 1991, most foreign investmentispprovals had been given on a case-by-case basis, Many regulatory agencies were involved in thé’ approval process, creating a nearly impenetrable complexity, These ‘Eeulatory agencies included| the Foreign Investment Promotion Board, the Ministry of Finance, the foreign ownership was pefmitted only up to 40 per cent, Second, foreign investment was only permitted if the foreigner pledged to ‘transfer technology, which required government approval of the technology ansfer plans. Thirdeach,cénipany required operating licenses that restricted it to certain actioivee and Specified volumes of production. The 1991 reforms reduced or removed these barrier, although linens wets sil Teguired for some activities. As of 1994, it was estimated that 80 percent of foreign invecteery Proposals fit into,cafegoriés for which the RBI was authorized to deal with investors on the baci ohne automatic. approval process. The remainder requited approval from the Foreign Investment Development Board (FIDB) andl Gould require lengthy negotiations over the terms and conditions for approval, Privatization proceeded very slowly. From 1991 through 2000, only 48 companies were privatized, all small or medium-sized businesses. In many of these businesses, the government relained en ownership pésition, In some cases, state enterprises simply sold shares to other state enterprises. Foreign inven, Aid not participate actively in the privatization process. Meanwhile, the goverment was determined to ‘maintain. @ controlling ownership stake in many firms, and to sell only firms that were viewed as “non. strategic.” ‘Through its vast array of regulations, the government was able to determine investment and production _AAccisions for the private sector. The government it was also able to affect private investment decisiony through its ownership of banks and by tightly controlling the capital market. Furthermore, the Congress ‘Ts ocumerts ahora edn vew we on by FAMANNA SHETTY ance Burs Sch Bane ntl Sp 2021. Cap oa an tng ermssions@ihbepharverdedu or 617.708.7850Page 11 9B06M082 Pogets ss 82 Party, in particular, J » Maintained close relationships wit i 4 conglomerates that al intaine lationships with the large, family-owned cong) Lah i one role within India, In addition, the government often retained a “golden shar ” that carried mean th ie ongoing right to veto certain management decisions. Hence, the privatization process did not an the surrender by the government of its power to intervene. REFORM PRIORITIES IN THE TWENTY-FIRST CENTURY ‘Surveys carried out in 2004 by the Confederation of Indian Industry in collaboration with the vee Bank suggested certain reform priorities from the perspective of India’s business commun’) The following raeesvicate the perventage of respondents identifying each factor a8)a major oF Severe tac growth, in declining order of importance: a Regulation and corruption 51% Infrastructure 34% Tax and customs administration 31% High taxes 28% : External finance 27% Boe Oh ‘Macroeconomic and policy instability 27% ‘Skill shortage 13% ‘Access to land 1074" 'A World Bank index that indicated hitind/Sod Biting diticlty (based on a maximum difficulty of 100} placed India at 90 for firing and 33 for hiring. In comparison, ‘China’s indicator stood at 40 for firing and 11 for hiring.” The Global Competitiveness zeport ranked India ‘Tard out of 75 countries on labor market mobility, while China ranked 23rd. A key‘ factor was that in India, government regulations required that businesses with more than 100 employees had to seek government ‘approval, rarely granted, for the firing ‘of workers. Reforms at the state level had faised the limit on the size of businesses needing such approval to firms of 300 to 500 employees, bul'restrictions remained. Workers were limited in their mobility as ‘well, since pensions typical ¢ ly were not potable when a worker moved from one company to another. Ra REGULATORY REFORMS AT IE STATE LEVEL, World Banflgurveyssindicdted that regulatory burdens differed among states and among cities. World Bank reports concluded that cities where firms faced a lower burden of regulation were likely to receive more investment;andyhad greater shares of ‘manufacturing activity than cities that were more heavily regulated, State governments established regulations in regard to access to land, and these regulations could have considerable impact on investment location decisions. Apart from land regulations, if a city had land shoriages, it would be less likely that new businesses would locate there. (Fe, (A survey, undertaken by the World Bank in collaboration with the Confederation of Indian Industries {asked business managers to identify the states that they thought had a better or worse investment climate than the'state in which they were currently based. The report concluded that: i pe Developme “Ft: eset Cate and Monufeturin Indust, nonce and Pate Se South Ash The World Bank, Washington, DC, November 2004, p. 10. o torheceee! jt Un South Asis Region 6 india: Investment Climate and Mat Pri : , Finan ar au ing nd, Pence and Pata Set Dove! Unt South Asia Region, ‘his dourent is autorizd for edveatorevew use oly by RAMANNA SHETTY, lance Business Schoo! Bangalore unt Sep 2021. Copying ex pastng i an Inngement otthought yy percent of respanden's, TPs" cent thought Move tn tt eon se, Ab ST ge climate of Uttar ‘Pradesh was Worse than. = he ‘S f pretty clear ranking of states ‘that enabled us eee the “best climate” states; Tamil Nadu, Karnata fi ae penaals i, states”; Delhi and Punj jab as “medium”; and Kerala, yy “poor elimate states.” . ‘a india wrote a working Montek Abluwalia a member of the Planning. Commission in the goveeiment on “apnasized paper entitled State Level Performance under Econom Reforms in ni. ae athe tale {hat India had been experiencing an ever-increasing regionalization’of pol ig, ey po eralzation at level were being driven by state rather than national issues. Furthermore, the Ps 199 Hetovermet the national level eliminated many of the previous controls exercised by the a eer bureaucracy, which left the state governments increasingly in controlyof the int Te a particular sates. In examining statistics from the 19908, Abluwalia concluded tha Gujarat clearly pulled ahead of India’s other states ‘The remarkable performance of Gujarat and ‘Maharashtra, both of which grew at over 8 per cent per annum in the 1990s, a rafe normally aisociated with “miracle growth’ economies, deserves careful study. Thése states) jelearly benefited the most in the post- reforms period, but it is important to notéithat/their superior performance was not the result of any conscious policy which limited the benefits of liberalization to these states, ‘as was the case for example in China, Where liberalization initially was deliberately limited to designated coastal zones, Their superior performance must be attributed primarily to the ability‘of these ‘tyo slates to provide an environment most conducive to benefiting from the new policies. Their experience, together with the experience of other strong performers should provide the basis for identifying the critical ingredients of ‘success in accelerating growthzywhich should be emulated by others. a ‘A World Bank publicaiid, in November 2004, provided further support for the analysis of the investment Glimate in each state, quite apart from the analysis of the investment climate for India as a whole. This report pointed out tat per-capita incomes in Maharashtra were more than three times those in Uttar Pradesh, However, the post-2000 years seem to have witnessed some significant changes in the relative attractiveneSs of India’s states. In 2000, for example, Maharashtra received 46 per cent of the FDI flows into India, but in'2003" iC eceived only 11 per cent ofthe FDI flows into India. In 2000, Delhi received 31 of the FD! flows into India, but in 2003, this figure ha fallen to 23 per cent 4 ‘THE WAY AHEAD Sinc 191, India had reduced its tariff and quotas and its restrictions on foreign investment, and had {achieved |some improvements in regulations. However, the world’s investment paradigm had also Changed since 1991. Businesses had become footloose in their location decisions, able to choose among a ‘growing number of increasingly attractive potential investment locations throughout the world. Even © “F tmorana te mesnent Cina ends: An IvestmentCinateAsssament Preered by the Word Bank Group Collaboration with the mn of Indian Ind. Washington, DC, 2000, p. 15. m-Sroup in ‘Montek Ahluwalia, vel Performance ur nomic Refo India, Center for i li Research on Economic Development and Policy Reform, Working Paper No. 96, Stanford University, Stanford, CA, March 2001, p. 6 “Tis documents authorized for educator review use ely by RAMANA SHETTY, Aliance Business Schoo Bs lance Business School Bangalore until Sep 202. Copying or posing isan ingame Permisera@hbep hare or 617-7837860 aaa aeeeeenePage 13 gB06m082 Indian-owned busines: ses could i India had improved and au invest in countries other than India. Although the investment climate in remaining political ieee Fis, Tndia's ability to increase investment had been Timited by its With Chive were inevitable. in the context of this new global investment paradigm. ‘Comparisons Exhibit 2 compares China i and India in regard fion. For the period 2000 to 2004, China greatly exceeded India eased o net FDI, GDP growth and inflation. For the PE Chin Se inflows and GDP growth ztes; yet inflaton in a Was substantially lower than inflation in India, except for 2004 Martin Wolf explained what he considered to be the most important differen ‘between China and India ‘that underlay this contrast in economic success. is : He summarized these in terms of significant political and social differences, pointing to weaknesses in each ofthese countries: “These politcal and socal differences explain in large mest the contrasts between the two development strategies. China's growth is ‘based on high savings, ‘massive investment ee infrastructue, universal basic education, rapid ‘pdasmalisation, an increasingly ‘deregulated labour market and an intemationally PE) ‘and competitive economy. India’s pattern of growth has been extraor inarily different « _ ithhas been service-based . - are ings are far lower than in China, 28\is Taestment in infrastructure. India’s Jpudugtriatisation has hardly begun. Literacy 1s lov ail lite education is well developed. ngia’s formal labour market is among the’most ‘ulated in the work. Regulations and relatively high protection against imports continue to restrict ‘competition in the domestic market." @ Martin Wolf, not completely fisic shotChina's future e2onomie growth, pointed to institutional Weaknesses. The rule of law, sas not Uidt-esablished, and so property rights and the protection of were tual property were at isk. Wolf emphasized iar geh of China's investment swent to state-owned, aan rprses, many of which opened inefilen Sa eve result that they could not repay their loans. This crtrhon ereated a severe weakness 10 China's -iuinedal sector, Reliance on foreign investment and the teading role of Hong Kang were indicators lof these weaknesses. Accompanying these weaknesses was the seat China's political system would not be “table for tie next stages of growth. However, the tisk a to a more demoerate;poitical system could Be ingly problematic, In contrast, India did not suffer from these weaknesses, -To achieve higier grctniates, India would have fo substantially increase its internal savings and FDI in Meier to accelerate its economic growth. Nevertheless, for certain activities, India seemed to be inoredsingly attractive, as Nandan ‘Nilekani, chief executive officer (CEO) of Infosys emphasized: ‘The [lobalisation of white-collar services hes become mainstream. This process, which took de sation Gnsform man facturers’ supply chains, is aceleraing as it reaches the ote desktop. India, with its wealth of well-educated English it : 7, peaking young people é fommanding, by sch-world standard, very Tow Wages, is at the hub. “Every coma ___apiring tobe global,” says Mr. Nilekeni, “has to have an India strategy." ‘ BO 2,7 Marin Wott ‘nda end China Part 1: On the Move: Aa Se tte bey : Als lat Toke Diferent oes in Pursuit of Economic “The Remote Future," The Economist, February 24, 2004, pts. qs doaaert autora eda row ue oy by RAMANNA SHETTY, lage Buhess Se :Aanoe Business School Banglore ut Sep 20. Copying ot posting ‘Porrissions@hbsp.harvard.edu or 617.783.7860 ° eae eee ee eer9B06M082 Fae ee ; might be asdefinitive For some foreign investors, the ongoing tensions with Pakistan over Kashish Te et suid to determining factor against investing in India. Nuclear tests by both Go Lived, the possibility of impose economic sanctions in 1998, Although sanctions had been limited and EE ye their reimposition remained. Meanwhile, terrorist attacks in India’s cities, pet Mil Se tisks #6 property Pakistan-India confliets, had the potential fo cause severe business {interruptions as Well a5 Tisks and personnel. For foreign investors, India remained a challenging puzzle.Page 15, ee Exhibit 4 DOING BUSINESS INDICATORS 2005 Indicator india] China7] OECD | __| Average Days required to start a business 71 48a] 219.5 Cost to start a business 2 36 [68 (% of income per capita) » Rigidity of employment @ | @a0 35.8 (100 is most rigid) & Cost of firing (weekly wages) 79 ‘90... 36.1 Time to register property (days) ore | 82 322 Cost to register property Ex) 5 48 (% of property value) ‘Legal rights (10 is most protection) 5 63 Disclosure index (101s most disclosure) [0.7 10 64 “Time to enforoe a contract days) an | 42s | 241 | 226.7 Cost to enforce a contract on |easr [ 5 | 106 (Go of debt value) & % : “Time to go through insolvency (years) 7 z 15 Recovery fale (cents on the dolia}@..| 128 | 315 | 738 eure od ant, mp tress warden EDEVELOPMENTResoucenDargBisness005 seein oe tioe org Exhibit 2 &, INDIA AND.CHINA DEVELOPMENT INDICATORS cS 200] 2001 2002 2003 | 2004 Foreign direct investment)net inflows (Balance of Paymerits} current USS billions) ‘China NA 3e4| 442( aag[ 535/549 India pS 3.6 55 5.6 48 5.3 | GDP growth (annial %) China“ So. = Ba a3 et{ 100] 10.4 India 39 52 44 86 69 Inflation, GDP deflator (annual %) (China 24 2A 06 26 E . 69 _.. |idie) 38 34 42 32 53 ‘| Per Capita Income (USS) China 930| 1000] 1100 1270| 1500 Lindia 450| _460| __470| _—_530| __630 » "Souree: Word Bark Development indicators Database “This documents authorized for educator review use only by RAMANNA SHETTY, Allance Business Schoo! Bangalore unl Se jance Business School Bangalore unt Sep 2021. Copying e posing Permissions@hosp harvard. edu o 617.783.7860 sida