Learning from China in wooing foreign investors

Durgadas Roy, The Statesman, Asia News Network, Calcutta

One of the most long-standing and widely accepted criticisms of successive governments and economic policymakers has been their failure to attract adequate amounts of foreign direct investment into the Indian economy.

Compared to most industrialized, developed economies, India followed a fairly restrictive foreign private investment policy till 1991, relying more on bilateral and multilateral loans with long maturity. The scenario changed after 1991, with the then finance minister, Manmohan Singh, opening the gates to liberalization. Foreign investment is now seen as a source of scarce capital and technology and managerial skills considered necessary in an open and competitive world economy.

So, why has India received in the last few years of economic liberalization only a fraction of the foreign investment that China gets in a single year? Progressively, India's policy on allowing the entry of foreign investment too has been liberalized, but if foreign investment is still chary of coming to India, we have to look beyond polices on paper to institutional weaknesses.

In 1991, approval of foreign direct investment proposals by the government was to the tune of US$2.2 billion, actual inflows being 65.8 percent of the amount. The momentum of both approvals and inflows reached a peak in 1997. However, after 1998, when the BJP-led coalition took over the reins of governance, the approval-inflow ratio shot up. The ratio went up from an average of 23.5 percent for the previous six years to 43.3 percent in 1998 and to 59.5 percent in 1999. For the first quarter of 2000, the ratio had risen to 93.1 percent.

A joint technical monitoring group of the Reserve Bank and Union ministry of industry has been preparing an estimation of FDI in India, using methodology that is universally recommended by the International Monitory Fund. According the working group, the estimates of FDI for the years 2000-2001, 2001-2002 and 2002- 2003 were $2.34 billion, $3.90 billion and $2.57 billion respectively. The new International Finance Corporation norms- based method led to much more impressive figures of $4.03 billion, $6.13 billion and $4.67 billion.

The UN World Investment Report 2003 stresses that there is very close linkage between direct investment and domestic policy. Both the nature and the amounts of FDI inflows get decided by the way in which a host economy is run. This is especially important now as developed economies are eager to invest in developing countries where they are likely to get higher return than in their domestic markets.

Recipients should, therefore, install proper institutional structures and cultivate competitive openness. India still has a long way to go in respect of openness -- its tariff barriers are way too high -- and that is clearly stated by the UN report. In China, by the year 2000, FDI accounted for 91 percent of exports of electronic circuits and 96 percent of mobile phones. Needless to say, FDI played a major role in exports.

In India, however, only 10 percent of manufactured exports is based on FDI. The figure will change for the better only if India becomes more open and competitive. The silver lining is that India is still perceived by the WIR 2003 team to possess an advantage (over China) in sectors like information technology, thanks to its English language skills and technical manpower.

Yet, the relative attractive forces of India and China will not change unless there is an effort at institutional change. The focus here naturally shifts to import competition and exports.

Apart from restrictive sectoral polices, the government discourages foreign investment through polices that seek to protect the domestic capital from competition. The restriction on an existing foreign partner setting up a new wholly owned company without the consent of the domestic partner of the ongoing venture and suspension of foreign acquisition and mergers, etc. deter investment.

However, the single largest failing must be recognized as poor governance that routinely places India in the topmost position in international rankings for corruption and at the bottom in rankings for competitiveness. This comes from political failure to transform the institutions of society into ones that allow a modern economy to emerge and function.

Though the actual FDI inflow in India in the 1990s increase significantly, it pales into insignificance in comparison to China. UNCTAD's ranking of countries in terms of foreign investment (relative to the size of economy) for the period 1998- 2000 is 119 for India and 47 for China. The ranking a decade ago was 121 and 61 respectively.

It shows that even at the start of the reforms, China's ranking was way ahead of India's and that China moved up the ladder much faster than India did in the 1990s. India's relatively poor performance can be explained thus: While China created an institutional mechanism that has overplayed the role of FDI, India created an institutional mechanism which underplayed FDI for achieving economic growth.

India's democracy generated an institutional mechanism of powerful vested interest groups who block FDI even in those areas where it can contribute significantly to achieving higher economic growth.

Consequently, the major part of a much smaller amount of FDI in India had been in the infrastructure sector, including such areas as telecommunications, and the power and fuels and services sectors such as software rather in manufacturing.

It is well documented in the literature of the Indian economy that industrial licensing and other government polices facilitated a few incumbent industrial houses, politicians and bureaucrats to reap huge harvests. This mechanism not only took away consumer surplus but also channeled a large part of savings into these hands.

What is needed is a strategic view of foreign investment as a means of enhancing domestic production and technological capability and also to access the external market for labor intensive manufactures.

This is what China has done. It would thus be better if the government focussed on aspects that the WIR 2003 identifies as key areas: A better FDI policy framework, faster market growth, higher consumer purchasing power, labor law reforms and an improvement in the tax regime.

The writer is Emeritus Fellow, University Grant Commission.