FDI and the ordinary Indian

Analysts of certain proclivities are making much of the fact that India is one of the world’s fastest growing economies, even though this statement reflects a deeply misleading picture of the business climate. This inclination to conflate comparative statistics and indices with notions of prosperity is risky because it can distort policy prescriptions.

For instance, the now defunct Ease of Doing Business (EoDB) ranking suggested that success in attracting global capital lay in fulfilling some hard metrics. But there are a host of other issues that global indices don’t capture but also go into creating a healthy business climate. The EoDB itself offers compelling proof: Despite the focused curating by the Modi government that saw India power up the rankings from 142 in 2014 to 63 in 2020, the pre-Covid-19 legacies of high unemployment and stalling growth persist.

The annual EoDB rankings made good media headline copy, one reason four authoritarian regimes of China, Azerbaijan, Saudi Arabia and the UAE sought to manipulate data (which is why the World Bank scrapped the exercise). But investors actually looking to spend hard dollars rarely gave it much credence. That would explain why China ranked second in terms of foreign direct investment (FDI) in 2021, according to UNCTAD’s World Investment Report despite an EoDB ranking of 31 in 2019. India, at EoDB rank 63, ranked seventh in the FDI stakes but was the only country to record a drop in inflows in 2021 (inevitable perhaps, since 2020 saw massive jump on account of Google and Facebook’s investment in Reliance’s Jio Platforms subsidiary).

So what, really, do foreign direct investors look for? The old EoDB parameters such as “dealing with construction permits” or “starting a business” do matter. But they present a partial picture because they reflect the views of larger corporations. To get an idea of what doing business is really like in India, global investors should talk to owners of small and medium businesses (SMEs), which used to account for 40 per cent of employment.

These enterprises work at the coalface of local bureaucratic systems. They are unlikely to share the same perceptions as big companies with the financial wherewithal to deal with the myriad permits and licences that are still needed to set up a business in India. In the absence of streamlined institutions, SME owners have to rely on their local “contacts” and, often local toughs, to sort through these issues. No surprise, the costs of getting electricity connections and sundry permits are immeasurably higher for them than for big corporations with access to powerful politicians and bureaucrats. No surprise, too, that all the Unicorns that India fetes are in the IT sector where local licence-permit regimes are relatively less oppressive.

Improvements in an EoDB metric such as “resolving insolvency” — which pulled India up the rankings with the introduction of the Insolvency and Bankruptcy Code — are meaningless for SMEs. Lacking the ability to access the Insolvency and Bankruptcy Code processes, most SMEs simply shut shop in their thousands as they did in 2016, 2017 and 2020 when, respectively, demonetisation struck and the Goods and Service Tax system was introduced on a crashed deadline and the country was abruptly locked down for Covid-19.

If India does not work smoothly for SMEs, it is unlikely to function optimally for large global corporations either. But few political regimes pay much attention to EoDB policies for this sector because the exercise is unlikely to yield prominent headlines nor do SMEs offer the kind of political contributions to sustain political parties.

The Modi government has a realistic appreciation of the inherent defects in India’s business environment and has responded by creating exceptional policy provisions to attract foreign investment via the signature production-linked incentive scheme (PLI). Since PLI enterprises are relatively new, it is unclear whether they’ll work. But one thing is becoming clear: These incentives are unlikely to be short-term in nature since India will have to constantly compete with rivals in the global investment race, such as Vietnam and Indonesia.

The experience with backward-area investment incentives offers an example of the limits of addressing weaknesses in the business climate with compensatory policies. As soon as the sunset clauses kicked in, the companies in these areas vanished too. Given Southeast Asia’s long experience with FDI, competing on compensatory policies could amount to a zero-sum game. Import substitution, which also lies at the heart of PLI schemes, also proved a failure in the seventies and eighties.  

The experience of both China and the Asian Tigers, in fact, point to a basic truth. For India to work as a dynamic global investment destination, it must work for its ordinary people — the small scale entrepreneur, the woman who aspires to economic independence by working in, say, a car or electronics factory, the ordinary citizen who seeks a secure life with access to basic education and healthcare. Foreign direct investment can propel these processes but only if governments work towards them too.