Is India really the “New China”?

In vivid contrast to just a few years ago, when Jim O’Neill, who came up with the BRICs concept, wanted to drop the country from the acronym in favor of Indonesia, India has now emerged as the undisputed queen of the emerging markets.  Along with this development comes a new mantra: “India is the New China.”

But how true is this assertion?  Like everything else related to India, the answer is complicated and equivocal.

Given the stark economic problems in other major emerging markets, India is looking good in comparison.  It has now displaced China to assume the mantle of the world’s fastest-growing major economy.  The stock market is outperforming those in the other BRICS nations.  India also received $7.1 billion in private equity funding for the first half of this year, 38 percent more than the same period in 2014.  In volume terms, the number of deals jumped 62 percent vis-à-vis the corresponding period last year.

The CLSA brokerage and investment banking agency encouragingly reports that:

Our recent meetings with investors in Singapore and Hong Kong reveal that India continues to be a ‘favored’ market among regional investors.  While some investors have reduced India weight, most investors believe in sharp 2HFY16 earnings recovery and focus on the long-term structural positives, retaining their overweight.

And a number of foreign companies have recently shown their faith in India’s prospects by announcing major expansion plans. I’ll have more to say about these in the next issue of Datapoints, but the logic driving all of them was pretty much summed up by a Mumbai-based entrepreneur and investor quoted in the Financial Times: “India is the last billion-person market left.”

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But because the politics of economic reform are much more challenging in New Delhi than in Beijing, India will never be able to replicate China’s meteoric economic rise over the last 30 years.  The past few weeks have offered ample illustration of this statement.

There is no denying that last summer’s hopes that Narendra Modi’s landslide election as prime minister would jump-start a quick economic renaissance have now faded.  The hype overlooked two key points: 1.) The country does not do rapid transformational change; and 2.) the “I” in India stands for “incremental.” 

Mr. Modi can claim that he brought about major changes in the northwestern state of Gujarat where he wielded unchallenged political authority during his long tenure as its chief minister.  The experience earned him accolades from the global business community and engendered a good deal of hubris on his part, such as when he confidently declared following his May 2014 election triumph that “ten years is all that is needed” to modernize the country.

But the dynamics of economic reform play out very differently on the national stage, given the growing fragmentation of the Indian political system.  And Modi has now run headlong into a truth that Montek Singh Alhuwalia, the distinguished economist and policy official, advanced many years ago:   The norm in India is “a halting process of change in which political parties which opposed particular reforms when in opposition actually pushed them forward when in office. The process can be aptly described as creating a strong consensus for weak reforms!”

This is an insight into the reform process that every entrepreneur and investor, not to mention prime minister and Cabinet official, should never cease bearing in mind.  Indeed, the just-concluded summer session of the Indian parliament demonstrated it in spades, as the Congress Party, the main opposition party, stalled progress on two key items on Modi’s economic reform agenda.

The first item is replacing the fragmented system of indirect taxes the central government and the states currently levy at different stages of the supply chain with a nationwide goods and services tax (GST), India’s version of the value-added tax.  The measure would help create a more unified market in India, increase productivity and enable higher GDP growth. UBS bank recently estimated that “The introduction of the GST is a key reform measure that could have immense macro implications for India’s growth potential.”

But consideration of the measure was shut down in the parliament’s upper chamber, which is controlled by the Congress Party and its political allies, even though the party supported the measure when it controlled the central government just a short time ago.  As ironically, Mr. Modi and his political party, the Bharatiya Janata Party (BJP), opposed the legislation when it was then out of power but now lines up foursquare behind it.

The BJP now decries the disruptive tactics employed by Congress though they are the same ones the BJP used when it was in the political wilderness.  Indeed, the feisty Sushma Swaraj, who is currently Mr. Modi’s foreign minister, was a major thorn in the side of the Congress Party when she led the BJP caucus in parliament’s lower house.

Another causality of the partisan bickering was Modi’s effort to simplify the lengthy and legally-convoluted process of acquiring farmland for much-need infrastructure projects and industrial projects.  The prime minister wants to amend the land acquisition act passed by the previous central government two years ago, which is widely judged to have substantially increased project development costs.

Political machinations surround this issue, too.  The BJP cynically supported the 2013 land legislation since it wanted to court India’s vast reservoir of rural voters in the run-up to last year’s parliamentary elections.  Once in office, however, Prime Minister Modi has expended much political capital on revising the legislation but so far to no avail.

I noted in a recent issue of Datapoints that Modi was close to abandoning the effort and this point appears now to have been validated.  Anxious to avoid being tagged as “anti-farmer” in the run-up to important state-level elections in Bihar, Tamil Nadu, West Bengal and Kerala, the prime minister and his BJP colleagues have punted on the issue.  Four months ago, Modi’s finance minister declared that the land reform bill would “determine a very large part of the progress India makes.”  Now he’s taken to encouraging individual state governments to move forward in lieu of action by the central government.

This is a tacit but clear acknowledgement that Modi’s momentum is dissipating.  The prime minister’s Independence Day address on August 15, delivered two days after the parliamentary session ended, said it all: Unlike last year’s speech, which brimmed with confidence and energy, his remarks last week were tepid and defensive.  Reuters quoted an unidentified member of the prime minister’s inner circle as saying that Modi was “upset about failing to further his reforms agenda and decided to ‘keep his head down’ and focus on improving performance.”

The GST reform is not dead, though if enacted in the next year or so it will likely be in a much diluted form that erodes the economic jolt it delivers.  The land reform effort, on the other hand, is in a deep coma.  At a minimum, it will take several years for the politics to line up with meaningful movement on this issue.

The past weeks underscore two key, reinforcing lessons about the politics of economic reform in India: 1.) The election season, and thus the political pandering to certain voter blocs, never ends; and 2.) There is no national consensus on the imperative of economic modernization.

In a report last month Moody’s Analytics pegged India’s true annual growth potential at near 10 percent.  It cautioned however that the “jury is still out on Prime Minister Modi, but the government’s failure to deliver on promised reforms is a major impediment to a broader economic growth momentum in the country.”  This week Moody’s warned that it might need to lower its growth forecast for India:

One main risk to our forecast is that the pace of reforms slows significantly as consensus behind the need for reform weakens once the least controversial aspects of the government’s plan have been implemented.

This analysis is cross-posted on the website of Geoskope, a business intelligence firm focused on key emerging markets, where I serve as chief knowledge officer.

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Connecting the Dots in India’s Business Portrait

The notes and observations below about India’s business climate are cross-posted at the website of Geoskope (geoskope.org), an intelligence company focused on key emerging markets, where I serve as Chief Knowledge Officer.

The following media items caught my attention this week, since they underscore two of Geoskope’s core messages about India: 1.) The country is a exasperating place to do business but also a potentially rewarding one if you are prepared to put in the effort; and 2.) There’s no substitute for getting out and seeing what is happening on the ground in India.

The first truth was expressed in an article in the New Delhi-based Business Standard about the lessons expatriate managers have garnered from their time in India.  It quoted the president of Panasonic India as saying, “One of the things that I have learnt while working in India is the virtue of being patient and having a sense of humility.”  An executive at the Indian subsidiary of Altran, the French technology consulting company, added that though the challenges are bigger than in Europe so are the opportunities: “You always have this feeling that everything is possible.”

Toronto’s Globe and Mail carried a good overview of the export opportunities for Canadian businesses in India.  Among other things, it stressed that patience and persistence were needed in order to capitalize on them.  It quoted the CEO of a Canadian software provider as saying that success requires a long-term commitment and that “Companies have to think in terms of years, not quarters.”

Part of the reason for this, according to Export Development Canada’s chief representative in India, is that the country has a “family-oriented” culture which places high value on personal relationships.  As a result, foreign companies have to spend time in the country to show local players they’re serious, all the more so now that India has once again become an emerging market darling.  The representative emphasized that “This is a hot market and Indian companies have lots of choice.  They are not going to answer your emails.  They are going to want to meet with you three or four times through the year.”

Reinforcing this last point, the Business Standard has a good article about the continuing prominence of family-run companies in India.

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New Delhi’s municipal government reports that per capita income in India’s capital rose 13.5 percent in the April 2014 – March 2015 period and that income levels there are three times higher than the national level.  Economic data issued by Indian government agencies are a bit suspect these days.  But the figures about New Delhi jibe with new projections by Oxford Economics.  According to the consultancy, Delhi will be the fastest-growing urban economy in Asia over the next five years and that overall five Indian cities will occupy places in the top six of the rankings.  All the more reason to focus on the Indian marketplace despite its many challenges.

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The importance of regional differentiation is another core Geoskope theme when it comes to the vast and variegated Indian marketplace.  Hindustan Unilever, the country’s largest fast-moving consumer goods company, has underscored this point by adopting a new strategy aimed at “serving many Indias.”  The approach segments the domestic market into 14 consumer clusters.

On a related note, McKinsey last year issued a good report on “Understanding India’s Economic Geography.”

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Speaking of the sensitivity to on-the-ground conditions in IndiaA Financial Times article about how transplanted Western business models have not fared well in the Indian ecommerce sector quoted Shailendra Singh, India managing director for US-based venture group Sequoia, as saying:

In India, clone businesses tend not to work well. What India needs are mutants, meaning businesses with the same underlying DNA as those that have worked elsewhere but which come with extra powers and abilities, or entirely new species suited to local conditions.

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Acquiring land in an efficient manner and at a reasonable cost has long been a huge challenge for many foreign companies with India ambitions, as IKEA’s on-going experience demonstrates.  A Forbes article on the problems dogging the Swedish retailer’s big plans for the Indian market quotes an executive: “Buying land has proved to be more difficult than we initially predicted…” The company has been forced to bring on more people in order to focus on complex real estate issues.  As things stand, IKEA believes it will take another two years before it can open its first store in the country.

Reform of the land acquisition process is key to Prime Minister Narendra Modi’s grand plans to resolve India’s vast infrastructure challenges and make the country into a global manufacturing powerhouse.  But his land reform legislation has stalled in parliament and in a recent media interview he seemed to signal he was done expending political capital on the issue: “This is not a matter of life or death for me. And neither was it the agenda of my party or the government. The initiative was in response to a demand from the states, and being a federal structure it was my duty to respond.”

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Another bane to Modi’s “Make in India” manufacturing initiative is New Delhi’s infamous red tape.  For years, surveys of business people rated India as having the worst bureaucracy in Asia and the World Bank’s Ease of Doing Business index ranked India this year at 142 out of 189 countries.  (For a more amusing perspective, see here.)  Modi has taken some steps to improve things and says he wants to do more.  But then the Indian commerce minister reports that 25 government ministries have their hands in “Make in India” policymaking.  Good luck with that.

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Speaking of choking red tape….

India is in a start-up frenzy.  Innovation guru Vivek Wadhwa wrote recently that “India is about to experience an entrepreneurship boom that will make America’s dot-com boom seem lame.”  And Indrajit Gupta, founding editor of Forbes India and a good friend of Geoskope, writes about the remarkable growth of entrepreneurship among India’s young people.

But here’s the bad news: Indian tech startup are moving overseas, mainly to Singapore and the United States, due to concerns about domestic regulatory burdens.  The Hindu newspaper quotes a Facebook executive as saying that the $22 billion acquisition of WhatsApp, the instant messaging firm, in the US was easier to do than last year’s $10 million purchase of an Indian software startup.  The executive explained that “the red tape and ambiguity in Indian rules and taxes were overbearing.”

The Indian government is moving to ease these encumbrances, but according to the Wall Street Journal “Indian startups might still prefer listing in the U.S. as investors there seem to appreciate the growth prospects of online businesses and are less concerned about present profitability.”  And even with the regulatory changes, Singapore-based firms like Flipkart, which is one of India’s hottest e-commerce companies, might not find it worth their trouble to engage domestic capital markets.

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Still, the Modi government must be getting some things rightFDI inflows into India jumped 22 percent in 2014, for a total of $34 billion, even as global FDI flows fell 16 percent.  The increase meant that India placed ninth among FDI-attracting countries last year, as opposed to 15th in 2013.  The United Nations Conference on Trade and Development, which compiled the data, believes that “FDI inflows are likely to maintain an upward trend in 2015” in the country.

Bloomberg also reports that 350 private equity transactions, worth $12.69 billion, have taken place in India so far this year, as opposed to 315 deals amounting to $10.39 billion in all of 2014.

And India comes out on top of this year’s Baseline Profitability Index, which measures the relative attractiveness of 110 countries and territories when it comes to foreign investment.  The index’s compiler attributes the result to a combination of favorable growth forecasts, perceptions of decreased government corruption and better investment protections following Mr. Modi’s election as prime minister.

Finally, according to a JP Morgan survey, India is the most attractive of the BRIC markets for North American investment professionals.  A bank executive adds that “The prospects of long-term economic growth, favorable demographics, BJP’s reform agenda, numerous investment opportunities and a democratic legal system have been cited as the most attractive factors for investing in India.”
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Repentant “Tax Terrorists” and Other Signs of Change in New Delhi

From senior government officials working longer hours and cutting back on their golf game, to the emphasis on Hindi in official documents, there are plenty of signs that a new order is descending on Delhi.  But perhaps the most poignant so far is the way Pranab K. Mukherjee, currently the president of India, has been forced into a public renunciation of the very tax policies he pursued just two years ago when he was finance minister.

The most significant consequence of the horrific November 2008 terrorist assault in Mumbai was actually self-inflicted.  The talented Palaniappan Chidambaram was shifted out of the finance ministry in order to whip the feckless home ministry into shape.  Mukherjee was appointed to fill the resulting vacancy, reprising an entirely unmemorable stint as finance minister in the early 1980s.  Significantly, while Chidambaram was an enthusiastic champion of the key economic reforms of the early 1990s when he was serving as commerce minister, Mukherjee was virtually invisible despite then heading up the Planning Commission, a key economic planning agency.

His second stint at the finance ministry, from early 2009 to mid-2012, was nothing short of disastrous.  He remained complacent as the global economic meltdown started to weigh in on India, preferring to emphasize expensive social welfare projects instead of productivity-enhancing structural reforms.  The budget he formulated in early 2011 was bereft of any serious commitment to rein in profligate spending and was laced with roseate assumptions that were quickly proved unfounded.  And the following year’s budget was so out of touch that a distinguished observer noted it was “shocking that a finance minister can ignore all the problems that he faces.”

Mukherjee’s tenure ended when he was kicked upstairs to the Indian presidency, the largely ceremonial head-of-state post.  By then India, hailed as the next China just a few years earlier, was being called the “first BRIC fallen angel,” the “Greece of Asia” and a “gasping elephant.”  The global ratings agency Standard & Poors was threatening to downgrade the country’s sovereign debt credit rating.  The announcement that economic growth in the first quarter of 2012 had declined to 5.3 percent, from over 8 percent just over a year earlier was so shocking that headlines in the Economic Times screamed “Goodbye 2020, Hello 1991!”  A Congress Party leader was even quoted as saying that “We have to rescue the economy from the ravages of Pranab Mukherjee.”

Most damagingly was the wrecking ball Mukherjee took to India’s reputation among global investors.  Searching for ways to pay for costly social spending, he devised exasperating tax policies directed at foreign companies doing business in India – this at the very moment when India should have been pulling out the stops to attract more overseas investment.  The most egregious case in point concerns Vodafone, the London-based telecommunications company, which in 2007 spent $11 billion to buy from a Hong Kong conglomerate majority ownership of what is now the second-largest telecommunications company in India.

Vodafone was subsequently hit with a $2.2 billion tax bill on its purchase.  The company resisted, arguing that the transaction was executed by offshore vehicles of the two principals and that in any case Vodafone was not the seller of the assets and so could not possibly be liable for a capital-gains tax.   After an extensive legal battle, the Indian supreme court in early 2012 agreed and reproached the government for overreaching its authority.

Having thus failed to prevail in the courts, Mukherjee attempted to re-write the law by proposing a retroactive tax on capital gains arising from cross-border purchases of Indian assets dating back 50 years, a piece of legislation that only furthered India’s reputation as an inhospitable investment destination.  According to Sanjaya Baru’s new book, Mukherjee gave Prime Minister Singh just one day’s notice that he was going to introduce the legislation.  The proposal provoked seven business associations from the US, the UK, Canada, Japan and Hong Kong to write a joint letter to Singh, warning that it “has called into question the very rule of law.”

The concept of retroactive taxation also drew criticism from the BJP, which labeled it “tax terrorism” in its recent election manifesto.   In its first official policy statement, Prime Minister Narendra Modi’s new government pledged to re-work the current tax regime so that it’s “non-adversarial and conducive to investment, enterprise and growth.”  It also promised to “create a policy environment which is predictable, transparent and fair.”

The irony is that this repudiation of the way Mukherjee approached things while at the finance ministry was issued not by Modi but by Mukherjee, who was discharging the traditional duty of the Indian president in outlining a new government’s agenda to a joint session of Parliament.  It’s an irony that many commentators overlooked, though it has much more import for the country’s prospects than the numerous stories in the press these days about miffed ministers and inconvenienced babus.

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Modi’s Economic Agenda: Encumbrances Ahead but an Opportunity Looms

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As the hoopla about Prime Minister Modi’s blow-out electoral ​triumph dies down, the constraints on his policy agenda are becoming clearer.  One of these is that the need to combat chronic inflation means ​the continuation of ​tight monetary policies at least for the foreseeable future.  Another is that rival political parties still ​control the upper house of parliament, which ​for now ​will have the power to disrupt important parts of Modi’s legislative agenda.  A third is that these parties also control most of India’s ​state governments, which have immense discretion over the major infrastructure projects he wants to accelerate.

​A key development in Modi’s favor, however, is the emergence of a large bloc of states in the northern and western parts of the country governed by administrations now looking to emulate the very​ economic model he crafted in Gujarat.  These states would do well to copy the reforms he enacted in the electricity sector, labor market regulation, and land clearances for industrial projects.

(UPDATE, June 10: The BJP government in Rajasthan is preparing legislation to enact critical labor market reforms.)

The emergence of a “Saffron economic bloc” of state governments would be a powerful force offsetting the other elements of the Indian system that will act to stymie the impatient Mr. Modi.  Its success also would have a potent demonstration effect for the rest of the country.​

Read the entire article at Fair Observer here.

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Time for Some Realism in U.S.-India Relations

In a piece on Foreign Policy’s website the other week, Tim Roemer, the immediate past U.S. ambassador in New Delhi, urged Washington officials to pay closer attention to India as a geopolitical and economic partner.  In his view, the country needs to be at the center of the U.S. strategic pivot to Asia and both capitals must, among other things, start work on a free trade agreement.  India’s success, Roemer emphasizes, is “a linchpin in America’s success in the 21st century.”

Roemer’s bottom line is correct but it’s still an odd exhortation to make given the recent visits to New Delhi by senior Obama administration officials – Secretary of State John F. Kerry last June and Vice President Joe Biden a month later – as well as the September summit meeting between President Obama and Prime Minister Manmohan Singh in Washington.  Strange, too, in light of the Obama administration’s efforts to craft a long-term strategic partnership, one that features greater Indian access to the latest U.S. military technology and a defense trade relationship that goes beyond a focus on one-off transactions to include joint research and co-production efforts. Indeed, this proposal was conveyed by then-Defense Secretary Leon E. Panetta during a trip to New Delhi in June 2012, during which he made clear that Washington sees India as a “linchpin” in the pivot strategy.  Mr. Kerry also used similar language during his own visit.

It’s true that the Obama administration in its first year displayed little interest in pursuing high-level engagement with India, a development abraded sensitivities in New Delhi, where elites had grown accustomed to the pride of place their country enjoyed in America’s strategic calculus during the George W. Bush years.  But since then, the Obama team has harkened back to the Bush administration’s emphasis of building up India’s strategic potential as a check against the rise of Chinese power.

So, the problem now is not U.S. indifference but Indian ambivalence. Continue reading