The Hindu Business Line : Why China wins the FDI race

MUCH hope is being placed on the Investment Commission — the newly approved foreign direct investment promotion body — and reforms in the telecommunications and insurance sectors to enhance FDI flows into the country. As per the FDI Confidence Index Survey 2004 of AT Kearney, a global management consulting firm, India is ranked third, next only to China and the US (up from the sixth position in 2003). This is despite FDI being below the Plan target and merely a tenth of what China received in 2003.

Why is China such an attractive FDI destination? Are its FDI policies much more liberal than India's, or its macroeconomic developments so very good? The macroeconomic parameters — the springboards for the FDI — of both the countries are almost at par. Amidst a global recession, both are logging high GDP growth rates. And both have huge domestic markets that are growing rapidly, thanks to a large middle class. Hence, in terms of economic potential, both China and India should be equally attractive to foreign investors.

Further, compared to India, China's FDI policy is more restrictive. Its legal system is weak, and its managerial/entrepreneurial capabilities not very different from India's. There is also the language barrier. And the absence of intellectual proprietary rights lends little protection to patents and brands.

China does not allow 100 per cent foreign investment in nearly a hundred industry segments, including such major areas as passenger cars, motorcycles, engine manufacturing and air-conditioners — the growth catalysts for a number of economies.

Similarly, in the consumer durables sector, FDI is restricted in the colour TV, picture tube and video recorders segments. In telecommunication, FDI is restricted to 25 per cent and 35 per cent, respectively, in basic and mobile telephony.

In contrast, in India, only in the small-scale sector and 22 sensitive industries are there FDI restrictions. Unlike in China, almost the entire manufacturing sector has been opened up to FDI. In telecommunications, foreign equity of 49 per cent is permitted.

China also does not have any automatic approval system for FDI. Foreign investments are subject to project-by-project approval by the government. In contrast, the entire commercial manufacturing sector in India, barring the small-scale segment, comes under the automatic approval route. Despite this, in 2003, China emerged the second largest FDI recipient, drawing in $53 billion compared to a paltry $4.3 billion by India.

It is a wrong to say that the low FDI into India is because of the country's restrictive policies vis-à-vis China's. But why then is India lagging far behind?

The main reason is the bureaucratic tangle. Though China has more approval procedures, it takes nearly double the time to start a business in India. According to the World Bank survey `Doing Business in 2004', while in China there are 12 procedures to start a business compared to India's 10, the time taken to start a business is 46 days against India's 88. For enforcing a contract, it takes 365 days in India compared to 180 in China.

Infrastructure is another area where China has the edge. While the per capita consumption of power is thrice that of India's, the cost of power is only half. The labour laws there are not that stringent. As per the World Bank report, the flexibility to retrench labour is higher; measured in terms of `firing index', it is 57 in China and 45 in India.

Cheap labour apart, the simple labour laws in China help enhance productivity. There are only 107 articles in the labour laws, each just one paragraph long. On the other hand, in India, there are more than 30 laws directly or indirectly related to labour regulations.

Tax incentive is another important aspect where China scores. It gives multiple tax benefits to foreign investors to upgrade technology and push up exports. Corporate tax is 33 per cent, compared to 36.6 per cent in India. China offers a two-year tax holiday from the year foreign investors make profits and 50 per cent tax concession three years thereafter. Also, for a further period of three years, 50 per cent tax concession is given for transfer of advanced technology. For export units, tax benefits are given if 70 per cent of the production is exported. Besides, indirect tax sops are given by way of exemption from value-added tax for transferring advanced technology.

In contrast, in India, foreign and domestic investments are treated on a par, perhaps fearing that industrialists would protest the lack of a level field. The policymakers are still under the belief that cheap labour, natural resources and a large domestic market are enough to attract FDI. For transfer of technology, foreign investors would want a better investment environment, catalysed by improved infrastructure, less bureaucracy and special incentives.

One of the key factors that favoured China as an FDI destination was the emerging need for "relocation of manufacturing operations" by multinationals to improve cost competitiveness. Even developed economies have become cost conscious because of the prolonged recessionary spell. Foreign companies invest in China, produce goods at lower costs and re-export to their own countries to counter the growing price competition in their domestic markets.

Investments made in China came to the rescue of the Japanese economy, which was reeling under recession for a decade. China became Japan's major trading partner in 2002, surpassing the US. The steady growth in Japan's trade with China was because of the buoyancy in demand for goods made in China by Japanese affiliates.

The FDI trend in the world is changing, from greenfield ventures to M&A (mergers and acquisitions). And with the focus turning to the services sector, especially IT, there is a big opportunity for India to attract FDI. Nearly half of the country's growth is driven by the services sector, which needs huge investments to raise itself to global standards.

Domestic resources, private or public, are not enough to meet this investment demand. Already, telecommunications and computer software have become the main sectors for FDI in the country. In 2003, about a fourth of the FDI approved was in these segments.

Thus, in these circumstances, it is imperative to have a re-look at the country's FDI promotion policy. It should not be confined to ah hoc policy changes and setting up new promotional bodies which are not vested with enough powers.

What is required is a comprehensive policy package and a single window clearance system. This would help foreign investors avoid the rigours of obtaining the various clearances.

(The author is a senior researcher in a New Delhi-based Japanese multinational firm.)

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