The Hindu Business Line : Budget low on FDI initiative

Growth in FDI has been catalysed by the general spurt in the economy and not by special measures in the Budget. The Finance Minister should ponder over fiscal incentives to woo foreign investors.

Foreign direct investment (FDI) is integral to the growth of the economy. Its share in the gross capital formation has grown from an annual average of 1.9 per cent during the 1985-1995 decade to 3.4 per cent in 2004.

Simultaneously, FDI stock in GDP rose from 0.5 per cent in 1990 to 5.9 per cent in 2004. Even so, the Budget has not focussed on the FDI sector with special incentives.

While the Finance Minister, Mr P. Chidambaram, has always emphasised on FDI in his Budgets, he has never accorded any special fiscal initiatives to promote it.

The FDI initiative has been characterised only by the unbundling of restricted policy and procedures. In contrast, India's neighbour, China, has showered fiscal incentives, besides providing a liberal regime for investment.

THE CHINA CONTRAST

In China, special income-tax incentives are accorded to foreign investors in special economic zones (SEZs) for manufacturing hi-tech products and investing in Research and Development.

In India, no income-tax incentive is available, except in SEZs. In China, foreign investors who adopt advanced technology enjoy a two-year tax holiday and are allowed 50 per cent tax exemption for the next six years. No such incentive is available to foreign investors in India.

In China, foreign investors ploughing back their profits after operating for five years are entitled to 40 per cent refund of the tax already paid on the reinvested amount. Not so in India.

On indirect taxes too, China grants a number of incentives. Technology transfer and technology development by foreign investors are exempt from value added tax (VAT).

Equipment imported for projects in the priority sector are exempt from tariff and import stage VAT.

But with the Budget doing little on this front, foreign investors appear to have been given the short shrift vis-à-vis the domestic enterprises.

THE INDIA ATTRACTION

The economy is booming and this has caught the fancy of the MNCs. The growth this year was driven by the manufacturing sector, unlike in the previous years when agriculture was the prime mover for growth.

Goldman Sach's Dreaming with BRIC: Path to 2050 predicted that India will be the third biggest economy by 2050.

Even more surprising, it predicted that the country would surpass Japan's GDP by 2032.

Countries, earlier lukewarm towards India, are now considering it an alternative to China. In the words of a Taiwanese Parliamentary delegation, which visited India for the first time in February last year, "It is in Taiwan's strategic interests to promote India as an alternative investment centre to China." India has a tenuous relation with Taiwan, which is the fourth biggest investor in China.

TOP FOREIGN INVESTORS

Undoubtedly, India has emerged a hot destination. The total foreign investment, including portfolio investment, rose from $6 billion in 2002-03 to $14 billion in 2004-05. Of the total FDI inflow during August 1991-2004, 57 per cent was invested in 2000-2004; the period that coincides with the sparkling economic growth.

In 2005, between January and November, FDI was $4 billion, excluding reinvested earnings and other capital.

This growth in FDI was catalysed by the general growth in the economy, and not by special measures in the Budget.

MAJOR INVESTORS

The major countries investing in India are Mauritius, the US, Japan, the UK and the Netherlands. During the pick-up period — 2000 to 2004 — the investment from these five countries accounted for over 66 per cent. Mauritius accounted for the biggest share of these investments.

However, the investment was not by locals, but by American and British subsidiaries looking to reap the special tax benefits under the Indo-Mauritius Tax Avoidance Treaty.

A feature of these major countries is that they have specialised areas of investment. Investors from Mauritius invest predominantly in telecommunications, electrical equipment and fuel sector (oil and power). In 2000-2004, about 83 per cent of FDI in telecom, 57 per cent in fuel sector and 31 per cent in electrical equipment came from Mauritius. From the US, investments flowed largely into the areas of electrical equipment mainly (computer and software), the service sector, transportation and consultancy services.

Of the total FDI flows into the electrical equipment segment in the country in 2000-2004, American investment accounted for 23 per cent or the second largest. Overall, the US is the major investor in electrical equipment since the major investors from Mauritius are Americans.

Nearly 45 per cent of the total FDI in the automobile sector came from Japan. Of the total FDI flow from Japan in 2000-2004, 64 per cent was in this sector.

The Netherlands emerged a major investor in India. It was the third biggest investor during 2000-2004. The chunk of the investment was made in electrical equipment and chemical sectors.

LESSONS FOR POLICYMAKERS

The UK was the fifth biggest investor during 2000-2004. British investors were attracted to areas of fuel (power and oil) and electrical equipment. They accounted for about 17 per cent of the total FDI flow in fuel during 2000-2004.

Investments from the UK accounted for about 10 per cent of the total FDI in this sector during 2000-2004.

These patterns of FDI flows provide enough lessons to policy-makers on how to tap foreign investments. India has several factors working in its favour vis-à-vis China.

The former has proved to be a true democracy and is home to the largest English speaking population with proven technological and managerial skills. . Yet, China has emerged the biggest investment destination in Asia.

Should the Finance Minister woo foreign investors with special fiscal incentives? China too has high domestic saving ratio (40 per cent) which is prudent for investment. But it is a more attractive destination, offering large doses of special fiscal incentives and cheap labour with flexible laws.

(This author is senior researcher in a Japanese MNC in New Delhi.)

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