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Why are foreign investors leaving?

AARATI KRISHNAN | Updated on November 07, 2014 Published on November 07, 2014

Time to leave Since nothing seems to work maradonna 8888/shutterstock.com

Instead of wrangling over FDI limits in new sectors, we need to see which Indian markets will work for them

Keen about convincing global investors that India isn’t a lost cause for FDI (foreign direct investment), the Government has been at pains to reassure them in the ongoing India Economic Summit. So you have the Finance Minister dutifully mentioning all the hot button issues that are said to vex foreign investors: retrospective taxation, land acquisition laws, mining rights, labour reforms.

But will this lead to an FDI surge? Don’t be too sure.

In recent years, there have been a number of marquee global names who have either reviewed their India plans or have scaled down their operations here: Nokia, Posco, ArcelorMittal in manufacturing, Fidelity, AIG, ING, New York Life in financial services, Walmart and Carrefour in retail.

Studying these cases suggests that when a foreign firm decides to pack up and leave the country, it is seldom because of a single pain point. Some serious research into each case is essential for the Centre to gain a better insight into what really drives FDI decisions.

Tax terrorism, really?

Take the case of Nokia, which recently shuttered its mobile phone manufacturing unit near Chennai, at one time one of its largest facilities worldwide. The reason most often cited for this is the unresolved tax dispute with Indian authorities.

In 2013, the Central Board of Direct Taxes (CBDT) raised a tax demand on this unit for not deducting tax on the royalty payments it made to its Finnish parent for software used in mobile handsets. The issue went into litigation and by the time Nokia’s parent had inked a deal to sell the business to Microsoft, the disputed amount of ₹3,000 crore had inexplicably swelled to ₹21,000 crore. With the CBDT freezing the unit’s assets, it was left out of the deal and Nokia finally decided to mothball it this week.

The tax authorities have certainly not acquitted themselves well in this case. It is difficult to explain why they waited for seven years after the unit commenced or why they raised such an exorbitant demand. But if this seems like a straightforward case of ‘tax terrorism’ bringing a global firm to its knees, there were other factors at play too.

For one, when it got embroiled in the tax dispute, Nokia was already losing market share in the Indian market, with the new breed of smartphones replacing its old-world feature phones. The Chennai facility mainly manufactured older feature phones. Two, given the shortage of skilled labour and infrastructure for full-fledged handset manufacture, Nokia’s Chennai unit functioned mainly as an assembly line for imported components, using plentiful low-cost labour. The question is whether the depreciating rupee and rising labour costs in India were also key factors that prompted Nokia to reconsider this investment.

Therefore, to really prevent a repeat of the Nokia episode, policymakers need to know what primarily drove the handset maker’s decision to quit India. Was the tax demand just the last straw for a facility that was already losing its competitive edge? Though the Vodafone tax case is frequently cited as damning evidence of India’s whimsical tax regime, let’s not forget that Vodafone is still present and thriving in India. Maybe the question we need to ask is why Vodafone is still so bullish on India despite being the object of ‘tax terrorism’.

Red tape or market conditions?

If it is tax tangles that are oft cited reasons for multinationals to quit India, global metal majors such as Posco, ArcelorMittal and the Vedanta group are said to have shelved some of their large projects because of red tape, land acquisition delays and non-availability of mines.

In July 2013, South Korean steel major POSCO made headlines after it decided to scrap its 6 million tonne steel plant in Karnataka, citing “market conditions and significant delays in acquiring land”. This project had been flagged off just three years before, in June 2010, at the Karnataka government’s Global Investor Meet.

This pullout, along with ArcelorMittal’s announcement two days later that it too was reviewing its Odisha steel project, attracted the usual criticism about how red tapism and policy uncertainties were forcing big investors to flee the country. Yet, POSCO has persisted with its (other) 12 million tonne Odisha steel project for 10 years now, despite very similar hurdles. Only last week, its chairman categorically stated that they “would never quit the project”.

Therefore, it is difficult to say if it was red tape that really prompted POSCO to shelve its Karnataka plant. There is a good possibility that the global steel glut, domestic slowdown and over-supply in the domestic steel market had an equal role to play in the decision.

FDI limits don’t matter

But if policymakers need to stop taking public statements at face value, they also need to change their attitude to FDI.

A number of global firms across sectors have decided to call it quits in India. Yet, regulators persist with the belief that all India needs to do to attract a flood of foreign capital, is to open up more sectors to FDI.

In fact, FDI relaxations often seem to be made with some sort of social objective in mind. So if India needs a supply of affordable homes and if its realty companies are neck-deep in debt, FDI in construction is promptly allowed to sort out this problem. If insurance penetration is abysmal and most insurers are loss-making, lo, we open it up to more FDI. If domestic airlines are burning up cash at a furious pace, foreign ones are expected to swoop in and rescue them.

But you can be sure that foreign investors who are looking to invest in India don’t share this charitable perspective. If they’re considering India at all, they’re doing it for hard business reasons. Therefore, while Indian policymakers may be keen to promote FDI in sectors which are loss-making and perpetually hungry for capital, foreign investors may not be enamoured of investing in these at all.

This could be why Indian financial services have seen an exodus of global players. The mutual fund industry, despite allowing 100 per cent FDI, has seen Fidelity, Merrill Lynch, AIG, Temasek, Standard Chartered and a string of other foreign players exit. The insurance industry, despite a pending bill in Parliament to hike FDI limits, has seen New York Life, Aviva, Aegon and several others throw in the towel.

Maybe what India needs to attract FDI is a completely different mindset. Instead of wrangling over which new sector needs higher FDI limits, why not ask prospective investors first about where they see the most opportunity? This initiative, combined with all-out efforts to retain global majors already in India, may be all the advertisement India needs to become the global hotspot for foreign investors.

Published on November 07, 2014
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