If Indians Aren’t Investing in India, Will Foreigners?

This article appeared on Economic Times (India) on September 21, 2014.

Narendra Modi came to power by promising fast economic growth to create millions of jobs. So, its mysterious that he has spent so much time on foreign visits and receiving foreign dignitaries like Chinese president Xi Jinping. Foreign relations matter, but cannot create millions of jobs — that requires structural reforms that dynamise Indian investment. Till now, industrial data does not reveal any investment boom. If Indians are not rushing to invest in India, will foreigners really do so?

Based on Chinese briefings, newspaper reports claimed that Xi would pledge $100 billion of Chinese investment in India. Actually only $20 billion of deals were signed; the rest was apparently hype.

Besides, only a tiny proportion of proposals translate into actual investment. ‘The Economic Freedom of the States of India, an annual report of the Friedrich Naumann Institute and Cato Institute, shows that of industrial memoranda of understanding signed by entrepreneurs in 2010-11, conversion into investment ranged from a low of 3 per cent in Bihar to a high of 18.4 per cent in Haryana, with Modis Gujarat achieving 8.5 per cent. A separate calculation for translation of memoranda into investment between August 1999 and July 2014 reveals an implementation rate ranging from 1 per cent in Bihar and Jharkhand to 13 per cent in Gujarat and 19 per cent in Haryana. Very low indeed.

Xi signed memoranda for investing in two industrial parks in Gujarat and Maharashtra at a total cost of Rs 40,000 crore. This sounds exorbitant. Even at one crore per acre, the land cost will be just Rs 2,500 crore. Top‐​class infrastructure is already available or coming via the Golden Quadrilateral and Dedicated Rail Freight corridor. The Chinese may offer cheap finance, but the huge debt nevertheless has to be serviced by India, so a careful look at costs ‑and relevance ‑is essential.

Over 600 Special Economic Zones have been approved since 2006, but barely 170 have come up, and these are mostly tiny software SEZs. Many promoters of SEZs have abandoned their projects for want of demand from industrialists, despite tax breaks. Companies setting up units in SEZs have to export more than they import, but can sell mainly in the domestic market. Mukesh Ambanis SEZ in Navi Mumbai lies mostly unfilled, and his proposed SEZs in Maha Mumbai and Haryana have been abandoned.

Even so, politicians want to create ever more industrial parks and corridors. Please, the problem is the lack of a climate that sparks an investment boom, not of parks and corridors. Big parks and corridors yield big kickbacks, which is why the Congress was fond of them. Modi is supposed to be different.

He went to Japan and returned with pledges of $35 billion in public and private Japanese investment. A Japanese official explained that this was conditional on a good investment climate in India that made such projects viable. Modi will be told the same thing when he goes to the US next week.

Big foreign investments make big headlines. Yet India itself has a savings rate of 30 per cent of GDP, and this once touched 37 per cent. It is contributed mainly by households and unincorporated businesses. Foreign direct investment in India is barely 1 – 2 per cent of GDP. This links India to global markets and technology, and so is disproportionately useful. But it is not the crucial driver of growth. That has to be local investment. Above all, it has to be investment by small and medium enterprises, which already contribute more to investment and growth than large corporations.

This lesson is driven home by R Vaidyanathans book India Uninc. He estimates that the share of the private corporate sector in GDP is under 18 per cent, while that of the non‐​corporate sector is 45 per cent. The share of the non‐​corporate sector is 64.6 per cent in construction, 74.2 per cent in trade and hotels, 81.4 per cent in transport (excluding railways), 51.6 per cent in storage and 60.8 per cent in real estate. The services sector has been the biggest driver of fast growth in the last two decades, but not mainly because of giant software or BPO companies — two‐​thirds of services growth has come from the non‐​corporate sector.

Yet the corporate sector ‑including foreign companies ‑gets all the glamour, headlines and VIP treatment. It gets easy access to credit and equity finance while small and medium enterprises are starved. Economic liberalization has benefited large businesses (including foreign ones) most. It has also greatly boosted small and medium enterprises, yet they remain disadvantaged in various ways.Lesson for Modi ‑dont spend so much time on foreign investors and dignitaries, focus instead on energizing Indian investment. Small and medium Indian companies can spur growth and employment far more than Xi or Obama.