Up, up and away

12 Jun 12
While India’s status as a beacon for growth remains intact, concerns over governance, innovation, infrastructure and knowledge transfer are holding it back, says Rohan Malik

By Rohan Malik | 12 June 2012

While India’s status as a beacon for growth remains intact, concerns over governance, innovation, infrastructure and knowledge transfer are holding it back, says Rohan Malik

India’s economic surge shows few signs of abating. A region of historic trade routes and vast empires, its massive and growing domestic market has today left it well placed for continued economic expansion.

The immense demand for basic goods and services from aspiring consumers, together with other factors such as the presence of a large, well-trained labor force keeping costs down, has left India’s growth at a very healthy 7%. While down from its previous rate of 8.5%—9%, few would argue that, in a challenging global environment, such a trajectory is an impressive signal of forward progress. Foreign investors need little encouragement to move into such fertile territory. With India’s emerging middle class acting as a magnet for overseas investment, Ernst & Young’s latest Indian attractiveness survey revealed that foreign direct investment (FDI) projects increased by 25% in the first 11 months of 2011, when 864 projects created an estimated 216,739 jobs. 


India’s loyal FDI clients

The survey’s findings suggest that investors continue to believe that India presents value and promising growth potential, both to those who want to produce and those who want to sell. Despite the uncertain global economy and the slight majority of businesses that are putting their investment projects on hold, there was not only an increase in the number of FDI projects in India from 2010 to 2011, but the value also increased by 13% and the number of jobs by 12%.

India attracts a variety of investment from all regions of the world, but more than half (52%) comes from the US, Germany, the UK and France. From Asia, Japanese and UAE companies represent 15% of the 864 projects recorded in the first 11 months of 2011. 

Companies continue to be convinced by India’s growth and foresee their presence in the country as a positive long-term opportunity. More than 60% of companies already present in India plan to increase their operations in the country. Our survey found that 71% of business leaders are keen to invest in the Indian market in the short term. Forty-seven percent plan to invest within 6 months and 24% between 6 and 12 months.

And, as in our survey results of last year, organic growth is still the preferred mode of investment in India. Fifty-five percent of companies considering entering or increasing their presence in India plan to expand their facilities, while 31% wish to increase their labor force. As these companies are familiar with the regulations and pitfalls in India, the organic growth route is likely to continue as the first choice for mode of investment. In contrast, only 24% of investors plan to acquire companies, 22% plan greenfield investment and 21% plan joint ventures. This is primarily due to the lengthy approval process for investment projects.

 

Clouds on the horizon?

But India still faces challenges. The Government has set out plans to enable tax authorities to make retrospective claims on overseas corporate deals and bring in new measures to reduce companies’ ability to avoid paying Indian taxes. However, critics say the proposals, which will allow the Government to pursue taxes on long-concluded transactions, will damage business confidence and impact prospective foreign investment.

And with the outlook for the global economy remaining uncertain, policymakers are moving to confront rising inflation and unemployment. To curb inflation, the Reserve Bank of India has raised interest rates by over 350 basis points since the beginning of January 2010, and the Government is increasing vocational training for at-risk youngsters.

The survey exposed investors’ concerns over the current state of infrastructure, governance and transparency in the country. Seventy six percent of respondents mention that improving infrastructure will have a high impact and is a prerequisite to attracting foreign investment. Our respondents are not alone in their concerns. The World Economic Forum rated Indian infrastructure 89th among 133 countries in a recent survey.

To nurture aspirations for global economic leadership and keep up with the growing rates of urbanization and the demand expansion that ensures, India needs to increase infrastructure investment. The Government, thankfully, recognizes this and is committed to doubling infrastructure spending to US$1t over the 2012—17 period, or about 9% of GDP, and is incentivizing investors with tax holidays.

About 60% of respondents believe that a better governance and transparency system will have a high impact on India’s attractiveness. Delays due to red tape, arbitrary regulatory decisions and corruption pose a big challenge for investors. In Transparency International’s Corruption Perception Index 2011 ranking, India slipped to 95th place among the 183 countries — down from 87th in 2010. In response, Indian policy-makers are moving services online to reduce the instances of bribery.

 

Manufacturing — the next big leap

Since 2007, the attractiveness profile of India has evolved. Although industry was always important, it has grown from supplying one half of FDI jobs in India in 2007 to almost two-thirds of FDI jobs in 2011. A quarter of our survey respondents see India among the world’s leading three destinations for manufacturing by 2020.

Between January and November 2011, investors committed US$50,813m to India, 78% of which went into the industrial sector, creating 299 projects and 131,846 jobs (61% of the total jobs), producing an average of 441 jobs per project. When investing in industrial projects in India, investors tend to target the industrial machinery, equipment and tools sector (115 projects) and the automotive sector (76 projects). In the first 11 months of 2011, automotives also topped the industrial projects in job creation, attracting 40,091 jobs.

These massive, high-growth sectors attract investors with the promise of selling to the rapidly growing middle class. The automotive sector, in particular, offers the chance to reach first-time buyers and establish brand loyalty. The industrial machinery, equipment and tools sector allows investors to supply the rapidly expanding Indian industry with components.

 

Innovation to power growth

Although India is now widely considered to be a services and industrial powerhouse, investors remain unconvinced about the country’s capacity as an innovation center. Investments in strategic functions and R&D have remained stable over the past five years and innovation is necessary to take its industrial and services sectors to the next level in terms of taking ownership of its future development.

Investors are divided on India’s position as an innovation center. In fact, a slight majority of the respondents (51%) do not see India as an innovation hub in their sector. This finding confirms the results of the Global Innovation Index, a 2011 study conducted by the Confederation of Indian Industry and INSEAD, the French business school, which placed India 62nd out of 125 countries on this measure. This lackluster ranking is based upon the inadequate quality of research infrastructure, the difficulty in finding relevant skills and the lack of a concrete government policy to promote innovation.

In addition to developing the quality of its infrastructure, India needs to increase collaboration between academic institutions and the corporate world before it earns recognition as an innovation destination. There is also a greater need for improved industrial-academic relationships, to promote breakthrough technology and stimulate demand for innovative products.

To enable companies to continue to spend money on new products and innovations in the face of continued economic gloom, governments of many countries have enhanced their tax credit provisions for R&D. Although the Indian Government does provide some incentives, more of these will be needed to drive innovation in the country. There is also a need for policy-makers to make its current intellectual property systems and copyright policy laws more secure and sound, and enable inventors to use the system at minimum or subsidized cost.

The overall outlook, however, remains positive. If policy-makers succeed in quickly improving infrastructure, governance and transparency, there is little doubt that India will continue to remain attractive to foreign investors — both now and well into the future.

 

Rohan Malik is Ernst & Young’s Advisory Markets Leader in India.


This article first appeared in the May edition of Dynamics

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