India: the new Asian tiger?

Business Horizons, May-June, 1995 by Philip Banks, Ganesh Natarajan

Over the past three years, India--the largest democracy in the world--has put into place the foundations of a deregulated market-driven system. The government appears to have secured broad social and political support for the direction of this change. This in itself attests to the outstanding leadership of Prime Minister Narasimha Rao and his finance minister, Dr. Manmohan Singh.

Clearly the government is banking on a deregulated environment for securing economic growth. Manufacturing is the engine driving the current faster growth, and foreign direct investment (FDI) is seen as essential in this strategy. So the economic policies instituted by the government, including such areas as removing import barriers and reducing tariffs and corporate taxation, are focused on making India a more attractive place to do business.

To examine the reasons why India is becoming so desirable to investors, A.T. Kearney and Gardner, Carton & Douglas surveyed 28 companies with global interests. Thirty-five percent of the firms had responsibility for the Asia-Pacific region, and some were located in the country from which Indian investments and operations were conducted.

The potential size of India's market, its location, the availability of significant natural resources, and its highly intelligent, skilled people were all cited as making India an attractive priority for global business. These factors, along with its language, cultural, and educational facilities, make India a competitor to China for foreign investment. Undoubtedly, India will increasingly become a more serious competitor in the future development of Asia and world markets.

Economic Changes

The size and growth of India's market depend largely on deregulation. It is no surprise, then, that changes in the foreign direct investment law and corporate taxation are of significant consequence to foreign investors. India has lowered the corporate tax rate and abolished the distinction between widely held and closely held corporations for tax purposes. Tax on companies incorporated abroad but earning income in India has been reduced from 65 percent to 55 percent. Because the majority of foreign companies in India tend to be incorporated there as part of a joint venture or other arrangement, most will be taxed at the lower domestic rate. And the Indian government is offering tax incentives for foreign investors, depending on the industry, location, and purpose of the foreign investment.

India is opening its markets to foreign goods as well. In the last two years, the country has reduced import duties on many goods and lowered the peak duty rate to 65 percent from 120 percent. The duty structure has been altered to reduce or remove irregularities in import duties on raw materials and components as compared with finished products. India also plans to reduce basic customs duties on project imports and capital goods. These reductions, along with much greater freedom to convert the rupee into other currencies, now allow foreign companies to operate more easily in India's large and growing market.

The one dark cloud in India's increasing economic strength is the fiscal deficit, which was 7.3 percent of GDP in 1993-94. The government's target for 1994-95 was to lower the fiscal deficit to 6 percent of GDP, largely as a result of increased revenues due to economic growth.

Foreign Investment

All three forms of foreign investment in India--portfolio, direct, and Indian overseas---are rising and should continue to do so as long as the political, economic, and social situations continue to improve. Portfolio investment has been a focus of international attention. There has been a rise in the activity of the Indian stock market and a surge in the foreign equity and debt offerings by various Indian companies. Parallelling these developments, private sector foreign business executives have been crowding into India and making investments.

By the end of 1993, $4 billion worth of foreign investment was contracted in India, compared to $221 million in 1991. Actual inflows of foreign investment for the fiscal year 1993-94 will be eight times the level of the previous year.

Direct investment is moving into a range of industry sectors. Investment approvals have been focused principally on five sectors: power fuel, oil refineries, food processing, chemicals, and electrical equipment and electronics. Collaborations since 1991 number 3,630.

Our study shows investors are optimistic when it comes to India. All the respondents to the survey who are now in India intend to stay. But perhaps even more important, 95 percent of the respondents in India are planning to expand their current operations. And 100 percent of the respondents not currently in India are interested in entering the market.

In 1993, laws on foreign investment in India were changed to allow greater ownership by the foreign investor. Despite this change, many companies entering India opt for joint venture arrangements because break-even can be achieved more quickly (60 percent achieve break-even within four years). Joint ventures also help in dealing with the numerous government organizations and regulations that still impede entry to the Indian economy.