OPEN FOR BUSINESS

Global Finance, Sep 2004 by Chaze, Aaron

As yet, India does not have a clear plan for how it will achieve these figures, but it still wants to match the kind of capital flows received by China in recent years. "FDI can be used as a tool for growth, especially as India needs investment in new capacities. India offers great opportunity with skilled labor besides having a large domestic market," says Vyas.

While the hurdle of political opposition can be easily overcome, the government's FDl policy is still very cumbersome and desperately needs streamlining. "We have to create a climate to attract investment. We need to reduce the investors' points of contact with the bureaucracy, streamline the current requirements of multiple approvals, introduce a uniform FDI policy and not the sectoral kind that we have now, and introduce fiscal competition between states to attract investments," says Ranade. Even in Mumbai, India's financial capital, an investor setting up a call center operation needs 15 different sets of approvals from various local and state government bodies, underscoring the kind of bureaucracy that even controls sectors that are relatively uncomplicated to set up and run.

Both FDI and portfolio investments are linked to overall investor confidence in the system-not just political, but infrastructural as well. If the system and the environment are unstable or too cumbersome, then investments may not be so forthcoming. Foreign portfolio flows, though less stable, were robust last year and amounted to $11 billion-the highest ever inflow since India opened up its stock markets in 1995. With less favorable conditions prevailing this year, few are expecting to see similar inflows. The key factor that brought in last year's bumper investment harvest was strong anticipated GDI* growth. "There were several factors that drove GDP growth last year, which will be difficult to sustain in the current year. We had a confluence of favorable factors, such as low interest rates, low inflation, high business confidence and a great monsoon," Ranade remarks.

One Country, Many Markets

The government knows well that faster GDP growth is critical to sustaining foreign investments, and its target is 7% to 8% growth for the next few years. This will be difficult to achieve without significant structural reforms. "Sustainablc higher growth is a challenge now. What we need is a combination of reform plus infrastructure creation," says Ranade.

A key recommendation of various think tanks and industry associations is the creation of a common economic market within India. Currently each state controls the flow of goods to and from other states, and each transit generates taxes for the local and state governments concerned. This has gradually led to an institutionalized mechanism for corruption, delays and consequently increased the cost of goods flowing through the country.

The introduction of a value-added tax (VAT) in place of the cumbersome excise duty, state taxes and octroi (city taxes) regime is planned with a phased introduction from April 2005. It is expected to go a long way in ensuring better tax compliance, besides making indirect taxation uniform across the country. A key benefit expected from the introduction of VAT is that the tax-to-GDP ratio will improve substantially from the current dismal 9.5% (state taxes add another 6%). According to the recommendations of the task force on tax reform headed by the government's chief economic adviser, Vijay Kelkar, the introduction of VAT will eliminate the revenue deficit by 2008-2009 and will increase GDP by 2%.