Saturday, February 11, 2012

The Safe Investment Climate in India

(I wrote this in July 2003. A few things have changed, but some fundamentals haven't about the purpose of a liberal economic regime, i.e., citizens must benefit. I posted my thoughts on the telecom licence cancellation a few days ago, but many things I've dwelt on here, hold nearly a decade later. Aren't we a fast moving nation?!)

 Doing Business in India (July 2003)

A survey presented at the World Bank summit on Development Economics, ranked countries on investment climate. Apparently, despite its tropical location India is not a hot place on this count and has a lot of work to do to catch up with the leading pack. At least, that’s what the survey suggested. India’s obviously doing better on  the developmental funding grid (which wasn’t presented at the summit) because this is the first time the bank has held this summit away from home.

Developments in recent years in the Indian business climate may give us cause to reflect on the findings of such surveys.

Pay an entry fee

“Liberalization” of several Indian sectors has assumed a dimension of relicensing with a high one time fee – payable directly or indirectly. The direct fee is often collected by the government as licence fees (licence fees payable for liberalized investment environment). After all, the government is sacrificing monopoly revenue to private sector players.  The government has auctioned licences in the telecom sector and radio broadcasting.

If you are more nationalistic, then government is allowing foreign players to make money in sectors that only Indian industrialists were allowed. The indirect fee  is paid by placing equity caps on non-Indian investment. In many cases, it is always quite clear that many Indian partners don’t have the resources to stay the distance in the particular industry. For example, the initial ventures in the automobile sector were joint ventures. There is now only one truly Indian company making passenger cars, i.e., Telco. Maruti Suzuki is the other half breed. Telecom equity caps have been raised from 49% to 49/76% (through the indirect route). We won’t dwell on the technicalities of “indirect”, suffice to say more foreign owned capital can now come in.

Renege on your initial commitments on entry

Many telecom companies defaulted on the initial licence fee payments. Some went to the extent of seeking court assistance to stay the guarantees that government could encash for such default. Apparently, the telecom companies overestimated the market size when bidding. Never mind if leading investment banks and management consultancy firms and banks went along with the initial estimates as well. Telecom companies have since struck a deal on a new “revenue sharing” regime.

Automobile companies defaulted in their export commitments made in return for concessional capital goods import duty.


Seek government regulations to protect your business interests

It turns out that some markets aren’t as big as industry players thought. But companies have already  invested substantially in the India related businesses. The 700,000 cars per year automobile market is not large enough to sustain a single global scale production facility. Most cars are priced at a range that is 25-50% the cost of a home in larger cities, and closer to 75 % in others. The only way to enlarge this market is through lower prices. Such low prices would be possible through free import of second hand passenger cars. However, the automobile sector (comprising largely of international companies now) has managed to convince government to effectively block out second hand passenger car imports through excessively high tariffs.

FM radio licencees, who’ve known for three years that they’d bid ridiculous amounts, now want government to do something to help them out! If the government does make an effort to help these licencees, the honest and intelligent companies who bid realistic amounts and didn’t win licences will be reassessing themselves as “honest and dumb”!

Get regulations to assist you in keeping prices high to keep investment viable

In some parts of the telecom arena, the government has managed to push up the cost of services through charging high entry fees to new entrants. This inherently placed government owned incumbents at a huge advantage. Notwithstanding this, competition has pushed prices down. Most recently, led by a large telecom company prices were pushed down even further for some services. (If you are looking for a DSL connection at home, go with the government provider whose monthly costs of usage will equal the license fee you have to pay to its competitors).

This has led to a huge dispute on “predatory” pricing ( pricing services below costs). The regulator is in the fray to examine why prices are so low!! Many of the telecom companies, the international equipment suppliers and consortia of banks who have financed their networks will not complain. Their risk capital will be de-risked through mandatory higher pricing.

In terms of investment climate, why would any enterprise find fault with:

  • Gaining rights to operate in a market without unlimited entry
  • Fearlessly pay whatever is the cost of entry including notionally accepting terms that place the enterprise in a competitively unequal playing arena with the incumbents
  • Once you are in,  convince government of the need to protect the industry from imports
  • Ensure that other domestic entrants pay high entry costs
  • Keep prices high to potentially justify investments of producers of goods and service and compete with the incumbents
  • Rely on the government to not use the clause that states that policies could be changed in future, even if such policies would ultimately benefit consumers and not producers.

This is virtually the path taken in sectors that were hitherto government monopolies and or with just a few large domestic players.

Telecommunications and automobile sectors have been cited.
The power sector would have worked for producers. A lot of the initial private power projects were lining up “sweetheart” deals with virtually zero risks with state electricity boards. In fact, were it not for a thinking state regulator questioning the need to buy power from the most expensive source, viz., the Enron power plant in Maharashtra, many of these plants would also be up and running.
The petroleum sector is in the midst of this. Apparently, new entrants have to create their network for retail products (motor spirits). It seems unlikely that players who do this would like a free entry of additional players.
Development of containerised movement of domestic freight traffic is similarly faced with a large incumbent (CONCOR) placed unequally vis-a-vis potential new entrants. Road traffic is the dominant mode of domestic freight traffic at present and efficiencies will drive down costs for consumers.
There is a perception that such restrictions (imports or investments) are not true for sectors like consumer electronics. Perhaps investment restrictions no longer exist, but try importing a music system and check out what you pay as duty at the Customs counter.

Of course, at the end of all this politicians heading government talk about how “liberalization” has not reached and affected the common man. Apparently, “liberalization” that pushes up prices and protects a new set of high cost domestic producers should have worked for common people!

The practised liberalization in India is in many instances “relicensing” with a few more players of non-Indian origin. If the size and scale of the investment is large enough, government, the banks and regulation will ensure that your investment is protected.

To go back to the World Bank study. How many countries propagate an investment climate that ensures that your investment is secure and profitable? 

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