Why foreign investors are fleeing India

Foreign investors have fled stock markets after the budget. The Sensex is down nearly 2,500 points. Small and midcap stocks have fallen even faster. Beyond the budget, other problems are growing too. They add up to a discouraging message: Foreigners, enter India at your own risk.

Andhra Pradesh chief minister Jagan Reddy has reserved 75% of jobs in industrial and infrastructure ventures for state residents. Madhya Pradesh chief minister, Kamal Nath, also pledged earlier this month to reserve 70% of jobs in private sector companies for locals. The Constitution forbids discrimination based on place of birth, but these gentlemen do not give a damn. Nor do they care that the Supreme Court says job reservations of all sorts should not cross 50% to preserve some space for merit. Hopefully, the Supreme Court will rescind the new quotas. Why focus just on CMs when Modi himself has proposed an additional 10% job reservation for the poor in both the public and private sector? This needs a constitutional amendment. Modi may not have the required votes yet. But foreigners can clearly see a rising momentum for expanding job quotas and extending them to the private sector.

Cynics say this is just a game. Corporates may respond by converting all upper-caste employees into consultants rather than salaried employees. Many have outsourced jobs like cleaning, driving and running canteens to contractors, but can now convert these contract workers into regular workers, meeting the quota requirement without actually changing the workforce at all. However, many foreign investors will balk at such tactics.

Optimists thought that after his landslide election victory, Modi would undertake radical reforms like enhancing labour flexibility. Instead, he has just enacted a National Minimum Wage, over and above the minimums already laid down by different state governments. Since economic conditions differ widely from state to state, a national norm makes no sense. The National Minimum Wage will be higher than wages in the most backward states, but lower than in advanced states that already have high wages. This will rob backward states of the one comparative advantage they have — low wages. It is one more disincentive for investment.

India competes for foreign investment with other developing countries. India already has higher rates than many Asian competitors in land, loans, electricity, rail and air freight, corporate tax and income tax. To these will now be added rising job quotas and minimum wages, backed by all political parties. No wonder very few companies quitting China want to shift to India.

Jagan Reddy also wants to renegotiate all high-priced contracts for solar and wind energy totalling 5,000 MW at a cost of Rs 21,000 crore. India’s renewable energy policy has aimed to create a major new industry through competitive bidding for renewable energy projects, knowing that bids will initially be high but fall as experience grows, technology improves, and scale economies kick in. Reneging on old contracts signed at high prices means brazenly replacing sanctity of contract with populist whim.

In successful markets, contracts are sacred and changes in rules do not affect old deals made under different assumptions. But our populist politicians are casting these principles to the four winds. One recent example was the changing of e-commerce rules to benefit Reliance at the expense of Amazon and Walmart.

The budget seeks to attract massive foreign investment. It proposes bidding by multinationals for subsidies to set up mega-factories in high-tech areas like solar energy silicon fabrication and mass-storage batteries. The subsidies demanded may be sky-high, to compensate for the risk of a latter-day Jagan Reddy demanding renegotiation. Does it make sense to attract foreign investment on terms resembling the ill-fated Enron deal?

To compete with Asian neighbours, India’s tax rates should be competitive. India is still struggling to lower corporate tax to 25% while Asian neighbours have lowered theirs to 15-20%. The budget sharply raised the peak income tax rate to 42.7%, much higher than in many competitors.

Many FIIs are trusts, subject to the same high income tax as individuals. These trusts are exiting India after the budget, causing the market crash. The Finance Ministry says such trusts can convert themselves to corporations, slashing their tax liability. Alas, many countries require their pension funds to be organised as trusts, and these cannot be converted into companies.

These populist moves have also hit domestic investors, though to a lesser extent, since they know the game better. Fiscal constraints mean the government lacks money to kick-start flagging investment. So, it seeks more from private and foreign investors. But that requires a conducive, competitive climate, which is absent. The outlook is bleak.

What do you think?