Corruption, corporate battles scaring away foreign investors?

India’s rise has captured the world’s imagination, as the economy grows at nearly 9 per cent a year and a growing consumer class buys cellphones, cars and homes. No wonder foreign companies are increasingly eager to tap that growth by investing here.

Or are they? Despite India’s stunning growth, foreign businesses and investors have started looking elsewhere. Foreign direct investment in India fell more than 31 per cent, to $24 billion, in 2010 even as investors flocked to developing nations as a group.

And in the last two months, foreign investors took $1.4 billion out of the Indian stock market, helping drive the country’s Nifty 50 stock index down 17 per cent from the all-time high it set in early November.

The decline in foreign investment highlights the challenges outsiders still face in India, two decades after policymakers started opening up the country to the world. For Indian leaders, the drop in outside money could make it harder to achieve the faster and broader economic growth that they need to create jobs and pull hundreds of millions of India’s 1.1 billion people out of poverty.

While inefficiency and bureaucracy are nothing new in India, analysts and executives say foreign investors have lately been spooked by a highly publicised government corruption scandal over the awarding of wireless communications licences. Another reason for thinking twice is a corporate tax battle between Indian officials and the British company Vodafone now before the supreme court.

Meanwhile, the inflation rate — 8.2 per cent and rising — seems beyond the control of India’s central bank, and has done nothing to reassure foreign investors.

Jahangir Aziz, an economist with JPMorgan in Mumbai, said that while Indian policymakers have been seemingly ambivalent toward foreigners, some other emerging economies have laid out red carpets. Lately, foreign direct investment to countries like Thailand, Indonesia and Brazil has surged. Direct investment into Brazil, for instance, jumped 16 per cent, to $30.2 billion last year, according to the United Nations.

Still hope

There is no doubt that investors and companies around the world are still placing bets on India’s growth. Last year foreign investors poured nearly $30 billion into the Indian stock market — and so, some profit-taking from the market’s all-time high last fall was probably to be expected. And last week BP announced that it would buy into oil and gas fields here for $7.2 billion, which would be the largest foreign investment yet in India.

But the broader trend signals that foreign firms and investors are concerned about their ability to do business in India.

Aziz and other analysts say the slowdown in foreign money is part of a broader pullback that also includes Indian companies. Private investment as a percentage of India’s gross domestic product fell to about 22 per cent in the current fiscal year, from 25.6 per cent a year earlier. Analysts say businesses are more cautious because of trouble getting regulatory approvals, as well as uncertainty about the direction of government policies.
So far, the shortfall has been made up by higher government spending and personal consumption. But economists note that these, alone, are not ingredients for sustained growth.

And despite prime minister Manmohan Singh’s promises, executives fear he will not be able to convince other policymakers to make necessary changes. Indian ministers often sidestep the broader agenda set by Singh, who designed India’s first big economic reforms in 1991 when he was finance minister.

He now heads a fractious political coalition. And recent corruption scandals, including allegations that kickbacks helped undermine last year’s poorly organised Commonwealth Games in New Delhi, have further eroded the government’s credibility.

Privately, business executives complain that Indian officials are adept at proclaiming their commitment to free markets but delay specific measures to ease restrictions. Doing so is politically difficult in India because many politicians, labour unions and civil society groups prefer government spending and domestic protectionism over further economic liberalisation.

In the retail industry, for instance, the country still bars foreigners from owning stores that sell more than one brand of products. That restriction, meant to protect India’s many small shopkeepers, prevents Wal-Mart, Tesco and others from selling to India’s growing consumer class. In recent months, Indian officials have sent conflicting signals about whether the government intends to ease that policy.

In insurance, MetLife, which has invested $139 million in an Indian firm, would like to put more money into the country. But it is restricted by rules limiting foreign ownership in insurers to 26 per cent — a ceiling that policymakers set in 1999 with the expectation that they would raise it in a few years.

MetLife, which has already hit that limit, cannot grow as fast in India as it can in Brazil, where it owns 100 per cent of its affiliate. Even in China, notorious for favouring its domestic firms, MetLife owns 50 per cent of its insurance operation there.

Concern over tax laws

Foreigners are also increasingly concerned about Indian tax laws. Vodafone, the global telecom giant, is battling tax officials who want it to pay about $2.5 billion in capital gains tax on its $11 billion acquisition of an Indian mobile phone company in 2007. Indian officials say Vodafone should have deducted the tax from the money it paid to Hutchison Whampoa, a Hong Kong-based company.

Vodafone says that no tax should apply because the transaction took place outside India and that if any tax applies, it should be paid by Hutchison. Analysts say Indian officials are billing Vodafone because Hutchison no longer does business in India.

The Vodafone tax case has other companies worried that they will be subject to unexpected taxes when they try to buy and sell their investments, said Nandan Nelivigi, a partner at the law firm White & Case in New York who advises companies on investing in India.

“Foreigners don’t want to avoid paying taxes in India,” he said. “But they just want to know what their tax liabilities are.”

Still, some executives say that doubts about India’s investment climate are being overplayed.

Gunit Chadha, chief of Deutsche Bank’s Indian operations, said that even though he would like policymakers to speed up the pace of reforms, he does not think India has become hostile to foreign businesses. Despite the recent downturn, he noted, the flow of funds is still much higher than as recently as 2004, when India attracted just $6 billion in foreign direct investment.

“Sometimes it’s a good idea to open the tap in a calibrated fashion, lest you flood the place and then have to erratically close the tap or clean the mess,” Chadha said. “You will always have a situation where some would argue you could have done a bit more or a bit faster, as is currently the feeling. But in a democracy like India, a more measured pace is beneficial.”