Major global corporations are watching India’s national election closely. While India remains a challenging business market, its size and promise excite the imagination. Beyond political rhetoric, campaign promises, and manifestoes, there are five major areas of reform that foreign firms would like to see from the next government to help ensure that the market’s potential edges closer to reality—liberalization of foreign investment restrictions; increased openness to trade and data flows; international taxation; domestic deregulation; and regulatory stability.
India has been steadily deregulating foreign investment restrictions for nearly thirty years. In fact, there are very few examples where India has increased restrictions on foreign investment. But there is still much more to be done, and without risking India’s national security. Many sectors have explicit foreign investment limits such as multi-brand ecommerce (0 percent), newspapers (26 percent), TV news channels (49 percent), insurance (49 percent), pension fund management (49 percent), power exchanges (49 percent), multi-brand retail (51 percent), banking (74 percent), and stock exchanges (49 percent). Restrictive Regulations
In addition to foreign equity caps, many sectors put unfair rules that only apply to foreign firms in given sectors. Examples include single-brand ecommerce (local sourcing), multi-brand ecommerce (geographical, investment, and sourcing rules), insurance (local control). Were the next Indian government to quickly put together a major package of foreign equity reforms, it would send a positive shockwave felt around the world.
Like India’s record of foreign investment liberalisation, trade has also been liberalised dramatically in recent decades. India has become a trade-dependent economy. India’s goods trade-to-GDP ratio stands at around 29 percent — higher than the United States and Japan. However, India suffers from a large goods trade deficit, only somewhat offset by a services trade surplus. This has triggered multiple steps in recent years to slow imports: Import tariff hikes; import substitution rules; and a reluctance to embrace multiple pending trade agreements. India has also tightened data flow rules in recent years.
This is a surprising step, as data flows are the life-blood of India’s own data services sector. It seems unlikely that the next Indian government will embrace real trade liberalisation unless the “Make in India” program becomes more successful. And new restrictions on data flows seem likely, barring a major redirection in current policy thinking.
While difficult to quantify, India’s churning regulatory system tarnishes India’s image as an investment destination. India’s national regulatory bodies often move quickly to slam regulations when they see harms in the market, often with little notice and paltry attempts to engage stakeholders meaningfully. In early 2014, the Ministry of Law & Justice had proscribed
a thoughtful process for developing legislation; this has been entirely ignored. While every regulator must retain the right to intervene in markets when required, this regulatory churn makes it difficult to develop credible business plans and comfortably allocate investments to India. Foreign firms would want to see the new government re-commit to thoughtful regulation that involves serious stakeholder engagement and analyzing the relative costs and benefits of potential regulatory interventions.
Five years ago, ending “tax terrorism” was a major business plank for the Bharatiya Janata Party’s attempt to win the national election. In particular, the Congress Party-led United Progressive Alliance (UPA) decision to use a “nuclear option” to tax Vodafone’s acquisition of Hutch Telecom through retrospectively amending the Income Tax Act terrified a generation of foreign firms who feared capital gains tax could be levied on prior profits going back decades.
In addition, there was a backlog of cross-border tax disputes that ran into the hundreds, with extremely slow progress. The last few years have seen some important advances. India has amended its tax treaties with Mauritius and Singapore, ending the capital gains tax exemption. A committee has been instituted to review new attempts to use the retrospective tax principle. And a new “Advanced Pricing Agreement” regime has been adopted to give clarity to foreign firms on their tax treatment. Some of these partially-done reforms will likely be reflected in the next version of the India Reforms Scorecard we will release after the current election.
Deregulation Is The Need Of The Hour
Many sectors of the Indian economy are quite open to foreign investment, barring some sectors outlined earlier in this piece. In those sectors, new opportunities can be driven by steps to deregulate the sectors. For example, the new Hydrocarbon Exploration Licensing Policy (HELP) released by the Ministry of Petroleum & Natural Gas, released in 2016, does not change foreign investment limitations. It does, however, improve on the regulatory framework for domestic hydrocarbon exploration and production, and is attracting greater international interest than the prior “New Exploration Licensing Policy (NELP).” But there is always more deregulation required, sometimes reflecting dominant positions enjoyed by state-owned entities such as in defence production, the insurance industry, and banking.
In the closing months of the Modi government, the government took a range of steps that harmed foreign investors perception of the market. These include the Reserve Bank of India’s limitations on cross-border data flows, and the Ministry of Commerce & Industry’s new rules around ecommerce. However, with a new government about to take office, foreign firms hope to see bold new steps to encourage foreign trade and investment.
Richard M. Rossow is Senior Adviser and Wadhwani Chair in US-India Policy Studies at the Center for Strategic and International Studies in Washington, D.C. Breaking Down Elections 2019 is a series of articles by experts of Center For Strategic and International Studies that will go beyond the headlines to provide a deeper look into what the 2019 Lok Sabha Elections means for the Indian polity and electorate.