Tag: foreign investment

When It Comes to the Wall Street Game, India and China Are Not Even in the Same League

China is not competing with India for the attentions of Western hedge funds. And though FDI to China has fallen off a cliff, given the vast stock of foreign capital already committed to China, it will take years before the total foreign commitment to India matches that already committed to China.

‘Wall Street Snubs China for India in a Historic Markets Shift’. Thus blared the Bloomberg headline a week ago:

A momentous shift is under way in global markets as investors pull billions of dollars from China’s sputtering economy, two decades after betting on the country as the world’s biggest growth story. Much of that cash is now heading for India, with Wall Street giants like Goldman Sachs and Morgan Stanley endorsing the South Asian nation as the prime investment destination for the next decade. That momentum is triggering a gold rush. Investors are paying close attention to the contrasting trajectories of two of Asia’s greatest powers. India, the world’s fastest-growing major economy, has vastly expanded infrastructure under Prime Minister Narendra Modi in his bid to lure global capital and supply lines away from Beijing. China, on the other hand, is grappling with chronic economic woes and a widening rift with the Western-led order.

In the days that followed, the article by Sivabalan, Chakraborty and Sircar was widely syndicated across platforms both in Asia and the West. Sitting by chance next to a colleague on a flight back from Vegas the other day, the article immediately came up. It fits the narrative of the moment so well. But what does it really tell us?

Globalization and deglobalization are complex phenomena. They involve multiple different dimensions of interaction: trade, direct productive investment and portfolio flows. Financial markets flows may tell a very different story than trade flows.

And in comparing India and China, there is a risk of equating apples and oranges. In their combined and uneven development, India and China are in very different places. When Modi’s government announces a target of an 11 percent increase in infrastructure spending to $134 billion for 2024 it seems a bold step that sets markets alight, because the Indian economy measured at market exchange rates is slightly larger than that of the UK. China is in a different league.

And, in any case and inevitably, our assessment of these data are entangled with broader narratives and political positioning. In commentary on the future of CCP-run China there is no place of innocence.

The loudest sources in the West on the state of China are, on the one hand, business people who have projects and wagers to promote, whether they are long or short China, and, on the other hand, China-watcher analysts and journalists many of whom can no longer safely return to China on account of their critical commentary and the repressive sanctions they might face. They write from the position of exile. Added to which we have the vantage point of India, which cannot help but be preoccupied with the question of who will be Asia’s #1.

My own position is that of a Western left liberal who broadly supports detente and peaceful adjustment of the world order and the Western “worldviews” that go with it, to accommodate China’s rise and the broader shift towards a truly multipolar world. In so doing, I hold to the possibility of distinguishing, as EU policy does for instance, between areas of cooperation, competition and rivalry. So I approach the dramatic narrative of transition pitched by the Bloomberg piece with a degree of skepticism.

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Look at the Bloomberg piece in detail and what does the evidence consist of?

The $62 billion hedge fund Marshall Wace has positioned India as its biggest net long bet after the US in its flagship hedge fund. An arm of Zurich-based Vontobel Holding AG has made the country its top emerging-market holding and Janus Henderson Group Plc is exploring fund-house acquisitions. Even Japan’s traditionally conservative retail investors are embracing India and paring exposure to China.

Then there are the quotes from portfolio managers in Singapore, the impressions of strong interest on investors calls, a smattering of fund flow data for Q4 2023, a Morgan Stanley outlook, a little geopolitical rumination and the observation that

(h)istory shows that India’s economic growth and the value of its stock market are closely linked. If the nation continues to expand at 7%, the market size can be expected to grow on average by at least that rate. Over the past two decades, gross domestic product and market capitalization rose in tandem from $500 billion to $3.5 trillion.

I don’t highlight this collagist approach so as to criticize it. This is how business reportage gets done, and history-writing too. But it does pose the question of the frame within which this collection of data and quotes should be placed.

It leads us to ask, how does portfolio investment, the kind of financial flows that are brokered by Wall Street hedge funds, fit into the broader picture of globalization? What is the scale of these flow? How do they compare to other vectors of globalization? And aside from the general story of China’s crisis and India’s rise, what is the specific history of these financial flows and their significance?

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Viewed in broader terms, the dynamics of China’s international economic integration right now are a picture of contrasts.

China’s trade surplus is hard to fully account for, but it is clearly gigantic and increasing in recent years. A figure of around $800 billion in surplus seems reasonable at the current time.

Source: Brad Setser

On net, China continues not to import capital – the issue highlighted by the Bloomberg piece – but to export capital to the rest of the world on an unprecedented scale. It is typical of China’s model that this outflow takes the form not of private capital flows, but of official reserve accumulation and accumulation of claims by state-controlled banks. Brad Setser has compiled these remarkable numbers of the shifting pattern of reserve accumulation in China.

So as far as global trade is concerned, plus ça change. China runs a huge surplus. The USA runs a huge deficit. For all the talk of rebalancing or decoupling, there is little evidence of any fundamental shift of the basic dual-pole structure of the world economy. In this schema, India is not an emerging challenger for China. As makes sense for a populous and poor developing country, for most of its history since independence, India has run trade deficits. It has imported capital. The only significant exception was the massive disruption of COVID. In Setser’s graph above it is the ore-coloured band below the USA.

Source: Trading Economics

 

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If you want to see dramatic changes in the world economy, decoupling and rebalancing, the place to look is not to trade, but FDI (Foreign Direct Investment). Since 2022, inbound FDI to China, once the world’s premier destination, has fallen off a cliff.

Of course, the interest rate hikes made 2022-2023 a bad period for global capital flows generally. India’s FDI flows are off their peak too. But the Chinese collapse is dramatic and clearly reflects investor worries about geopolitics and the domestic policy regime in China.

As recently as a few years ago, FDI to China was outstripping India’s by a huge margin. In 2023 FDI to India, even running below its peak rate easily exceeded that. to China.

This clearly does reflect a shift. But given the vast stock of foreign capital already committed to China – which is in the order of several trillions dollars – it will take years before the total foreign commitment to India will match that already committed to China. The huge investments by Apple and Tesla are indicative both of the change in direction and the time and money it will take to achieve a substantial rebalancing.

Furthermore, given China’s sophistication in manufacturing and the political pressures for decoupling, one would in any case expect a rebalancing from foreign-led investment into China, to Chinese-led investment in locations like Vietnam, Mexico etc. As China develops, it is not surprising that the net balance of direct investment should shift from a large surplus to a deficit. Added to which, given China’s vast current account surplus, we would expect the capital account to be in deficit i.e. for China to be exporting rather than importing capital. China cannot import capital on a huge scale whilst exporting the way it does. The giant infrastructure projects of One Belt One Road were once widely seen as an “escape valve” for China’s surpluses. That was Chinese out-bound FDI.

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One of the unusual and important aspects of China’s globalization is that it was led by trade and FDI i.e. international flows directly connected to the production and distribution of goods. By contrast, portfolio investment, the variable that the Bloomberg article focuses on, the acquisition across borders of financial claims in the form of bonds and equities, has only recently taken on any significance at all.

It is a striking feature of China’s international balance sheet that on the liability side (i.e foreign claims) inward FDI is more than two times larger than foreign portfolio claims. Meanwhile on the Chinese asset side, private portfolio claims are a very minor component, dwarfed by Chinese FDI and even more by official reserves and quasi-official reserves (other) held on the balance sheets of state banks.

If you look at US Treasury data on US holdings of foreign financial assets it would seem that US investor claims against India already exceed those against China – $287 billion to $243 billion. If anyone took those numbers at face value there would be no cause to write the kind of piece that appeared in Bloomberg. The numbers are misleading because they fail to capture all the indirect ways in which US investors, notably those of the hedge fund variety, actually locate their holdings of financial assets. Much of it is held offshore or through indirect vehicles, not captured in the Treasury data.

Thankfully, the Rhodium group in 2021 prepared an in-depth report on the depth of US China financial connections.

All told Rhodium figures that American investors had $1.2 trillion in financial claims against China at the end of 2020, most of that in equities. It seems pretty certain that despite the recent enthusiasm for India’s booming stock market, this figure exceeds any equivalent claims on India.

The real question is why the scale of claims on China is not far larger. The answer is that serious accumulation of portfolio claims against China began only a decade ago when China began a slow and partial opening-up of its financial markets. Up to that point the restrictions of short-term capital movement were a key part of what some observers dubbed the Bretton Woods 2 system under which Beijing fixed the exchange rate of the RMB – first against the dollar and then a basket of currency – and managed capital flows to maintain the peg.

Though Wall Street has been pushing the China connection since the 1990s and the China connections of figures such as Dalio, Paulson and Schwarzman are the stuff of legend, the partial globalization of Chinese finance is a relatively recent phenomenon.

Source: Robin Brooks

The striking fact is that despite China’s centrality to global trade, until 2015 non-resident portfolio flows to other EM far outweighed those to China.

It was only in the course of the 2010s that the network of Western bank presence expanded dramatically significantly across China.

Source: Petry 2023

As researcher Johannes Petry points out in a fascinating paper,

Until January 2020, onshore access to Chinese capital markets was very restricted for global financial institutions. Foreigners were not allowed to freely participate in Chinese markets, and they could only operate onshore by forming a joint venture with a Chinese financial company or setting up wholly foreign-owned enterprises (WFOEs).

It was after 2016 that foreign portfolio claims were allowed to surge. And it was only in 2020 amidst the global crisis of COVID that non-resident portfolio investment in China came to dominate the entire EM scene. In 2020 and 2021 hundreds of billions in portfolio flows poured into China. This was completely unprecedented.

The historic irony is that Wall Street’s very long-term play on China finally began to pay off precisely at the moment in which geopolitical tension made its continuation less and less tenable. As voices like Li Yuan and Lananh Nguyen noted in October 2021 and November 2021 in the NYT, there was a stark contrast between Wall Street’s new infatuation with China and the mood both within China and on the broader global political scene.

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The break came in 2022. The combination of surging inflation, interest rate hikes and Putin’s war, suddenly shifted the global mood. The talk was now of polycrisis. As the IIF data show, non-resident portfolio investment in EM generally collapsed. China was particularly hard hit. On an annualized basis, the swing from peak to trough in portfolio investment to China was a massive $400 billion.

As is true for FDI, there is no doubt that the combination of global geopolitical escalation, the disaster of Chinese COVID policy over the summer and fall of 2022, the implosion in the real estate market, and now the stock market rout, have made China extremely unattractive as a destination for capital flows.

India and other EM are profiting. But portfolio flows to India were also subject to shocks – admittedly on a much smaller scale. And there is no evidence in the aggregate data on portfolio flows in 2023 for a surge into India in any way commensurate with the collapse in flows to China.

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The Chinese authorities are not oblivious to the scale and impact of these shocks. They seem to be doing their best to obscure the scale of their gigantic trade surpluses and reserve accumulation. The FDI numbers are embarrassing and we should expect to see noises out of Beijing welcoming new investment. Beijing is also actively intervening in the stock market, not for the sake of foreigners of course, but to avoid a disastrous blow to the wealth of China’s upper middle class.

Though the interventions are not targeted at foreign portfolio flows, the impact on foreign interests is real. In the days since the Bloomberg article on India appeared, there have been huge opportunistic flows into China equity funds, looking to benefit from the official intervention.

The big worry on Beijing’s part are not the relatively modest foreign portfolio flows. The real risk is that giant pools of Chinese wealth will start heading for the exit. It is not foreign jitters but a general panic and capital flight that is the real threat to Xi’s regime. It is not surprising to see a tightening of foreign exchange controls.

The essential point is that Beijing has always approached financial integration with the West cautiously. If portfolio investment takes a breather, Beijing will shrug. Western interests that play by Beijing’s evolving rules will continue to be welcome. But China is not competing with India for the attentions of Western hedge funds.

Adam Tooze holds the Shelby Cullom Davis chair of History at Columbia University and serves as Director of the European Institute. A version of this article was originally published on his newsletter, Chartbook, and is republished here with permission. 

 

Precipitous Decline in FDI in Last Two Years of Modi’s Tenure

The government is trying its best to build a narrative projecting India is the fastest-growing economy post-COVID. But the reality is that there is a general decline in FDI flows globally, and India is not bucking the trend.

This piece was first published on The India Cable – a premium newsletter from The Wire & Galileo Ideas – and has been republished here. To subscribe to The India Cable, click here.

Foreign investment inflows (FDI) into India may be drying up even faster in 2023-24 than in 2022-23, when net FDI inflows declined 27% to a mere $28 billion. It was the biggest decline in a decade. Many global analysts have expressed concern over the unprecedented decline in net FDI inflows in 2022-23. Now, it seems that 2023-24 could be a bigger cause for worry.

Speaking on CNBC TV18, a Grant Thornton analyst said there was a 92% decline in cross-border M&A deals in India in the first half of 2023 (they publish monthly data). One assumes that this deep, declining trend is not going to reverse during the rest of the year (both calendar and financial).

A 92% decline may reflect serious underlying trends. One, it will curtail overall FDI flows in 2023-24, because cross-border M&As are a big component. During the Covid year of 2020, Reliance Jio alone attracted $20 billion via acquisition of up to a 33% stake in it by Google and Facebook. Two big share acquisitions dominated overall FDI flows into India. Some big pension funds and sovereign wealth funds also invested in Reliance Jio in 2020. Other startups (unicorns) also got equity investments in 2020-2021.

The acquisition of technology shares formed a substantial chunk of FDI inflows into India in recent years. This has dried up in 2023, and is clearly showing up in the 92% decline in cross-border mergers and acquisitions, as pointed out by Grant Thornton.

Global growth pessimism is an important reason for this big decline in cross-border M&As. Western corporations are cautious about making big investments. A rise of 4-5 percentage points in interest rates in the US and EU, which has sucked easy money out of the system, is another reason. Such moneys have found their way into India to do leveraged buyouts. Geopolitical strategy is also important. India had begun to shun Chinese FDI after the 2020 border clashes with China. China has been a large investor in Asian economies over the last 10 years. In fact, most top tech startups in India had big initial doses of Chinese investments, but are having to look for non-Chinese sources for subsequent rounds of funding. All these factors have come together to create a perfect storm.

The last two years of Modi’s tenure may bring in the lowest FDI. The government is trying its best to build a narrative projecting India is the fastest-growing economy post-COVID. But the reality is that there is a general decline in FDI flows globally, and India is not bucking the trend.

A lot of hype has been generated to attract FDI in chip manufacturing, with the government offering nearly $10 billion of direct subsidy to the Vedanta-Foxconn combine. This was launched by the PM himself in Gujarat last year. But the joint venture fell apart last week and there is no clarity on how the chip project will be revived. This, and the Micron chip assembly and testing plant announced during the PM’s US visit, are being touted as big potential FDI inflows in this fiscal. But experts in semiconductor manufacturing suggest that such complex foreign technology-led investments will take time to fructify, if at all. Merely throwing large subsidies around is not enough, as the Vedanta-Foxconn experience shows.

Meanwhile, Indian startups are also in a tight corner, as funding dries up and the much-touted  ‘100 unicorns’ narrative is also becoming difficult to sustain. They are all drastically restructuring their business models, moving away from high burn rates to enforce profitability and unit economics as global liquidity supporting startups dries up. It has not helped that some of the poster boys among unicorns like Byju’s face serious corporate governance problems.

It appears that tech startups will also not attract much M&A-linked FDI this year. Overall, it doesn’t seem like a pretty picture for the Modi government, which is projecting itself as a darling of global investors.

Former chief economic advisor to the Modi government, Arvind Subramaniam, said in his report that India has not been able to raise FDI inflows from the low annual average of 2% of GDP. In fact, in recent years, it has gone further down to 1.5% of GDP. China, South Korea and Malaysia received 3-4% of their GDP as FDI inflows in their high growth phase, says global investor and author Ruchir Sharma. If India were to achieve FDI inflows of 4% of GDP, it would receive close to $150 billion annually. This is nowhere in sight, though PM Modi has made heavy pitches to Japan, UAE and Saudi Arabia for chunky investments in infrastructure via their sovereign wealth funds. Even Modi’s much-vaunted personal rapport with the heads of Gulf states has not brought in the big-ticket FDI flows promised during his numerous visits since 2014. An honest appraisal of FDI flows during the last nine years of the Modi government would not present a very happy picture. But as is this regime’s wont, this is easily buried under self-congratulatory headlines.

Amazon, Tata Say Centre’s E-Commerce Rules Will Hit Businesses

The government’s tough new e-commerce rules announced on June 21 aimed at strengthening protection for consumers, caused concern among the country’s online retailers.

New Delhi: Amazon.com Inc and India’s Tata Group warned government officials on Saturday that plans for tougher rules for online retailers would have a major impact on their business models, four sources familiar with the discussions told Reuters.

At a meeting organised by the consumer affairs ministry and the government’s investment promotion arm, Invest India, many executives expressed concerns and confusion over the proposed rules and asked that the July 6 deadline for submitting comments be extended, said the sources.

The government’s tough new e-commerce rules announced on June 21 aimed at strengthening protection for consumers, caused concern among the country’s online retailers, notably market leaders Amazon and Walmart Inc’s Flipkart.

New rules limiting flash sales, barring misleading advertisements and mandating a complaints system, among other proposals, could force the likes of Amazon and Flipkart to review their business structures, and may increase costs for domestic rivals including Reliance Industries’ JioMart, BigBasket and Snapdeal.

Amazon argued that COVID-19 had already hit small businesses and the proposed rules will have a huge impact on its sellers, arguing that some clauses were already covered by existing law, two of the sources said.

The sources asked not to be named as the discussions were private.

The proposed policy states e-commerce firms must ensure none of their related enterprises are listed as sellers on their websites. That could impact Amazon in particular as it holds an indirect stake in at least two of its sellers, Cloudtail and Appario.

On that proposed clause, a representative of Tata Sons, the holding company of India’s $100 billion Tata Group, argued that it was problematic, citing an example to say it would stop Starbucks – which has a joint-venture with Tata in India – from offering its products on Tata’s marketplace website.

The Tata executive said the rules will have wide ramifications for the conglomerate, and could restrict sales of its private brands, according to two of the sources.

Tata declined to comment.

The sources said that a consumer ministry official argued that the rules were meant to protect consumers and were not as strict as those of other countries. The ministry did not respond to a request for comment.

A Reliance executive agreed that the proposed rules would boost consumer confidence, but added that some clauses needed clarification.

Reliance did not respond to request for comment.

The rules were announced last month amid growing complaints from India’s brick-and-mortar retailers that Amazon and Flipkart bypass foreign investment law using complex business strcutures. The companies deny any wrongdoing.

A Reuters investigation in February cited Amazon documents that showed it gave preferential treatment to a small number of its sellers and bypassed foreign investment rules. Amazon has said it does not give favourable treatment to any seller.

The government will soon issue certain clarifications on the foreign investment rules, Indian commerce minister Piyush Goyal told reporters on Friday.

(Reuters)

US Lobby Group Urges India Not to Tighten Rules for Foreign E-commerce

India is considering revising FDI rules after Indian traders accused Amazon’s Indian division and Walmart’s Flipkart of bypassing investment regulations.

New Delhi: A US lobby group which represents firms including Amazon.com and Walmart has urged India not to tighten foreign investment rules for e-commerce companies again, according to a letter seen by Reuters.

India is considering revising the rules after traders in the country accused Amazon’s Indian division and Walmart’s Flipkart of creating complex structures to bypass investment regulations, Reuters reported this month. The US companies deny any wrongdoing.

India only allows foreign e-commerce players to operate as a marketplace to connect buyers and sellers, but local traders say the US giants promote select sellers and offer deep discounts, which hurts business for smaller local retailers.

In 2018, India changed its foreign direct investment (FDI) rules to deter foreign firms offering products from sellers in which they have an equity stake. The government is now considering tightening those rules again to include sellers in which a foreign e-commerce firm holds an indirect stake through its parent, Reuters reported. Such a change could hurt Amazon as it holds indirect stakes in two of its biggest online sellers in India, Cloudtail and Appario.

Also read: Why It’s Time to Start Making Amazon Pay

Citing the Reuters story in a January 28, 2021 letter, the U.S.-India Business Council (USIBC), part of the US Chamber of Commerce, urged the Indian government not to make any more material restrictive changes to e-commerce investment rules. “Any further changes in FDI rules would limit e-commerce firms from leveraging their scale,” USIBC said in the letter seen by Reuters.

USIBC also asked India’s Department for Promotion of Industry and Internal Trade (DPIIT) to engage in substantive consultation with companies on e-commerce regulation.

USIBC and DPIIT did not respond to a request for comment.

After the Reuters story was published last week, the Confederation of All India Traders (CAIT), which represents millions of brick-and-mortar retailers, said it has received assurances from India’s commerce minister that policy changes were in the offing.

On Saturday, CAIT in a statement said the USIBC letter was an “uncalled for intervention” which runs against the interest of 85 million traders. “Such a hue and cry is not understandable,” CAIT said, adding that it had also written a letter in protest to the USIBC President.

Also read: India Will Not Be Able To Ignore the Threat of Tech and Data Oligopolies for Long

The government is also considering prohibiting online sales by a seller who, for example, purchases goods from an e-commerce entity’s wholesale unit, or any of its group firms, and then sells them on the entity’s websites, Reuters has reported.

The 2018 rule changes soured relations between India and the United States as Washington said the policy changes favoured local e-commerce retailers over US companies.

Industry sources told Reuters on Friday that the prospects of such frequent policy changes in India have alarmed Amazon, which has committed $6.5 billion in investments in India, and Walmart, which invested $16 billion in Flipkart in 2018.

The USIBC letter said that “investments require reasonable policy predictability and fair treatment”. “USIBC is concerned that material changes to the FDI policy creates uncertainty and impacts investor confidence, as well as business continuity of existing investments,” it said.

Amazon declined to comment on the USIBC letter. Walmart and Flipkart did not respond to requests for comment.

(Reuters)

Watch | The Wire Business Report 1: Mistakes of Samvat 2074 and Lessons for 2075

For The Wire Business Report, Mitali Mukherjee takes a look at what this year has meant for small investors.

This Diwali, The Wire is bringing a new show for its viewers for an unfiltered view of the economy. Watch Mitali Mukherjee every week on The Wire as she connects the dots for us on The Wire Business Report.

In the first episode, Mitali Mukherjee takes a look at what this year has meant for small investors.

Samvat 2074 may well be a year that investors would want to forget quickly. Let’s take a look at what this year has meant for a small investor. Someone who’s setting aside, with some difficulty, a little piece of their earnings for a rainy day.

Fixed deposits that were often considered the “safest” haven – as also the bane of the equity market’s existence – suddenly seem to be not that safe anymore. PMC has taught people that they can be unceremoniously denied access to their own money.

Added to that, there’s a second googly in the FD universe. The RBI has introduced a repo linked lending rate regime – which basically implies quarterly adjustment of FD rates too.

Indian Miners Lobby Against Government Plans for National Coal Index

The index is central to Prime Minister Narendra Modi’s push to attract foreign investment in the coal sector, which could open up trading of coal futures and options.

New Delhi: Indian miners are lobbying against a government proposal to link a new coal index to international prices, documents reviewed by Reuters show, which could delay creation of the index.

India plans to create a national coal index to end state-run Coal India’s control over prices and privatise the coal sector, as the energy-hungry nation for the first time looks to invite bids from global firms for coal mining blocks by end-2019.

A government panel has proposed two price formulas, both of which use prices of imported coal to arrive at a benchmark, government documents reviewed by Reuters showed. One of the proposals includes a plan to link the index directly to a foreign counterpart, such indexes in Indonesia and Australia.

Both proposals would likely hike local coal prices closer to international prices, potentially denting local coal’s competitiveness as it is typically lower-quality.

The index is central to Prime Minister Narendra Modi’s push to attract foreign investment in the coal sector, which could open up trading of coal futures and options.

Also Read: Thousands Hold ‘Coal Satyagraha’ in Chhattisgarh, Say Public Hearing Was Staged

But the index faces an objection from industry group Federation of Indian Mineral Industries, which counts Rio Tinto’s India unit and India’s Adani Enterprises among members.

It wrote to the government in August arguing against basing prices on imported coal and urged it to instead base prices on Coal India’s fuel supply agreements and e-auctions.

(Reuters)

India to Exempt Foreign Portfolio Investors From Higher Taxes: Government Official

The official said the government will either issue a notification or an executive order to exempt foreign portfolio investors from the increase in surcharge on super-rich taxpayers. 

New Delhi: India is likely to exempt foreign portfolio investors from an increase in taxes that was part of the budget approved by parliament but heavily criticised, a government official said on Thursday.

The budget provided for increased personal income taxes on those with annual income of more than Rs 20 million ($283,045).

Also read: Union Budget 2019-20: All You Need to Know

The official, who declined to be named, said the government will either issue a notification or an executive order, which could be later submitted to parliament for approval, to exempt the foreign portfolio investors, mainly registered as trusts, from the increase in surcharge on super-rich taxpayers.

Barring Select Sectors, Nehru Was Not Opposed to Foreign Investment 

Those blaming the country’s first PM for today’s economic ills don’t know that in 1961, at least two-fifths of the organised large-scale sector and one-fourth of the entire modern sector in India was under foreign investment.

Note: This article is being republished on the occasion of Nehru’s 52nd death anniversary.

Sadly, in contemporary times, Jawaharlal Nehru, India’s first and tallest prime minister, is often misunderstood and misrepresented. Prime Minister Narendra Modi’s tirade against Nehru in Parliament recently shows this misunderstanding.

Often, Nehru is blamed for many ills in today’s India. Efforts are being made to damage his legacy. One area where Nehru’s legacy is often misunderstood is economic policy. He is often portrayed as a particularly dogmatic socialist leader who was against business and foreign investment.

The rich work of academics and economists like Michael Kidron, Nagesh Kumar, Arvind Panagariya among other scholars gives us a glimpse of Nehru’s approach towards foreign investment – an important part of economic policy.

Receptive attitude towards foreign investment

Contrary to popular perception, the Nehru government had a relatively liberal and open foreign investment regime. In early 1947, foreign companies were concerned about the fate of their investment in independent India as they feared nationalisation (i.e. the state forcefully taking ownership of foreign companies). Nehru was fully aware of these concerns. On December 15, 1947, Nehru told a chamber of commerce in Calcutta that his government would welcome foreign capital and technical assistance. Later, on April 6, 1949, Nehru himself articulated the foreign investment policy statement. In this statement, he noted that his government would encourage new foreign capital on mutually advantageous terms.

He promised ‘national treatment’ to foreign investors (i.e. no discrimination between domestic and foreign companies) and assured foreign investors of no restrictions on remittances of profits and dividends. Further, the statement noted that though majority ownership by Indians was preferred, foreign capital having control over a company for a limited period will not be objected if in national interest.

Nehru’s vision on foreign investment was re-articulated by his finance minister, John Mathai, who in his 1950-51 budget speech said that “foreign capital is necessary in this country, not merely for the purpose of supplementing our own resources, but for the purpose of instilling a spirit of confidence among our own investors”. Finance minister Mathai then went on to state that it is necessary for India to consider providing reasonable conditions of security and fair treatment to foreign investors who are willing to take the risk of investing their money in India. This not just showed a friendly attitude towards foreign investment but also underlined the importance of providing security and protection to foreign investment in India as a means to attract investors to India.

The credit for this relatively liberal stand on foreign investment goes entirely to Nehru because the 1948 Industrial Policy Resolution (IPR) had adopted a hostile tone to foreign investment. The resolution said that a law be enacted to scrutinise every single foreign investment project before giving approval and that, as a rule, the major interest in ownership and effective control should always be with Indians. This hostility towards foreign investment was shared by the Indian National Congress and also by the left-wing parties. In fact, even Indian private industry was not pro-foreign investment. As policy analyst Sanjaya Baru has observed, the ‘Bombay Plan’ prepared by leading Indian industrialists like JRD Tata and GD Birla, in 1945, asked the government to step in and fill the investment gap rather than allow foreign direct investment. The ‘Bombay plan’ wanted the Indian government to give preference to external loans and foreign aid instead of foreign investment.

But Nehru was pragmatic enough to understand that foreign investment was critical for India to plug the savings gap and to bring in valuable foreign exchange. Thus, while announcing the foreign investment policy statement on April 6, 1949, Nehru, guided by national interest and not any ideology or dogma, significantly diluted the 1948 IPR.

In the second five-year plan, in 1957, foreign investment was further liberalised by the government, giving a host of concessions and incentives to foreign investors. At the beginning of the third five-year plan in 1961, as Nagesh Kumar has written, the Indian government issued a list of industries where foreign investment was welcome. This included some industries that were reserved for the public sector like drugs, fertilisers, synthetic rubber and aluminium.

In 1961, according to Kidron’s estimates, at least two-fifths of the organised large-scale sector and one-fourth of the entire modern sector in India was under foreign investment.

Against nationalisations of foreign investments

An integral aspect of Nehru’s approach towards foreign investment was the absence of large-scale, ideology-driven nationalisation of foreign companies or foreign stock. On February 17, 1948, Nehru, in a speech to the Constituent Assembly, made a case against nationalisation by saying that “if we squander our resources in merely acquiring for the state existing industries….for the moment we may have no other resources left, and we would have spoiled the field for private enterprise too. So, it is far better for the state to concentrate on certain specific, vital, new industries, than go about nationalising many of the old ones”.

Nehru articulated the same view on nationalisation in his letter of March 3, 1953 to all the chief ministers. He also assured foreign investors that if their investments were nationalised, fair and equitable compensation would be given. Indeed, the Indian Constitution as adopted in 1950 recognised the right to property as a fundamental right.

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Padma Desai and Jagdish Bhagwati, in a paper written in 1975, argue that since Nehru’s approach towards socialism was Fabian-type gradualism, “nationalizations of existing capital stock were de facto ruled out”. Nehru’s stand on nationalisation was in complete contrast to what had happened in countries like Soviet Russia where foreign investment was expropriated by the state without compensation or restitution in violation of international law. This showed that while Nehru was inspired by the Soviet Union economic model, he was also fully aware of the excesses of communist regimes. He ensured that India didn’t make the same mistakes notwithstanding the popular sentiment against foreign investment prevalent at that time in a newly independent India. It’s remarkable that the prime minister of a country that had just got independence from 200 years of colonial plunder and loot by the British could show such intellectual and political courage.

Thus, barring some instances of nationalisation, guided by national interest, such as nationalisation of some foreign oil companies, in 1953-55; and nationalisation of the imperial bank that had 10% British ownership, foreign investment was not nationalised in Nehru’s India. Even where nationalisation took place, compensation was paid.

Nehru and investment agreements

Another less known fact about Nehru’s approach to foreign investment is that in 1957 and in 1964, as P S Rao – one of India’s leading international lawyers – reports, India entered into a limited investment protection agreement with the US and West Germany, respectively. Rao writes that India’s agreement with the US covered losses to American investors due to non-convertibility of currency, profits and capital-repatriation; and losses suffered due to expropriation or due to damage of physical assets caused by war, revolution or insurrection. Similarly, the agreement with West Germany also covered losses caused due to expropriation and non-convertibility of Indian rupees into West Germany currency. While these agreements were not full-fledged bilateral investment treaties (BITs), they did contain some elements of investment protection such as protection from unlawful expropriation and full protection and security, which are now widely recognised as an integral part of any foreign investment protection treaty.

None of this is to suggest that Nehru’s economic model was flawless. Indeed his five-year plans attracted criticism. T N Srinivasan, one of India’s leading economists based at Yale University, critiqued the excessive focus on capital and heavy industry. He argued that “had a greater share of investment been devoted to labour-intensive light manufacturing industries producing consumer goods to supply domestic and foreign markets, growth would have accelerated and reduced poverty much more than what was achieved during 1950-80.” Similarly, Milton Friedman, the great American economist who championed free-markets, critiqued the Indian investment strategy for focusing on two extremes i.e. capital and heavy industry, on one hand and handicrafts on the other hand at the cost of small and moderate size industry.

M R Masani and C Rajagopalachari (who founded the Swatantra Party –the only intellectually rigorous experiment in Centre-right politics in India, which failed) also critiqued Nehru’s economic policies for creating a ‘license-permit-quota raj’. Notwithstanding these weaknesses, the Indian economy grew at a healthy rate of 4.1% per annum from 1951 to 1965.

Why is Nehru’s legacy misunderstood?

For several reasons but, as historian Ramachandra Guha has consistently argued, a good part of this blame should be shared by Nehru’s heirs and his political descendants especially Nehru’s daughter, Indira Gandhi. It’s Indira Gandhi who gave Nehruvian socialism a bad name. From 1965 to 1980, India witnessed what Arvind Panagariya so appropriately describes as a phase where socialism struck with vengeance. Contrary to Nehru, Indira Gandhi, for political reasons, went on a nationalising spree. She nationalised banks in 1969, and from 1972-74, she nationalised a number of firms such as coal mines, copper, aluminium, general insurance and textiles. She imposed various layers of regulations on businesses by enacting draconian laws like the Monopolies and Restrictive Trade Practices (MRTP) Act in 1969 and the Foreign Exchange Regulation Act (FERA) in 1973. FERA, in particular, turned out to be disastrous for foreign companies leading to the exit of Coca-Colas and IBMs from India. In short, as senior journalist Inder Malhotra has argued, Indira Gandhi stretched the ‘license-permit-quota’ raj for too long, whereas after a stable and solid start from 1950-65, the time was ripe for India to move towards an outward-looking economic model based on export promotion as South East Asian countries had started doing. No wonder, the Indian economic growth rate fell to a miserable 2.9% per annum in 1966-80.

It finally took a massive balance-of-payments crisis in 1990-91, the collapse of communism in Soviet Russia and Eastern Europe, rise of China and spectacular success of South East Asian economies by using market-forces, for India to realise that it could no longer postpone its tryst with free markets. Finally, under the leadership of P V Narasimha Rao and Manmohan Singh, in 1991, India started its bold experimentation with free-markets. Since then, it has been a story of one step forward, two steps back.

In sum, to be fair to Nehru, he was a bold, visionary and a pragmatic leader guided by national interest and not merely by some dogma or ideology. The study of the foreign investment regime under his leadership shows this. True, he made mistakes like all leaders do. But he deserves to be judged fairly keeping in mind the context in which he operated. For this to happen, as Guha rightly says, Nehru needs to be rescued from his political descendants.

Prabhash Ranjan is an assistant professor of law at the South Asian University and a visiting scholar at Brookings India. Views are personal.

Moody’s Boost to Modi: What We Should and Shouldn’t Celebrate

The old rating of Baa3 has really not come in the way of either more foreign investment or higher foreign borrowing. So, is the celebration a little overdone?

The old rating of Baa3 has really not come in the way of either more foreign investment or higher foreign borrowing. So, is the celebration a little overdone?

narendra modi moody's rating india

On Friday, the credit rating agency bumped India up one notch. Credit: Reuters

The Narendra Modi government is celebrating the upgrade of India’s sovereign credit rating by Moody’s Investors Service. The new rating places India at Baa2, up a notch from Baa3. The outlook has also been raised from positive to stable, while other ratings including the one for short-term local currency have seen an upgrade by a notch each.

It is important to place Moody’s action in perspective and understand what this upgrade actually means. Also, what all should the government be wary about to maintain the newly acquired rating and even improve it further in the coming years?

India’s last upgrade by Moody’s was 13 years ago in 2004. And that was a far bigger development. That was when India re-entered the investment grade category on a rating scale devised by Moody’s, after a gap of six years. From June 19, 1998 (in the aftermath of India’s nuclear tests in Pokhran) to January 22, 2004 India remained classified in the non-investment or ‘junk’ category.

Things were not so bad in the 1980s. From January 28, 1988 to October 3, 1990, India had a credit rating of A-2, the highest investment grade rating it ever got. But on October 4, 1990, it was downgraded to Baa1 in the wake of India’s twin crisis of worsening balance of payments and fiscal indiscipline. On March 26, 1991, it was further downgraded two notches to Baa3, which was the last category of investment grade rating. On June 24, 1991, India plunged into the non-investment category at Ba2, a downgrade of two notches.

It was upgraded to investment grade at Baa3 on December 1, 1994 and remained there till early June 1998.

The investment grade under Moody’s rating scale has 10 notches, starting with Aaa, which has the smallest degree of risk, and ending with Baa3, which has a moderate credit risk. Till Thursday, India was at Baa3 and now it has moved up to Baa2.

Experts point out that the ten categories of rating under the investment grade are further classified under four broad groups. Aaa is ranked at the top with the smallest degree of risk. Aa1, Aa2 and Aa3 are categories that are meant for countries with a very low credit risk (China, for instance, is rated at Aa3) and A1, A2 and A3 are assigned to countries that are seen to be having a low credit risk. The fourth group consists of Baa1, Baa2 and Baa3, which are countries with a moderate credit risk.

Methodology politics

What has happened now is that India’s rating has moved up only one notch within the investment grade category and it still remains within the last group that classifies countries with a moderate credit risk. In other words, India’s credit risk profile continues to be defined as moderate.

Why it took so long for India to move only one notch within the investment grade category with a moderate credit risk profile is a comment on the effectiveness of Moody’s rating methodology as also on the government’s ability to influence the rating agency to recognise the many policy developments that could have merited an earlier upgrade.

In the last 13 years, investment flows from abroad have seen a steady rise and Indian companies have been borrowing more from overseas markets, though it could be argued that the terms of these loans could have been better with a higher rating from Moody’s. Nevertheless, a rating of Baa3 has really not come in the way of either more foreign investment or higher foreign borrowing. So, is the celebration a little overdone?

narendra modi
The Modi government is in a celebratory mood perhaps because it has now succeeded in convincing Moody’s to improve India’s rating. It has been trying to get an upgrade in the last couple of years, but it has succeeded only now. The Manmohan Singh government too had tried, but did not succeed in securing an upgrade.

The immediate impact of India’s rating upgrade will be positive in terms of access to foreign loans at relatively easier terms. Investment flows into the country are also likely to increase. Indian companies looking for loans and capital on easier terms would certainly benefit.

Warding off future downgrades

But its consequences for the government’s macroeconomic management may not be entirely positive.

One, the increased flow of foreign exchange into the country is likely to put further upward pressure to the exchange rate of the Indian rupee, which is already significantly overvalued. Exporters may not like further appreciation in the value of the Indian rupee, which went up on Friday after the decision on the rating upgrade became public.

Exports growth in the first seven months of the current financial year has been tepid and with an appreciating rupee the government’s task to promote exports will become even more challenging. Imports are also likely to see a surge with the appreciating rupee and this might not augur well for the country’s current account deficit that has already widened to over two per cent of gross domestic product (GDP).

Two, one of the factors that helped the rating upgrade for India was the government’s improved fiscal situation. In each of the last five years, the Union government has succeeded in reducing the fiscal deficit, though by a small margin. From 5.8% of GDP in 2011-12, the Union government’s fiscal deficit declined to 3.5% in 2016-17. The combined fiscal deficit of states and the Centre also has not yet gone out of control, though its progress at 6.4% of GDP in 2016-17 gave the Moody’s some confidence in India’s ability to stay on the path of fiscal consolidation.

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Therefore, the challenge of staying on the path of fiscal consolidation becomes even more pressing in the current year as also in the coming years. The fiscal deficit target of 3.2% of GDP for 2017-18 is under stress, as non-tax revenues have declined and the pressure on the fisc has risen on account of additional expenditure on account of public sector bank recapitalisation and infrastructure spending. There is also a demand from influential sections within the government to relax the fiscal deficit reduction targets and give a pause to the implementation of the fiscal responsibility and prudent budget management practices to be stipulated under a proposed law.

Meeting the fiscal deficit target for the current year and laying out a road map for further fiscal consolidation in the coming years is of utmost importance if the Moody’s rating needs to be upgraded further. Worse, if there is any slippage in meeting the fiscal deficit target, the rating will be adversely affected. “A material deterioration in fiscal metrics and the outlook for general government fiscal consolidation would put negative pressure on the rating,” says Moody’s in its statement on Friday.

Three, the government has to be mindful about the health of the banking system. Moody’s has warned that “the rating could also face downward pressure if the health of the banking system deteriorated significantly”. The government has laid out a Rs 2.11 lakh crore plan for recapitalising the state-owned banks.

But its implementation in itself is not a panacea for the banking sector. Recapitalisation will help the banks to improve their capital adequacy and increase lending. But equally important will be early resolution of their stressed assets, strengthening their management systems so that past imprudent steps like lending to risky projects are not repeated and a revamped ownership structure that makes them more nimble-footed and free from political interferences.

If the health of the banking system does not improve in the next year or two, the risks of a downgrade may lurk once again.

Four, India’s rating is likely to come up for a downward review if its “external vulnerability increased sharply”. For India, oil prices are certainly a factor. India continues to be hugely dependent on imported oil, whose prices of late have begun to rise. If these prices rise and the government is not able to manage their consequences in the domestic economy through prudent pricing policies, then the newly acquired rating can be subjected to a review. The government has to be cautious on this front.

And finally, India’s rating can be sustained and indeed improved if the government continues to stay on the path of fiscal consolidation and bring its debt under control. Moody’s has noted that the combined debt of the governments has risen to 68 per cent of GDP, which is significantly higher than the median rate of 44% for all countries classified under the Baa group. While there are many other positive countervailing factors in India’s case, but further growth in debt can be a cause for concern.

Similarly, stress on more institutional reforms and implementation of key pending reforms in the areas of land and labour laws could help Moody’s consider an upgrade for India. But given the current political situation, it is unlikely that the Modi government will like to spend its political capital for undertaking tough and unpopular reforms like those that will relax land acquisition rules and make labour laws more flexible.

For the present, the Modi government is content celebrating its rating upgrade by Moody’s. And why not? The ruling party at the Centre is fighting a crucial Assembly election in Gujarat, one of India’s foremost industrialised states. Less than three weeks ago, the World Bank released its 2018 Ease of Doing Business report that raised India’s rank in ease of doing business from 130 to 100, the highest jump that any country has seen so far in one year. And now, Moody’s upgrades India’s credit rating!

If elections could be won with the help of good economic news about India coming from international agencies like the World Bank or Moody’s, leaders of the Bharatiya Janata Party should consider themselves fortunate and the release of these reports quite timely.

By arrangement with Business Standard.