Two recent reports paint different pictures of India as a business destination. The World Bank?s ?Doing Business? report ranks India at 122 out of 181 economies. In its neighborhood, India is found to be better than only Bhutan and Afghanistan as a place for doing business. It ranks as among the worst in the world in contract enforcement and payment of taxes. In short, the report heavily downgrades India as an investment location.
UNCTAD?s ?The World Investment Report? (WIR) hails India as the second most attractive FDI destination in the world. The cross-country data on FDI inflows vindicates this optimism. India is found to be the 4th largest recipient of FDI in 2007 in East, South and SouthEast Asia. At $23 bn, it was the 8th best FDI performer in the developing world last year. More importantly, it?s catching up fast with FDI hotspots like Singapore ($24.1 bn), Saudi Arabia ($24.3 bn) and Mexico ($24.7 bn). Is doing business a non-issue for FDI then?
A foremost factor for long-term investors is the size of the domestic market. This is followed by the availability and costs of skilled labour. Then there is the ease and cost of raising financial resources in host countries. Export-oriented investors watch out for infrastructure like storage facilities. And all of them look long and hard at the prospective returns on investment.
India scores well in most of the above except infrastructure. Difficulties in acquiring land, setting up factories, obtaining electricity connections and other permits add to transaction costs, which increase with subsequent supply constraints. Transaction costs are very important, so why aren?t they spoiling India?s FDI party?
The answer is that high transaction costs are not ?sufficient? conditions for discouraging FDI. Investors are prepared to factor in these costs if they perceive substantive benefits from other attributes of the host economy. Both China and India are ranked pretty low in doing business, yet they are among the largest recipients of FDI. Their strong locational attributes like large markets and a wide pool of skilled labour are viewed by long term investors as sources of benefits capable of negating transaction costs.
In markets with high transaction costs, what can help are incentives like tax holidays, single window clearances and access to industrial land, as can creating fenced enclaves with world class infrastructures,a strategy that worked well in China. In India too, despite the sound and fury over their justification, SEZs have got some incremental FDI.
A key aspect that often goes unnoticed in India?s FDI story is that 60 per cent of India?s FDI is located in ?knowledge-intensive? services like IT, tourism, management consultancy, telecom, refining and exploration. All these segments depend critically on skilled labour, which is also essential in India?s key FDI-attracting manufacturing segments like automobiles and pharmaceuticals. In all these industries, FDI
investors look for efficient skilled labour and also assess the economy?s capacity to maintain this labour?s efficiency over time. This needs well-developed technological capabilities and quality higher education. Only a well-qualified and technically sound labour force can adapt to the challenges of reorganisation in production processes. Something that?s taking place in these industries all the while!
This is where India appears to have moved ahead of several others. Many developing countries got stuck to good application of ?know-how? and couldn?t graduate to the next higher level of creating ?know why?. But India has done so thanks to both public and private R&D efforts and outstanding human skills.
Long term investors in India are not fools. They will continue to invest here till our quality skills score higher than those of most others. Notwithstanding India?s poor skills in doing business!
The author is a visiting research fellow at the Institute of South Asian Studies in the National University of Singapore. These are his personal views