Why India Is Not a Destination for Foreign Direct Investment

In late November 2011, Indian Prime Minister Manmohan Singh and his Congress Party capitulated to their coalition partners, Trinamool Congress and the DMK, opposition parties and small traders, on an earlier decision designed to expand foreign direct investment (FDI) in the country's nearly $550 billion multi-brand retail sector. India had witnessed a $29.4 billion FDI decline in Fiscal Year (FY) 2011, a 28 percent decline from FY2010, and slipped to the 14th position among highest FDI destinations from the 8th in 2009. Of more recent vintage, India's industrial output through March 2012 shrank 3.5 percent from a year earlier.

The Singh government had agreed to allow major multi-brand retailers, such as Wal-Mart and France's Carrefour SA, to open superstores and to own 51 percent of a joint venture (what single brand retailers, such as the United Kingdom's Marks and Spenser, are presently allowed). In return, these multi-brand retailers would agree to domestically invest at least $100 million (with 50 percent of this investment in developing Indian infrastructure), source at least 30 percent of their products from local suppliers, and confine their operations to 53 cities with populations exceeding one million. Presently, these retailers are restricted to operating only wholesale joint ventures in India.

Although the Singh government did not need Parliament's approval for its decision to allow expansion of FDI by these multi-brand retailers, the Prime Minister announced to Parliament that the earlier decision will be suspended until a political consensus is reached, as those opposed argued that millions of small shopkeepers would be left unemployed by the policy change. In contrast, Commerce and Industry Minister Anand Sharma forecasted that this new influx of retail FDI would generate over 10 million new domestic jobs (with 5 to 6 million in logistics) over the next three years. Minister Sharma recently stated that he hoped a consensus could be reached on this issue, and his department is holding discussions with all stakeholders, including consumer associations and farmers.

The largest fraction of retail business is in the food sector (63 percent of the total in 2003), where retail stores and employment are merely the tip of the iceberg. The entire Indian food supply chain rests in a state of morbid inefficiency - an economic and humanitarian disaster. There are more than 500 million people dependent on small scale farms in India who have been exploited socio-economically for generations by lack of infrastructure, dominance of feudal landlords, higher castes, money lenders, wholesalers and traders. Many of these small scale farmers are in favor of FDI in retail.

In late December 2011, the Singh government faced another political embarrassment when the Indian Parliament failed to enact long-awaited major anti-corruption legislation - an issue that has helped keep FDI out of India. The Singh government had promised to successfully address the issue before year's end, and proposed to establish a national corruption administrative body, or Lokpal, to assuage concerns among foreign investors that the Congress Party is unable to enact needed policy changes.

Corruption is a deeply contentious issue in India, as political parties engage in giving and taking bribes as the political landscape shifts among parliamentary alliances. In 2008, a government auction of telephone licenses at below market prices cost the Indian government an estimated $36 billion. Recently, graft attached to the 2010 Commonwealth Games in New Delhi resulted in $4 billion "disappearing." A popular anti-corruption movement galvanized grassroots political protests in India in the latter half of 2011.

As in the earlier vote on expanding FDI opportunities for multi-brand retailers, the Trinamool Congress Party, led by West Bengal Minister Mamata Banerjee, blocked the anti-corruption legislation because of opposition to a provision in the legislation requiring Indian states to establish their own version of an anti-graft administrative body - even though the party had agreed with the provisions in the bill when it had passed through the Indian Parliament's lower house, or Lok Sabha, two days earlier. Further, on March 30, 2011, a tribunal suspended approval of an already approved $12 billion steel plant in Orissa by Posco from South Korea, citing reasons pertaining to impact on the local tribal population and environment.

And to add further insult to injury, with Indian government officials only recently promising to promote policies that would be favorable to FDI, the Singh government proposed a Union Budget containing two dozen new taxes targeted at foreign investors designed to help close India's anticipated budget and trade deficits. In response to these new tax proposals, a coalition of seven major business associations, representing some 250,000 companies located in the U.S., Canada, Britain, Japan and Hong Kong, sent a letter to Prime Minister Singh warning that this proposed budget "is now prompting a widespread reconsideration of the costs and benefits of investing in India."

It is anticipated that the Indian Parliament will pass this budget, including its new FDI taxes, in the near future. With The Times of India reporting that the Samajwadi Party is now cooperating with the Congress Party-led UPA government, it is anticipated that the first challenge for the Singh government will be to allow for 51 percent FDI ownership by major multi-brand retailers. This initiative is ostensibly to be part of the Singh government's effort to roll out its 2012-13 reform agenda.

The conflicting signals from the Congress Party and Prime Minister Singh's government are reflective of the presiding government's overall weakness at creating an environment conducive to FDI. It is also a result of a legislative structure that, as of the 2009 elections, consists of a 543 seat Lok Sabha, with 364 political parties arranged in four identifiable coalitions, or fronts, and a remaining fifth group of members that are non-aligned with any other political front.

Given this fragmented national legislative structure, the weak leadership exhibited by the Singh government, and the inordinate bullying power that a tiny political entity, the Trinamool Congress Party, wields, one has to ask a fundamental question: Are India's political governance institutions up to the challenge of establishing an environment conducive to encouraging FDI and full membership in a 21st century global political economy? The verdict is still out.