Advantage China: 5 reasons that hold back India from getting investors

Prime Minister Narendra Modi wants India to be "atmanirbhar (self-reliant)". The Rs 21 trillion stimulus he announced last week had a mix of reforms and incentives for foreign and domestic investors. The Prime Minister and Chief Ministers believe that India can court international business away from China, the world’s manufacturing hub and presumably the source of the coronavirus pandemic. Taking away China’s business won’t be easy. India, with its red tape and unskilled workforce, is a difficult place for business. Subhomoy Bhattacharjee lists five factors that pull down India in its race with China.

Subhomoy Bhattacharjee, Business Standard
19th May

The nearly Rs 21 trillion economic package Finance Minister Nirmala Sitharaman announced over five press conferences last week is meant to improve India’s ability to draw long-term domestic and foreign investments. A common theme marks the announcements: relief is linked to the future performance of a sector. Help for sectors dwarfs the immediate cash relief of about Rs 37,000 crore given—in the form of free food grains or trains to states—to millions of workers and their families suddenly left without income in the national lockdown to contain the coronavirus disease (Covid-19).

Steps like working capital relief for micro, small and medium enterprises (MSME), giving street vendors Rs 5,000 crore as credit facility, or allowing states to make additional borrowing of up to 5 per cent of the GDP (up from 3 per cent) are consistent with the aim to help revive India’s economy.

Prime Minister Narendra Modi has said the Rs 21 trillion package aimed to make India "atmanirbhar (self-reliant)", which "will prepare the country for tough competition in the global supply chain, and it is important that the country wins this competition".

An analysis of the five major reasons India is seen as a difficult place to do business explains if the package will make an impression on foreign investors.

Decide, quickly

On March 22, a day before Modi announced the lockdown, the union cabinet cleared a Rs 48,000 crore plan to encourage foreign investments by promoting large-scale domestic manufacturing of mobile handsets and their parts. The scheme, Production-Linked Incentive (PLI), was ambitious but it took more than a year to develop from the drawing board even though the Prime Minister’s Office had steered it. PLI was framed in the backdrop of the US-China trade war last year, but when it was finally announced the coronavirus pandemic has possibly made it redundant. PLI aimed to claw a large portion of a $485 billion annual global market, of which 60 per cent is shared between five companies: Chinese giants Huawei, Xiaomi and Oppo, USA’s Apple and South Korea’s Samsung.

As India woos manufacturers based in other countries, mostly China, it faces two image problems: slow decision-making and the threat of criminal action against company managements. Sitharaman addressed the second problem by offering “easy registration of property, fast disposal of commercial disputes, rationalization of related party transaction related provisions” and most significantly an assurance to decriminalise most offences under the Companies Act, 2013, including those under corporate social responsibility.

The Prime Minister’s Office had suggested forming an inter-ministerial committee of secretaries from the Niti Aayog, finance and commerce ministries to quickly roll out a scheme that eliminates India’s weakness in becoming a mobile manufacturing hub. That PLI still took so long shows why pulling in investments from China will be hard for India. Chief Ministers speak eloquently at investment meetings about single-window clearance systems in their states, but what they promise often doesn’t happen quickly or smoothly.

“Local agents often promise adequate infrastructure to the firms which is later not implemented as the hard infrastructure in India has several quality issue,” noted a paper that was written by Prof. Rupa Chanda, RBI chair professor at IIM-Bangalore, along with Mridula Roy, of the same institute, and that tracked Japanese investments in India. The State Business Reform Action Plan (BRAP) since 2014 has ranked states on being business friendly. BRAP, launched by the union government’s department for promotion of industry and internal trade (DPIIT) in partnership with the World Bank, has listed obstacles businesses face in states.

Chanda and Roy’s paper said Japanese investments are concentrated in business-friendly states of Haryana and Maharashtra. Guidelines in BRAP’s annual survey for 2019 said states have to be nimble in making decisions. “An investor/ entrepreneur should have information about all clearances/ approvals required to set up a business, to avoid running around to get such information”.

The survey said that, “In case where an investor has applied for multiple permits/ NOCs/approvals, the investor shall be notified as and when each approval is accorded, without waiting for other approvals”. That process should seem obvious, but clearly it is not so and it is one annoying reason for investment proposals falling through the cracks in India.

DPIIT’s guidelines say states must ensure that “all queries must be addressed within a timeline of 15 days”. A glaring example of delay in decision is the Ahmedabad-Mumbai bullet train project Japan is financing with a soft loan of 13.8 billion yen that comprises 81 per cent of the cost. Modi and his Japanese counterpart Shinzo Abe agreed upon the project at a summit in December 2015 summit but construction began three years later in 2018.

Labour, ‘a very severe obstacle’

The centre and states have reformed their labour laws, prompted by the economic crisis caused by the lockdown. The centre plans to combine 40 labour laws into four codes—a well-conceived decision, say analysts. States have an average of 52 labour laws each but their attempt at reforms is unlikely to impress investors. Uttar Pradesh, Madhya Pradesh and Assam have suspended about 45 of their laws by administrative notifications or ordinances. For example, the “Uttar Pradesh Temporary Exemption from Certain Labour Laws Ordinance, 2020” does not commit that the changes will be permanent. States may announce labour reforms but there are central government laws in force, too. Investors prefer stability rather than back and forth to make decisions.

“Labour intensive sectors feel more constrained by labour related regulations. More of them report that finding skilled workers, hiring contract labour, and terminating employees is a major or very severe obstacle,” said a joint Niti Aayog-IDFC report in 2015.

About start-up companies, the study said getting construction permits and environment clearances takes more time than complying with labour laws. Each clearance takes time, so it is difficult argue that the low level of investments in states like both Madhya Pradesh, Uttar Pradesh and Assam has to do with labour laws. For instance, a union labour ministry matrix on legal reforms in states shows that Uttar Pradesh has not set up a timeline for delivery of government services. Maharashtra, Goa, Odisha and West Bengal are yet to make it mandatory to pay workers' wages in bank accounts. Those are labour reforms, too.

In this context, the measures Sitharaman announced in her economic package are promising. These include universalisation of minimum wage and timely payment of wages to all workers including unorganized one. She has also proposed employers must offer all workers an appointment order, including presumably those on contract. These measures are subject to how states carry them out. The risk for investors is to guess how many and in which order reforms in this large menu will be implemented.

Spare capacity

India has a massive spare capacity in sectors like steel, said Seshagiri Rao, joint managing director and chief financial officer at JSW Steel, at a webinar organised by Care Ratings last week. Capacity is unlikely to be used fully for several quarters because of the demand destruction in the economy. “We need to firm up policies to make steel exports viable. That is where we are looking at present,” said Rao.

It is the same for most other sectors, said Sanjiv Chadha, managing director and chief executive officer of Bank of Baroda. “It will be close to nine months before normalcy returns and it is debatable what that normal would mean”, he said. A report by Crisil, a ratings and research agency, said there would be a 22 per cent contraction in demand for consumer discretionary products, like automobiles and consumer durables, in Financial Year (FY) 2020-21 and a muted recovery thereafter.

A consequent dip in capacity utilisation means any additional investment is ruled out till FY 2021-22. It is difficult to figure out how any investment from China or elsewhere could see profits for some years in these circumstances. The investments would most probably be in capital-intensive sectors, which means a higher capital to output ratio. The Niti Aayog-IDFC paper notes that such investments would most likely be in auto, auto parts, two wheelers, automobiles, engineering goods, petroleum refining, pharmaceuticals and software.

Not skilled for the job

Most of India’s labour force is of no use for its industry. Data from the skill development ministry shows just 3.3 million of the country’s 450 million workers had got some sort of skill training by January 2020. Of them just half, or 1.7 million, had a job. In a sunrise sector like electronics, a government reply in Parliament noted that the Electronic Sector Skill Council of India had trained just 2.83 lakh people in three years till FY19. Less than 50 per cent of the trained people found a job. In states considered less developed, like Assam, governments have tried to protect unskilled labour with nativist measures.

A Deloitte report for DPIIT notes “majority of the small and micro units …all the industrial units in the State are mandatorily required to employ 90 per cent of their total workforce from within the State, which becomes difficult in the absence of skilled manpower”. As a result, companies considering making India their base will have to finance large-scale training of the workforce before employing them. Companies would rather wait for someone else to train workers, whom they can draw away with incentives later. The government has large-scale training programmes, but their success is modest.

The Pradhan Mantri Kaushal Vikas Yojana has trained 7.3 million people after it last year got a target of training 10 million in four years. Media reports though say a majority of the people trained either were dissatisfied or didn’t find employment. Less than 3 lakh people have been trained under the revamped Apprentices Act, which was to reskill 50 lakh by 2020. India’s unskilled labour is a disincentive for any manufacturing company to relocate from China’s coastal industrial belt where there are millions as trained human resource.

Power shock for investors

To reform the power sector the government has proposed to amend the Electricity Policy, 2003. To prepare for reforms, the centre has offered a Rs 90,000-crore bailout for electricity distribution companies. This brings on a sense of deja vu. A Bill in 2014 proposed similar amendments, but it failed when states did not agree to it. It is not difficult to figure out why. The electricity sector was in losses then. States wanted the financial load of electricity distribution companies to reduce before agreeing to give up the money-spinning parts of the power sector. But five years later, discoms' cumulative dues to power generation companies are worse, reaching Rs 85,000 crore in December 2019.

“We have been pleading with the centre to clear this legacy dues of the discoms. Because of Covid-19 the new revenue deficit of the discoms is going to be phenomenal, my estimate says it could be close to Rs 30,000 crore of fresh dues,” said Anil Sardana, managing director and chief executive officer of Adani Transmission.

Exasperated, the centre in June 2019 made it mandatory for discoms to prepay power generators through Letters of Credit (LC) issued by banks. It effectively meant the discoms were to fend for themselves.

Power sector in India is in a fix: there is surplus generation capacity but cash-starved discoms cannot afford to buy it. A new investor would have to secure captive power plants, with all the attendant problems of securing coal linkages, establishing transport network for the fuel and then having to get environmental nod.

The centre plans to liberalise coal mining, throwing it open to commercial miners on the same terms as is applicable for the oil and gas sector. That should help companies needing assured power supply. Rules for mining, too, have been eased to allow joint mining leases for more than one minerals. It has taken 50 years to reach this level of clarity.

The centre has to notify changes in laws for reform in these sectors. That will take time. Meanwhile, the clock is ticking for investors planning to move out of China. The presence of so many moving parts has stymied the best domestic investors in India, and it could be most uncomfortable for foreign investors.

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A few links for further reading

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