India too expensive for business

Budget 2013

Without adequate labour at a relatively low cost, investors will opt for Bangladesh or the Philippines

As Finance Minister Chidambaram prepares to present his Budget, the UPA will be hoping he recreates the magic of his ‘Dream Budget’ of 1997.

That exercise may have finally fallen far short of the promise it held, but the Government could do with even a short-term feel-good exercise.

It will not only counter the negative political image the UPA has developed in recent months, but could also help create an environment that would revive the ‘animal spirits’ in investors.

In trying to recreate the popular approval he received 16 years ago, Chidambaram will have to come to terms with the many changes that have taken place since then. In 1997, there was little ambiguity about the reform wish-list of the different stakeholders.

Chidambaram just had to meet the diverse demands — even if it did not all add up — and it became everyone’s dream budget.

Fading clarity

In contrast, today, at least some of the clarity on what constitutes an ideal reform has been lost. We were told for months, if not longer, that allowing foreign direct investment in multi-brand retail was the signal global investors were waiting for.

The Government absorbed the political pain that went with the decision in the apparent belief that it would mark a turning point in the attitude of foreign investors to India. But if there has been any such dramatic turnaround in investor attitudes, it remains an extremely well kept secret.

While there may have been the predictable statements of appreciation from industry, the mood of foreign investors remains deeply apprehensive. This disdain about the Indian economy is not confined to foreign investors. Indian investors are just as keen to invest abroad rather than in India.

This tendency to prefer foreign locations for a significant portion of their investments extends from major Indian business houses taking over global brands in the developed world to smaller Indian exporters.

The problem then is not one of whether the Government allows foreign investment in one sector or the other, but the conditions that investors face in the Indian economy.

The Budget has to address the fact that the costs of doing business in India are too high for investors of all hues.

Reforms and rising costs

Unfortunately, the discourse over the costs of business in India has been preoccupied with two elements: The macro problem of inflation and the micro one of dealing with corruption.

While it can be no one’s case that these are not important factors requiring close attention, the focus on them has been so overwhelming that little attention has been paid to an equally critical question: Is there anything about the reform strategy that has contributed to the rising costs of doing business in the country? It is becoming increasingly evident that the reform process has been less sensitive to the relative costs of doing business in India than it should have been. Much of the attention has been confined to a single indicator: The rate of inflation.

The preoccupation with the inflation rate has been so complete that the Government has not hesitated to use anti-inflation measures, such as high interest rates, that increase the costs of doing business. There has been little attention paid to developing a strategy against inflation that is more sensitive to costs.

The insensitivity to costs has, arguably, had its greatest impact on India’s original advantage of relatively cheap labour. The reformers have been so keen to develop infrastructure that foreign investors will feel at home in, that little attention has been to the costs of that infrastructure. This high-cost infrastructure has typically been concentrated in a few cities. The reform process has then insisted that the user must pay for this higher cost infrastructure. This raises the costs of living in cities with the infrastructure.

Labour concerns

If the wages rise fast enough to meet this increase in costs, the labour costs become greater than the alternatives available to foreign investors. And if the wages do not cover the higher costs of living in the cities, the workers are less likely to come to live in them. Without adequate labour available at a relatively low cost, there is no reason for investors — foreign or Indian — to prefer this country over its competitors, whether it is garment manufacturing in Bangladesh or Business Process Outsourcing in the Philippines.

A 2013 version of the dream budget would then break out of the foreign-versus-Indian-capital dogma of the liberalisation debate so far and focus on the challenge of reviving the cost advantage that India needs to attract investment of all hues.

Whether this is done by making major Indian cities more welcome to labour or by developing new centres are matters of detail. The Budget must demonstrate that the Government is willing to look for innovative instruments to make the Indian economy more attractive to investors. In order to do so, the Government must acknowledge that among the many changes that have taken place since the reforms began, the strategy of simply opening up the economy has lost much of its potency. Most of the low hanging fruits of the reform process have been plucked.

As it evaluates the more uncertain options, the Budget must be willing to recognise that, like the Nehruvian ideology before it, liberalisation too can outlive its utility.

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