Monday, June 4, 2012

Investing in India: The Governmental Risk


In Mckinsey’s Report, “What happens next?”, the section titled, “The state market,” notes that businesses will have to depend heavily on governmental reforms in fiscal policy if they are to find success in a particular country; “The reason is simple and compelling: no single factor is more likely to reverse the global economic expansion than a widespread failure by these states to meet the challenges that face them. This threat cannot be taken lightly. Suboptimal policy choices will dampen economic growth; bad choices could, in the worst-case scenarios, threaten geopolitical stability. This may well be the biggest macro-risk businesses face in the decade ahead.

The last statement is particularly relevant when applied to a country like India. First, the GDP growth rate reached a nine year low at 5.3%.[1]  In fact, some fear that India’s double digit growth rate was far too optimistic considering that it “has grown pretty consistently at 6% since the mid 1980s, with the exception of a faster period in 2004-2007.”[2]

Second, foreign investors are suffering due to the government’s inability to allow them access to the Indian market. For instance, in 2011, retail stores such Wal-Mart and IKEA were given access to India’s market for a couple of minutes at most. The Indian government made changes to its policy on banning foreign supermarkets, only to revoke the decision immediately afterwards. 

Third, even when the government does grant access, it can change its mind and the country’s regulations, as it pleases. Take the example of Vodafone, a company that won a Supreme Court case on the government’s decision to retroactively tax its acquisition of Hutchison Essar in 2007. But the finance minister then proceeded to make amendments to the very law that protected Vodafone. Now the company faces a tax charge estimated at Rs. 20,300 crores ($3.594 billion!).[3] According to an article in The Economist, Vodafone remains committed to its investment of $18.6 billion, “even though its value has fallen by perhaps a third since it was made in 2007.”

The same article cites that companies such as Vodafone and IKEA remain hopeful because “India is still growing faster than economies in the rich world and has vast potential as a manufacturing centre and as a market.”[4] Maybe the government will be forced to revise its policies given the poor economic outlook (even the rupee has reached a record low rate of 56.50 to one dollar) and the danger of losing the upcoming elections in 2014. Until then, companies will have to take into account the effects of political incompetence and indecisiveness when looking to invest in India

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