Sunday ET: After news of slowing growth & imminent ratings downgrades, will US investors go cold on India?

By: William Avery

We Americans are not big on nuanced judgements. Up or down. In or out. Hero or zero. With us or against us.
Since the turn of the millennium India has been hot as a destination for American investors. Over the past 12 years companies from the US have made cumulative foreign direct investments (FDI) of over $10.6 billion in India.

So when American investors see the recent news from India — slowing growth, corruption, planned retroactive changes to tax laws, imminent ratings downgrades — will they now go cold on India?

Not likely, for two reasons: because India has become too important globally to ignore; and because competition among Indian states to lure investors will compensate for shortcomings in central government policy.

The recent actions of the Indian central government, especially the planned retroactive changes to tax laws, suggest policymakers reckon that India has reached a level of significance in the global economy such that foreign investors cannot afford to ignore it. They may well be right.

India is now 3% of nominal world GDP (6% in purchasing power parity terms), and however fast it grows — whether 9%, 7%, or even 5% — it will only gain in significance as it outpaces the US, with Europe and Japan even farther behind.

What Kind of Investment

The question is not whether foreign corporations and financial investors will come to India, but what types of investments they will make. The nature of these investments will determine whether India achieves the kind of economic growth needed to begin to lift 400 million people out of poverty.

Every dollar of foreign investment is not created equal. The Sensex crossed 20,000 in 2008 partly on the back of strong foreign fund inflows the previous year. The inflow turned to an outflow in 2008, with foreign investors pulling nearly $500 million out of India-focused funds in October 2008 alone; by the end of the year the Sensex had lost over half its value. Easy come, easy go.

Nothing the Indian central government has done (or failed to do) will keep such financial investors out of India. They may lighten their allocations to India, they may switch to more defensive sectors, they may even short the market now and then, but they will not ignore India.

American mutual fund dollars, however, is not what India needs. India needs firms from the US and other nations to make large, and largely irrevocable, bets on fixed-capital investments in manufacturing.

An investment in fixed capital is the FDI equivalent of putting a wedding ring on India’s finger. Anything short of that is just a fling: both sides might have some fun (make some money), but at the first sign of trouble in the relationship, the investor can be out of India.

The Factories

Such fixed investments have great value to India, and not just because they are as difficult to unwind as a marriage. Manufacturing FDI is just what India needs if it is to achieve poverty reduction.

When the Ford Motor Company was planning its first factory in India in 1995, it was negotiating with two states — Maharashtra and Tamil Nadu. The story goes that J Jayalalithaa, then as now chief minister of Tamil Nadu, directed her staff to do whatever it took to get Ford to the state, saying that if Ford comes, the others will too.

Ford came to Tamil Nadu, and the Chennai region became a major centre of automobile manufacturing, home to not just carmakers but countless component suppliers as well. Tamil Nadu and its citizens have earned back a thousand times over whatever concessions Jayalalithaa gave to lure Ford.

One Equals Four

Jayalalithaa realised instinctively what economists have demonstrated to be true: for every job created in manufacturing as many as four others are created in downstream, upstream or adjacent industries.

One American component supplier in the heat-transfer industry is currently considering a $10-million investment in western India for one reason only: its largest customer, also American, is itself planning to build a major factory in the same state. Thanks to investments like these, India’s domestic supply chain is strengthening across a broad range of manufacturing sectors, bringing jobs and opportunities to the nation’s poor.

The Ford story shows that there is one thing that can save India’s central government from itself: the states. Gujarat chief minister Narendra Modi made news recently by summing up his policy toward investors as “no red tape, only red carpet.”

No matter how paralysed central government policy is, there will always a few enterprising chief ministers eager to bring foreign investors to their states. Given the balance of state and central power in India, there is little that the central government can do (short of nationalisations) to completely thwart such a chief minister.

So American and other foreign investors will continue to flock to India; the growth produced by two decades of economic liberalisation has ensured that. To be sure, if central government policy is welcoming, then more investors will make big-ticket capital investments.

But India is a big place, and even an incompetent central government cannot possibly foul up the entire country. The 400 million Indians still living in poverty can be thankful for that.
(The writer, a former US diplomat, is the author of China's Nightmare, America's Dream: India as the Next Global Power)