When Intel president Craig Barrett was asked what was the biggest

hindrance to investing in India when compared to China, he said that

the quality of infrastructure in China was far superior. The absence of

adequate roads, airports, power and a world-class telecommunications

network is the greatest constraint preventing India from achieving the

high GDP growth rate that it covets, and that its neighbour China

demonstrates so impressively every year.

FDI averaged about 1.7% of GDP in the past few years, in an economy

that is growing at an average annual rate of 6% since economic reforms

started in the early 1990s. According to figures put out by the

Ministry of Finance, FDI inflows in the fiscal year ended March 2003

fell 24% to just $4.6bn from $6.1bn in the previous year. Despite the

new expanded definition put out this year of what constitutes FDI (it

now includes reinvested profits by multinational companies) in line

with global practice, China still gets about 10 times as much FDI

annually as India does.

PM positive

In an interview with the Financial Times published in early November,

the Indian prime minister, Atal Behari Vajpayee, dismissed the

suggestion that FDI into India would remain far lower than that into

China. He said that in the past five years his coalition government had

strengthened the institutional base for reforms, including the

regulatory framework in the telecoms and power sectors, that had

contributed to the growth and privatisation in these key sectors.

Ceilings on foreign investment in protected industries were being

raised and a new law would help to set up special economic zones in the

country that would be free of restrictive tax and labour rules, he said.

But foreign investors complain that progress is too slow and halting.

Singapore Airlines, Cogentrix and P&O (see box) pulled investments

committed to India because of entrenched xenophobic lobbies in the

nationalist government and bureaucratic apathy. Foreign direct

investors who made large investments in power and telecoms, two key

infrastructure sectors singled out by the prime minister, are still

locked in litigation with the government and regulators over their

investments.

The stalemate between the Indian government and foreign sponsors over

the $3bn Enron-promoted Dabhol power plant in western India, once

billed as India’s biggest foreign investment, has perhaps inflicted

lasting damage to India’s prospects as an investment destination. The

plant has been shut for more than two years after the state-owned power

distribution company refused to pay Dabhol the “high” tariff for power

and annulled the contract. The Indian government, which stood guarantee

to part of the contract, has not been able to renegotiate the tariff or

find a new buyer. The foreign promoters, which include General Electric

and Bechtel, want to sell out but the issue is mired in so much

litigation that a solution is unlikely to be found soon.

Telecoms tangle

In telecoms, the government changed the rules of the game in the late

1990s, resulting in a similar tangle of litigation. Mobile phone

companies have challenged the move to allow fixed line phone companies

to provide limited mobile phone services using a cheaper CDMA (code

division multiple access) technology. That, they allege, is a violation

of the contract under which they purchased mobile licences from the

government. In late October, the telecoms regulator directed a

fixed-line Indian phone company that bent the rules to grab a chunk of

the mobile phone market to pay a penalty. But the government also

proposed to do away with separate fixed line and mobile licences and

bring them under a single unified licence.

The mobile phone companies, which together have 19 million subscribers,

are pressing for compensation of about Rs180bn ($4bn) for the licence

fees that they have already paid, a plea that has yet to be heard. “GSM

[Global Standard for Mobiles] companies must be compensated [for the

licence fees paid] if a unified licence is to be introduced,” says

Donald Peck, who heads CDC Capital Partners, a private equity investor

in mobile phone company BPL.

Mr Peck concedes that rapid change in technology is challenging all

telecoms companies but asserts that it is important for the regulator

to keep up with the changes and also be seen as fair and even-handed.

“Late entrants have done better in this sector. They pay lower

equipment costs and licence fees. We are ahead on the market growth

projections we made three years back, but revenues and profits are

lower than we expected. Consolidation is inevitable,” Mr Peck says.

Raising the ceiling

Limits on foreign investment pose another challenge. Current rules

limit FDI in telecoms companies at 49%. A move to raise this limit to

74% has been delayed because the government is having second thoughts

on the “security concerns”, an issue raised by nationalists opposed to

foreign control in Indian companies. When Bharti Tele-Ventures,

part-owned by Singapore Telecommunications and private equity firm

Warburg Pincus, launched its IPO last year, foreign portfolio investors

could not buy many shares because foreign ownership in the company was

already about 40%. Mr Peck says that Indian regulations put foreign

portfolio and direct investment under the same limit, and if foreign

private equity investors (FDI under Indian law) cannot sell their

shares to foreign portfolio investors, they often have to settle for a

lower exit price.

Stock market strife

Local stock market regulations can get in the way, too. CDC invested in

Satyam Infoway, an internet access start-up, before the boom in

internet stocks. At its peak, Satyam Infoway could not be listed in

India because Indian listing rules required that a company must make

profits for three years before it goes public. The company listed on

Nasdaq instead but CDC could not sell its shares because the Indian

rules then barred the conversion of Indian shares into American

depository receipts (ADRs). The rules have since changed and CDC

converted its shares to ADRs, but the boom is long over.

Several foreign insurers that have joint ventures in India, such as

Prudential, Standard Life, Aviva, Sun Life, American Insurance Group

(AIG) and Allianz, consider the cap on foreign equity in insurance –

26% – very restrictive. Given that the insurance business involves

entering into long-term contractual relationships with a policy-buyer,

companies cannot be seen to be capital deficient or financially weak,

says Sunil Mehta, who heads AIG’s investment arm in India. Moreover,

because foreigners can own 100% of an Indian asset management company

and, from early this year, up to 49% of private Indian banks, there is

no reason why investment in insurance companies should be pegged lower,

he adds. Most insurers want the limit raised to 49%, a level endorsed

by both the insurance regulator and a government-appointed panel on FDI.

Sensing opportunity in a country where just two state insurance

companies served one billion people, insurers waited three years before

India’s parliament finally passed the law opening up insurance in the

late 1990s. Frank Wisner, a former US ambassador to India who later

worked for the AIG, was among those who lobbied for opening up

insurance. AIG signed a Memorandum of Understanding with the Tata group

in 1994 and has set up two joint venture insurance companies, one for

life insurance and the other a general insurance company.

Benefits for all

AIG’s Mr Mehta points to the “collateral benefits” of opening up to

long-term capital. “New jobs are created, new consumers are being

serviced and more long-term capital is being invested in the capital

markets that go into building the roads, power plants and ports that

India needs,” he says. Current rules put the minimum start-up capital

for an insurance company at Rs1bn ($22m). This means that foreign

equity is capped at about $6m (26%), a level of investment that does

not warrant serious attention of a large global insurance company, Mr

Mehta notes.

Many put the restrictive rules down to a colonised mindset that

distrusts foreigners. Critics of liberalisation argue, for instance,

that foreign insurers will repatriate Indian savings abroad. That

charge is unfounded, says Mr Mehta, because Indian insurance companies

are not allowed to invest offshore and, given that the business takes

at least seven years to break even, there will be no profits to

repatriate. AIG’s private equity arm has moved foreign savings onshore

by investing about $450m in Indian toll roads, bridges, telecoms,

biotech and retailing companies, he says.

Privatisation is slow

Privatisation, started more than a decade ago but, dogged by political

opposition, has failed to attract much FDI. Japanese company Suzuki, a

long-time partner in a local car venture, finally wrested control over

it in 2002 after private competitors had whittled down its dominant

market share. In August 2003, CDC Capital Partners bought Punjab

Tractors in a $50m privatisation sale and, even though the deal was

struck with the government, it took two months for the Foreign

Investment Promotion Board to clear it.

The sale of National Aluminium was pulled last year after opposition

from both workers and politicians. The privatisation of public sector

oil and gas companies faces several roadblocks because the minister in

charge of them is a staunch nationalist. Last year, Indo British

Petroleum (IBP), a state oil company, was put on the block, only to be

bought by Indian Oil, another state oil company, which bid an

exorbitant price for it.

In September 2003, the Indian Supreme Court put off the sale of

Hindustan Petroleum, billed as India’s first billion dollar

privatisation sale, ruling that parliament must first clear the sale.

Several foreign oil companies looking to enter India’s growing and

newly deregulated oil marketing sector are keen to buy Hindustan

Petroleum. Anglo-Dutch energy company Royal Dutch Shell lost the bid

for IBP and bankers say it was interested in Hindustan Petroleum.

Investment plans

Shell is an important FDI investor in India, having committed firm

investments of more than $750m to the country, including a $600m port

and India’s first private sector liquefied natural gas (LNG) terminal,

which was completed in September.

The energy sector, where Shell’s investments are focused, is moving

from a regulated to a deregulated structure. This has opened up

opportunities for foreign investors, such as Shell, to enter a vast and

growing market, but it also brings challenges. For instance, gas

transportation is still controlled by the government and state

companies. The rules guiding access to the existing pipeline grid by

new private companies is best mediated by a regulator. A new petroleum

regulatory bill is awaiting parliamentary approval, but until that

happens private companies must negotiate a mutually agreed tariff

royalty with the government. Also, the government still sets the

ceiling and floor prices for natural gas; in a competitive environment

the market should set product prices.

Shell India’s chairman, Vikram Singh Mehta, says: “The challenge is to

move from the past, when the government was the regulator, to setting

up an independent regulator. Companies such as ours can work in this

new set-up.” He would not say whether Shell would bid for Hindustan

Petroleum if it is put on the block. It has plans to grow organically

and is working on the first phase of its retail oil-marketing plan to

set up its gas stations by next year, he says. Shell recently received

government approval to set up 2000 retail gas stations.

Port problems

Captain Jimmy Sarbh, director, P&O Ports in India, firmly believes

that India’s “unaccountable” bureaucrats are responsible for the

country losing valuable FDI. Three years ago, P&O, which has

invested more than half a billion dollars in developing Indian ports,

was ready to invest $300m in building a trans-shipment port in Kochi

Vallarpadam in southern India. The government had invited bids and

P&O Ports, the sole bidder, won. However, charges of creating a

foreign monopoly over India’s shipping trade resulted in the company’s

bid being turned down. “It is a shame that India and Kerala (the local

state) lost the opportunity, but bureaucrats here are simply

unaccountable,” he says. Not only did the country lose FDI but foreign

competing transhipment ports in Salalah, Aden, Colombo and Singapore

thrived because no Indian port was available to handle Indian cargo, he

adds. Indian exporters eventually paid the price.

And this was not the first time P&O was thwarted in its attempt to

build an Indian port. After extensive studies of various sites on the

western Indian coast in 1997, P&O picked Vadhvan, north of India’s

biggest port, Mumbai, to develop a deep-water port that would have

eased congestion in the main port. Environmental activists in the area

raised an alarm over ecological damage that the port would bring and

litigation followed that eventually forced the company to abandon the

plan. Mr Sarbh, who still believes that Vadhvan is a great site and

could be the Rotterdam of India, says an Indian company might build a

port there someday.

Mr Sarbh’s persistence and persuasive skills in dealing with Indian

bureaucrats and his bosses back in London – possibly the reason why

P&O has stuck it out in India for the last eight years – seem to

have finally paid off. After the setback to the company’s plans in

Kochi in the south, he says, P&O discovered that the potential for

growth in cargo volume is far higher in the north because India’s

manufacturing hinterland is located there. The company developed Nhava

Sheva and bought Mundra, two ports in Maharashtra and Gujarat, and both

are doing brisk business.