When Narendra Modi was swept into power in India at the end of May, winning the election with a huge majority, international investor response was unprecedented. While India’s stock market surged by 25% to $1430bn, the value of mergers and acquisitions rose by 31% to $23bn according to Grant Thornton, as a host of deals that had been put on hold prior to the elections were brought to completion. The Bhartiya Janata Party’s parliamentary success marked a national political shift as this was the first time since independence that a single party had won an outright majority. Additionally, the election of a pro-business politician as prime minister offers hope that the country’s recent economic decline will be reversed.

As its chief minister for 12 years, Mr Modi has overseen significant economic growth in the state of Gujarat, and Reshmi Khurana, managing director of risk advisory firm Kroll, maintains that Mr Modi's business-friendly reforms in Gujarat have been a key reason why investor confidence has improved throughout the whole of India since the elections. “The market’s mood is based on trend-spotting,” says Mr Khurana. “One of the bold measures that the prime minister announced after entering office was a steep rise in passenger fares and freight rates, fuelling expectations of a turnaround in the economy.”


Although Mr Modi’s reformist agenda has significantly boosted investor confidence in India – in the new budget, the government increased foreign ownership restrictions on defence manufacturing to 49% – a perennial problem the country has faced in boosting inward FDI is the significant autonomy India’s regional states retain over economic policy. Although India’s federal governance structure grants considerable autonomy to local governments over economic issues, this has led the states to significantly diverge in their FDI performance.

Maharashtra soars ahead

Data from greenfield investment monitor fDi Markets shows that India attracted the second largest number of projects in Asia last year, with Maharashtra state attracting 22% of FDI in the country. Rajasthan, India’s largest state by area, attracted less than 1% of FDI during the same period.

Although a common criticism among international investors is that India’s decentralised governance framework means FDI regulations can be unpredictable, as they vary by state, Maharashtra’s efforts to reform foreign ownership restrictions in the agriculture, industry, infrastructure and petrochemicals sectors have enabled it to become India's leading FDI destination. For its efforts, the state has experienced considerable success, as the government’s decision to allow 100% foreign ownership of oil and gas projects attracted more than $24bn of investment between 1991 and 2012, according to India’s Department of Industrial Policy and Promotion.

According to fDi Markets, while the metals, automotive original equipment manufacturing and financial services sectors attracted the most greenfield investments in Maharashtra in 2013, the local government's efforts in developing road, railway and airport infrastructure has helped top attract international companies to the state, including US software company IBM, South Korean steel conglomerate Posco Iron & Steel and French hotel group Accor. Although Maharashtra is the most industrialised state in India, according to the central statistics office's Annual Survey of Industries, the local government’s decision to support the growth of a host of new special economic zones (SEZs) which focus on pharmaceuticals, biotechnology, textiles, automotives and auto parts means the state is home to the largest number of SEZs in India.

Delhi NCR picks up

The Delhi National Capital Region (NCR) state, the heart of India's central government, has also made significant improvements to become one of the country's top five investment destinations. Delhi NCR has historically faced significant capacity constraints, and its success in attracting FDI worth $19.2bn, according to Ernst & Young (EY), has been down to the government’s efforts to reduce the state’s infrastructure bottlenecks.

While the local government’s focus on developing infrastructure led the state’s manufacturing, retail and construction sectors to experience the rapid growth – EY estimates that the three sectors attracted 67% of inward FDI to Delhi NCR – Vivek Mehra, executive director of professional services firm PwC India, says the government must do more to reduce local manufacturers’ cost of doing business. “Currently, it is easier to import parts into India than it is to manufacture them,” he says. “The government’s focus should be on developing manufacturing and levelling the playing field with the help of FDI.”

One way in which this challenge is being addressed is through reducing the cost of transportation with the Delhi Mumbai Industrial Corridor, which will also cover the states of Uttar Pradesh, Haryana, Rajasthan, Gujarat and Maharashtra. Moreover, its decision to build a multimodal, high-axle load dedicated freight corridor between Delhi and Mumbai will significantly enhance the state’s position as India’s logistics hub. Although the project is still in the first phases of design, when complete it will encompass 13 industrial areas, giving investors located in Delhi NCR access to a range of infrastructure facilities, such as power supplies and rail connections to ports.

Too many policies?

While more regional governments across India have reformed their states’ business environments through easing FDI ownership restrictions and investing in supportive infrastructure, a lack of policy coordination across the states means policy uncertainty remains a key deterrent for foreign investors. The fDi Report, which is an annual review of greenfield FDI provided by fDi Intelligence, reveals that while India attracted the second largest share of FDI into Asia-Pacific last year, its inward FDI stock has consistently been declining, most recently dropping from $30bn in 2012 to $17.5bn in 2013.

Moreover, while local governments have made more efforts to increase transparency and accountability in deal making, tackling corruption and over-zealous bureaucracy continue to be a significant challenge in all states. While India’s ranking on the World Bank’s 2014 Doing Business report fell by three places to 134, Pranjal Sharma, consulting editor at Indian magazine Businessworld, maintains that local states need to coordinate more closely with central government to lower the bureaucratic barriers facing foreign businesses establishing operations in India. “The central ministry has to work with the state ministry on due diligence and permissions,” says Mr Sharma. “The multiple avenues of due diligence on new projects are undertaken sequentially, not simultaneously, leaving investors waiting for years for clearances. Thus, process reform is more relevant than policy reform.”

Although several local governments have done much to distance themselves from the central government’s decision in 2013 to impose a retrospective tax liability fine of $2.2bn on UK-based telecommunications firm Vodafone, critics maintain that ineffective efforts have been placed at the local level to implement clear taxation guidelines for foreign businesses. “India’s entire tax system must be overhauled,” says Mr Mehra. “Despite the importance of FDI, we continue to tax foreign investors while foreign institutional investment goes untaxed. This is not the policy in any developed country.”

Booming Bangalore

Indeed, attempts by the state of Karnataka’s local government to progressively implement taxation reforms have led to a significant influx in FDI. Its gradual approach to bringing in property tax reforms through developing a joint implementation programme with the Asian Development Bank has considerably boosted investor confidence, putting it among the five Indian states that attracted the most FDI last year, according to fDi Markets. Moreover, the local government’s recent move to boost Karnataka’s manufacturing and technology sectors through industrial policy has made its capital, Bangalore, India’s leading manufacturing and technology hub.

The Karnataka government’s move at the start of 2014 to create the state’s first national investment and manufacturing zone, offering entrepreneurs operating in the semiconductor, biotechnology and ICT industries incentives such as subsidised office space, means that the state is expected to become a key investment destination in India. While Bangalore attracted more than $50bn in greenfield FDI between 2003 and 2014 according to fDi Markets, the whole state’s IT sector attracted $37bn in FDI, which is the equivalent to 19% of total investment.

For Mr Mehra, Karnataka’s efforts to reform its business environment and focus on technology will put it at the cusp of growth in coming years. “[Encouraging] FDI in technology signals to the world that this is a strong and positive business environment,” he says.