In recent months there has been a wave of criticism of India’s deteriorating investment environment. During a visit to the country in July 2012, Singapore’s prime minister Lee Hsien Loong called India’s business environment "complicated” for foreign investors. In the same month, US president Barack Obama was equally candid in an interview to a news agency, saying that US businesses found it hard to invest in the country and that there are too many sectors limiting or prohibiting FDI.

Since coming to power three years ago, the United Progressive Alliance (UPA), led by prime minister Manmohan Singh, has been accused of inflicting policy paralysis on the country. According to Moody’s Analytics latest report on India, the government itself is the “single biggest factor weighing on business confidence and economic outlook". Indeed, decision-making has stalled in recent years as the government has been occupied with fire-fighting a series of corruption scandals, including those involving the country's coalfield licences, and 2G, in which politicians and government officials in India were found to have illegally undercharged telecoms companies for frequency allocation licences.

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To dispel fears of policy paralysis, on September 14, 2012, India's cabinet cleared a number of much-needed reform measures, such as allowing FDI in multi-brand retail and allowing foreign carriers to buy into domestic airlines, up to a 49% limit. But some investors remain concerned about the lack of clarity afforded by the country's FDI policies. Moreover, investors are wary following the cabinet's decision earlier in the year to introduce a General Anti-Avoidance Rule (GAAR) to counter aggressive tax avoidance. 

Letting the giants in

Retail reforms have been a particular bone of contention for India's government. At the end of 2011, the UPA-led government tried to push through a rule to allow 51% FDI in multi-brand retail. Together with a rule that would allow 100% FDI in single-brand retail, it was touted as a defining reform initiative.

The allowance of 100% FDI in single-brand retail was finally made a reality in September 2012. But, although the cabinet cleared the 51% proposal, the government was later forced to make a U-turn due to opposition from its key ally, the Trinamool Congress, whose support keeps it in power. It was a little-needed reminder of how politics can often trump economics. 

Pushing through FDI in multi-brand retail – allowing global giants such as Wal-Mart, Carrefour and Tesco into the Indian market – has been another issue of contention. The main opposition party, Bharatiya Janata Party, has been a particularly strong opponent to the policy as it says that such companies would threaten the livelihood of millions of small storeowners.

Multi-brand retail reform has also faced opposition from India's states. The UPA government’s efforts to forge a consensus on the issue suffered a setback when initially only two of the country's 28 states and two of its seven union territories formally provided support in writing. The list was later widened to include eight more states, but many of the country's major states including Kerala, Bihar, Orissa, Madhya Pradesh, Tripura, West Bengal and Uttar Pradesh did not support the reform. 

Despite this, the government has shown resolve for its reforms and on September 20, 2012, announced its decision to allow FDI in multi-brand retail.

Dividing opinion

The Indian government is also looking to actively address the lack of clarity in FDI policy for single-brand retail. In July 2012, Swedish furniture-maker Ikea was ready to set up a fully owned entity in the country with an investment of $1.9bn, but wanted a relaxation from the stipulation that it must source 30% of its requirements from micro and small units. Eventually, the government agreed.

Vayalar Ravi, the minister of overseas Indian affairs with the additional charge of micro, small and medium enterprises, remains opposed to this decision, however. “Any relaxation which they demand, if it affects my people and industry, I won’t accept”, he told The Times of India.

The government is also divided over whether to allow foreign investment into the pharmaceuticals sector. After Japan’s Daiichi Sankyo acquired Ranbaxy in 2008 and US-based Abbot Laboratories bought Piramal’s formulations business in 2010, there were concerns that such acquisitions would impact upon the supply of affordable, generic drugs to the Indian population. One solution proposed by the Department of Industrial Policy and Promotion is to route all FDI proposals for brownfield pharmaceuticals companies for case-by-case approval through India's Foreign Investment Promotion Board.

Another cause for concern for foreign investors is the country's tax regime. Retrospective taxation has already affected UK telecoms giant Vodafone, which entered India four years ago by acquiring the assets of Hutchison Whampoa through an offshore transaction. Vodafone was slapped with a $2.5bn tax bill, which it successfully contested in India’s supreme court. The court ruled that the sale by a non-resident of shares in a company could only be taxed if the shares are situated in India. To overrule this judgement, an amendment to the Income Tax Act was made to tax the sale of non-Indian shares that derive their value from India.

Making progress

There is a ray of hope for foreign investors, however. Reformist P Chidambaram assumed the position of finance minister, for the third time in his career, in July 2012. Mr Chidambaram has already sent a strong signal that the UPA is looking to restore confidence to investors and remove the perceived difficulties in doing business by modifying or fine-tuning policies if necessary.

Mr Chidambaram is reviewing the proposals on retrospective taxation. So far there has been no tax demand on Vodafone, while the unpopular GAAR has also been deferred by a year. To encourage more FDI, parity has been introduced for long-term capital gains taxation of 10% between portfolio and private equity investors, who account for a significant proportion of the investors into India. Acquisition of shares amounted to one-third of overall flows in the form of equity of $35.8bn in 2011-12.

Private equity investors have also been exempt from long-term capital gains taxation on sales of unlisted securities in initial public offerings, subject to a securities transaction tax. But it is still felt that if genuine non-resident investors can exit their private equity investments on a tax-free basis, it will provide a very powerful incentive to invest via the FDI route.

Such moves have bolstered inflows into India's economy, but FDI still remains depressed. The latest numbers for April to July 2012 show that direct investment into India declined to $5.8bn, compared with $9.2bn from April to June 2011, according to data from the Reserve Bank of India. Foreign investments by Indians abroad fared no better. Together with portfolio and FDI, other inflows such as external commercial borrowings and non-resident Indian deposits reduced to a trickle in June 2012 when compared to June 2011.

FDI inflows will pick up only when India becomes more attractive as a place to do business and the investment climate improves significantly. The reform agenda must go forward in other areas such as pensions and insurance to boost the flagging India growth story, and the tax regime must be more stable with a fair mechanism for resolving disputes. 

N Chandra Mohan is an economics and business commentator based in New Delhi.