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India’s Business Environment

By 2024, Prime Minister Narendra Modi wants to make India a US$5 trillion economy. However, with India’s nominal gross domestic product (GDP) currently estimated at US$2.9 trillion, many analysts question whether the goal can be achieved. Some would call the US$5 trillion economy a marker.

In early 2019, the projected GDP growth rate looked promising; however, just a few months later the rates had slipped. In November, the World Bank had to revise its earlier projection of a seven percent growth rate to a more realistic 6.1 percent.

Several factors have been responsible for the decline in India’s GDP growth. According to a World Bank report, private consumption growth dropped from 7.3 percent last year to 3.1 percent in June 2019. Manufacturing growth plummeted to below one percent compared to over 10 percent in 2018 and car sales fell by 23.3 percent during the second quarter of 2019 in comparison to the same period in 2018. Also, the national unemployment rate reached a 45-year high.

Yet, some context is necessary at this point. To get a better sense of the Indian economy, it is important to understand which sectors are leading contributors to the country’s GDP. First is the services sector (includes real estate, education, health, hotels, banks, electricity, gas, and water supply etc.) with 61.5 percent, followed by the manufacturing sector at 23 percent and the agricultural sector at 15.4 percent. Some analysts therefore argue that the Indian economy is too dependent on domestic consumption, which has recently been disrupted by structural reforms designed to formalize the economy.

The government’s structural reforms like the roll-out of the Goods and Services Tax (GST) and policies like the 2016 act of demonetization took its toll on the country’s growth trajectory, particularly, the unorganized and small scale businesses. It impacted the sector’s access to financing, which in turn changed the way many micro, small, and medium enterprises (MSMEs) do business in the country. Many expect the economic growth to stabilize over the near-term, before showing more sustainable progress in the long-term. This is why foreign investors are advised to take a longer-term view of India’s economy-as one undergoing an important transition, rather than being in a slump.

Still, India is not the only country experiencing an economic slowdown. In October, the International Monetary Fund (IMF) said it expected slower growth in 90 percent of the world. While India slipped to seventh position on the World Bank’s global GDP rankings in 2018, it is still ahead of other BRIC countries like Brazil (9th) Russia (11th), trailing only China in second position.

When it comes to the economy, the government has not been tone-deaf. The change in pace that structural reforms have placed on businesses has partly inspired several responsive initiatives. Most recently, in September, the government announced the single largest reduction in corporate income tax in almost three decades. The corporate tax cut will reduce tax on domestic companies by almost 10 percentage points, helping stabilize MSMEs and allowing the country to compete more readily with emerging economies like Vietnam and Indonesia for foreign investment.

Investment climate

Offering a huge market, low labor costs, and government commitment to businesses, India has become an attractive destination for foreign investment. Despite the sluggish growth projections by Indian and international financial institutions, India is among the top 10 countries for foreign direct investment (FDI) in the world.

In the last five years, India has received US$286 billion in FDI. Further, according to the Annual Report put out by the Department for Promotion of Industry and Internal Trade (DPIIT), India received its highest ever FDI inflow at US$64.37 billion in 2018-19. Services, computer software and hardware, and telecommunications were the largest sectors for FDI equity inflows in 2018-

19. In terms of the top investing countries, Singapore and Mauritius were the highest contributors to India’s FDI flow at US$16.2 billion and US$8.1 billion, respectively.

FDI is permitted in the country under two routes – automatic and government. Under the automatic route, foreign investors do not need prior approval from the government or the central Reserve Bank of India (RBI). Under the government route, foreign investors need to submit a proposal and supporting documents on the Foreign Investment Facilitation Portal online, which will be reviewed by the relevant authorities.

Some of the sectors that allow 100 percent FDI investment through the automatic route include agriculture, automobiles, capital goods, chemicals, manufacturing, petroleum and natural gas, renewable energy, and textiles, among others. India is also trying to move more sectors from the more restrictive government route to the automatic route.

Since 2017, India has announced several FDI reforms. Around 30 sector-based reforms – such as in infrastructure, single brand retail trading, construction, and development – have been undertaken by the government in the last five years. Illustrating these efforts to liberalize the investment environment, the DPIIT in August 2019 opened coal and single brand retail up to 100 percent FDI under the automatic route.

Ease of doing business

The government has recently repealed 50 laws to improve the ease of doing business in India. This repeal has paid off as India moved up 14 places to rank 63 on the World Bank's ease of doing business index. But it’s hardly any surprise: for a third year in a row, India has been featured in the list of the top 10 countries that have improved the most on ease of doing business.

According to the Doing Business 2020 Report by the World Bank, India is ranked positively because of the following reforms:

  • Fees were abolished for the company incorporation form (SPICe), while the electronic format of memorandum of association and articles of association made it easier to set up;
  • The construction and building permit process was streamlined to make it less expensive and time consuming;
  • Trading across the borders became easier as post-clearance audits, integrating trade stakeholders onto a single electronic platform;
  • Resolving insolvency was made easier by promoting reorganization proceedings in practice.

Where to invest

India is diverse. The country hosts more than one billion people spread out across 29 states and seven union territories. These states all have their own laws and incentives for doing business, and as a result, each state has a very unique investment profile. Infrastructure and suppliers may be available in one state, which does not have the same low costs and incentives as another.

During the market entry planning phase, foreign investors should consider selecting three to five states for closer review. Ideally, the shortlisted states should have an established cluster for your industry, or a highly competitive incentive structure for businesses that can afford to be patient. After making the shortlist, investors can then begin to examine specific points that will have the most impact on the trajectory of their business, such as land, labor, and operational costs.

Business performance of Indian states

Based on the contribution to India’s GDP, the top five performing states are Gujarat, Maharashtra, Karnataka, Andhra Pradesh, and Tamil Nadu.

Meanwhile, according to the National Council for Applied and Economic Research 2018 State Investment Potential Index (N-SIPI), the top five investor friendly states are Delhi, Tamil Nadu, Gujarat, Haryana, and Maharashtra. This perceptions-based survey ranks the competitiveness of Indian states on six pillars – land, labor, infrastructure, economic climate, political stability and governance, and business perceptions.

Further, these six pillars are classified under four broad categories – factor driven (land and labor), efficiency driven (infrastructure), growth driven (economic climate, and political stability and governance), and perceptions driven (ranking of business climate built on firm surveys).

According to the survey, in terms of the economic climate, Delhi, Telangana, and Gujarat are among the top three states. In case of infrastructure, Delhi, Punjab, and Haryana have been identified as the leading states. For governance and political stability, the top three spots are occupied by Tamil Nadu, Haryana, and Punjab. For procuring labor, Tamil Nadu, Andhra Pradesh, and Telangana have been ranked as the top states.

While Gujarat, Maharashtra, and Tamil Nadu present a strong business case when it comes to the overall ranking, investors should look deeper to understand how each state caters to their industry.

Special economic zones (SEZs)

In the 1960s, the government used export processing zones (EPZs) to promote exports. To address the infrastructural and bureaucratic challenges of the EPZs, the government established SEZs in 2000 under the Foreign Trade Policy. SEZs were designed to encourage foreign and domestic investment, increase India’s exports, and create employment opportunities.

Under the Special Economic Zone Act, 2005, several EPZs were converted into SEZs including notable zones in Noida (Uttar Pradesh), Falta ( West Bengal), Visakhapatnam (Andhra Pradesh), Chennai ( Tamil Nadu), Cochin (Kerala), Indore (Madhya Pradesh), and Kandla and Surat (Gujarat).

SEZs are popular among foreign investors as they offer infrastructure, duty-free exports, 100 percent income tax exemption on export income for the first five years, exemption from the GST, among other facilitative measures.

Currently, 238 SEZs are operational in India, and as of November 2019, 417 SEZs have received formal approval for operation. Presently, 20 states including Manipur, Nagaland, Karnataka, Telangana, Haryana, Rajasthan, Punjab, and Goa, and two union territories in India have approved SEZs.

SEZs are operational or received approval for operation in sectors like agro-processing, food processing, IT and electronics, biotechnology, pharmaceuticals, engineering, textiles, and footwear/leather, among others.

SEZs often target certain industries, which can increase the likelihood that investors will find the infrastructure, supplier network, skilled labor, services, and incentives they need to do business. Investors that are not export-oriented may otherwise explore industry clusters in commercial office parks.

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