cOUNTRY PROFILE Overcoming financial barriers for exporters
INDIA SEPTEMBER 2010
Dougal Crawford, Senior Economist
Since the early 1990s, the Indian economy has become
more market-orientated and open to trade and foreign
investment. This has helped raise economic growth from
an average of 5½% a year in the 1980s to 7% over the
past 15 years (Chart 1). Correspondingly, poverty has fallen;
while still low, per capita income has risen from around
US$300 in the 1980s to US$1000. Overall, India is the
11th largest economy in the world at market exchange
rates and due to its high growth rate and large population
India is moving quickly up the league tables.
Chart 2 summarises our assessment of some key risks
faced by exporters and investors in India. Most macro risks
– such as business cycle volatility and the risk of sovereign
default – are low by emerging market standards. A greater
impediment is the business climate, shown in Chart 2 by
the high difficultly in enforcing contracts.
India | September 2010
Unlike in most other countries in Asia, the key driver of India’s
economy is domestic activity. This largely reflects its very
large domestic market of nearly 1.2 billion people.
The large domestic market – together with fiscal and
monetary stimulus – enabled India to weather the global
financial crisis (GFC). In 2009 the economy grew by nearly 6%;
outperforming all other major Asian countries except China.
Over 8% growth is expected in 2010 and 2011 (Chart 3, LHS).
The drawback of this healthy growth has been higher
inflation. However, price growth is expected to ease going
forward, as policy stimulus is withdrawn and agricultural
output rebounds after a poor monsoon in 2009 (Chart 3, LHS).
India has an investment grade sovereign risk rating.
For long-term foreign currency bond risk, Standard & Poor’s
rates it BBB-, Fitch BBB-, Moody’s Baa2. However, the
fiscal deficit is large at 10% of GDP (including off-balance
sheet items), and a failure to rein it in could threaten fiscal
sustainability; public sector debt is already high at 75%
of GDP. On this front, the recent withdrawal of costly petrol
and diesel subsidies is a positive.
Currency risk is relatively low. The currency depreciated
sharply in late 2008, as heightened global risk aversion
prompted net capital outflow and made it difficult for
Indian companies to rollover external debt. But, as investor
confidence returned the balance of payments has gone
back to surplus and the currency has stabilised. Foreign
exchange reserves worth US$280 billion, or 23% of GDP,
are a substantial buffer against any further setbacks
(Chart 4, end-2009 figures).
Over the longer term, the government will need to tackle
India’s restrictive labour laws and poor infrastructure to boost
growth and develop its manufacturing sector. So far, efforts to
reform labour laws –particularly the requirement on companies
with more than 100 workers to seek government permission
before retrenching workers – have hit stiff opposition.
Developments in the infrastructure sector have been more
promising. The government has boosted its infrastructure
spending and is encouraging private sector participation,
including by foreigners.
India | September 2010
India is the world’s largest democracy, with a British-style
parliamentary system. Freedom House, the political and civil
rights monitor, rates India as ‘Free’, one of the few countries
in Asia to gain this rating.
According to the World Bank, India ranks in the bottom quartile
of countries for political stability (Chart 5). However, the
decisive victory by the Congess-led United Progressive Alliance
in the May 2009 election should see this rating improve.
The new Congress-led coalition is more cohesive than the
2004-2009 variant, as it does not have to rely on a raft
of far-left parties for its parliamentary majority.
The government continues to pursue economic reforms and
liberalisation. Notably, a new tax code is set to be introduced
in 2011, which aims to simplify the country’s unwieldy tax
structure. Costly oil and diesel subsidies have also been
abolished. Overall, though, changes have been, and will
continue to be, gradual. Not least because there is some
resistance to economic reforms from within the Congress Party.
The attractions of India as an investment and trade
destination are considerable. First, its vast growing domestic
market of nearly 1.2 billion people — on some estimates 400
million people will enter India’s middle class over the next
15-20 years. Second, the large and skilled English-speaking
workforce. However, barriers to investment and trade are
significant, if declining.
Of key concern to foreign investors are India’s burdensome
bureaucracy and regulations. On the World Bank ease of doing
business gauge – which measures ‘regulation and red tape
relevant to a domestic small to medium-size firm’ — India ranks
poorly at 133 out of 183 countries (Chart 4, LHS). Enforcing
contracts and starting a business is particularly difficult.
The World Bank estimates that a plaintiff in a payment dispute
has to go through 46 procedures, which take an average 1420
to India Today’s State of State report, the populous states of Bihar,
days to complete and costs 40% of the claim.
Jharkhand and Uttar Pradesh are seen as some of the more difficult.
Another issue is that the business climate varies between
Still, steps are being taken to improve the regulatory environment.
India’s 30 states (and five territories). State governments
A new tax code is planned for 2011. Under the draft code, corporate
have broad powers, resulting in regulation varying markedly
tax rates will be cut slightly and a goods and services tax will replace
on such issues as land use, the environment and labour.
the plethora of indirect taxes. For many industries the foreign
Moreover, anti-industry protest movements, often driven
investment approval process has been streamlined and operating
by local farmers, have thwarted numerous investments,
regulations revised and simplified. Special economic zones (SEZs),
particularly in the poorer northern and eastern states. For
which offer tax immunities, zero customs duties, less restrictive
example, in Orissa, a planned US$12 billion steel mill and iron
regulatory and labour laws, have also been created. However, the
ore mine by South Korean steel-maker Posco – viewed as
agriculture sector remains off limits to foreign investment and plans
India’s biggest single foreign direct investment – has been
to further liberalise the retail sector and privatise state-owned
repeatedly delayed due to land protests and legal challenges,
businesses have met stiff opposition. Investment in the SEZs has
despite receiving government clearance in 2005. In general,
also been hamstrung by difficulty in acquiring land and fears that
the more prosperous southern and western states are seen
concessions would be withdrawn in the future.
as more reformist and open to foreign investment. According
India | September 2010
India is the world’s second most populous nation and one of
the most diverse, with 18 officially recognised languages.
Moreover, the population is growing relatively strongly,
at 1.6% per year, making it a very young population, with
a median age of 25. However, while strong economic growth
has lifted average incomes, poverty remains a serious social
issue. India is home to 40% of the worlds’ poor (Chart 7).
Worse, poverty is concentrated in certain groups and in
certain areas of the country.
• Despite being officially illegal, social and economic
discrimination due to the Hindu caste system remains
prevalent, especially in rural areas. India’s ‘scheduled
tribes’, which number 8% of the population, also suffer
• In general, according to the World Bank, the southern The government is committed to reducing income inequality and
and western regions are more prosperous, socially stable maintaining communal harmony. In its latest five year agenda,
and rapidly modernising, while the northern and eastern it announced plans to expand the National Rural Employment
regions are significantly poorer and more politically Guarantee program (100 days of work in public program for
volatile. poor families), implement a nationwide subsidised food scheme
for families under the poverty line and implement universal
On occasions, India has experienced religious based communal
secondary education. The government is also attempting to reduce
tensions and violence. For example, in 1992 the destruction
discrimination based on the basis of Hindu caste, ethnicity or
of a Mosque in the holy city of Ayodhya by Hindu nationalists
religious beliefs through affirmative action and social policies.
sparked widespread riots. In Mumbai alone, more than 900
people were killed. More recently, in 2002 religious violence
in Gujarat resulted in over 700 deaths.
Overall, India is viewed as relatively stable (Chart 8). However,
the government is dealing with a few security issues.
Foreign embassies continue to warn of a high terrorist threat.
In November 2008, a series of coordinated terrorist attacks
was launched in Mumbai. Over 170 people were killed. Attacks
have occurred elsewhere in India in recent years, including
Maoist rebels know as ‘Naxalites’ are active in parts of
east and central India. Their stated aim is to establish a
Communist state on behalf of the poor. They are a significant
force in rural areas of Bihar, Jharkhand, Chhattisgarh, West
Bengal and Orissa and have attacked government officials,
infrastructure and industry, including mining operations.
In 2007, Prime Minister Singh stated that the Maoists pose
the most serious threat to national security and began A number of insurgent groups operate in India’s seven north-
to organise a more coordinated response to the threat. eastern states (Assam, Meghalaya, Tripura, Arunachal Pradesh,
According to Ministry of Home Affairs, there have been over Mizoram, Manipur, and Nagaland). These groups are seeking greater
10,000 casualties from Naxalite related violence in the past autonomy or independence for their ethnic or tribal group. According
five years. to the South Asia Terrorism Portal (SATP), violence is particularly
concentrated in Manipur and Assam.
India | September 2010
INDIA - SELECtED INDICAtORS*
INtERPREtINg ChARt 2
Business cycle risk. A volatile business cycle can
Population (mn) 1.16 be a special headache for exporters and investors,
Official language Hindi/English because it means that downturns will be steep –
and corporate casualties will be high.
UN Human Development Index** Medium
Currency risk. In today’s world of widely floating
exchange rates and sophisticated currency hedging
GDP ($US bn) 1236 techniques, some degree of currency volatility
GDP per capita ($US) 1031 is quite acceptable, and presents little risk. But
Real GDP growth (15 year average, %) 6.8 where a country has a weak balance of payments
or is prone to wide swings in capital flows, it can
Fiscal balance -10.4
suffer sudden and dramatic currency moves that
Public debt 75.7 can bankrupt large swathes of its corporate and
Foreign direct investment 2.0 banking sectors.
Current account -2.1 Currency inconvertibility risk. If the country
suffers from a weak balance of payments, not
External debt 18.4
only is it prone to steep currency depreciation, but
Foreign reserves 22.9 there is a temptation for the government to impose
S&P foreign currency debt rating BBB-/stable exchange controls that prevent importers from
converting local currency into foreign currency in
OECD country risk rating 3
order to make trade payments.
Systemic banking risk. Weak balance sheets
World Bank - Ease of doing business 123/183
and poor lending practices can sometimes trigger
Freedom House - Political rights and civil liberties Free sector-wide banking crises.
Transparency International - Corruption Perception Index 84/180 Sovereign default risk. Fiscal mismanagement
*All 2009 figures unless specified can put governments under financial strain
**The HDI is composite measure of human development: long & healthy life (life expectancy),
to which they respond by running up arrears
education (literacy & education enrolment) and income (GDP per capita) with, or defaulting on, overseas suppliers and
creditors. With the sovereign cut off from credit,
***Expressed as % of GDP unless specified
a sovereign default also increases the likelihood
of sharp downswing in the economy, currency
inconvertibility and a systemic banking crisis.
Difficulty/cost of enforcing contracts. If you get
into a contractual dispute, will the country’s legal
and judicial system help or hinder you in pursuing
a claim? Drawing upon World Bank data on the cost
and time involved in enforcing contracts (at www.
doinbusiness.org) we seek to measure the degree
of help or hindrance
The measure scale runs from negligible to extreme.
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