What Foreign Investors Want to Hear From India

Ajit Solanki/Associated Press A man counting U.S. dollars at a Western Union money transfer outlet in Ahmedabad, Gujarat.

This week, India’s finance minister, P.Chidambaram is headed to stump for foreign direct investment in the United State and Canada. This comes after a recent similar run through Singapore, Japan, Hong Kong and Britain. His messages are familiar: the India growth story, reducing fiscal deficits and an admission that 5 percent growth is uninteresting.

But he may be missing the point: investors (including small-time ones like me) already know the sales pitch and want to believe it. But they’re not buying: foreign direct investment into India dropped by $5 billion in 2012, to $27 billion. What is holding back foreign investment decisions are the risks associated with investing in India, which Mr. Chidambaram needs to address head on.

Here are the top five things he should tackle to convince foreign investors to put money into India:

1. Exchange rate stability: The Reserve Bank of India reference rate for Indian Rupee versus U.S. dollar exchange was 40 in April 2008 and lately has been hovering around 54. Investments made in 2008 via F.D.I. need to generate 35 percent returns just to break even after repatriation. Instead of generating a risk premium for having believed in the emerging market story, most investors will not make money on these investments.

India’s current account deficit hit a record level of $32 billion in the December 2012 quarter, up 46 percent from a quarter before, and is approaching 7 percent of GDP. At these levels investors will likely have no confidence in the currency, so the finance minister should be looking to present a credible plan to cut this deficit without focusing purely on promoting exports.

2. Taxation predictability: The timing and extent of GAAR (General Anti Avoidance Rules, proposed by Mr. Chidambaram’s predecessor) is an unpredictable overhang that will keep investors at bay. How does an investor model returns when the tax burden is unknown And please, let us not bring up “retroactive” taxation in any context (with the exception perhaps of fraudulent transactions).

Most investment vehicles are ephemeral and pooled at many levels, so claw-backs of gains or coughing up historical tax expenses are unfair to the last person left holding the figurative bag.

3. Progressive regulation: There are certain sectors where the regulator has changed the rules after sizeable foreign investments were made. Imagine acquiring a license to operate, investing billions of dollars in operations and then having the license revoked, or having the fees you can charge your customers changed, or the commissions you can pay your distributors decimated. Overtly investor-friendly regulatory regimes are the need of the hour.

4. Impediments to entry: To begin with, let us remove sector limits on F.D.I. and year-long approval processes as these are anachronistic in a competitive market for capital. When allowed, a number of well-meaning valuation guidelines on transactions involving Indian counterparties make free market investment decisions slow and cumbersome.

5. Hurdles to exit: Restrictions on overseas listings destroy significant investor value - certain sectors, especially technology, are not well understood in retail equity markets in India. Nothing will drive F.D.I. more vigorously to India than a string of IPOs that attain stratospheric valuations on global exchanges.

Even without all these risks, investors do not have it easy in the Indian market. They face operational challenges ranging from corporate governance to high valuations. In listed markets, India’s return on equity spreads (the additional return relative to the global indexes) have narrowed recently, so returns no longer justify the risks in the near term.

Especially when capital flows have many options, it behooves India to highlight reforms that allow investors to focus on generating returns instead of fighting the system. India sorely needs F.D.I. to return to 8 percent-plus growth. So dear Mr. Chidambaram, we are happy to hear the sales pitch, but please linger on the risks as well this week.

Shyam Kamadolli is an Indian American entrepreneur turned venture capitalist.  His investment portfolio includes technology startups in the US and in India.  He blogs on entrepreneurship, investments and other passions at blog.kamadolli.com and can be followed on twitter @kamadoll.  All opinions expressed are his own personal views.