Remarks at World Bank-CII Conference on Improving India’s Investment Climate

By
Praful Patel
Vice President, South Asia Region
The World Bank Group
Taj Lands-End, Mumbai, India, November 24, 2004

Welcome to this one-day conference to discuss and debate three recent studies, the World Development Report, the India Investment Climate Assessment and the Doing Business Indicators for India. The World Bank is honored to partner with the Confederation of Indian Industry in bringing you, I hope, a fresh set of ideas - and challenges - critical to a growing India. We are very pleased to have been able to bring together business leaders and policy makers from around India. And what better place to gather than in Mumbai: the vitality and entrepreneurial spirit of this great city is energizing. Millions from across India come here in search of their dreams. Millions more dream of this city. Mumbai has proved a fertile ground, unleashing the creative energies and talents of many who have made this their home. But one doesn't need to look hard in Mumbai - or elsewhere in India - to see that wide disparities exist.

So let me begin with a challenge to our collective imaginations today: imagine if each Indian state could achieve a "best practice" investment climate. Our calculations suggest that the economy would grow by an additional 2 percentage points and reach the sustained 8 percent growth rates needed for ongoing poverty reduction. The Government of India's own Tenth Five Year Plan recognizes this sharply. It estimates that the Indian economy needs to grow consistently at around 8 percent a year over the next decade to create 100 million new jobs; to reduce the poverty rate to 11 percent. 

What do we need to reach that "best practice"?

The World Bank President, Jim Wolfensohn, was in New Delhi last week where he described India as a country moving at two speeds. One India in the global fast lane of entrepreneurial talent and technological creativity. In this lane, Indian companies are becoming a global presence. Think Tata, think software giants like Infosys and WIPRO. Think Ranbaxy, now the ninth-largest generic pharmaceuticals company in the world. The World Bank, too, saw this fast-lane India when it opened an Accounting Processing Center in Chennai in 2001 to tap into world class accounting skills.

In India's other lane are the country's over 250 million poor people. Most live in villages but many are migrating to urban areas in search of a better life. Unleashing the entrepreneurial talents of these millions of Indians is a formidable challenge. But imagine the India where these additional millions of citizens find an opportunity to live their dreams, to reach for economic freedom and contribute to the wealth of their communities. This is the challenge of reaching 8 percent growth to put a cold number to it. Put differently, it's the challenge of making a difference in millions of lives. It is the challenge that will take India from a great nation to a great global nation.     

And when India puts its mind to something, it can achieve it. Just look at the remarkable progress over the past decade in increasing incomes and improving living standards. Poverty declined and many social indicators have improved significantly.

Driving these improvements was the ambitious reform program beginning in 1991. Opening the economy, deregulating the economy, marked a new willingness to allow market forces the freedom to work. The scope of the program included industrial and trade liberalization; financial deregulation; improvements to supervisory and regulatory systems; and policies more friendly to privatization and foreign direct investment.  India achieved an average growth rate of nearly 6 percent over the last two decades. Last year it was 8.2 percent.

But how can India sustain a growth rate of 8 percent and more? We would be foolish to take these  considerable achievements for granted. Growth during the past decade has not been strong enough to make a deeper attack on poverty reduction. It has not been sufficiently broad-based. The services sector has performed impressively. So much so that the India service hub was a contentious issues in the last American election. But with a few notable exceptions like biotech and pharmaceuticals, growth in industry - which still has the greatest potential to provide high-wage employment for the large and growing labor force - has been less impressive. Organized manufacturing provides just 7 million jobs, under 2 percent of total employment. And between fast-lane India and the over 250 million citizens who live below the official poverty line, there are wide disparities in incomes and opportunities, disparities between rural and urban areas, disparities within cities, disparities across regions.

As I said, when India sets its mind to something it can make a real difference. And that collective mind seems to me in widespread agreement that much more needs to be done to achieve the country's economic potential. You can feel that energy today. That mind seems, too, to recognize that a vibrant private sector is central to leading the way. It means firms investing, creating jobs, and improving productivity. It means increased private domestic investment coupled with improved productivity. And it means sharp improvements in India's investment climate, nationally and sub-nationally and - don't forget - in comparison with other investment destinations in Asia too.

India has such advantages: today it boasts the third largest reservoir of skilled and technical manpower. It has a local market among the largest in the world. Raw materials are abundant. Relative macroeconomic stability prevails. Private investment should be flocking here to make a major hub for manufacturing and labor-intensive services.

But this isn't happening yet. India's record in attracting private investment has not been very impressive. Private investment, largely financed from domestic savings, averaged around 15 percent of GDP in the 1990s - below the average for low-income countries. Certainly below where you need to be to accelerate growth to a sustainable 8 percent a year. FDI to India has averaged around only US$ 5 billion annually over the recent past. It has been US$ 40 billion annually to China. Indian manufacturers have become more competitive over the past decade and exports have grown. But the share of Indian manufacturing exports in the world stood at a mere 0.7 percent in 2000. 

Looking around it's easy to imagine an enormous potential still to be tapped. Looking closer, recent World Bank research shows that private sector performance in India continues to be constrained by a range of bottlenecks. Today my colleagues will share the results of three recent World Bank reports, helping us take a closer look. One is the India Investment Climate Assessment 2004, based on a survey of manufacturing firms which we did in partnership with CII. The next is the Doing Business Report 2005.  The third is the latest World Development Report 2005.

Let me share a set of headline items coming out of these reports. Let me highlight some of the critical investment climate bottlenecks and the costs they have imposed on Indian business.

First, infrastructure. Access to reliable infrastructure is a key constraint facing Indian businesses. Just take power: nationwide, the power shortfall in 2002/03 was about 11.4 percent for peak demand. Comparing India with findings of similar analyses, manufacturers here face almost 17 significant power outages each month. In Malaysia it is one, in China, less than five. That translates into about 9 percent of the total value of output of firms lost due to power breakdowns. It is less than a quarter this level in Malaysia and China. As you know all to well I suspect, generators are standard industrial equipment in India. Some 61 percent of Indian manufacturing firms own generators compared to 27 percent in China. And all this means that India's cost of power is 74 percent higher than Malaysia's, 39 percent higher than China's.  Indian manufacturing pays a high cost for a low quality power supply.

There can be change. In the past three years some power bottlenecks have eased. The percentage of Indian firms owning generators fell by around 10 percent over this period. This reflects progress with sector reforms. The enactment of the Electricity Act in 2003 is definitely a step in the right direction. But much more needs to be done to make the enabling legal and structural environment work.

Take transport. Capacity and quality constraints in roads and railways also impose costs on firms. India currently has no inter-state expressways linking the major economic centers. It has only about 3,000 kms of four-lane highways. Look at China which has built 25,000 kms of four-to-six lane, access-controlled expressways in the last ten years.  Improving road infrastructure will require a significant increase in investment. In part, this can be addressed through better cost recovery from users. But it will also require reducing uncertainties arising from political interference and weak contract enforcement which has held private sector participation back. There can also be short to medium term gains in strengthening the financial performance and accountability of road agencies and state public works departments. Likewise, Indian Railways is also in urgent need of reform if it is to provide an efficient means for transporting goods. Ports and airports urgently need to be modernized.

The second set of bottlenecks I am going to call, bureaucracy for a basket of issues ranging from the official paper chain to corruption. While the License Raj has been substantially reduced at the center, it survives in many states, along with a  pervasive 'Inspector Raj' that imposes high costs on businesses. The median time to start a new business in India is 89 days. It is 2 days in Australia, 5 days in the US, 18 days in the UK, and  41 days in China. In India, 14 percent of senior management time is spent in dealing with state government officials for various regulatory issues. The figure is 8 percent in China.  On average Indian manufacturers face 7.4 visits a year from government officials. In Malaysia, the average number of visits is less than 3. A key challenge for India is to streamline business entry and operation procedures, to reduce delays and opportunities for rent seeking. This will require re-engineering the entire gamut of business regulatory processes, at both the state and local levels. And to do so based on clear principles of transparency, absence of discretion, and accountability.

Third labor markets. Restrictions in the hiring and firing of workers are identified in the reports presented today as another key challenge of doing business in India. Employment in India's registered firms  is highly protected. Labor rationalization is difficult; it discourages the hiring of labor in the organized sector. This is especially burdensome for exporters who have to compete with other exporting countries. Figures show that the typical Indian firm reported excess labor of 17 percent: the main reason, labor laws and regulations. The literature shows that flexible labor markets hold out the best chance of creating new jobs in the formal sector.  Going forward, key priorities for the central government include the repeal of legislation blocking layoffs in registered firms, legislation to ease constraints on the hiring of contract labor, and a gradual rationalization of the entire gamut of Labor and Wage Laws. But state governments, too, have an important role. They can facilitate labor rationalization, even within the current legal framework.  Indeed some states have already shown the way forward on this.

The fourth constraint I see is access to finance. Problems in accessing financing are often cited as a major hurdle for small and medium sized businesses in India.  Only half of small businesses here have active bank credit lines. The efficiency of SME credit markets can be tremendously improved through reforms in the legal framework for loan recovery and bankruptcy. And by improving credit information. At the same time, banks must focus on building the necessary capacity for better credit appraisal and risk management of SME portfolios.

Those are four key road blocks on India's path to greater foreign and domestic investment and the sort of investment climate needed to encourage that. But let's not forget the broader policy landscape. Industrial policy stands in the way of doing business in India too. Here it's a case of eliminating remaining preferences, product reservations and investment ceilings for small-scale producers. These all have the  unintended consequence of preventing smaller firms from growing and competing on world markets. Indeed such policies amount to nothing less than an anti-growth strategy for business.  India would also gain from allowing FDI in the retail sector, which remains closed. There are gains too in further raising FDI limits in sectors where caps exist, such as banking, insurance and airports.

Trade policy reforms also need to be accelerated. Here the challenge is to aggressively reduce import tariffs to a single low rate. To be ambitious and do this over the next three years, phasing out remaining tariff exemptions, specific tariffs and anti-dumping duties.

One of the biggest barriers to competitiveness is the lack of a unified VAT regime across states. There was a high likelihood of VAT being introduced in at least the major states in April 2004. This remains an urgent priority for the private sector.

May I depart from my business script for a moment. I want to suggest to India's private sector that there are an additional set of challenges that might seem on the face of it to be the business of government; not your obvious challenges. I propose they are the business of all of us. The private sector could make a real contribution by putting two things on your radar screen in the name of good business. One is HIV/AIDS. There is no clear picture yet of what the economic impact will be of this disease in India. But if our experience in Africa is anything to go by - and for many years of my life Africa has been my focus and indeed the place I call home - all I can say is trust me, sit up and take note. India now has more HIV-infected people than South Africa. We suspect vast under-reporting and a conservative number is about 5.5 million infected people in India. There are good practices worldwide where the private sector has been able to make a contribution.

My other "non-business" issue for the radar screen is youth. About 50 percent of India's population is younger than 25 years. Creative thinking about the transition these young people must make from school to work will determine whether there is a job to go to. And indeed for too many still, notably girls, whether there is a school to go to. I offer these two additional issues because for India to go from great nation to great global nation, these two challenges have the power to subvert many other gains made.

We began by imagining an India in which all states had best practice investment climates. Today's landscape shows us considerable variations between states. In one of the reports before us today, the India Investment Climate Assessment 2004 - as in the previous study four years back - respondents were asked to rate all states other than their own for their general investment climate. The six states that attracted almost all the FDI were rated to have a better investment climate by the majority of respondents. These "better climate" states are Maharasthra, Delhi, Gujarat, Andhra Pradesh, Karnataka, Punjab, Tamil Nadu and Haryana. The first three states are also the only ones to have registered growth in per capita incomes greater than 6.5 percent.

Differences in the quality, availability and cost of infrastructure are critical in explaining the differences in investor perception of the investment climate across states.   Analysis indicates that the main reason why the "better climate" states have been rated more highly - and why these states attract almost all FDI to India - is to be found in their better physical infrastructure. But what really counts is that these states have been able to make a difference, to make a change.

My colleagues will take you into the details behind some of the headlines I have flagged here today. There is a formidable reform agenda ahead to improve India's investment climate to the point where India becomes globally competitive. And I know too that these headlines are not foreign to you;  considerable thinking has already gone into the details of how to shift the business environment. These are well articulated in the Government of India's Common Minimum Program. The challenge now is the aggressive implementation of the program.

For the time has come to make  "India Inc." happen across a far broader horizon than the current bright shining spots. And to make India Inc. happen for many, many more people. This great country has shown before just how something can be done when you put your minds too it. I sense that mind being made up and we, at the World Bank, stand ready to partner with Government and the private sector in this tremendous enterprise ahead.

Without it, growth will lag and the central aim of poverty reduction which is going to take all of 8 percent growth and more, will not be achieved within a reasonable period of time.

Thank you.