Investment

Why Modinomics has failed to attract foreign investment

Published

3 months ago

July 3, 2024

Why has private investment been so weak? The answer: Modinomics understands return, but is cavalier about risk. On the face of it, Modinomics is a strategy specifically designed to encourage investment, indeed to convince the whole world to “Make in India”. Yet, global investors have been reluctant to beat a path to India’s doorstep and even domestic firms have been investment-shy, especially in manufacturing. So, at the start of a fresh term, the question to ask is: What has gone wrong? Why is foreign direct investment (FDI) declining and overall investment stagnant?

This situation must frustrate the government because for the past 10 years, measure after measure has been rolled out to encourage investment. The country’s infrastructure has been transformed. The corporate tax rate has been cut. Generous production subsidies have been made available. Tariffs have been imposed to provide protection to domestic producers. Bank balance sheets have been cleaned to enable them to hand out long-term loans. These have involved considerable work and great public expense. But so far, the private sector’s response has been tepid.

Why? Look again at the measures. Many are designed to reduce costs, some to increase revenues, and others to enhance after-tax profits. But all share a common goal: Increasing the returns to investment.

Of course, firms care about returns. But they are also extremely sensitive to risk. In many cases, risks can be contained, using techniques such as reversibility and scalability. For example, portfolio investors have the option of taking money out quickly, which encourages them to invest in the first place. That explains why foreign portfolio inflows have been healthy even when FDI inflows have not.

Service firms typically manage risk by employing scalability. If someone wants to sell IT services, for example, all that is needed are a few talented people, some computers and decent connectivity. If the plan works out, the firm can be scaled up gradually.

But manufacturing is very different. Investments are large, indivisible, and difficult to reverse. That means that managers need to carefully consider the risks of any investment before approving any significant project.

In Narendra Modi’s first term, measures were taken to address such investment risk. There was a concerted effort to restore macro stability by introducing an inflation targeting regime and cutting the fiscal deficit. The government also tried to reduce risks for banks by providing them with legal recourse via the IBC in case the loans went wrong.

But during the second term, the idea of risk mitigation eluded Modinomics. Some of the measures taken increased investor risk. We highlighted some of these problems earlier in Foreign Affairs. From an investor’s perspective, risks emanate from three types of state action that favour competitors, are directly coercive, or jeopardise the supply chain. Consider each.

The first is what could be termed “national champions risk”. On numerous occasions, the government has abruptly changed the policy framework when it saw the opportunity to promote a national champion. The attraction of such an approach is obvious: If it is successful, an Indian firm will invest, become large and successful, and enter the global fray. But this strategy has a drawback — it deters all the other domestic firms from entering the same manufacturing space or even a different space, out of fear that once their irreversible investment is made, the policy framework will be changed to their disadvantage.

Examples of this risk are numerous: It has materialised in online and physical retail, airports, cement, ports, telecoms, and media. Our invocation of “2A stigmatised capitalism”— the privileged status enjoyed by the Reliance and Adani Groups — is not a cute slogan, but the lived reality or feared anticipation of many firms, domestic and foreign.

The second risk stems from direct and coercive state action, such as aggressive tax collection. Admittedly, such policies can benefit the government, with reportedly around 40 per cent of income tax (corporate and individual) revenue accruing from additional tax demands. But if ED or tax authorities raid selectively, while regulatory agencies render arbitrary verdicts, or actions verge on extortion as in the electoral bonds saga, risk perception deteriorates sharply. As a result, lakhs of crores of investment can be destroyed. And even the apparent revenue benefits may prove elusive over the long-term, since historically most additional tax demands are ultimately overturned in the courts.

In particularly prominent cases, Cairn/Vedanta and Vodafone invoked bilateral investment treaties to challenge the government’s retrospective imposition of taxes. The government dithered when international arbitration upheld their claims. Even when the government eventually withdrew the tax, it was done tardily (after seven years) and more out of duress than conviction. Further, it allowed all its bilateral investment treaties to lapse, viewing them as a problem rather than as a means to reassure investors.

Finally, there is supply chain risk. Today, virtually no manufacturing product is made solely from domestic materials. For India to become internationally competitive — and convince the world to “Make in India” — manufacturing firms need to be assured that they will have access to raw materials and inputs from anywhere in the world. But every time a tariff is increased or a product ban imposed, or even when such measures are floated by the government, firms worry about their access to low-cost supplies.

How can the government reassure investors against these risks? Some actions are conceptually simple. For example, Vietnam has sought to mitigate supply chain risks by signing FTAs with all the major trading powers, thereby assuring investors that they can count on having access to supplies, both now and in the future. But more generally, reducing risk requires persistent action and, above all, inaction or restraint. Like reputation, a good risk environment is easily damaged but painstakingly difficult to build and sustain.

In some ways, this risk-return perspective also points to some deeper flaws in the Modinomics attempt to “do a China”. For a start, the Chinese model was never merely about increasing returns by providing subsidies and infrastructure. It was also about reassuring investors that the state was right behind them, working to minimise their risk. Indeed, it is precisely because China has recently abandoned that second element of its long-standing strategy that its growth has slowed and confidence has collapsed.

Moreover, to always be like China is one thing but to become like China is a different matter. In India, the government works on the soil of democratic and administrative procedure, long baked into the system. Even a centralised India can never become China.

So, there is bad news and good news. The bad news is that reversing India’s reputation as a high-risk destination will not be easy. The good news is that China’s problems have forced investors to revisit their calculations, rendering them willing to take on more Indian risk than in the past. But not too much more. Not if they continue to worry that the Damocles’ sword of expropriation via tax and ED raids hangs over them; not if their old investments can be jeopardised at the behest of their government-favoured competitors; and not if the liberalising policies of yesterday can become history today.

Policy actions can raise returns. But reducing risks demands much more. Modinomics has not been equal to that. Felman is Principal, JH Consulting and Subramanian is Senior Fellow, Peterson Institute for International Economics and former CEA, Government of India

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Economy

S&P/TSX composite tops 24,000 points for first time, U.S. markets also rise Thursday

Published

1 day ago

September 26, 2024

Anne Joseph

TORONTO – Canada’s main stock index closed above 24,000 for the first time Thursday as strength in base metals and other sectors outweighed losses in energy, while U.S. markets also rose and the S&P 500 notched another record as well.

“Another day, another record,” said Angelo Kourkafas, senior investment strategist at Edward Jones.

“The path of least resistance continues to be higher.”

The S&P/TSX composite index closed up 127.95 points at 24,033.83.

In New York, the Dow Jones industrial average was up 260.36 points at 42,175.11. The S&P 500 index was up 23.11 points at 5,745.37, while the Nasdaq composite was up 108.09 points at 18,190.29.

Markets continue to be optimistic about an economic soft landing, said Kourkafas, after the U.S. Federal Reserve last week announced an outsized cut to its key interest rate following months of speculation about when it would start easing policy.

Economic data Thursday added to the story that the U.S. economy remains resilient despite higher rates, said Kourkafas.

The U.S. economy grew at a three-per-cent annual rate in the second quarter, one report said, picking up from the first quarter of the year. Another report showed fewer U.S. workers applied for unemployment benefits last week.

The data shows “the economy remains on strong footing while the Fed is pivoting now in a decisive way towards an easier policy,” said Kourkafas.

The Fed’s decisive move gave investors more reason to believe that a soft landing is still the “base case scenario,” he said, “and likely reduces the downside risks for a recession by having the Fed moving too late or falling behind the curve.”

North of the border, the TSX usually gets a boost from Wall St. strength, said Kourkafas, but on Thursday the index also reflected some optimism of its own as the Bank of Canada has already cut rates three times to address weakening in the economy.

“The Bank of Canada likely now will be emboldened by the Fed,” he said.

“They didn’t want to move too far ahead of the Fed, and now that the Fed moved in a bigger-than-expected way, that provides more room for the Bank of Canada to cut as aggressively as needed to support the economy, given that inflation is within the target range.”

The TSX has also been benefiting from strength in materials after China’s central bank announced several measures meant to support the company’s economy, said Kourkafas.

However, energy stocks dragged on the Canadian index as oil prices fell Thursday following a report that Saudi Arabia was preparing to abandon its unofficial US$100-per-barrel price target for crude as it prepares to increase its output.

The Canadian dollar traded for 74.22 cents US compared with 74.28 cents US on Wednesday.

The November crude oil contract was down US$2.02 at US$67.67 per barrel and the November natural gas contract was down seven cents at US$2.75 per mmBTU.

The December gold contract was up US$10.20 at US$2,694.90 an ounce and the December copper contract was up 15 cents at US$4.64 a pound.

— With files from The Associated Press

This report by The Canadian Press was first published Sept. 26, 2024.

Companies in this story: (TSX:GSPTSE, TSX:CADUSD)

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Economy

S&P/TSX composite up more than 100 points, U.S. stocks also higher

Published

2 days ago

September 26, 2024

Anne Joseph

TORONTO – Canada’s main stock index was up more than 100 points in late-morning trading, helped by strength in the base metal sector, while U.S. stock markets were also higher.

The S&P/TSX composite index was 143.00 points at 24,048.88.

In New York, the Dow Jones industrial average was up 174.22 points at 42,088.97. The S&P 500 index was up 10.23 points at 5,732.49, while the Nasdaq composite was up 30.02 points at 18,112.23.

The Canadian dollar traded for 74.23 cents US compared with 74.28 cents US on Wednesday.

The November crude oil contract was down US$1.68 at US$68.01 per barrel and the November natural gas contract was down six cents at US$2.75 per mmBTU.

The December gold contract was up US$4.40 at US$2,689.10 an ounce and the December copper contract was up 13 cents at US$4.62 a pound.

This report by The Canadian Press was first published Sept. 26, 2024.

Companies in this story: (TSX:GSPTSE, TSX:CADUSD)

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Investment

Tempted to switch to an online-only bank? Know the perks and drawbacks

Published

2 days ago

September 26, 2024

Anne Joseph

Switching to an online-only bank more than a decade ago was just another way Jessica Morgan was trying to save money at the time as a new grad.

“Saving money was the main motivator,” Morgan, now a financial educator and founder of Canadianbudget.ca, recalled.

“After graduating, you no longer qualify for student rates where you might get free banking and I didn’t want to go back to paying fees for giving the bank my money to hold.”

Digital lenders have grown in popularity in recent years, with more players popping up in the sector and traditional banks beefing up their online offerings. But some Canadians may still be hesitant to bank with a financial firm that doesn’t have physical branches where you can talk to an employee face-to-face.

Natasha Macmillan, director of everyday banking at Ratehub.ca, says some of that hesitancy to switch to an online lender is loyalty.

“There’s a large portion of Canadians who have had the same bank account for many years … they’re just hesitant to switch because it’s what they know.”

Tedious paperwork to switch banks can also discourage many Canadians from making the move despite the ease of opening online-only bank accounts, Macmillan added.

“There’s that aspect of you still need to sit down, do your research and then pick that online-only bank,” she said.

Data security concerns have also sowed seeds of doubt among many who are contemplating the switch, and prefer to continue to work with traditional banks with long-established reputations, Macmillan said.

Morgan said she often hears concerns from her clients — “What if I need help? Is this bank safe to use?” or more logistical questions, such as having access to an ATM or getting certified cheques.

One of the only major snags she personally recalls running into with her online lender was when she was purchasing a home.

“I needed to get a certified cheque, like, right away if I was going to put in an offer,” Morgan said. “You can get a certified cheque but it takes three days or so. They courier it to you.” She ended up going to her husband’s traditional bank to get day-of service.

Most online-only banks tend to offer banking products, such as savings accounts, with higher interest rates compared with traditional banks. Many also offer access to cash through any bank ATM without charge.

“Digital banks have generally a lower cost structure than a traditional bank and those savings will be passed on to the customer,” said Mahima Poddar, group head of personal banking at EQ Bank. For example, EQ offers a high-interest chequing account with no fees on everyday banking and unlimited transactions.

But customers should be aware they can’t deposit cash into their account and they can only withdraw bills, not coins.

“We don’t offer depositing of cash, but all of our research has shown that the use of cash is really diminishing,” Poddar said. “There are very few reasons why you need to urgently deposit.”

Customers also have to get used to doing all their banking by phone or through the company’s website or app.

Poddar added she thinks Canadians are more open to change, especially after the COVID-19 pandemic, which accelerated the need for better online banking services.

While trust in traditional institutions plays a strong role in choosing a bank, Poddar said EQ has the same level of protection and is governed by the same regulators as the big six banks in the country.

Lisa Brandt, 61, switched to online-only Manulife Bank more than five years ago. She says she has benefited from the move and has saved a lot of money over time on various banking fees.

“It puts me in the driver’s seat,” she said.

However, she did run into an issue once with depositing a cheque after she sold her home.

“If you’re going to deposit a couple hundred thousand dollars from a house sale, you’ll have to courier (the cheque) to them,” she said.

“It’s not quite as simple as walking into a branch and saying, ‘Give me my money.'”

While many online-only banks have been growing their consumer banking product offerings, traditional banks tend to have more financial product options, not only for individuals but also for small businesses.

“What we have heard from some Canadians is while they might be moving their chequing, savings and GIC accounts to those (online-only) spaces, they’re still maintaining a mortgage with the big players,” Macmillan said.

It’s not about moving all assets to one bank but weighing options on an individual basis, such as picking a bank with the lowest fee on a chequing account but moving investments to another bank for a better return, she explained.

“We’re starting to see that flexibility where people are shopping around for the best opportunity that can give them the most bang for their buck,” Macmillan said.

She added it is important for people to identify why they’re thinking of switching and find an online-only bank that aligns with their goals.

“It’s finding that happy medium where you do feel trust and security, that lower cost and fees and also the convenience and accessibility,” Macmillan said.

This report by The Canadian Press was first published Sept. 26, 2024.

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