cOUNTRY PROFILE

Overcoming financial barriers for exporters

INDIA

APRIL 2013
Analyst contact:

Dougal Crawford, Senior Economist [email protected]

OVERVIEW
Since the early 1990s, the Indian economy has become more market-oriented and open to trade and foreign investment. This has helped raise economic growth and lower poverty. Overall, India is the 11th largest economy at market exchange rates, but a high growth rate and large population means that it is likely to move quickly up the league tables. Nonetheless, despite recent progress, India still faces significant challenges, including large fiscal and external deficits, high inflation, weak infrastructure, burdensome bureaucracy and still high levels of poverty.

Economic growth has averaged 8% over the past 15 years. Correspondingly, poverty has fallen; while still low, per capita income has risen from around US$300 in the 1980s to almost US$1600. However, it is still well below the regional average and gains have been unequally distributed across India.

Chart 2 summarises the key risks faced by exporters and investors in India. A significant impediment is the business climate particularly contract enforceability. The business climate varies considerably by state and industry. Rupee volatility and, more recently, slowing growth are other challenges for exporters and investors.

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India | April 2013

ECONOMY
India has become an important export market for Australia. India is Australias 4th largest export market, consuming nearly 5% of Australia exports. Major exports are coal, gold and educationrelated travel.

Against the US$, the rupee dropped by 22% from end-2011 to April 2013 one of the worst performances of all emerging market currencies (Chart 2). Nonetheless, the probability of an external debt crisis looks low. The gross external debt load is low at 18% of GDP the Indias economic outlook has deteriorated. GDP growth has slowed under the weight of high interest rates, falling business confidence and a weaker external environment. Business confidence has been dented by high interest rates, general economic uncertainty, and the governments failure to press ahead with structural reforms. The governments capacity to respond to the growth slowdown has also been limited by its lack of fiscal flexibility the general government deficit is running at around 8% of GDP (including off-balance sheet items) and public debt is equivalent to 65% of GDP. Inflation has remained stubbornly high despite the weakness in GDP growth. This may point to deeper supply-side problems of infrastructure, business supply chains and the labour market failing to keep up with rapid economic growth. Roads are just one example: they compare poorly with those in most other Asian economies. A less obvious example is the limited availability of cold storage facilities and refrigerated transport; as a result, one fifth of all food produced is reportedly wasted. government chiefly borrows domestically. Moreover, while FX reserves have fallen recently, they are still a sizeable buffer against capital flight. Reflecting these factors, India has an investment grade foreign currency sovereign risk rating Standard & Poors and Fitch: BBB- and Moodys: Baa3. S&Ps T&C assessment meaning the likelihood that the sovereign will restrict external debt repayments by non-sovereigns is BBB+.

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India | April 2013

POLITICS
India is the worlds largest democracy, with a British-style parliamentary system. Freedom House, the political and civil rights monitor, rates India as Free, making it one of the few countries in Asia with this rating. In contrast to this robust democracy, India ranks in the bottom quartile of countries for political stability, according to the World Bank (Chart 5). The strong electoral showing of the Congress Party led United Progressive Alliance (UPA) in 2009 gave Prime Minister Manmohan Singh an opportunity to forge a relatively stable second-term government, because the UPA no longer had to rely on support from far left parties to maintain its parliamentary majority. The government continues to pursue economic reforms and liberalisation, but changes have been, and will continue to be, gradual. One reason is the resistance to economic reforms from within the Congress Party and its coalition partners. Next elections are due by May 2014.

BUSINESS
India has numerous attractions as an investment and trade destination. First, its vast and growing domestic market of nearly 1.2 billion people on some estimates 400 million people will enter Indias middle class over the next 15-20 years. Second, the large and skilled English-speaking workforce. Still, barriers to investment and trade are substantial, if declining. Of key concern to foreign investors is Indias burdensome bureaucracy and regulations. On the World Banks ease of doing business gauge which measures regulation and red tape relevant to a domestic small to medium-size firm India ranks poorly at 132 out of 185 countries (Chart 6, LHS). Enforcing contracts, paying taxes and starting a business are particularly difficult. The World Bank estimates that a plaintiff in a payment dispute has to go through 46 procedures, which take an average 1420 days to complete and costs 40% of the claim. Another issue is that the business climate varies between Indias 30 states (and five territories). State governments have broad powers, resulting in regulation varying markedly on such issues as land use, the environment and labour. Moreover, anti-industry protest movements, often driven by local farmers, have thwarted numerous investments, particularly in the poorer northern and eastern states. For example, in Orissa, a planned US$12 billion steel mill and iron ore mine by South Korean steel-maker Posco viewed as Indias biggest single foreign direct investment has been repeatedly delayed due to land protests and legal challenges, despite receiving government clearance in 2005. In general, the more prosperous southern and western states are seen as more reformist and open to foreign investment. Still, steps are being taken to improve the regulatory environment. The government in September and October 2012 announced a raft of reforms, including opening up the multibrand retail sector and aviation to foreign ownership. A Cabinet Committee on Investment has been established to quicken approval of large projects. A new tax code is also in the works, with a goods and services tax replacing the plethora of indirect taxes. In addition, special economic zones (SEZs), which offer tax immunities, zero customs duties and less restrictive regulatory and labour laws, have been created. But investment in the SEZs has also been hamstrung by difficulty in acquiring land and fears that concessions could be withdrawn in the future.

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India | April 2013

SOCIETY
India is the worlds 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% a year. However, while strong economic growth has lifted average incomes, poverty remains a serious social issue, especially compared to the progress made in reducing poverty rates in the rest of Developing Asia (Chart 7). 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. Indias scheduled tribes, which make up 8% of the population, also suffer economic marginalisation. India periodically experiences sectarian tensions and violence. For example, in 1992 the destruction of a mosque in the holy city of Ayodhya by Hindu nationalists 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.

SECURITY
Some issues to watch. Terrorism. Foreign embassies warn of a high terrorist threat. In November 2008, a series of coordinated terrorist attacks was launched in Mumbai. More than 170 people were killed. Attacks have occurred elsewhere in India in recent years, including New Delhi. Naxalites. Maoist rebels known as Naxalites are active in parts of east and central India. 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. The North east. A number of insurgent groups operate in Indias seven north-eastern states (Assam, Meghalaya, Tripura, Arunachal Pradesh, Mizoram, Manipur, and Nagaland). These groups are seeking greater autonomy or independence for their ethnic or tribal group. According to the South Asia Terrorism Portal, violence is particularly concentrated in Manipur and Assam. Border disputes. Indias relationship with Pakistan has been strained since partition in 1947. The ongoing territorial dispute over Kashmir remains an obstacle to improved relations. Indias relationship with China has improved, but border demarcation in the north east state of Arunachal Pradesh remains a sensitive issue, as is Chinas growing ties with Pakistan, Myanmar and Sri Lanka.

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India | April 2013

INDIA - Selected indicators*

People Population (bn) Official language UN Human Development Index** Economic*** GDP ($US bn) GDP per capita ($US) Real GDP growth (15 year average, %) Fiscal balance Public debt Foreign direct investment Current account External debt (2010) Foreign reserves S&P foreign currency debt rating OECD country risk rating Governance World Bank - Ease of doing business Freedom House - Political rights and civil liberties Transparency International - Corruption Perception Index
*All figures are 2012 unless specified **The HDI is composite measure of human development: long & healthy life (life expectancy), education (literacy & education enrolment) and income (GDP per capita) ***Expressed as % of GDP unless specified

Interpreting Chart 2
1.21 Hindi,English Medium Business cycle risk. A volatile business cycle can be a special headache for exporters and investors, because it means that downturns will be steep and corporate casualties high. Currency risk. In todays world of widely floating exchange rates and sophisticated currency hedging techniques, some degree of currency volatility is quite acceptable, and presents little risk. But where a country has a weak balance of payments or is prone to wide swings in capital flows, it can suffer sudden and dramatic currency moves that can bankrupt large swathes of its corporate and banking sectors. Currency inconvertibility risk. If the country suffers from a weak balance of payments, not only is it prone to steep currency depreciation, but there is a temptation for the government to impose exchange controls that prevent importers from converting local currency into foreign currency in order to make trade payments. Systemic banking risk. Weak balance sheets and poor lending practices can sometimes trigger sector-wide banking crises. Sovereign default risk. Fiscal mismanagement can put governments under financial strain to which they respond by delaying or halting payments to overseas suppliers and creditors. With the government cut off from credit, a sovereign default also increases the likelihood of a 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 countrys 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 scale runs from negligible to extreme.

1,947 1,592 7.0 -8.1 65.0 1.7 -4.2 18.1 290.0 BBB-/negative 3

132/185 Free 94/176

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