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India’s Protectionism Might Hinder Its Economic Growth — and Affect Global Partnerships

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India’s Protectionism Might Hinder Its Economic Growth — and Affect Global Partnerships

India’s growth and global heft crucially depends on its economic openness and willingness to provide a level playing field to foreign companies.

India’s Protectionism Might Hinder Its Economic Growth — and Affect Global Partnerships
Credit: Flickr/Jon Russell

Indians elated by projections of a post-COVID-19 economic recovery must remember that these projections are predicated on India maintaining an open economy. New Delhi may feel bullish about the recent projections by global investment conglomerates Morgan Stanley and Goldman Sachs that India’s economy will bounce back in 2021 and grow at over 5 percent in 2022.

But this optimism is only partly based on faith in the revival of animal spirits once the economy is reopened after months of closure. Another key assumption, however, is an Indian economy that trades more with the world and offers a level playing field to investors.

Rising protectionism, arbitrary taxation, and excessive regulation that target foreign investment do not project the image of an India that is open and welcoming. These factors could limit India’s potential and hinder growth.

All countries use the “infant industry” argument to protect domestic companies, but one of the legacies of colonial rule in India has been the Indian state’s distrust of foreign corporations. India’s paradox is that the country needs foreign investment and technology, but the state makes it difficult for foreign companies to enter and operate in the Indian market.

Political opposition within India to the entry of large scale foreign enterprises comes from organizations like the Confederation of All India Traders, a group claiming to represent 70 million small retailers, and groups like Swadeshi Jagran Manch that oppose all foreign investment.

This opposition is the reason why India still prevents foreign investment in multi-brand retail.

Therefore, when Walmart first entered India in 2007 it was as part of a joint venture with Bharti Enterprises to set up wholesale stores across the country. A decade later in 2018, Walmart entered the e-commerce market when it bought a majority stake in Flipkart, an Indian start up e-commerce platform.

Amazon entered the Indian market in 2012 and today has 40 odd offices, 67 shipping centers, 1,400 delivery stations, and a work force of more than 60,000 in addition to 155,000 contractors. Today, Amazon and Walmart, through its ownership of Flipkart, together own 70 percent of India’s online shopping market.

However, instead of making it easier India has made it tougher for e-commerce companies like Amazon and Walmart to operate freely.

For a start, they operate with a handicap: as foreign e-commerce entities they cannot own inventory or discount merchandise. As a Bloomberg Quint column noted this is akin to operating “with one hand tied behind their back.”

Further, in December 2018, the Indian government announced Personal Data Protection rules according to which any foreign firm operating in India in the digital and internet arena would have to follow India-specific rules and regulations when it came to data security and privacy of individual data. To build an innovation-centered economy, India needs to allow free flow of data, not restrict it.

These rules affect technology companies like Microsoft, social media companies like Facebook and Twitter, and entertainment companies like Netflix, as well as foreign portfolio investors. But they are especially problematic for e-commerce companies as they restrict their trade practices like offering huge discounts.

Both Amazon and Walmart are also facing anti-trust cases filed by Indian regulators that charge both companies with violating Indian law that forbids foreign e-commerce companies from giving preferential treatment to certain sellers on their platforms.

Another grievance of foreign companies has been the lack of a level playing field for foreign investors. In August 2020, Future Retail announced it was selling its entire business to Reliance. Amazon filed a lawsuit arguing that this was a breach of a contract that Future Retail signed with Amazon in 2019 when Amazon invested $200 million in that company. Amazon won an injunction from a Singapore tribunal, but in November 2020, the Competition Commission of India (CCI), approved the Future Retail-Reliance deal.

If India seeks to attract investment, the message foreign companies receive in India should be one of a level playing field, not that you can only be successful if you partner with large Indian corporations.

Foreign investors seek stability in markets, as well as the political, economic, and social spheres. Stable taxation policies and limited regulatory policies are a key part of this. The Indian state, however, has a strong regulatory streak combined with the notion that the only way to resolve its revenue crunch is to tax companies as much as possible.

One such example is that of retroactive taxation. In 2007, Vodafone purchased a Cayman Islands-based investment firm that held a stake in Hutchinson Essar India Ltd. The Indian government sought capital gains tax from this purchase and the dispute went to India’s Supreme Court where the apex court held that “the government’s tax jurisdiction didn’t extend to the Cayman Islands.”

Instead of accepting this, in 2012, the Indian government changed its tax code “giving itself the power to go after M&A [mergers and acquisitions] deals all the way back to 1962 if the underlying asset was in India.”

Vodafone challenged this retroactive taxation and in 2020 an international arbitration tribunal in The Hague sided with Vodafone and termed India’s tax demand a “breach of fair treatment.”

If New Delhi accepts the decision and moves on, it will help the country regain some of its prestige with foreign investors.

With almost 20 percent of the world’s workforce, the majority of which is unskilled, employment generation and skill development have long been the key focus of every Indian government. This is what led to a manufacturing policy that favors MSMEs (Micro Small and Medium Enterprises) instead of large-scale enterprises like in China.

While opposition to foreign companies comes from the mom and pop stores, e-commerce may help solve many problems.

For those who are concerned that companies like Amazon and Walmart will wipe out the small businesses, they would do well to remember that these conglomerates actually learned from their experience in China – and from their Chinese competitor Alibaba – of the benefits of training and supporting SMEs (small and medium enterprises).

This explains why Amazon has set aside $1 billion, of its total $6 billion investment in India, to help MSMEs. In 2019, Walmart announced its Walmart Vriddhi Supplier Development Program (Walmart Vriddhi) to help train 50,000 Indian MSMEs to supply to the global market.

Foreign companies are also more likely to invest in research and development (R&D), which is critical to boosting economic growth rates. Global expenditure on R&D as a percentage of GDP stands at 2.29 percent, but India spends less than 0.63 percent.

Foreign companies, whether in pharmaceuticals or technology, have demonstrated that they are willing to invest in R&D. In 1998 IBM set up a research lab in India and General Electric’s largest research lab outside of the U.S. is in India.

India has long sought self-sufficiency in the economic arena, but it has often bordered on protectionism. Seeking to build your own brands and ensuring that your domestic companies are not wiped out by foreign competition is a noble goal. Preventing competition within the Indian market and using regulation to benefit indigenous companies is not the way to build a global economy.

Dr. Aparna Pande is a research fellow and director of the Initiative on the Future of India and South Asia at the Hudson Institute, Washington, DC.