Author: Udayan Gupta

As prime minister Narendra Modi begins his term in office, global market watchers are hopeful that it could signal a sea change for India’s governance, economy and friendliness to business. But most are tempering that enthusiasm with a dose of skepticism.

The death in late May of Gopinath Pandurang Munde, a newly appointed Indian cabinet minister, in a car accident in New Delhi quickly brought home the stark difference between the new Bharatiya Janata Party‒led government in India and the old Indian National Congress party. The 64-year-old cabinet minister died while riding in a Maruti, a small car equivalent to, say, a Toyota. This is totally unheard of, notes an Indian finance professional based in Delhi. “Under the Congress [party] a cabinet minister would go about in an entourage of four or five cars with the police leading the way.”

The new government in India is barely weeks old, but already India’s 1.3 billion people are noticing the difference. Fighting back against the cronyism that was so rampant in the Congress party administration, new prime minister Narendra Modi has warned all his cabinet and state ministers against hiring family and relatives, even distant ones. And in an order to quickly increase the capital available for industry, the Reserve Bank of India has instituted a reduction in the statutory liquidity ratio that determines the amount of money banks must invest in government securities before offering credit to the wider economy. On June 14, the SLR will drop by 50 basis points to 22.5% of banks’ net demand and time liabilities, which RBI head Raghuram Rajan says “will give banks more freedom to expand credit to the nongovernment sector.”

Another vexing problem may already be on the mend. India’s current account deficit narrowed to $32.4 billion or 1.7% of GDP at the end of March, down 63.1% from the $88 billion a year earlier. “As soon as investors see the first signals of growth-supportive policies, you will see a definite turnaround on the ground,” notes Adi Godrej, chairman of the Godrej group, one of India’s largest conglomerates.

Still, the task for the new prime minister is challenging. He needs to re-frame a market economy that has all the potential for dynamic change and explosive growth but is mired in old-style economics and crony capitalism. He also has to find a way to repair India’s image, damaged by charges of corruption and poor economic management.

 “Have you ever seen a country that exports wheat and imports breads? We are exporting iron-ore and importing steel. In this country, power units of 20,000MW capacity are closed down…. Coal mines are also closed down…. For me, the life of the nation has disappeared.” Modi told India TV in late May.

As soon as investors see the first signals of growth-supportive policies, you will see a definite turnaround on the ground.

- Adi Godrej, Godrej Group

The focus has to be on opening up India’s capital markets, removing the myriad barriers that impede the free flow of foreign capital and restrict domestic institutional investments. Also necessary is a reallocation of capital away from cash-guzzling government enterprises and giant family-owned combines into new ideas in technology, the life sciences and healthcare—strategic industries that address domestic needs and provide a springboard to global markets.

 “Nothing can happen without overhauling the tax code,” says Hiren Ved, director and chief investment officer of Alchemy Capital Management, a Mumbai-based asset manager that has been one of the best performing Indian funds in 2014. And with the changes in the tax code there must be a willingness not to retroactively revise the code arbitrarily, says Ved. “ No more Vodafones. The Vodafone case may still bring in a few billion in taxes, but it will cost more in lost investments and MNCs [multinational corporations] walking away.”

The Vodafone tax case involves a 2007 offshore transaction between Vodafone, the UK telecom company, and Hong Kong‒based Hutchison Whampoa Group. Vodafone purchased the Hong Kong group’s stake in an India-based telecom business. Although the transaction was totally offshore, the Indian tax authorities maintained that it involved the transfer of an Indian asset and therefore was subject to capital gains taxes in India. Indian authorities attempted to impose a $2.5 billion tax liability on the transaction, valued at $11.1 billion. Vodafone argued that the position it took was based on the tax rules then in effect. When the Indian Supreme Court ruled in favor of Vodafone, the government passed retroactive laws to cover the transaction.

The case is yet to be settled, but in early June the new Finance Ministry indicated that the retrospective tax would likely be scrapped. Instead, the Income Tax Act would be amended to clarify that the law would only be applied prospectively. As newly appointed Finance minister Arun Jaitley prepares his first budget speech, there is widespread belief that there will be other changes in the tax law, if only to attract increased foreign direct investment (FDI) and bring in multinational corporations.

Still, the Vodafone story casts a negative light on India’s controversial double-tax-avoidance policy with various countries. The goal of the policy, of course, is to stop companies from using tax havens or transferring pricing rules to avoid paying taxes. While capital from tax-treaty countries accounts for most of the foreign capital invested in India—in 2013, for example, $6 billion of FDI came to India from Singapore and $4.9 billion, from Mauritius—DTA policies also have led to a succession of controversies related to transfer pricing.

Transfer pricing is the international tax practice of allowing MNCs to shift income from high-tax jurisdictions to their operations in low-tax jurisdictions in order to reduce the firm’s tax burden. The OECD is looking to change this international tax practice, but any development on this front is still far from a given (see our cover story from last September for more on tax havens and transfer pricing). Meantime, some countries—such as India and the US—are using double-tax-avoidance practices and closing tax loopholes in order to drive tax receipts. But not everyone thinks it is a good idea, and a number of MNCs have had controversial tax cases with the Indian authorities, including SABMiller, IHC Mauritius, Sanofi-Aventis, Mitsui and GE.


“Why not have foreign investors invest directly?” asks Avneet Kochar, a veteran investment consultant who specializes in cross-border investments.  A low capital-gains tax rate—one that kicks in after an initial time period, say three years—might lower initial tax receipts but would greatly boost long-term receipts and bring in new multinationals.

 “Investing through tax havens is not only bureaucratic and cumbersome, it does little in the way of improving communications between asset managers and their investments,” says Kochar.

Direct investing would bring investors and company “promoters” face to face, allowing for better due diligence and greater transparency. Because there is lax enforcement of contracts in India, promoters take undue advantage of the fear of the long legal fight—which every investor holds. But first there has to be efficient contract law enforcement. If you promise performance or returns and then don’t deliver, there has to be financial retribution. In addition, there has to be stability in the legal and regulatory environment.


During a lecture in October, Modi stated that a “strong economy is a driver of national security,” emphasizing that delinking the two, as had been the norm under previous governments, was inappropriate. He talked of a stronger military sector and combined it with a discussion of areas of domestic economic weakness, whether in defense production, electronics manufacturing or cyberwarfare. But he also has acknowledged the need for developing the healthcare, life sciences and technology sectors—where there is both domestic need and global demand.

Entrepreneurially driven technology companies such as Infosys and Sathyam have built global businesses and created significant shareholder value for investors. Technology hubs such as Bangalore, Gurgaon and Noida have created jobs faster than traditional government enterprises and the mature, family-controlled conglomerates.

But access to capital is still constrained despite the size of the pie, says a recent KPMG report on Indian banking.  As late as 2011, rural India accounted for less than 10% of outstanding credit. As for the micro, small and medium enterprise (MSME) sector—which accounts for 45% of registered businesses—only 33 to 34% of MSMEs had any access to bank or institutional financing.

The Modi government also plans to open up such key areas as defense, where foreign investors are currently allowed to own no more than 26% of an investment, ostensibly for security reasons. Finance minister Jaitley has indicated that he may loosen all restrictions on such areas because of their importance and potential contributions to the overall economy.

On the day that the Bharatiya Janata Party won a parliamentary majority in India’s Lok Sabha, the Sensex hit a record high 25,000, the rupee exchange rate moved to 59.3 rupees against the dollar. And a slew of companies filed to raise equity in the public markets.

All is not going to change overnight. But during the short time it has been in power, the Modi government seems to be saying all the right things, making all the right moves.


The landslide victory for the right-wing, Hindu nationalist BJP, led by Narendra Modi, in the recent parliamentary elections has upped expectations of better governance and a revival of the Indian growth story, says Deepak Parekh, chairman of HDFC, India’s fifth-largest bank by assets.

Global Finance: What does Modi’s government mean for India’s economy?

Deepak Parekh: Well, on the economic front, the worst was behind us even before the elections. India had reined in both fiscal and current-account deficits, and the rupee had clawed back to a sustainable level after having hit an all-time low in August 2013, owing to measures taken by both the government and the central bank, RBI.

While markets had priced in a victory for a Modi-led government, the overwhelming majority has raised expectations, brought in hope and optimism that this government will deliver. I am confident that India will be able to break out of the sub-5% GDP growth of the past two years.

GF: List five top priorities for the Modi government.

Parekh: The to-do list is exhaustive. To my mind, initially it would be better to focus on unclogging and fast-tracking projects in the pipeline stuck for want of approvals, [and on] providing better administration—not big-bang reforms. Improving inter-ministerial coordination is the third area. I think the biggest change will be seen in the decision-making process.

Starting a new business in India has to be simplified with fewer approvals and better transparency to boost manufacturing and create jobs. An assurance from the prime minister that the tax environment will be less hostile will go a long way. Many multinational companies investing in India believe in its long-term potential, yet they are saddled with onerous tax litigations. India has paid a heavy price for policy flip-flops and uncertainty.

A message of zero tolerance for corruption from the prime minister will be very important.

GF: Do you think the investment cycle will be revived in short term?

Parekh: Last year, India managed to garner FDI (foreign direct investment) inflows of $24 billion, mainly in sectors like services, automobiles, telecom and pharmaceuticals, despite a slowdown. If approvals are sped up and restrictions removed in sectors like insurance or defense, I think FDI inflows will increase substantially. Given the change in sentiment, FII (foreign institutional investor) inflows will increase as more companies tap the markets to raise capital. It’s a good sign of revival.

GF: What do you think should be done to get infrastructure projects going?

Parekh: Infrastructure remains a priority area. Clearing projects in sectors like power, and providing access to coal or gas for ventures is important. Energy security may be ensured with increased domestic exploration and production (E&P) and reducing India’s dependency on energy imports. India must also move toward market-based energy pricing. Unless the environment is made more conducive, foreign companies will be reluctant to make investments in high-risk E&P business here. Also, India does not have sufficient technology or skill sets in E&P. So getting the policy right is very critical. Investors will come only if they believe that the sanctity of contracts is honored. 

Long-term infrastructure funding needs deep financial markets. Further, funding long-gestation projects can be challenging as banks resources are pre-empted due to CRR / SLR [cash-reserve and statutory-liquidity-ratio]) norms and priority sector lending.

So, there is merit in exempting banks from these norms as far as infrastructure lending is concerned. Banks may also be allowed to raise long-term funds through secured bonds to prevent asset liability mismatches.

GF: Do Indian banks fear entry of more foreign banks?

Parekh: Financial penetration in India is still extremely low, so there is enough business and scope to grow for foreign, private- and public-sector banks.            

~ K.A. Badarinath


For faster growth and more rapid job creation, there is mounting recognition that capital has to be channeled towards entrepreneurial businesses, the real drivers of job creation and growth. “We have world-class talent available here but need clean investment and a favorable tax environment,” says Ramesh Radhakrishnan, a partner with Artiman Ventures in Bangalore. “There is a young brigade of Indians who want to be entrepreneurs, but they need a nurturing environment.”

The poster children of the new technology economy are successful e-commerce companies such as Ad1Quity, a mobile advertising platform; EFarm, a supply chain platform for agriculture; and Mobstac, a mobile publishing platform. All have been launched by home-grown entrepreneurs and financed by foreign investors.

But perhaps the classic entrepreneurial company is a pure technology play: Tonbo Imaging, a Bangalore-based company launched by Arvind Lakshmikumar, an engineer who studied at India’s Birla Institute of Technology and at Carnegie Mellon. Tonbo makes imaging solutions for a variety of industrial and military applications, a technological approach to enhanced vision. As Tonbo explains, modern-day battlefields, critical infrastructures, unmanned reconnaissance, transport vehicles driving in the dark—all offer challenging environments for effective visualization. Smoke, dust, fog and camouflage make observation and navigation difficult. Tonbo’s solution cuts through the visual clutter.

Ironically, Tonbo might never have happened. Although Lakshmikumar was able to raise some seed money from angels in India, there was great skepticism about a “state-of-the-art Indian high-tech company” from India-based venture capitalists. And because there was no credible venture backing, potential partners and customers stayed away. So Tonbo incorporated in Singapore and raised more than $6 million from Artiman Ventures, a Palo Alto venture firm. Suddenly, it had cut through the financial clutter as well. Today its customers hail not only from India but from other Asian, as well as European, countries.

~ Udayan Gupta