Broken BRIC: Why are foreigners fleeing India’s economy?

NEW DELHI, India — Prime Minister Manmohan Singh knows that India’s flagging economy badly needs foreign capital. And he's desperately trying to do something about it. 

This week, he appointed an influential former International Monetary Fund economist to head India's central bank. Last week he rolled back regulations and stumped for new economic reforms. “Once again, we will prove the naysayers and Cassandras of doom wrong,” he vowed.

Meanwhile, the stock market has been tumbling. 

Everybody loves an optimist. But a more jaded speechwriter might have replaced the prime minister's ancient Greek reference with a phrase adapted from contemporary Detroit: Would the last one out of India please turn out the lights?

Over the past year and a half, formerly bullish investors have been climbing over each other to get out of India, leaving billions of dollars on the floor. Worse, despite repeated moves to make the country look more attractive, the great pullout shows little sign of slowing.

It turns out that new decrees and fine sounding speeches don’t make up for years spent attempting to machete-hack through India's extra-strength red tape.

“They promise the moon, but they can't deliver,” said Rajinder Singh, whose firm, LexJurists, is working to extricate several US investors from stymied hotel and resort projects in the state of Rajasthan.

Apart from what the central government offers, the states promise single-window clearances for investments; help with acquiring land at below market prices; and an easy path through reams of rules and regulations.

But once the money is committed, something as simple as getting a liquor license can take years. And if there's an election and a new government comes to power, you just might have to start over, one lawyer explained.

In the latest move to staunch the bleeding, last week India eased rules on foreign direct investment (FDI) by multi-brand retail chains like Walmart, and boosted limits or streamlined procedures for investing in other potentially attractive areas, such as the booming telecommunications sector.

For retailers, it scrapped requirements that they only operate in cities with more than a million people, and that compelled them to source 30 percent of their products from local small and medium-sized companies — anathema to the Walmart business model.

But observers point out these moves hardly amounted to acting “boldly and decisively” — the prime minister's own analysis of what will be required to bring back the days of 8 percent economic growth.

“It has an effect on sentiment, but investment is not going to flow in just because you open the gates,” said Dharmakirti Joshi, chief economist at Crisil, the India arm of Standard & Poor's.

In fact, the reforms were not even as bold as advertised in mid-July, when 13 business sectors, including the potentially lucrative defense and insurance industries, were slated for liberalization. The cap on defense investments, for instance, was not raised from 26 percent, as expected. For the insurance sector, parliament must pass a bill before the FDI cap can be increased 26 to 49 percent.

Moreover, that earlier, bolder list itself wasn't enough to stoke much enthusiasm.

Even as those reforms were tabled, some of India’s biggest investors announced they were slowing or abandoning billions of dollars worth of investments.

In July alone, Korea’s Posco scrapped plans for a $5.3 billion steel plant in Karnataka, and Luxembourg-based ArcelorMittal canceled plans for a $12 billion steel plant in Odisha. And over the past year or so, some major global companies — Fidelity, Morgan Stanley, Royal Bank of Scotland, and New York Life to name a few — have scaled down investment plans or simply left the country.

For infrastructure-challenged India, that's a serious blow, especially now. India has always lagged far behind China in foreign investment. But last year FDI plunged 21 percent to a woeful $36.9 billion, compared with China's $111.6 billion. And over the past two months foreign mutual funds have also fled Indian markets, pulling out some $10 billion out of Indian stocks and bonds to stem losses associated with the plummeting rupee.

The combination could well create a vicious cycle, according to Crisil's Joshi. Without FDI, which is spent on actual projects (as opposed to shares) and thus more difficult to withdraw, every dollar that foreign mutual funds pull out of the market increases India's current account deficit (the shortfall of money flowing in versus out of the country). That in turn causes the rupee to drop in value. And that drop in value results in currency losses that encourage foreign investors to pull even more money out of the market.

“It's very fragile,” Joshi said.