India: Bears get more ammo as pressure mounts on government

The New York Times turned India basher this week, as a downgrade by Standard & Poors and a proliferation of economic statistics point to a grim economic downturn unless the government takes some swift action.

So should you pull your money out of India?

Everybody else will be, Maquarie says, according to Reuters. Valuations are more attractive in other emerging markets, to start with. But India is also looking especially dismal after the government's recent decision to apply a retroactive tax penalty on Vodafone's acquisition of Hutch Telecom from Hutchison Whampoa in an offshore transaction. Changing the rules retrospectively doesn't exactly reassure potential foreign investors. But the impact could be broader.

According to the Times of India, as much as 40 percent of India's inbound investment (some of it "circular"), which is routed through Mauritius to avoid taxes, could be hit by a move to tax offshore transactions.

And that's one of India's main plans to increase tax revenue and fight its burgeoning budget deficit — S&P's main complaint.

Rediff.com points out some other discouraging statistics.

The pace of gross fixed capital formation at 2004-05 prices was negative at 0.2 percent during April-December 2011 against 8.9 per cent in April-December 2010, the web site reports.

The share of aggregate capital formation, thus, dropped to 30.6 per cent of GDP from 32.8 percent.

Corporate investment intentions have dried up and the situation is expected to improve slowly in 2012-13. Project finance data also show a downtrend, according to the Reserve Bank of India.

Writing for the New York Times, economist Tyler Cowen argues that things could well get worse before they get better, too. 

Apart from problems passing economic reforms to spur foreign investment in retail and reduce the government debt by deregulating gas prices, India has other issues that may not be solvable at all, Cowen says:

Agriculture employs about half of India’s work force, for example, yet the agricultural revolution that flourished in the 1970s has slowed. Crop yields remain stubbornly low, transport and water infrastructure is poor, and the legal system is hostile to foreign investment in basic agriculture and to modern agribusiness. Note that the earlier general growth bursts of Japan, South Korea and Taiwan were all preceded by significant gains in agricultural productivity.

For all of India’s economic progress, it is hard to find comparable stirrings in Indian agriculture today. It is estimated that half of all Indian children under the age of 5 suffer from malnutrition.

Another worry is that India’s services-based growth spurt may have run much of its course. Call centers, for example, have succeeded by building their own infrastructure and they often function as self-contained, walled minicities. It’s impressive that those achievements have been possible, but these economically segregated islands of higher productivity suggest that success is achieved by separating oneself from the broader Indian economy, not by integrating with it.

India also has one of the world’s most unwieldy legal systems, and one that seems particularly hard to reform. On the World Bank’s Doing Business Index, the country ranks 132 out of 183 listed countries and regions, behind Honduras and the West Bank and Gaza, and just ahead of Nigeria and Syria. One undercurrent of talk is that the days of “the license Raj” have returned, referring to the country’s earlier subpar economic performance under a regime of heavy government regulation.