Tuesday, 17 May, 2022
HomeOpinionWhy foreign investors don’t put their money in north Indian states

Why foreign investors don’t put their money in north Indian states

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Regardless of a flurry of investment summits across north India, no major northern state attracts any meaningful share of FDI.

Recent debates over changes in fiscal federalism have brought back into question the primordial Indian north-south divide. For the most part, the debate is centred on the more advanced southern states being penalized for developing faster than their northern counterparts.

Having achieved higher levels of economic and social development, the southern states over the past few decades, essentially, pay for most of north’s welfare spending. Using the 1971 census as the basis for the federal fiscal distribution was the tacit contract holding delicate north-south unity. Reversing that basis could risk unleashing another wave of south-centric sub-national politics.

Since the liberalisation of the Indian economy in 1991, FDI inflows have been a major source of economic development. While there is no available data on India’s state-level FDI inflows, the data released by Reserve Bank of India—on the FDI applications received by regional RBI offices—is a reasonable proxy.

These figures further highlight the north-south economic divide.

FDI inflow divergence

From 2000 to 2017, Mumbai accounted for 31 per cent of the FDI inflows, followed by Delhi at 20 per cent. The other four major destinations were Chennai, Bengaluru, Ahmedabad, and Hyderabad. Regardless of a flurry of investment summits across north India, no major northern state attracts any meaningful share of FDI.

In the absence of any major studies explaining the FDI-inflows divergence across Indian states, it is important to study what drives this difference. Some of the factors that explain the divergences are variable investment climate, agglomeration effect, competitive capitalism, and the quality of institutions.

Investment climate can be defined as a set of investor friendly policies enacted by the state governments to attract investments. It is evident that southern and western states such as Gujarat, Maharashtra, Tamil Nadu, Andhra Pradesh, and Karnataka have relatively more favourable investment climates than the northern states.

Comparing Gujarat and Punjab helps highlight this. In 1991, both the states were almost similar in terms of per capita income, urbanisation, literacy rate, infrastructure quality, and industrialization. But since then, they have taken on radically different trajectories. Gujarat adopted an investment friendly climate since 1991, while Punjab exhibited a feeble commitment to it. From 2000 to 2017, Gujarat accounted for one of India’s highest share of FDI inflows, while Punjab received only 0.4 per cent of the inflows.

There is also a very strong agglomeration effect with respect to FDI inflows, whereby destinations with high levels of investments, tend to attract more. The presence of investment seeking competition by neighbouring states is also seen to force state governments to adopt more investor friendly policies. Gujarat adopting investor-friendly policies after feeling a competitive capitalist pressure from neighbouring Maharashtra testifies this. However, the complete absence of such competing capitalist pressures for northern states explains their complacent attitude towards adopting investment friendly policies.

The political variable

There is a general consensus that Indian institutions lack capacity and are over bureaucratised. This incentivises institutional innovation at the state level. Evidence suggests that investors reward such innovation. Gujarat offers an interesting insight here. India’s pre-1991 central licensing system had compelled state-level bureaucracies to develop strong investment monitoring skills.

As shown by political scientist Aseema Sinha, the Gujarat bureaucracy did not abandon this post-1991, rather constantly monitored investment applications and rigourously followed up with the interested companies. This resulted in Gujarat having one of India’s highest implementation to proposed investment ratio.

While the aforementioned factors help shed light on the state-level divergence in FDI, the strongest explanatory variable is politics. Political scientist Kanta Murali shows that the configuration of the electoral coalitions helps explain the varied state-level policy outcomes with respect to attracting investments.

Focusing on the core groups within electoral coalitions, she classifies the coalitions supporting a party based on socioeconomic factors. Out of the four coalitions (narrow capitalist, narrow poor, wide capitalist, and wide poor), the parties that are supported by a ‘narrow capitalist coalition’ – comprising wealthy core groups with strong business representations and a low class-bias — are the most likely to enact investor friendly and less redistributive policies.

Evidence strongly supports her arguments. Lingayats, Vokkaligas, and Brahmins supported Karnataka’s electoral coalition from 1994 to 1999. These are the dominant caste groups in the state and feature strong industrial linkages. This ‘narrow-capitalist’ coalition was responsible for the investor-friendly policies.

In contrast, most north Indian parties are backed by ‘narrow or wide poor’ electoral coalitions. This results in less investment friendly and more redistributive policies.

The current debate is focused only on narrow disagreements regarding the formula for federal fiscal distribution. While this might seem like a major political risk right now, it’s extremely important for policymakers and scholars to address the factors driving this developmental divide. A failure to do so could inevitably lead to a gulf that can endanger the very meticulously constructed national unity of the country.

Srijan Shukla is a student of comparative politics and international relations at McGill University.

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