FDI lessons from China

Indian Express, 18 Sept 2006

Continuing the focus on India and China the IMF launched two new books on the side lines of the IMF World Bank Annual Meetings in Singapore on Tuesday. "India goes global" discusses India's expanding role in the global economy, and while "India and China, learning from each other" focusses on the reforms that have worked in these countries and what the two giants may learn from each other.

One of the biggest differences in the two countries has been in attracting FDI. While China has managed to attract a huge amount of FDI, India receives a fraction of the FDI China does. Should India learn from the Chinese experience in how to attract large amounts of FDI? While at first blush the answer may be yes, one needs to look beyond the numbers. One of the reasons why China has attracted much higher levels of FDI is that it has given special preferences to foreign investors compared to domestic investors. India, on the contrary, offers a level playing field to domestic investors and consequently does not make it relatively more attractive for foreigners to come. Morevoer, some studies have found that as a consequence of its lop-sided policies, Chinese local companies have not developed the way the dynamic private sector in India has.

Commenting on how India can learn from the Chinese experience Wanda Tseng, Deputy Director, Asia Pacific Department, IMF, said that given India's fiscal situation India cannot afford to give fiscal incentives to foreign firms. Even if it was appropriate to do so, which it is not. While the IMF supports liberalizing FDI in India, it is mainly in terms of the regulatory environment that is equal for both domestic and foreign investors, and in a transparent framework providing the supportive infrastructure for FDI. If the SEZs create an enclave where they can clear ports very quickly and there is a good transport structure then India should go ahead with them "but certainly in terms of tax incentives, this is not an area that India needs to follow the Chinese example."

Steve Dunaway, also Deputy Director at the Asia Pacific Department of the IMF, added, "The problem the Chinese are now having is of getting rid of the incentives." Last year the Chinese wanted to unify their corporate income tax, and they ran into considerable opposition from the foreign-owned firms. Consequently, the Fund is very skeptical about the use of fiscal incentives to attract FDI because they may in the end create more problems than they solve. Equal treatment should be given to domestic and foreign firms. This is also the stated policy of the Chinese government now. Areas in which China can learn from India including banking reforms. India has been able to reform its public sector banks better than China has.

The papers in the book offer some lessons on the Indian experience. This can help Chinese banks reform their internal controls, their governance mechanisms, and probably the hardest thing for a bank to do, particularly for a state-owned bank, how to price risk to make loans at a proper interest rate. The stock market reforms in India is another area one where the Chinese have gone through a long period where the stock market in China has not done well. The experience from India can help the Chinese regulators and Chinese practitioners in terms of developing their market. Fiscal correction in India and China would be a joint learning experience. Both countires have to learn how to decentralise funding effectively and ensure that local governments have the money to meet the health and education requirements.

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