Economists and analysts across the board believe that the Indian economy has entered a 5 – 10 year bull market phase. What if at all should hold you back from investing in India. The risks mentioned below are generic in nature and apply equally to both, direct investments (FDI) and secondary market investments (mostly FIIs):
- Risk Relating to Uncertain Business Environment: Companies who want to do business or want to invest in India have to deal with a number of challenges including obtaining construction permits, complex labor laws,and inadequate investor protection norms, lack of established or effective avenues for legal redress, poor enforcement of existing regulations and uncertainty of laws. A lot of the jurisprudence around corporate and commercial laws in India is still evolving and there may be modifications or changes to existing laws at fairly regular intervals which businesses must keep track of. A recent case in point was the retrospective amendment of tax laws in the Vodafone case.
- Systemic Risks: Corruption, Bribery and Corporate Frauds – Emerging economies like India suffer from a number of issues which slow down the growth of entrepreneurship and business. High level of corruption creates an uneven business environment where the best and the most meritocratic are often beaten by the better connected. This in turn results in suboptimal services and infrastructure. For more than one reason, anti-fraud and anti-corruption legislations are either not very developed or are poorly enforced in emerging markets.
- High Barriers to Entry: Starting from lack of basic infrastructure to product distribution and supply chain management, emerging markets present some very complex entry barriers. Country specific regulations also prevent foreign manufacturers from retailing their products directly and may force them to partner with local players. For example, Wal-Mart tried to set up its multi brand retail outlets in India but could not succeed because of opposition under various state laws. Global companies governed by strict anti-corruption laws in their home countries.
- Lack of Transparency: In emerging economies, there is very little transparency into the inner workings of the government and its various agencies as compared to other developed nations. For India, this lack of transparency has proved to be a major obstacle in attracting foreign investment for many years. Lack of information makes it harder for foreign investors or partners to accurately evaluate local companies. Even from an accounting perspective the Indian Accounting Standards (Ind-AS) are not in line with the GAAP or the IFRS in some material respects.
- Inadequate Infrastructure: The lack of efficient infrastructure creates a major operational challenge for businesses. In addition a lot of times, the management and senior level executives find it difficult to relocate to emerging economies like India citing infrastructure inadequacy.
For example, distributing goods requires companies to cope with an existing road network/infrastructure (in terms of quality as well as numerous taxes imposed at state boundaries).
- Intense Competition: The business landscape in emerging markets is very intense. In Indian and Chinese markets in particular, one can see products from all over the world competing with each other and trying to capture a significant market share mostly because of the sheer size of these two markets. Further, both these counties have a major portion of their population in the below 30 age bracket. A young demography creates a higher growth rate for these emerging countries in comparison to advanced countries.
- Lack of Intellectual Property Protection: Intellectual property rights are not taken as seriously in emerging economies and protection of such rights often proves to be extremely difficult and often futile for corporations from countries with a strong legal system. Without the certainty of patent rights, companies have little incentive to research and develop new products/technology because the financial reward is limited (Patents ensure that companies will earn back the money they invest). Similarly, lack of trademark protection often results in long drawn legal battles and often in dilution of brand value for well established brands when they come to such markets.
- Political Risk: Political risk refers to uncertainty regarding adverse political decisions. Any changes in the policies of the Government of India, particularly any going back to the earlier system of high government regulation may have a materially adverse impact on the business environment of India. In addition any political instability in India, particularly in the larger state elections over the next 2-3 years and any geo-political instability in the region will have an adverse impact the business environment of the country.
- Currency fluctuations: Fluctuation in international currencies often gives or takes away the advantage of investing in an emerging market.Particularly in industries like Information Technology, Oil & Gas etc, a currency fluctuation can turn a gain into a huge loss.
Further, foreign ownership of Indian shares is regulated by the Government of India and by the Reserve bank Of India. As of the end of the first quarter of FY 2014, foreign ownership of the S&P BSE Sensex had risen to over 23%. In case the funds and entities investing in India need capital in their home countries, there could be a massive pulling out of funds from India. This (as we last witnessed in 2008), has a domino effect on sale of equities which is a major risk of investing in all emerging markets.
- Cultural challenges: Hiring local talent often proves to be difficult for new entrants in India. Traditionally, Indian businesses are family owned and have very relaxed working environments. It often proves difficult to fit employees from these organizations in a system driven structure. Further, in India there are as many religious and cultural minorities as the number of spoken languages.