Wed, Feb 4, 2015

Expert Q&A: Outlook for Japanese Investment in India

Japanese companies have been investing in India for over 50 years, with Japan consistently among the top five investors in India in terms of FDI over the last five years. Furthermore, it has been among the top two or three sources of FDI if one removes Mauritius and Cyprus, which are usually conduits of investment and not the ultimate source of the FDI.

Today, there are signs that India is becoming an even more important destination for Japanese companies looking for international growth. Indeed, one of the first things that India’s Prime Minister Narendra Modi did upon taking office last year was to open a Japan desk within his office, staffed by Japanese-speaking individuals, to facilitate information-sharing and addressing inquiries. This Q&A features insight from Kroll’s Asia Head Tad Kageyama and India Office Head Reshmi Khurana on the geopolitical factors behind the renewed interest; the cultural and business challenges that Japanese investors should be prepared to address; and strategies for mitigating these risks.

Reshmi, have you been seeing growing Japanese interest in India?

RK: Most definitely. Our Kroll team in India has seen a significant uptake in pre-transaction casework, especially in the areas of business intelligence, entire market sector assessments and pre-investment due diligence. In the last year, the work we do in India for Japanese clients has increased by over 50 percent.

Tad, you work closely with numerous Japanese firms. What factors do you see driving this increased interest?

TK: Actually, several developments have converged over the past year to make India more attractive for “new” Japanese investment:
First, we have a changing geopolitical landscape. For example, China has become a more problematic investment climate due to decreasing economic growth, increasing labor costs and a frequent inability for investors to enforce their rights in disputes, especially those involving intellectual property. On the other hand, India’s growth rate is expected to surpass China’s in the next two years.

With a growing consumer class that is driving exciting demand in multiple sectors, India is not just seen as a low-cost manufacturing hub, but also a high-potential revenue-generating market. India’s highly educated, English-speaking workforce is another advantage.

Second, Japanese investors were heartened by last year’s landslide election victories of Prime Minister Narendra Modi and the conservative Bharatiya Janata Party (BJP), both considered to be pro-business. Mr. Modi ran on a platform of growth and anti-corruption, so expectations are very high and positive that the government will follow through on its promises and plans.

Third, India is geographically well positioned to serve as a gateway to frontier markets, especially Africa. All indications point to Africa becoming an economic powerhouse over the next 50 years; more than half of the population is under the age of 20, while a growing middle class, estimated at currently 350 million people, is projected to reach 1.1 billion by 2060.1 While challenges exist, building the region’s infrastructure and meeting massive consumer demand present vast opportunities, which Japanese companies can tap through India.

For Japanese investors, India’s story is one of potential that remains to be tapped. In 2013, India received 5 percent of the total outbound Japanese FDI into Asia in U.S. dollar terms. This is relatively low compared to Thailand’s share of 25 percent and Indonesia’s share of 10 percent. India’s goal should be to increase this share.

Tad, you made a point of saying “new” Japanese investment. Is there another angle to Japanese business in India?

TK: It is important to note that Japanese companies have been operating in India for decades, some for over 50 years. Many of these mature companies are reassessing their position in India. A trend seems to be emerging where these operations, often staffed by senior people, are transforming themselves into self-reliant business units. In these situations, we are seeing more investigative casework related to fraud, compliance and disputes, as opposed to pre-transaction due diligence.

Reshmi, what is India’s perspective when it comes to Japanese FDI?

RK: From financial year (FY) 2009/2010 to FY2013/2014, Japanese FDI into India has grown by a cumulative average growth rate of 16.6 percent in U.S. dollar terms. This number would have been significantly higher had there not been a dip in FY2011/2012 and the depreciation of the yen. If you include investments made by local subsidiaries of Japanese companies, which do not count as FDI, the total investments made by Japan Inc. into India is even higher.

Japanese FDI is attractive in that it is perceived to be highly stable, reflecting long-term commitments. Additionally, Japanese FDI is focused in areas where there is greater need, such as in manufacturing and technology transfer. And of course, Japan is a key political and economic ally.

Foreign investors, including Japanese investors, had become increasingly wary of the risks in India over recent years. Reshmi, where do you see improvements in the current risk landscape?

RK: Until the election victories of Mr. Modi and the BJP last year, partisan politics stalled any meaningful economic development for many years, both domestically and through FDI. However, with a pro-business leader installed and a majority party now in control of India’s parliament, the stage is set for passing anti-corruption reform, faster approvals for infrastructure projects, and the deregulation of natural resources that are key for energy and utilities. The thresholds for foreign direct investment in select industries such as defense, manufacturing and insurance should also see an increase.2

Japanese investors should especially be encouraged by the fact that one of the first things Modi did in taking office was to open a Japan desk within his office, staffed by Japanese-speaking individuals, to facilitate information sharing and addressing inquiries.

Other positive signs have been recent decisions issued by the Indian Supreme Court that have come down in favor of foreign investments. Passage of the Companies Act, 2013 also raises the bar for corporate governance with an eye toward greater transparency and stronger anti-corruption controls.

Tad, when you talk with Japanese investors and companies, what worries them most about operating in India?

TK: Certainly, India’s complex and ever-changing regulatory regime continues to be highly unsettling. Obtaining licenses and/or approvals can be excruciatingly slow and without any certainty that applications will be successful. Tax predictability or I should say, unpredictability and the specter of protracted litigation can also cause an investor to walk away from a potential opportunity. Additionally, while expectations continue to be generally very positive, the lack of movement in opening up the retail sector to FDI comes as a disappointment.

Because any reforms will take time to achieve, Reshmi, what should investors and companies be aware of now when contemplating doing business in India?

RK: There are some specific characteristics about which investors and companies in India must be very vigilant:

  1. Opaque relationships often exist among government bureaucrats, politicians, regulators and business.
  2. Local business partners and local management principally drive business success.
  3. Financial recording and reporting standards do not generally conform to global standards.

Given these difficulties, how should Japanese investors approach investing in India, Reshmi?

RK: Companies must do their homework pre-transaction, then maintain a rigorous program of post-transaction controls. Before I go into specifics, I must share one vital piece of advice with investors: While there may be numerous investors pursuing a limited number of opportunities, do not let the pressure to close a deal sway you from conducting in-depth due diligence. A deal that looks great on paper may be a financial and reputational disaster waiting to happen. There are many successful investors in India, and they are the ones who have taken the time to fully understand and assess the risks they are undertaking.

Investors must also be prepared to invest in good accounting systems to ensure transparency of information as well as robust training for staff members. While there is a new generation of entrepreneurs who are accustomed to generally accepted accounting practices, the concept has yet to be embraced country-wide. Ongoing training as well as periodic unannounced audits may also be necessary to enforce compliance and transparency in books and records.

Tad, are other regions competing for Japanese investment?

TK: Indonesia is one region that springs to mind about which Japanese companies are feeling positive. They are attracted by Indonesia’s large middle-income market that is expected to grow, and they are equally encouraged by the new president’s direction to provide a favorable environment for foreign companies. Additionally, an anti-corruption push by the government is helping reduce the risk for foreign investment. FDI flows3 from Japan to Indonesia grew by a cumulative average growth rate of nearly 40 percent from 2008 to 2013, significantly higher than the growth of FDI to India.

Tad, how should Japanese investors interested in India proceed as the government makes progress with its pro-business agenda?

TK: As I said earlier, Japanese companies have successfully been doing business in India for decades, so I think it’s more a matter of finding the opportunities that make the most sense for them, and then following Reshmi’s advice of thoroughly understanding the risks and rewards of that opportunity.

I would further advise Japanese companies to resist the temptation of trying to control all business activities from their Japan headquarters or installing a Japanese manager at the India site without the support of a strong second layer of local experts. This can be quite counterproductive in India. Instead, we find that trusted local management and local liaisons who understand the market environment are much better positioned to deliver successful results. This makes pre-transaction due diligence all the more valuable when it comes to finding those trusted partners.

Of course, things can change over time. Thus, many of our Japanese clients that rely on us for pre-transaction services related to investments in India are equally interested in our post-transaction guidance in risk mitigation strategies for areas that range from labor issues to cyber security to supply chain/third party risk assessments.

Sources:

1 Tracking Africa’s Progress in Figures, African Development Bank, 2014, http://www.afdb.org/fileadmin/uploads/afdb/Documents/Publications/Tracking_Africa%E2%80%99s_Progress_in_Figures.pdf
2 For a more in-depth look at the election’s implications, see Kroll’s white paper “Does India’s New Government Mean Business?” at http://kroll.com/intelligence-center/white-papers/india-new-government-mean-business
3 On Payment basis, net, flow, USD

 


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