Since the original BRIC reports came out in the early 2000s, global economists, banks and governments have watched the BRIC economies with interest. The years that followed have been a mixed bag for all of them, but in 2018 it is safe to say that India and China continue to show strong growth compared to the rest of the world. Many global companies are thinking of setting up an India office and see this as the right time to step into one of the most attractive economies at present.
AMA has worked for over 30 years with many global companies setting up a presence in India. In the early 2000s, most companies thought of an India office as a "good to have". Over the years an India branch office has become a "must have" – a necessity without which a global business may not be able to maintain its size, momentum and innovation. At the same time, global businesses are wary of the Indian legal and tax systems, bureaucracy and "chaos".
The reality of the investment opportunity in India lies somewhere between the two narratives. In our experience dealing with businesses, we see that the key to a successful India office lies in adapting to the local market, being prepared for its unique challenges and risk-proofing your venture.
The Indian economy has grown at respectable rates over the last 15 years. It now stands poised for rapid but more stable growth. The expected GDP growth rate over the next 5 years is estimated to be between 7% and 10%. India is expected to be a $25 trillion dollar economy by 2025. There has been strong improvement in global trade and there are more and more entrepreneurship stories. India was, for a long time, the manufacturing hub and the call centre hub for global businesses. It is now also a research centre, a profit centre and much more in its own right.
With a growing skilled workforce, the potential for growth in technology, software, services and even industrial sectors is immense. By 2020 India will have the largest young population in the world and even currently has the third largest group of scientists and technicians in the world. There is a rising middle class with increasing disposable incomes and changing spending patterns. Consumerism comes to India much after the West but is on track to catching up, with 129 million urban mass consumers.
Infrastructure is possibly the area that requires the most work in a country of this size and scope. Modernisation is the need of the hour, and as the economy has moved from an agrarian one to an industrial one, infrastructure is front and centre of the agenda for central and state governments. The Government recently announced that it had electrified the last non-powered village in the country. Current estimates peg the planned investment for the next 20 years to be c.$1.5 trillion, covering highways, railways, ports, industrial corridors, housing, etc.
The economy was opened up to overseas investments in the early 1990s but the effects have been most prominent after the early 2000s. The current Government (elected in 2014) is seen as strongly pro-business and with its strong majority, also does not suffer from the problems of coalitions (which stalled many a reform with preceding governments). Several reforms are being rolled out simultaneously, including the largest tax reform in the history of India – replacing all indirect taxes with a single goods and services tax (GST).
There is also a strong push for the economy to move from a cash-based one to formal banking systems. India's rank on the world's Ease of Doing Business Index rose from 142 to 100 last year. Admittedly this shows that there is much work to be done, however there is also a commitment from Government agencies to effect improvements rapidly. Compared to many emerging economies, India continues to have a greater political stability and stronger economic laws and decision-making, all of which are favourable to businesses.
The above factors have made India among the top investment destinations globally for companies and investors. Yet, many companies continue to treat an Indian branch expansion with wariness, or choose to not engage at all. This is because several 'proven' business models failed when they came to India and yet others found themselves wrapped in red tape. There is a general impression that there is a great deal of "chaos" in India – and this is absolutely true. Lengthy Government approval processes, confusing banking guidelines and the presence of a large unorganised sector (which may also compete with your product or service) are enough to scare many.
What are the challenges that businesses face when they try to set up an India office? Broadly, there may be systemic issues or specific issues. Systemic issues are those that affect all businesses in India or in a certain sector. Specific issues are those which specifically affect overseas companies looking to set up an Indian branch.
1. Complex taxation systems
India has both direct and indirect taxation in the form of income tax (IT) and goods and services tax (GST). The latter replaces many taxes, including service tax, value added tax, central sales tax and others. Both IT and GST systems are moving towards greater online reporting, however both require in-depth analysis and interpretation of tax law. There are also several monthly, quarterly and annual tax compliances for companies of all sizes. In addition to this, tax scrutiny/assessment or tax audit can often be a lengthy, time-consuming process, with extraneous factors influencing outcomes at times.
2. Regulation of FDI and foreign exchange
The Reserve Bank of India (RBI) controls all foreign exchange inflows and outflows, directly or through the banking system. Foreign direct investment (FDI) in India was historically heavily regulated, it is now more liberalised. However there are detailed compliance requirements for remittance of capital into India and for repatriation of profits to a parent outside India. Remitting money into or out of India through banking channels also requires a substantial amount of paperwork. Similarly, taking a loan from an overseas parent company falls under the External Commercial Borrowing (ECB) guidelines which restrict certain sectors from borrowing and place limits on amounts, interest rates, agreements, etc.
3. Complex legal systems and slow-moving judiciary
A relic of the British era, India's legal system is complicated and often archaic. There are several legacy laws that continue to apply to companies and individuals. All businesses require multiple registrations and certificates and manufacturing entities face the highest compliance burden. Labour laws are strict, however most small to medium sized companies do not have strong unions. Delays in court cases can stretch to decades and it is quite ordinary for all directors of a company to received personal notices in litigations against the company.
It's therefore not surprising that most corporates prefer to settle disputes via arbitration and mediation rather than take the legal route.
4. Transfer pricing requirements
Transfer pricing requirements apply under the Indian tax law to companies which have transactions with their overseas parents, subsidiaries or group companies. The net of a "related party" for transfer pricing is extremely wide and therefore can bring a multitude of transactions under the scanner. There is a high risk of summary negative assessments, penalties and punitive damages being levied for actual or perceived non-compliance.
5. Differences in market
In size and scope, India is an extremely complex marketplace. For consumer brands in particular, it can be overwhelming to formulate a strategy. This is because of the multitude of regional languages, the varied income ranges of consumers, the difficulty of setting up a distribution network and so on. Local competition usually exists and has the first mover advantage. There is also a thriving and fragmented unorganised sector which cannot be analysed and competed with.
6. Differences in culture and problems with JV partners
Among the specific issues that overseas companies face is the difference in culture. This can be either work culture or social customs (or both). It therefore takes longer to establish a good JV partnership and both partners may occasionally find themselves befuddled by the actions of the other. There are often conscious and unconscious biases at play, which make integration difficult. In addition, employees in India are trained differently from employees in European or American contexts. So the conflict continues as Indian employees find themselves reporting to an overseas manager, or vice versa.
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With all of these unique challenges, many companies choose to back out after a market study. Others start operations but find they are unable to achieve the growth rates they planned. But for each of these, there is also a success story of an overseas company that came prepared to face the challenges and adapted itself to win in the market. The key, then, is to know what your company is getting into, to consult experts as much as possible and to adapt your offering for the market. The final requirement is patience – there will definitely be surprises along the way but with preparation and patience the Indian branch office could become a powerhouse of the global business.
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The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.