Part I: The Lure Of India

Are the multinationals really welcome?

Foreign direct investment has increased since the start of the reforms, but inflows are still anemic, especially compared with the amount China attracts. In the past fiscal year, India took in about $5.5 billion in foreign direct investment, about 8 percent of China's $64 billion.

Recognising the need to increase the flow of foreign funds, the government has pledged to raise annual foreign direct investment to $15 billion within three years, and to $50 billion within five.

The prime minister has established an investment commission to attract foreign capital, is encouraging Indian executives abroad to invest in India, and has met CEOs from many large multinationals and promised to clear the investment hurdles they face.

But a patchwork of national and state regulations continues to hamstring investment strategies. In many industries, foreign companies find acquisitions harder to make in India than in most other emerging markets. Mining and power generation, for instance, are closed to all but the most determined investors. The government had to work with one of them -� South Korea's Posco -� to overcome local resistance in the state of Orissa to a $12 billion project combining iron ore mining and steel production. That deal represents the largest single foreign investment in India.

In many sectors (such as air transportation, construction, and telecommunications) investment restrictions are falling more quickly. Hutchison Telecom, SingTel, and several private equity firms are placing bets on the burgeoning mobile phone market. The government has promised to liberalize other industries during the next few years; retail banking, for instance, is set to be opened up in 2009.

Restriction on foreign ownership is hardly the only issue making India a less-than-attractive place for many multinationals contemplating investments. Labour laws, for example, prevent a company with more than 100 employees from firing any of them without the state government's approval -� a roadblock for any business that might consider building a large-scale factory to take advantage of India's low labour costs. Paradoxically, auto parts makers and other companies have used capital-intensive business models to stay below this regulation's threshold.

Red tape is also a disincentive. The World Bank estimates that Indian senior managers spend about 14 percent of their time dealing with regulatory issues (compared with about 8 percent for their Chinese counterparts). Starting a business in India takes 89 days, on average, more than twice as long as in China. Closing a business is just as difficult. Reducing or removing such barriers would show that the government is serious about meeting its targets for foreign direct investment.

Isn't China the richer opportunity?

Adil S Zainulbhai is a director in McKinsey's Mumbai office. This commentary first appeared in India Abroad, the newspaper owned by rediff.com, courtesy McKinsey Quarterly.