Doctrine Of Separation Of Powers

December 7, 2014 by admin Leave a Comment

by Bani Mahajan

Editors Note: The Doctrine of Separation of Powers, was proposed by Montesquieu, in his
work, De lespirit des lois, although the first thought of separating the legislative power was
proposed by John Locke, into: discontinuous legislative power, continuous legislative power and
federative power. In 1787, The founding fathers of the United States of America, incorporated
this principle into their constitution. Montesquieu proposed the basic principle to be that the
same person should not form part of more than one of the three organs of the government.
Ideally, that means that Ministers should not be elected. This is one principle that is different
between the Indian and United States government, where the Secretaries to the President are
non-legislative appointees.Accumulation of power in any more than one of the branches of the
government, would amount to the base of tyrannical rule, whether self-appointed or elected. The
Indian Constitution has not expressly recognized the Doctrine of Separation of Powers, but there
is also the assumption that one wing of the government will not interfere with the other. Cases
like I.R Coelho v. State of Tamil Nadu and Indira Gandhi v. Raj Narain, observed the separation
of powers was limited, unlike the United States. However, none of the three separate organs of
the Republic can take over the functions assigned to the other, even by resorting to Article 368.

Introduction

Power corrupts and absolute Power tends to corrupt absolutely.

The separation of powers is based on the principle of trias politica. The Doctrine of Separation
of Power is the forerunner to all the constitutions of the world, which came into existence since
the days of the Magna Carta. Though Montesquieu was under the erroneous impression that
the foundations of the British constitution lay in the principle of Separation of Power, it found its
genesis in the American Constitution. Montesquieu had a feeling that it would be a panacea to
good governance but it had its own drawbacks. A complete Separation of power without
adequate checks and balances would have nullified any constitution. It was only with this in
mind the founding fathers of various constitutions have accepted this theory with modifications
to make it relevant to the changing times.[i]
The Doctrine of Separation of Powers, a vintage product of scientific political philosophy is
closely connected with the concept of judicial activism. Separation of Powers is embedded in
the Indian Constitutional set up as one of its basic features. In India the fountain-head of power
is the Constitution. The sovereign power has been distributed among the three-wings:

-Legislature
-Executive

-Judiciary

The doctrine of separation of powers envisages a tripartite system. Powers are delegated by the
Constitution to he three organs, and delineating the jurisdiction of each.[ii]
The position in India is that the doctrine of separation of powers has not been accorded a
constitutional status. In the Constituent Assembly there was a proposal to incorporate this
doctrine in the Constitution but it was knowingly not accepted and as such dropped. Apart from
the directive principles laid down in Article 50 which enjoins separation of judiciary from the
executive, the constitutional scheme does not embody any formalistic and dogmatic division of
powers.[iii]

Historical Background

The tripartite model of governance has its origin in Ancient Greece and Rome. Though the
doctrine is traceable to Aristotle but the writings of Locke and Montesquieu gave it a base on
which modern attempts to distinguish between legislative, executive and judicial power is
grounded.
The doctrine may be traced to ancient and medieval theories of mixed government, which
argued that the processes of government should involve the different elements in society such
as monarchic, aristocratic, and democratic interests. The first modern formulation of the doctrine
was that of the French writer Montesquieu in De lesprit des lois (1748), although the English
philosopher John Locke had earlier argued that legislative power should be divided between
king and Parliament.[iv]
Locke distinguished between what he called:

1. Discontinuous legislative power

 2. Continuous executive power

Federative power.

He included within discontinuous legislative power the general rule-making power called into
action from time to time and not continuously. Continuous executive power included all those
powers, which we now call executive and judicial. By federative power he meant the power of
conducting foreign affairs. Montesquieus division of power included a general legislative power
and two kinds of executive powers; an executive power in the nature of Lockes federative
power and a civil law executive power including executive and judicial power. [v]

It was Montesquieu who for the first time gave it a systematic and scientific formulation in his
book Esprit des Lois (The Spirit of the laws) published in the year 1748.[vi] Locke and
Montesquieu derived the contents of this doctrine from the developments in the British
constitutional history of the 18th Century. In England after a long war between the Parliament and
the King, they saw triumph of Parliament in 1688, which gave Parliament legislative supremacy
culminating in the passage of Bill of Rights. This led ultimately to a recognition by the King of
legislative and tax powers of the Parliament and the judicial powers of the courts. At that time,
the King exercised executive powers, Parliament exercised legislative powers and the courts
exercised judicial powers, though later on England did not stick to this structural classification of
functions and changed to the parliamentary form of government.[vii]

After the end of the war of independence in America by 1787 the founding fathers of the
American constitution drafted the constitution of America and in that itself they inserted the
Doctrine of separation of power and by this America became the first nation to implement the
Doctrine of separation of power throughout the world.

The constituent Assembly Of France in 1789 was of the view that there would be nothing like a
Constitution in the country where the doctrine of separation of power is not accepted. In France,
where the doctrine was preached with great force by Montesquieu, it was held by the more
moderate parties in the French Revolution.[viii] However the Jacobins, Napoleon I and Napoleon
III discarded the above theory for they believed in the concentration of power. But it again found
its place in the French Constitution of 1871.
Later Rousseau also supported the said theory propounded by Montesquieu. England follows
the parliamentary form of government where the crown is only a titular head. The mere
existence of the cabinet system negates the doctrine of separation of power in England as the
executive represented by the cabinet remains in power at the sweet will of the parliament.
In India under the Indian constitution there is an express provision under article 50 of the
constitution which clearly states that the state should take necessary steps to separate judiciary
from the executive i.e. independence of judiciary should be maintained.
Montesquieus Theory

According to this theory, powers are of three kinds: Legislative, executive and judicial and that
each of these powers should be vested in a separate and distinct organ, for if all these powers,
or any two of them, are united in the same organ or individual, there can be no liberty. If, for
instance, legislative and executive powers unite, there is apprehension that the organ concerned
may enact tyrannical laws and execute them in a tyrannical manner. Again, there can be no
liberty if the judicial power be not separated from the legislative and the executive. Where it
joined the legislative, the life and liberty of the subject would be exposed to arbitrary control, for
the judge would then be the legislator. Where it joined with the executive power, the judge might
behave with violence and oppression.[ix]

Writing in 1748, Montesquieu said:

When the legislative and the executive powers are united in the same person or in the same
body of magistrates, there can be no liberty, because apprehensions may arise, lest the same
monarch or senate should exact tyrannical laws, to execute them in a tyrannical manner. Again
there is no liberty if the judicial power be not separated from the legislative and the executive.
Where it joined with the legislative, the life and the liberty of the subject would be exposed to
arbitrary control; for the judge would be then a legislator. Where it joined to the executive power,
the judge might behave with violence and oppression.

There would be an end of everything, where the same man or the same body, whether of nobles
or of the people, to exercise those three powers, that of enacting laws, that of executing the
public resolutions and of trying the causes of individuals.[x]

The theory of separation of powers signifies three formulations of structural classification of

governmental powers:

1. The same person should not form part of more than one of the three organs of the
government. For example, ministers should not sit in the Parliament.
 2. One organ of the government should not interfere with any other organ of the
government.

One organ of the government should not exercise the functions assigned to any other
organ.[xi]

Now the question in subject is whether this doctrine finds a place in England?
In England the King being the executive head s also an integral part of the legislature. His
ministers are also members of one or other Houses of Parliament. This concept goes against
the idea that same person should not form part of more than one organ of the Government.

In England House of Commons control the executive. So far as judiciary is concerned, in theory
House of Lords is the highest Court of the country but in practice judicial functions are
discharged by persons who are appointed specially for this purpose, they are known as Law
Lords and other persons who held judicial post. Thus we can say that doctrine of separation of
powers is not an essential feature of British Constitution.[xii]

Principle of Checks and Balances

The doctrine of separations of powers may be traced back to an earlier theory known as the
theory of mixed government from which it has been evolved. That theory is of great antiquity and
was adurnbrated in the writings of Polybius, a great historian who was captured by the Romans
in 167 BC and kept in Rome as a Political hostage for 17 years in his history of Rome.
Polybius explained the reasons for the exceptional stability of Roman Government which
enabled Rome to establish a worldwide empire. He advanced the theory that the powers of
Rome stemmed from her mixed government. Unmixed systems of government that is the three
primary forms of government namely, Monarchy, Aristocracy and Democracy were considered
by Polybius as inherently unstable and liable to rapid degeneration.
The Roman constitutions counteracted that instability and tendency to degeneration by a happy
mixture of principles drawn from all the three primary forms of government. The consuls, the
senate and the popular Assemblies exemplified the monarchical, the aristocratic and the
democratic principles respectively.

The powers of Government were distributed between them in such a way that each checked and
was checked by the others so that an equipoise or equilibrium was achieved which imparted a
remarkable stabiliy to the constitutional structure. It is from the wok of Polybius that political
theorist in the 17th Century evolved that theory of separation of powers and the closely related
theory of Checks and Balances. [xiii]

Effects
The doctrine of separation of powers as propounded by Montesquieu had tremendous impact
on the development of administrative law and functioning of Governments. It was appreciated by
English and American jurists and accepted by politicians. In his book Commentaries on the
Laws of England, published in 1765, Blackstone observed that if legislative, executive and
judicial functions were given to one man, there was an end of personal liberty. Madison also
proclaimed: The accumulation of all powers, legislative and executive and judicial, in the same
hands, whether of one, a few or many and whether hereditary, self-appointed or elective may
justly be pronounced the very definition of tyranny. The Constituent Assembly of France
declared in 1789 that there would be nothing like a Constitution in the country where the
doctrine of separation of powers was not accepted.[xiv]

Importance

The doctrine of separation of power in its true sense is very rigid and this is one of the reasons
of why it is not accepted by a large number of countries in the world. The main object as per
Montesquieu in the Doctrine of separation of power is that there should be government of law
rather that having will and whims of the official. Also another most important feature of the above
said doctrine is that there should be independence of judiciary i.e. it should be free from the
other organs of the state and if it is so then justice would be delivered properly. The judiciary is
the scale through which one can measure the actual development of the state if the judiciary is
not independent then it is the first step towards a tyrannical form of government i.e. power is
concentrated in a single hand and if it is so then there is a cent percent chance of misuse of
power. Hence the Doctrine of separation of power do plays a vital role in the creation of a fair
government and also fair and proper justice is dispensed by the judiciary as there is
independence of judiciary.

Also the importance of the above said doctrine can be traced back to as early as 1789 where
The constituent Assembly Of France in 1789 was of the view that there would be nothing like a
Constitution in the country where the doctrine of separation of power is not accepted. Also in
1787 the American constitution inserted the provision pertaining to the Doctrine of separation of
power at the time of drafting of the constitution in 1787.[xv]
Defects
Though, theoretically, the doctrine of separation of powers was very sound, many defects
surfaced when it was sought to be applied in real life situations. Mainly, the following defects
were found in this doctrine:

a) Historically speaking, the theory was incorrect. There was no separation of powers under the
British Constitution. At no point of time, this doctrine was adopted in England.
As Prof. Ullman says: England was not the classic home of separation of powers. It is said:
Montesquieu looked across foggy England from his sunny vineyard in Paris and completely
misconstrued what he saw.

b) This doctrine is based on the assumption that the three functions of the Government viz
legislative, executive and judicial are independent of distinguishable from one another. But in
fact, it is not so. There are no watertight compartments. It is not easy to draw demarcating line
between one power and another with mathematical precision.

1. c) It is impossible to take certain actions if this doctrine is accepted in this entirety. Thus,
if the legislature can only legislate, then it cannot punish anyone, committing a breach of
its privilege; nor can it delegate any legislative function even though it does not know the
details of the subject-matter of the legislation and the executive authority has expertise
over it; nor could the courts frame frame rules of procedure to be adopted by them for the
disposal of cases. Separation of Powers, thus can only be relative and not absolute.d)
Modern State is a welfare State and it has to solve complex socio-economic problems and
in this state of affairs also, it is not possible to stick to this doctrine. Jusice Frankfurter
said; Enforcement of a rigid conception of separation of powers would make modern
Government impossible. Strict separation of powers is a theoretical absurdity and
practical impossibility.[xvi]

e) The modern interpretation of the doctrine of Separation of Powers mans that discretion
must be drawn between essential and incidental powers and one organ of the
Government cannot usurp or encroach upon the essential functions belonging to another
organ, but may exercise some incidental functions thereof.[xvii]

f) Fundamental object behind Montesquieus doctrine was liberty and freedom of an

individual; but that cannot be achieved by mechanical divison of functions and powers. In
England, theory of Separation of Powers is not accepted and yet it is known for the
protection of individual liberty. For freedom and liberty, it is necessary that there should be
 Rule of Law and impartial and independent judiciary and eternal vigilance on the part of
subjects.[xviii]

Indian Outlook

In India, the doctrine of separation of powers has not been accorded a constitutional status.
Apart from the the directive principle laid down in Article 50 which enjoins separation of judiciary
from the executive, the constitutional scheme does not embody any formalistic and dogmatic
division of powers.[xix]

The Supreme Court in Ram JawayaKapur v. State of Punjab[xx], held:

Indian Constitution has not indeed recognized the doctrine of separation of powers in its
absolute rigidity but the functions of the different parts or branches of the government have been
sufficiently differentiated and consequently it can be very well said that our Constitution does not
contemplate assumption by one organ or part of the State of functions that essentially belong to
another.

In Indira Nehru Gandhi v. Raj Narain[xxi], Ray C.J.also observed that in the Indian Constitution
there is separation of powers in a broad sense only. A rigid separation of powers as under the
American Constitution or under the Australian Constitution does not apply to India. However, the
Court held that though the constituent power is independent of the doctrine of separation of
powers to implant the story of basic structure as developed in the case of KesavanandaBharati
v. State of Kerela[xxii] on the ordinary legislative powers will be an encroachment on the theory
of separation of powers. Nevertheless, Beg, J. added that separation of powers is a part of the
basic structure of the Constitution. None of the three separate organs of the Republic can take
over the functions assigned to the other. This scheme of the Constitution cannot be changed
even by resorting to Article 368 of the Constitution.

In India, not only is there a functional overlapping but there is personnel overlapping also. The
Supreme Court has the power to declare void the laws passed by the legislature and the actions
taken by the executive if the violate any provision of the Constitution or the law passed by the
legislature in case of executive actions. Even the power to amend the Constitution by Parliament
is subject to the scrutiny of the Court. The Court can declare any amendment void if it changes
he basic structure of the Constitution.[xxiii] The President of India in whom the Executive
Authority of India is vested exercises law making power in the shape of ordinance making power
and also the judicial powers under Article 103(1) and Article 217(3) to mention only a few. The
Counsel of Ministers is selected from the Legislature and is responsible to the Legislature. The
Legislature besides exercising law making powers exercises judicial powers incases of breach
of its privilege, impeachment of the President and the removal of the judges. The Executive may
further affect the functioning of the judiciary by making appointments to the office of the Chief
Justice and other Judges. [xxiv]

Judicial Opinion on the Doctrine of Separation of Powers

The separation of power there were times where the judiciary has faced tough challenges in
maintaining and preserving the Doctrine of separation of power and it has in the process of
preservation of the above said Doctrine has delivered landmark judgments which clearly talks
about the independence of judiciary as well as the success of judiciary in India for the last six
decades.

The first major judgment by the judiciary in relation to Doctrine of separation of power was in
Ram Jawaya v state of Punjab[xxv]. The court in the above case was of the opinion that the
Doctrine of separation of power was not fully accepted in India. Further the view of Mukherjea J
adds weight to the argument that the above said doctrine is not fully accepted in India. He states
that:

The Indian constitution has not indeed recognize the doctrine of separation of powering its
absolute rigidity but the functions of the different parts or branches of the government have been
sufficiently differentiated and consequently it can very well be said that our constitution does not
contemplate assumption, by one organ or part of the state, of functions that essentially belong to
another.

Later in I.C.GolakNath v State of Punjab[xxvi], SubhaRao, C.J opined that

The constitution brings into existence different constitutional entitles, namely the union, the
state and the union territories. It creates three major instruments of power, namely the
Legislature, the Executive and the Judiciary. It demarcates their jurisdiction minutely and
expects them to exercise their respective powers without overstepping there limits. They should
function with the spheres allotted to them
The above opinion of the court clearly states the change in the courts view pertaining to the
opinion in the case of Ram Jawaya v State of Punjab related to the doctrine of separation of
power. The came one of the most land mark judgments delivered by the Supreme Court in
KeshvanandaBharti v Union of Indiathe court was of the view that amending power was now
subject to the basic features of the constitution. And hence, any amendment tampering these
essential features will be struck down as unconstitutional. Beg, J. added that separation of
powers is a part of the basic structure of the constitution. None of the three separate organs of
the republic can take over the functions assigned to the other7. Hence this further confirmed the
opinion of the court in relation to the doctrine of separation of power.

Then in Indira Gandhi Nehru v. Raj Narain, where the dispute regarding P.M. election was
pending before the Supreme Court, opined that adjudication of a specific dispute is a judicial
function which parliament, even under constitutional amending power, cannot exercise i.e. the
parliament does not have the jurisdiction to perform a function which the other organ is
responsible for otherwise there will be chaos as there will be overlapping of the jurisdictions of
the three organs of the state. Also the constituent Assembly Of France in 1789 was of the view
that there would be nothing like a Constitution in the country where the doctrine of separation of
power is not accepted. So if there is a provision then there should be proper implementation and
this judgment emphasis on that point only.

Also in I.R. Coelho vs. State of Tamil Nadu[xxvii], S.C. took the opinion opined by the
Supreme court in Kesavananda Bharaticase pertaining to the doctrine of basic structure

and held that the Ninth Schedule is violative of the above said doctrine and hence from now on
the Ninth Schedule will be amenable to judicial review which also forms part of the basic
structure theory..

From the above few case laws right from Ram Jawaya v state of Punjab in 1955 to I.R.
Coelho vs. State of Tamil Nadu inthere has been a wide change of opinion as in the beginning
the court was of the opinion that as such there is no Doctrine of Seperation of Power in the
constitution of India but then as the passage of time the opinion of the Supreme Court has also
changed and now it do includes the above said Doctrine as the basic feature of the Constitution.
Evaluation of the Doctrine
In strict sense the principle of separation of powers cannot be applied in any modern
Government either may be U.K., U.S.A., France, India or Australia. But it does not mean that the
principle has no relevance now a days. Government is an organic unity. It cannot be divided into
water tight compartments.

History proves this fact. If there is a complete separation of powers the government cannot run
smoothly and effectively. Smooth running of government is possible only by co-operation and
mutual adjustment of all the three organs of the government. Prof. Garner has rightly said, the
doctrine is impracticable as a working principle of Government. It is not possible to categorize
the functions of all three branches of Government on mathematical basis. The observation of
Frankfurter is notable in this connection. According to him Enforcement of a rigid conception of
separation of powers would make Government impossible.18

It is my opinion that the doctrine of Montesquieu is not merely a myth it also carries a truth, but
in the sense that each organ of the Government should exercise its power on the principle of
Checks and Balances signifying the fact that none of the organs of Government should usurp
the essential functions of the other organs. Professor Laski has aptly remarked: It is necessary
to have a separation of functions which need not imply a separation of personnel.[xxviii]

Edited by Nikhil Variyar

Factors Influencing Foreign Investment Decisions

Now that you understand the basic economic reasons why companies choose to
invest in foreign markets, and what forms that investment may take, it is important
to understand the other factors that influence where and why companies decide to
invest overseas. These other factors relate not only to the overall economic outlook
for a country, but also to economic policy decisions taken by foreign governments
aspects that can be very political and controversial.

The policy frameworks relating to FDI and FPI are relatively similar, although there
are a few differences.
Direct investors tend to look at a number of factors relating to how they will be able
to operate in a foreign country:

the rules and regulations pertaining to the entry and operations of foreign
investors

standards of treatment of foreign affiliates, compared to nationals of the host

country

the functioning and efficiency of local markets

trade policy and privatization policy

business facilitation measures, such as investment promotion, incentives,

improvements in amenities and other measures to reduce the cost of doing
business. For example, some countries set up special export processing zones,
which may be free of customs or duties, or offer special tax breaks for new investors

restrictions, if any, on bringing home (re-patriating) earnings or profits in the

form of dividends, royalties, interest or other payments

The determinants of FPI are somewhat more complex, however. Because portfolio
investment earnings are more likely to be tied to the broader macroeconomic
indicators of a country, such as overall market capitalization of an economy, they
can be more sensitive to factors such as:

high national economic growth rates

exchange rate stability

general macroeconomic stability

levels of foreign exchange reserves held by the central bank

general health of the foreign banking system

liquidity of the stock and bond market

interest rates

In addition to these general economic indicators, portfolio investors also look at the
economic policy environment as well, and especially at factors such as:

the ease of repatriating dividends and capital

taxes on capital gains

regulation of the stock and bond markets

the quality of domestic accounting and disclosure systems

the speed and reliability of dispute settlement systems

the degree of protection of investors rights

A ccording to an Ernst & Young survey, while India has been one of the leading destinations for shared services, it

is rapidly emerging as a manufacturing location for many foreign corporations.

By 2020, 25 per cent of survey respondents see India among the world's leading three destinations for
manufacturing.

So, what do investors seek in India? Ernst & Young has found 10 factors that foreign investors find most attractive
while deciding to invest in India.

1. High potential of domestic market

Factor that investors find attractive: 50 per cent

The recent FDI data mirrors the emergence of manufacturing for FDI. In 2011, 78 per cent of investment in terms of
value went to the manufacturing sector in comparison to 14 per cent for shared services.

. Cost competitiveness

Factor that investors find attractive: 45 per cent

This is despite the fact that in terms of number of projects, 54 per cent of FDI projects were related to services and
34 per cent were manufacturing-led.

. Access to highly qualified workforce

Factor that investors find attractive: 25 per cent

Underscoring the potential in the domestic market, 35 per cent of the companies surveyed nominated India as an
attractive destination for domestic manufacturing and 21 per cent as an attractive base for manufacturing for the
global market.

4. Demand-driven growth model

Factor that investors find attractive: 23 per cent

When investing in manufacturing projects in India, investors tend to target the industrial machinery, equipment and
tools (115 projects) and the automotive (76 projects) sectors.
5. High productivity

Factor that investors find attractive: 15 per cent

About 65 per cent of the respondents believe that an improvement in quality of logistics and transportation will
accelerate India's attractiveness as a destination for manufacturing.

6. Leading location for manufacturing facilities

Factor that investors find attractive: 13 per cent

Investors show strong confidence in India to maintain this performance in the long term. Only 11 per cent of the
survey respondents see India being surpassed by more dynamic countries.

7. Support for innovation

Factor that investors find attractive: 12 per cent

Twenty-nine per cent believe that India will continue to experience rapid growth in the coming years.
. Political stability

Factor that investors find attractive: 8 per cent

Investors are also more demanding. They want to secure their investments in easily accessible (63 per cent) and
predictable business climates with FDI-friendly regulatory environments (62 per cent).

9. Ease of doing business

Factor that investors find attractive: 2 per cent

Indian business conditions raise concerns among global leaders. The survey respondents believe that improving
infrastructure network (76 per cent) and better governance and transparency system (60 per cent) will have a high
impact on India's attractiveness.

10. Importance of CSR initiatives

Factor that investors find attractive: 1 per cent

In the long term, investors highlight innovation as a challenge for India. Forty-three per cent of investors think that it
needs to improve the quality of its labs and research institutions.

More specifically, 38 per cent of investors cite distance between research institutions and corporations as a roadblock
to developing new products in the country.
Foreign Direct Investment in India Up 61% since Last Year

Attracting FDI, or foreign direct investment, was one of the key promises made by
the now one-year-old Narendra Modiled government. Has the government kept its
promise?

According to data from the RBI (Reserve Bank of India), India attracted foreign direct
investment worth $34.9 billion between April 2014 and March 2015, or fiscal year
2015. This quantum was up 61.7% from the previous fiscal year.

It appears that Modis trips abroad are working, and that his schemes and plans
have attracted foreign direct investment into the country.

FDI IN RETAIL
Until 2011, foreign direct investment (FDI) was not allowed in multi-brand retail,
forbidding foreign companies from any ownership in supermarkets, convenience
stores or any retail outlets. Even single-brand retail was limited to 51 per cent
ownership. In January 2012, India allowed 100 per cent FDI investment in single-
brand stores, but imposed the requirement that the single brand retailer would have
to source 30 percent of its goods from India. On 7 December 2012, India allowed 51
per cent FDI in multi-brand retail. Manmohan Singh, the then prime minister of
India, felt that this would be beneficial for both consumers and farmers. Agricultural
marketing was also expected to be benefited with the introduction of new
technologies. googletag.cmd.push(function() { googletag.display('div-gpt-ad-
1403676981883-0'); }); Manmohan Singh was credited with bringing about this
policy change aimed at making India friendlier for businessmen. With this decision,
international companies, especially the supermarkets, were able to increase their
presence in the multi-brand retail sector of India. However, they were not allowed to
own more than 51 per cent stakes in these establishments. This step was regarded
as the most important one in the last two decades, especially with regard to reforms
in India. Political Controversies

There has been a fair share of controversy surrounding the then UPA government's
decision to permit FDI in retail sector. The decision to allow 51 percent FDI in the
multi-brand retail sector came under attack from the opposition in the Rajya Sabha.
The government had, on its part, aimed to justify the decision saying it was only in
the best interests of India.

Reasons for promotion of FDI in Retail

The major benefit of FDI is that it is both supplementary and complimentary with
regards to local investment. FDI lets a company gain better access to top class
technology and supplementary funds. They are also exposed to management
practices in vogue around the world and also get the chance to become a part of
the global market system. The Indian government had commissioned Indian Council
for Research on International Economic Relations (ICRIER) to perform a study on the
effect of organised retailing practices on its unorganised counterpart. ICRIER
submitted the report during 2008. The study hinted at the advantages that the
growth of organised retail will have for various participants like the consumers,
manufacturers, and farmers. The government decided on the basis of the results in
other countries and the ICRIER study that this decision would result in a greater
influx of FDI in both back and front end infrastructure. It was expected that the
agricultural sector would become more efficient and be in a better position to use
technology. It was also expected that this decision would result in more and better
jobs being created and the best practices around the world will be introduced in
India. Both farmers and consumers will see more convenient prices and higher
quality in future and this will help both the classes. The government also put in an
obligatory condition before foreign companies for procuring 30 percent supplies
from local producers in order to provide a fillip to the manufacturing sector in India.
Jobs are expected to be available in both rural and urban areas thanks to greater
back and frontal operations resulting from more FDI. Domestic retail entities and
traders are expected to pull up their socks and increase their efficiency ever since
this decision. Consequently, the consumers are expected to receive better services
and the producers who provide the source products also get better payment.

Process of FDI in Retail

There is no such procedure for short listing the companies. International companies
who are willing to invest in either single or multi-brand retail can put in their
applications with the Department of Industrial Policy and Promotion. Here the
applications are reviewed in an effort to determine their suitability as per the stated
guidelines. Subsequently, the Foreign Investment Promotion Board, Ministry of
Finance will consider the applications before providing the final approval.

Advantages of FDI in retail

India's retail industry is one of the biggest around the world when it comes to the
privately owned ones. The industry has seen some major restructuring thanks to the
FDI structure becoming more liberal than before. The benefits of FDI in retail, as per
experts, carry greater weightage than the cost related implications. With FDI in
retail, operations in distribution and production cycles are expected to become
better. Owing to factors such as economic operations, the cost of production
facilities will come down as well. This will mean a greater choice of products at
lesser and justifiable prices for the customers. As a result of FDI, companies will be
able to bring in technology and skills from other countries and this will help in
infrastructural development of India. This will also help in creating more value for
money for the buyers. After FDI in retail, it is possible to set up a properly organised
chain of retail stores as the capital to do is readily available. The investment can be
regarded as a long term one as the physical capital put into a domestic company is
not liquidated easily. This is its main difference from equity capital. ICRIER had also
predicted that if FDI in retail was introduced in India during 2011-12, the Indian
economy could have grown by 13 per cent, the unoganised sector could have seen
a 10 per cent growth and the organised sector could have increased by 45 per cent.

Disadvantages of FDI in retail

Experts say that while analysing the positives and drawbacks of FDI in retail, both
the government and the opposition did not refer to the Parliament Committee report
where its effects had been studied in great detail. The committee had taken into
cognizance many witnesses, NGOs, individuals, and trade associations to come up
with the said report. The Committee visited various corners of India and also went
through reports and gathered knowledge about the experience of similar decisions
in other countries. It also enquired from several government departments regarding
the matter. The Committee had surmised in its report that the number of people
getting jobs will be lesser than the amount of people losing the same as a
substantial amount of marginal and small farmers will be wiped out. Some other
problems expected out of this were aggressive pricing and prevalence of monopoly.
As per the Committee's report almost 8 percent of India's workforce is employed in
the unorganised retail sector. This comes up to roughly 40 million people. It has
been stated that FDI in retail will generate 2 million jobs. However, the Committee
had stated that it is not a proper indication as it does not take into account the
number of people who already work in the retail sector. ICRIER had executed a
second study on the effects of FDI in retail during 2011 and in that it had stated that
FDI will bring about a fantastic shopping experience for the consumers. It had
actually interviewed 300 people from the middle and high income groups. Thus, in
effect, the efforts of the Parliament Committee were overlooked for a private
organisation. Experts have questioned the logic of ICRIER to question 300 people in
a country with a 1.2 billion population and more than 40 per cent who can be
termed as poor. The Parliamentary Committee report on FDI was never discussed in
Parliament itself, and as per experts, it is not a good sign as far as the democratic
system in India is concerned. As per ICRIER, consumerism is positive for economic
growth. In 2008 the first survey had dealt with 2020 small and unorganised retailers
whereas the total count of such entities in India at that time was 6 million. Leading
economic experts from outside India have also posed the same question. They have
also pointed at the labour practices of organisations such as Wal-Mart. Most of these
are not exactly healthy for workers. This has also led them to ask if such processes
were really required in India. It is being said that the lobby favouring FDI in retail in
India has invested at least Rs 52 crore and experts opine this could have had a
major say in the way things turned out.

Challenges in introducing FDI in retail

Indian market has high complexities in terms of a wide geographic spread and
distinct consumer preferences varying by each region necessitating a need for
localisation even within the geographic zones. While India presents a large market
opportunity given the number and increasing purchasing power of consumers, there
are significant challenges as well given that over 90 per cent of trade is conducted
through independent local stores. Challenges include: Geographically dispersed
population, small ticket sizes, complex distribution network, little use of IT systems,
limitations of mass media and existence of counterfeit goods.

Political opposition to FDI in retail The then opposition party in India, Bharatiya
Janata Party (BJP) was opposed to FDI in retail. As stated by the then Leader of
Opposition in Lok Sabha and now Union Minster for External Affairs, Sushma Swaraj,
the UPA never tried to create any consensus regarding the issue or talk with the
opposition prior to their campaign in support of FDI in retail. Swaraj also expressed
her worries regarding the possible condition of small traders and farmers once FDI
was introduced in retail. She stated that the big retailers were not coming to India
because they wanted to be charitable but because they saw India as a major
market. Mulayam Singh Yadav, the head of Samajwadi Party, and an opponent of
FDI in retail also questioned the logic of introducing the same only in the bigger
cities with more than 10 lakh people. Yadav felt that this decision would only result
in unemployment. Trinamool Congress (TMC), a former ally of UPA, had left the
coalition during September 2012 as a mark of protest against steps like FDI in retail.
Now that the BJP-led government is in power at the Centre, it is to be seen whether
it goes ahead with the decision to allow 51 per cent foreign direct investment (FDI)
in multi-brand retail by the UPA-II government. Though Nirmala Sitharaman, in
charge of the commerce and industry portfolio as well as a minister of state for
Finance and Corporate Affairs , has stated that the party is against FDI in multi-
brand retail, reversing the decision of the previous government will not be easy,
given the Narendra Modi government's keenness to woo investment, both domestic
and foreign, to improve the Indian economy.

ADVANTAGES OF FDI

Integration into global economy - Developing countries, which invite FDI, can gain
access to a wider global and better platform in the world economy.

Economic growth - This is one of the major sectors, which is enormously benefited
from foreign direct investment. A remarkable inflow of FDI in various industrial units
in India has boosted the economic life of country.

Trade - Foreign Direct Investments have opened a wide spectrum of opportunities in

the trading of goods and services in India both in terms of import and export
production. Products of superior quality are manufactured by various industries in
India due to greater amount of FDI inflows in the country.

Technology diffusion and knowledge transfer FDI apparently helps in the

outsourcing of knowledge from India especially in the Information Technology sector.
Developing countries by inviting FDI can introduce world-class technology and
technical expertise and processes to their existing working process. Foreign
expertise can be an important factor in upgrading the existing technical processes.
For example, the civilian nuclear deal led to transfer of nuclear energy know-how
between the USA and India.

Increased competition - FDI increases the level of competition in the host country.
Other companies will also have to improve on their processes and services in order
to stay in the market. FDI enhanced the quality of products, services and regulates
a particular sector. Linkages and spillover to domestic firms- Various foreign firms
are now occupying a position in the Indian market through Joint Ventures and
collaboration concerns. The maximum amount of the profits gained by the foreign
firms through these joint ventures is spent on the Indian market.

Human Resources Development - Employees of the country which is open to FDI get
acquaint with globally valued skills.

Railways: With a view to liberalise FDI in the railways sector, FDI in certain
activities (including suburban corridor projects through public-private partnerships,
high speed train projects, mass rapid systems etc.) pertaining to the railways
industry was allowed up to 100% under the automatic route subject to the sectoral
guidelines to be issued by the Ministry of Railways. Accordingly, under the new FDI
policy, the list of prohibited sectors has been revised to replace railway transport
with railway operations, thus permitting foreign investment in railway transport
under the automatic route.

Impact: FDI in the railways sector was a much necessary measure in order to
improve the infrastructure of the cash-strapped sector which is one of the most
widely used mode of transportation in India.

(ii) Pension Sector: The New FDI Policy has affirmed that foreign investment in the
pension sector will continue to be governed by the Press Note 4 of 2015 dated April
24, 2015 which permits foreign investment in the pension sector up to 49% as
against the limit of 26%. FDI up to 26% will be allowed under the automatic route
whereas FDI beyond 26% and up to 49% will be subject to the approval of the
Foreign Investment Promotion Board (FIPB).

Impact: The increase in FDI limits in the pension sector will lead to greater capital
infusion in the insurance sector which, in turn, is likely to boost innovation and
introduction of superior technology in the sector.

(iii) Defence sector: The new FDI policy also provides for FDI up to 49% (from the
erstwhile 26%) in the defence sector, under the government approval route along
with certain conditions that are required to be satisfied. Proposals above 49% will be
considered on a case to case basis. For some of the other key changes under the
defence sector please refer to our hotline available at -

Impact: The erstwhile conditions relating to the defence sector failed to attract
sufficient foreign investment. However, it is believed that the conditions for FDI in
defence as provided under the new FDI policy will enable India to access modern
technology and reduce the level of imports. However, due to the presence of
restrictions and the levels of approval that may follow, we are unsure of the impact
that it may create to attract foreign investors.

(iv) FDI in Pharmaceuticals: The new FDI policy consolidates the changes in FDI in
the pharmaceuticals sector, as notified earlier to provide for 100% FDI in
greenfield and brownfield projects under the automatic route and approval route
respectively, in the pharmaceuticals sector. DIPP had vide Press Note 2 of 2015
dated January 21, 2015 carved out medical devices out of the pharma sector and
thereafter permitted FDI in the medical devices segment up to 100% under the
automatic route.

Impact: Under the erstwhile FDI policy, medical devices and pharmaceuticals were
being treated similarly even though the two industries are considered different from
each other. The new FDI policy acknowledges this difference and provides for 100%
FDI in medical devices separately from pharmaceuticals. As a result, the conditions
applicable to the pharmaceuticals sector would not be applicable to the medical
devices industry. For example, while the ban on non-compete clauses in the
pharmaceutical industry was justified, it would not yield desirable results if applied
to the medical devices industry.

(v) FDI in Insurance: In a much awaited move, the government has increased the
cap of FDI inflow into the insurance sector from 26% to 49%. Foreign investment
would be under the automatic route up to 26% and under the government or
approval route for any investment above 26% till 49%. Some of the other key
changes under the insurance sector please refer to our hotline available at -

However, there has been a recent proposal by the Insurance Regulatory and
Development Authority (IRDA) which states that all insurance companies seeking
higher foreign ownership should comply with norms that restrict such increase to
only companies owned and controlled by Indians at the parent level.

Impact: This FDI change will not only boost foreign investment in the otherwise
restricted insurance sector, but will also encourage global insurance companies to
set up their operations in India. However, if the proposal of the IRDA is made law,
this would become challenging for large multinational companies to make / increase
their existing investments in Indian insurance companies.
ENTRY STRUCTURES

INCORPORATING A COMPANY IN INDIA:

It can be a private or public limited company. Both wholly owned & joint ventures
are allowed. Private limited company requires minimum of 2 shareholders.

LIMITED LIABILITY PARTNERSHIPS:

Allowed under the Government route in sectors which has 100% FDI allowed
under the automatic route and without any conditions.

SOLE PROPRIETORSHIP/PARTNERSHIP FIRM:

Under RBI approval. RBI decides the application in consultation with Government
of India.

EXTENSION OF FOREIGN ENTITY:

Liaison office, Branch office (BO) or Project Office (PO). These offices can
undertake only the activities specified by the RBI. Approvals are granted under
the Government and RBI route. Automatic route is available to BO/PO meeting
certain conditions.

OTHER STRUCTURES:

Foreign investment or contributions in other structures like not for profit

companies etc. are also subject to provisions of Foreign Contribution Regulation
Act (FCRA).

Government eases FDI norms in 15 major sectors.

Townships, shopping complexes & business centres all allow up to

100% FDI under the auto route. Conditions on minimum capitalisation
& floor area restrictions have now been removed for the construction
development sector.
 India's defence sector now allows consolidated FDI up to 49% under
the automatic route. FDI beyond 49% will now be considered by the
Foreign Investment Promotion Board. Govt approval route will be
required only when FDI results in a change of ownership pattern.

Private sector banks now allow consolidated FDI up to 74%.

Up to 100% FDI is now allowed in coffee/rubber/cardamom/palm oil &

olive oil plantations via the automatic route.

100% FDI is now allowed via the auto route in duty free shops located
and operated in the customs bonded areas.

Manufacturers can now sell their products through wholesale and/or

retail, including through e-commerce without Government Approval.

Foreign Equity caps have now been increased for establishment &
operation of satellites, credit information companies, non-scheduled air
transport & ground handling services from 74% to 100%.

100% FDI allowed in medical devices

FDI cap increased in insurance & sub-activities from 26% to 49%

FDI up to 49% has been permitted in the Pension Sector.

Construction, operation and maintenance of specified activities of

Railway sector opened to 100% foreign direct investment under
automatic route.

FDI policy on Construction Development sector has been liberalised by

relaxing the norms pertaining to minimum area, minimum
capitalisation and repatriation of funds or exit from the project. To
encourage investment in affordable housing, projects committing 30
percent of the total project cost for low cost affordable housing have
been exempted from minimum area and capitalisation norms.
 Investment by NRIs under Schedule 4 of FEMA (Transfer or Issue of
Security by Persons Resident Outside India) Regulations will be deemed
to be domestic investment at par with the investment made by
residents.

Composite caps on foreign investments introduced to bring uniformity

and simplicity is brought across the sectors in FDI policy.

100% FDI allowed in White Label ATM Operations.

ENTRY ROUTES FOR INVESTMENT IN INDIA

Under the Foreign Direct Investments (FDI) Scheme, investments can be made in shares, mandatorily and fully
convertible debentures and mandatorily and fully convertible preference shares of an Indian company by non-
residents through two routes:

Automatic Route- Under the Automatic Route, the foreign investor or the Indian company does not require
any approval from the Reserve Bank or Government of India for the investment.

Government Route- Under the Government Route, the foreign investor or the Indian company should obtain
prior approval of the Government of India(Foreign Investment Promotion Board (FIPB), Department of
Economic Affairs (DEA), Ministry of Finance or Department of Industrial Policy & Promotion, as the case
may be) for the investment.

Types of Instruments to invest in India

Equity shares

Fully Compulsorily and Mandatorily convertible Debentures.

Fully Compulsorily and Mandatorily convertible Preference shares.

Issue of other types of preference shares such as non-convertible, optionally convertible or partially
convertible, has to be in accordance with the guidelines applicable for External Commercial Borrowings
(ECBs).

Forms of FDI incentives[edit]

Foreign direct investment incentives may take the following forms:[citation

needed]
low corporate tax and individual income tax rates
tax holidays
other types of tax concessions
preferential tariffs
special economic zones
 EPZ Export Processing Zones
Bonded warehouses
Maquiladoras
investment financial subsidies[8]
free land or land subsidies
relocation & expatriation
infrastructure subsidies
R&D support
derogation from regulations (usually for very large projects)

Foreign Direct Investment

Last updated on: June 20, 2015

Introduction

Apart from being a critical driver of economic growth, foreign direct

investment (FDI) is a major source of non-debt financial resource for the
economic development of India. Foreign companies invest in India to take
advantage of cheaper wages, special investment privileges like tax
exemptions, etc. For a country where foreign investments are being made, it
also means achieving technical know-how and generation of employment.

The continuous inflow of FDI in India, which is now allowed across several
industries, clearly shows the faith that overseas investors have in the
country's economy.

The Indian governments policy regime and a robust business environment

have ensured that foreign capital keep flowing into the country. The
government has taken many initiatives in recent years such as relaxing FDI
norms across sectors such as defense, PSU oil refineries, telecom, power
exchanges and stock exchanges, among others.
Market size

FDI into India through the approval route shot up 162 per cent to US$ 1.91
billion in the first ten months of the ongoing fiscal year, indicating that
government's effort to improve ease of doing business and relaxation in FDI
norms may be yielding results.

FDI to India doubled to US$ 4.48 billion in January 2015, the highest inflow in
last 29 months, from US$ 2.18 billion in January 2014.
 The foreign inflows have grown to touch US$ 25.52 billion during the April-
January 2014-15, up 36 per cent year-on-year (y-o-y), from US$ 18.74 billion
in the corresponding period last fiscal, according to Department of Industrial
Policy and Promotion (DIPP) data. The top 10 sectors receiving FDI include
telecommunication which received the maximum FDI worth US$ 2.83 billion
in the 10 month period, followed by services (US$ 2.64 billion), automobiles
(US$ 2.04 billion), computer software and hardware (US$ 1.30 billion) and
pharmaceuticals sector (US$ 1.25 billion).

India received the maximum FDI from Mauritius at US$ 7.66 billion, followed
by Singapore (US$ 5.26 billion), the Netherlands (US$ 3.13 billion), Japan
(US$ 1.61 billion) and the US (US$ 1.58 billion) during April-January 2014-15
period. Healthy inflow of foreign investments into the country helped Indias
balance of payments (BoP) situation and stabilised the value of rupee.

Also, deals worth US$ 3.4 billion across 118 transactions were struck in
January in India, compared with US$ 1.6 billion across 87 transactions in
January last year and US$ 1.2 billion across 74 deals in the same month a
year before that, according to a Grant Thornton report on merger and
acquisition (M&A) and private equity (PE) activity.

Inbound deals have more than tripled in value, led by the Herman-Symphony
transaction worth US$ 780 million and three other deals worth more than
US$ 100 million each.
Investments/Developments

Based on the recommendations of Foreign Investment Promotion Board

(FIPB) in its meeting held on February 17, 2015, the Government has
approved ten proposals of FDI amounting to Rs. 2,857.83 crore (US$ 452.72
million) approximately.

Bengaluru-based business process outsourcing (BPO) firm Hinduja

Global Solutions Ltd (HGS) has announced that it has acquired a majority
stake in Colibrium Partners LLC and Colibrium Direct LLC. The acquisition has
been made by HGS Colibrium Inc, a US subsidiary of HGS, which would own
89.9 per cent of Colibrium, a wellness automation technology firm.
Insurance Australia Group Ltd (IAG) is set to raise its stake in its
general insurance joint venture with the State Bank of India (SBI) from 26 per
cent to 49 per cent, in the first such instance after Parliament cleared a bill
on March 12 that raised the maximum permitted foreign stake in insurance
sector.
 The Maharashtra government has signed a memorandum of
understanding (MoU) with the Swedish furniture retailing giant, IKEA, to set
up two to three stores, with an estimated investment of around Rs 1,800
crore (US$ 285.14 million). Maharashtra is one of four states, including
Telangana, Karnataka and Delhi-National Capital Region (NCR), identified by
IKEA to open its stores.
Lowe's Services India Private Limited, a subsidiary of Lowe's
Companies, has opened its global innovation center (GIC) in Bengaluru,
India. The GIC will focus on next-generation customer experience by laying
emphasis on technology and analytics to provide customers with a more
personalized shopping experience.
ThyssenKrupp Aerospace, part of ThyssenKrupp AG, the Garmany-
based conglomerate, and supplier of aerospace materials and logistics, has
announced its foray into the Indian aerospace market with the setting up of a
facility in Bengaluru. So far the company has invested around Rs 25 crore
(US$ 3.96 million) in the facility, which employs around 30 people
European aircraft major Airbus, which had sourced more than $400
million worth of components from India in the past year, has signed an
agreement with Bengaluru-based Dynamatic Technologies for supply of flap-
track beams for its A-330 wide-body planes
India has received proposals worth Rs 21,000 crore (US$ 3.32 billion)
from companies under the Union governments Make in India programme. Of
this, Rs 6,000 crore (US$ 950.61 million) of proposals have already been
cleared.
Twitter Inc is planning to set up a research and design (R&D) centre in
Bengaluru to grow faster in emerging markets. This will be the San Francisco-
based companys first such facility outside the US.
Keiretsu Forum, a global angel investor network with 1,400 accredited
members, has forayed into India by opening a chapter in Chennai.
CDC, the UKs development finance institution, has invested US$ 48
million in Narayana Hrudayalaya hospitals, a multi-speciality healthcare
provider. CDC will receive a small minority stake in return for its investment.
Government Initiatives

The Government has amended the FDI policy regarding Construction

Development Sector. The amended policy includes easing of area restriction
norms, reduction of minimum capitalisation and easy exit from project.
Further, in order to give boost to low cost affordable housing, it has been
provided that conditions of area restriction and minimum capitalisation will
not apply to cases committing 30 per cent of the project cost towards
affordable housing.
Relaxation of FDI norms are expected to result in enhanced inflows into the
Construction Development sector consequent to easing of sectoral conditions
and clarification of terms used in the Policy. It is likely to attract investments
in new areas and encourage development of plots for serviced housing given
the shortage of land in and around urban agglomerations as well as the high
cost of land. The measure is also expected to result in creation of much
needed low cost affordable housing in the country and development of smart
cities.

The government has also raised FDI cap in insurance to 49 per cent from 26
per cent through a notification issued by the DIPP. The limit is composite in
nature as it includes foreign investment in forms of foreign portfolio
investment, foreign institutional investment, qualified foreign investment,
foreign venture capital investment and non-resident investment.

Also, Indias cabinet has cleared a proposal which allows 100 per cent FDI in
railway infrastructure, excluding operations. Though the initiative does not
allow foreign firms to operate trains, it allows them to do other things such
as create the network and supply trains for bullet trains etc.
Road Ahead

Foreign investment inflows are expected to increase by more than two times
and cross the US$ 60 billion mark in FY15 as foreign investors start gaining
confidence in Indias new government, as per an industry study. "Riding on
huge expectations from the incoming Modi government, global investors are
gung ho on the Indian economy which is expected to witness over 100 per
cent increase in foreign investment inflows both FDI and FIIs to above US$
60 billion in the current financial year, as against US$ 29 billion during 2013-
14," according to the study.

India will require around US $1 trillion in the 12th Five-Year Plan (201217), to
fund infrastructure growth covering sectors such as highways, ports and
airways. This requires support in terms of FDI. The year 2013 saw foreign
investment pour into sectors such as automobiles, computer software and
hardware, construction development, power, services, and
telecommunications, among others.5

The proposed Tesco-Tata joint venture announced on Tuesday would be be a test

case for foreign direct investments (FDIs) in Indian retailing. The government has
mandated that foreign companies invest a minimum of $100 million and half the
total FDI go in back-end infrastructure within three years of the first tranche. Yet,
Tesco is taking a 50 per cent stake in the Tata-owned Trent, which already runs
hypermarkets under the Star Bazaar brand. Although the multi-brand FDI retail
policy mentions fresh investment of $100 mn, the subsequent clarifications made it
seem that funding in new facilities was mandatory.
However, how much must be spent by foreign retailers on new investments is still a
grey area.

Keenly watched
Trent has said the proposed partnership will operate and build on the existing
portfolio of Star Bazaar stores in Maharashtra and Karnataka, thereby triggering a
debate on new ventures versus expansion of existing ventures. Consutants and
retailers Business Standard spoke to noted the sector would closely watch how the
Tesco-Tata JV would comply with the prescribed rules.

FAMILY MANAGED BUSINESS

Family Managed Businesses In India - The Opportunities And The

Challenges
Family businesses are the lifeline of Indias economy. Almost 90% of Indian businesses are family-owned,
which makes the rest of the business community largely dependent on them. Be it as their vendors,
transporters, contractors or distributors; non-family corporations collaborate with family firms on various
levels. Parimal Merchant, Director of the Center of Family Managed Businesses, S.P. Jain Institute
of Management and Research, India, explores in this article the challenges and opportunities that
Indian family businesses face.
 Although family businesses are vital to the Indian economy, little
attention is paid unless there is an opportunity to criticise them.
They are often accused of a lack of professionalism, of
nepotism, infightings, and mismanagement. There is a famous
clich, which is quoted frequently and seems to have been
accepted as a universal truth: The first generation builds, the
second generation consolidates, and the third generation
destroys the family business. When accusing family businesses
of such a short life span it is often conveniently forgotten that
longevity is an objective difficult to achieve for any business. In
1982 the book In Search of Excellence by Tom Peters and
Rober H. Waterman listed 62 companies as high performers. By
1992 most of them were languishing. Similarly, in Fortune
magazines yearly list of top 500 companies; onethird of the
companies listed in 1970 had vanished by 1983. In reality,
survey findings reveal that the average life of a corporation in
Japan and Europe is no longer than 12.5 years independently of
whether they are family-owned or not (Jagdish Sheth, "The Self-
Destructive Habits of Good Companies"). There are many
reasons for short life cycles in businesses, yet, family ownership
is often particularly mentioned. In reality, however, the contrary
is frequently the case: Family businesses on average not only
outlive, but also outperform non-family corporations. A Morgan Stanley study shows that family firms
generated Return on Equity of 18.5% as compared to 14.1% from non-family corporations (John Ward
2007, quoted by Amy Schuman, FBCG, Inland Press, February, 2010). A Newsweek (April 12, 2004)
study shows that family firms outperform their rivals in all leadingstock indexes of Europe.

Indian Family Businesses

The majority of Indian family businesses are quite young. India faced wars in 1962, 1965 and 1971; it was
only after 1980 that the economic environment became more business friendly. As a result the period
from 1980 to 1995 was one in which a large number of family businesses were established and
prospered. Many of those family businesses split up over the last few years due to family differences.
There are some families with large business operations, but the majority are SMEs. Family businesses
have a culture that is often at the same time entrepreneurial, flexible, paternalistic, agile and frugal. Since
the family's name is at stake, they stand for values, long-term commitment, relationship orientation, and
dependability. Indian family firms are also highly efficient. They often have to work with limited resources
and make the most out of it. A multinational car plant can get free land from the Indian government and
access to financing from capital markets, but for the majority of family businesses each step is a
challenge. Yet, they embrace it with a true entrepreneurial spirit. Indian family businesses also have
distinct advantages, particularly that of vigilant ownership. The family owners' commitment and visibility
leads to higher productivity in the business. Their dedication and perseverance enables them to extract
opportunities from complex non-routine problems. In addition, family firms also tend to be less
bureaucratic and can take fast decisions. Their stakes are emotional as well as economical and they are
likely to look for sustained value creation. As a result they can move faster with unconventional logic, can
go counter-cyclical and can reach for new opportunities.
The Challenges

Indian family businesses enjoy various advantages due to their inherent characteristics and a social
culture that supports their structures. However, these advantages can be destroyed if the family is not
united; as the family grows, the challenge is to keep a sense of unity. These are a set of typical
challenges that Indian family businesses face today:

1. The Next Generation

The greatest challenge concerns the gap between family generations: A business founder is used to
doing everything himself. Thus developed the unique culture of the present Indian family business:
Inward-looking, owner centric, smaller scale, with a restricted perspective, and conservative mindset. This
culture eventually becomes a hurdle in absorbing 'outsiders'. The same culture also poses a serious
challenge in absorbing the next generation family members: Different generations, seeing the world
differently are supposed to work together. It can be a difficult thing as the young generation is often in a
hurry and has big ambitions, while their elders are more conservative and skeptical.

The gap keeps on getting wider and wider. When conflict escalates between fathers and sons it is often
the mother, who takes the role of CEO (Chief Emotional Officer). This is a common story in many Indian
family businesses.

2. Attracting and Retaining Non-family Employees

Another possible challenge is non-family employees joining the family firm: The culture, which has
solidified over time, becomes a barrier for accepting 'outsiders'. Business owners are often at a loss as to
how much authority a non-family employee should be able to attain. In most Indian family businesses
stakes are high: It is not easy to put their own destiny in the hands of non-family employees. Having
founded the business, the owner is used to having insight into all aspects of his business. Allowing the
same insight to an outsider can be hard. On the other hand non-family employees may also have
difficulties in adjusting to the family business culture. They are used to structured corporate environments.
In family businesses that structure may be missing.

It is important that time is bestowed on new professionals so they can settle. Many Indian family business
owners end up selecting non-family employees based on their performance in the corporate world without
paying much attention to their 'fit' with their own firm's culture. They forget to spend time in facilitating the
settling down process.

3. Women of the Family Joining the Family Business

Indian family businesses are still largely male dominated. The role of women in business and employing
women is largely accepted and encouraged in India. However, when it comes to hiring women in the
family business, there are reservations. Within the Indian social context of business families, bringing up
the children is considered primarily a responsibility of the mother. Thus, whenever the issue of women in
the family business is raised, it is subject to her ability to balance between her duties at home and her
duties at work. However, as more and more women are highly educated, they are demanding a say in the
family business. The traditional family model is still disapproving of it, yet increasingly it will have to
respond to these demands. It is only reasonable for family businesses to tap into this huge source of
talent.

The Realities

The Indian business landscape has started expanding fast. With the involvement of the older generation
alone, such growth is unthinkable. While the parent generation needs to accept this, the next generation
has to learn to appreciate their parents wisdom and understand that there is no substitute for hard work.

The solution to these challenges requires an understanding of the family business dynamics and a
separation of people from problems. Family business members should learn that no one is wrong but that
each generation has a different culture. Once families learn about these cultures and understand the
need to appreciate different perspectives, whether young or old, they will be able to harmoniously work
with professionals as well as across generations. Thus, if family businesses can manage these dynamics,
they will be better placed to reap the benefits of the great range of opportunities in the Indian economy
and beyond.

UPFRONT/SPECIAL | Nov 2, 2015 | 3038 views

Corporate governance
paramount for family businesses
to thrive
by Aveek Datta

Good governance in all aspects of business, including remuneration policy,

allocation of roles and responsibilities to family members, constituting a
strong and independent board and induction of professionals from outside,
are factors that lead to family businesses creating shareholder value
sustainably

Family businesses, or economic ventures that are promoted and often managed by various
members of an entrepreneurial family, have played a crucial role in shaping the economic
landscape of the country since the days of Indias struggle for Independence. Yet, a recent
study finds that only five percent of family businesses are able to sustain creation of wealth for
shareholders beyond the fifth generation.
The single most important differentiating factor that separates this five percent from the
remaining 95 percent and ensures the long-term sustainability of family-run enterprises is a
sound mechanism of corporate governance, according to Adi Godrej, the 71-year-old patriarch of
the Godrej family and chairman of the eponymous business group that has interests ranging
from packaged consumer goods to real estate and chemicals.

Delivering the keynote address on Monday at the Family Business Conclave organised in
Mumbai by the FaB Network, an initiative of some members from the alumni of the Indian
School of Business, Godrej stated that robust corporate governance practices were all the more
essential for family-run firms since these entities have to endure all the complexities of
promoter shareholders interacting as family members as well as for the purpose of business.
The additional level of complexity exerts itself most significantly at the time of a generation
change, Godrej said.

The current Godrej Group chairman is a member of the third generation of the business family
and, as Godrej pointed out, as many as nine members of the family belonging to the third and
fourth generations were active in the business.

Godrej said a good corporate governance system in a family business should be able to identify
business participants be they employees or professionals from the promoter family and
clearly demarcate the roles and responsibilities linked to their talent and capabilities.

At the Rs 30,000 crore-conglomerate, which Godrej leads at present, family members are
welcome to take up management roles, provided they have the requisite academic qualification
and have passed through the rigour of regular jobs and project execution responsibilities in the
middle of the business ladder at the group.

Godrej also said that historically, family-managed businesses in India, barring a few, have been
perceived to be run unprofessionally and have therefore been unable to attract and retain the
requisite non-family management talent needed to drive the business. This reluctance is largely
due to the fact that these businesses are seen to operate on the whims of the owners or
promoters, Godrej said.

Sanjay Nayar, CEO of private equity firm KKR India, echoed Godrejs view at another panel
discussion that was part of the same conclave. Nayar said PE investors like KKR have found
glaring gaps in management bandwidth beyond the first layer of management, which mostly
comprise members of the promoter family, at some family enterprises they have evaluated for
investment.

In a few tough years that we had in the past, we realised that one of the key characteristics of a
company that is sustainable in the long-term is good management professionals at the second or
third level of management, Nayar said and made it clear that KKR would prefer to stay away
from investing in companies where such management bandwidth didnt exist and where the PE
firm wasnt allowed to create a path for such professionals to enter the firm.
Godrej, who is also chairman of ISBs board of directors, emphasised on the importance of
maintaining the right balance between personal and professional relationships with family
members. We have tried to achieve this in institutionalising two interactions between family
members for business discussions, Godrej said. One is a weekly lunch at office where
performance updates can be shared, tough questions can be asked and feedback provided. The
other is an annual meeting of the family business board. As far as possible, we avoid discussing
business at the dinner table.

As a family business, we have to maintain the right balance between our personal and
professional relationships with family members. We work so closely with family members that
the lines blur more frequently than one would like. We have tried to tackle this challenge by
institutionalising two interactions with business discussions first is a weekly lunch together at
office and second is an annual meeting of the family business board. These interactions provide
invaluable platforms for us to share performance updates, ask tough questions to one another,
provide feedback and share experiences. As far as possible, we try to keep business discussions
to these settings and avoid them at the dinner table.

Read more: http://forbesindia.com/article/special/corpo-rate-governance-paramount-for-

family-businesses-to-thrive/41473/1#ixzz3rnH8kpez
 India's Business Families: The
Survival Model
Team BT Edition:null

WE RECOMMEND
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No stakes are ever higher than those of survival. Poised as it is between

extinction and endurance, the Indian business house as a genus is,
undoubtedly, endangered. And yet, not every species in it will necessarily be
snuffed out. For, a combination of strong genes and acquired adaptability to a
hostile environment has equipped some of these houses with the resilience
needed for thriving in the new millennium. But just which ones are they?
What, indeed, are the crucial qualities needed for survival? It is to answer
these questions, after rigorously auditing each and every aspect of the
functioning of the country's family business groups, that the BT Business
House Survival Index has been constructed, with a mandate for assessing the
future of India's 50 largest business houses.

The Indian business house, of course, embodies a quintessential dualism. In

most aspects of strategic, operational, and financial evaluation, it can be
treated like a collection of individual, stand-alone businesses, each charting its
own course, with distinct results. However, the presence of a single rudder-the
ambitions and desires of the family that owns the group-also demands an
assessment of inter-business relationships in terms of convergence of strategic
intent, of synergies in operations, of inter-corporate financial flows.
Simultaneously, the existence of a family, with its unique internal dynamics,
compulsions, and stability issues, adds yet another dimension to the
evaluation of the survival prospects of the business house. These complexities
make it necessary to devise and apply an assessment model that must span the
entire range of factors between corporate strategy and kinship sociology. Thus
it is that the BT Business House Survival Index comprises a set of interlocking
assessment modules, gauging the survival potential of a business house along
the axes of strategy, operations, and change.
THE STRATEGIC SURVIVAL INDEX
Lured into a business with licences or driven by the prospect of growth,
without checking the fit between internal capabilities and the demands made
by those sectors, the Indian business house has traditionally sacrificed
strategy at the altar of opportunism. Thus, a crucial indicator to the likelihood
of a business group's survival in the face of competition is the evidence of the
emergence of strategy. Applying the well-known five-forces framework of
competitiveness created by strategy guru Michael Porter, the generic choice
for today's business group is between cost-leadership and product focus as it
strives to attain the distinctive, inimitable competitive edge that is the
hallmark of corporations that can keep rivals at arm's length. The proof that
such a choice is being made for every business improves the prospects of a
group. Conversely, the absence of such decisions implies that the businesses in
question have no defined distinctiveness, and offer little by way of unmatched
value to the customer. Vital too is the assertion of strategic intent in a group's
plans. Is it, for instance, going global, or, at least, pursuing global scale? Has it
made innovation and customer focus the bedrock of all its activities? Is it
weaving speed, flexibility, and quick response time into the very fabric of all its
actions?

THE CHOICES. The features that a business house with a clear strategy in
place demonstrates are the obvious measures for the group's strategic
quotient. Thus, its cost position vis- -vis rivals, supported by backward
linkages to operations, reveal whether or not it is aiming to provide the lowest
prices in the marketplace. Alternatively, the business that makes uniqueness
its strategic plank must invest in, and deliver, differentiated products that
competitors cannot match. Attendant to this choice are factors like
technological leadership, economies of scale, marketing skills, and, crucially,
core competence-driven focus. Indeed, the extent to which a business house
concentrates on its core businesses is a vital measure used by the BT Business
House Survival Index. And, most important, the determination to persist with
its strategic positioning is visible in its efforts to build competitive advantages
 at every stage of the value chain.

THE PORTFOLIO. Some, or even the majority, of the individual businesses

of a group may survive. But what of the future of the collective entity? The
ability of a sizeable proportion of its largest enterprises to overcome
competition may be a necessary condition for a business house to thrive and
grow, but it isn't sufficient. For that, a suitable mix of businesses is essential,
serving the multiple purposes of generating cash for new investments, of
targeting emerging high-growth opportunities, of keeping pace with changing
trends in consumer demand, and of allowing the group to leverage its core
strengths.

THE CONCLUSIONS The higher the

contribution to the
Strategic focus will be a
cause for concern for the family total turnover made
business by stable businesses,
Attempts to improve
operational performance are ideally with high
gathering pace
marketshares in low-
The shift towards
divestment in non-core growth, low-
businesses is discernible
competition markets, the more solid is the
Despite ingenious
financing, funding the future foundation of the group for survival in the
will be difficult
Family instability is
future. And while a presence in high-growth,
posing a serious threat to high-competition markets and sectors
survival
promises prospects for the future, the perfect
portfolio will be biased in favour of businesses that have high marketshares in
areas where they do not make unreasonable demands on the group's financial
and managerial resources.

Conversely, too many low-marketshare businesses in low-growth areas are

obviously going to prove a drag. Vital, too, is a balance between businesses
that will generate funds, and those that will demand investments, with a skew
on either side weakening the survival potential. And the Strategic Survival
Index culminates with an evaluation of the group's awareness of its
competencies, measured in terms of the extent of focus on, and divergence
from, core businesses, and its sensitivity to the regulatory environment when
packing its portfolio.

THE OPERATIONAL SURVIVAL INDEX

I t is in the quality of their processes that Indian business houses tend to
display the greatest differences among themselves. While many of the older
groups have been unable to shake off practices that were state-of-the-art when
they were born, but are antediluvian now, others have succeeded in revamping
their processes and systems continuously. The quest for operational
efficiencies, aimed at squeezing every drop of redundancy out of the
organisation in a bid not only to contain costs, but also to optimise product
quality, is an on-going one around the world. As Indian business houses strive
to compete with global corporations, this ability is going to be a clear
differentiator between those who survive and those who fall by the wayside.

Click here to Enlarge

MANAGEMENT PRACTICES. When it
comes to gauging the effectiveness of a
business house at improving its operations, it
is both the effort and the results that count.
First, the use and frequency of techniques like
benchmarking, total quality management,
justin-time inventory management, business
process reengineering, supply chain management, or customer and employee
surveys are essential indicators of attempts to sharpen operations. However,
precisely because such initiatives often lead business into a cul-de-sac that
offer no benefits to the bottomline, the BT Business House Survival Index also
takes into account the actual consequence, measured through the change in
operating costs as a percentage of turnover over five years, as well as the
turnover per employee. Thus, evaluations of effort and outcome have been
combined.
FINANCES. The lifeblood of the business house for survival, essential for
circulating strategies and capabilities, is, of course, the ability to bankroll
posterity. Transcending the balance-sheet and the profit-and-loss account,
which provide annual snapshots of performance evaluated in rupees and
paise, the financial depth of a business group is really a measure of its
competence for making new investments when necessary, for ensuring healthy
cash-flows year after year, for having the capacity to withstand hard times
without having to put its assets into hock. The real muscle that proves
financial strength, therefore, is the potential of the business house for raising
and servicing capital. The barometers?

Principal among them is the debt-equity ratio, which is a clear indicator of

how much the group can borrow in future. Almost as important is the felicity
with which the group has serviced its capital in the past, gauged through the
Return On Capital Employed (ROCE). The next step: satisfying investors by
offering them sizeable returns, which, naturally, is a function of the post-tax
profits that the group has at its disposal for distribution to shareholders, and
for shoring up its net worth. That makes profitability-measured as the ratio of
profit-after-tax to sales-a crucial indicator of latent financial vitality. Finally,
the usage of other resources at the disposal of the group-measured in terms of
the ratio between assets and turnover- indicates whether its crown jewels are
paying for their upkeep, or merely rusting in the throne-room. The BT
Operational Survival Index considers the current performance on these
parameters as the launching pad for financing the future.

THE CHANGE SURVIVAL INDEX

The one characteristic that tomorrow's survivors among the country's business
houses will share is that they will not be held hostage by history. For, only
those groups that successfully break with the past-in strategy and structure,
processes and products-will be able to adapt themselves to the demands made
by the eco-logical niches which they occupy. These changes will manifest
themselves in the form of responses to the external environment as well as
internal compulsions. Nor can this adaptation be a one-off affair: as the
environment changes continuously, so must business.

Click here to Enlarge

Spotting candidates for survival, therefore,
involves identifying those business houses that
have prepared themselves for continuous
change. A formidable challenge for any
corporation operating in any kind of market, acquiring the ability for instant
and unrelenting transformation-often in anticipation of, rather than as a
reaction to, external change-is doubly difficult for the business group which
tends to be hobbled by anachronisms, prejudice, and irrational drivers like
blind ambition untempered by strategic intent.

ADAPTABILITY. Just how does this willingness for constant makeovers

manifest itself? Telling clues lie in the extent and frequency of changes
undertaken over the six years of liberalisation, and, especially, the speed with
which the first transformation following the sweeping economic changes of
1991 was wrought. For, only a business house that has acquired a certain
momentum of change will be able to sustain it in future. The revealing signs of
change can be seen at the level of structure-in the form of the restructuring of
businesses, the reconfiguration of companies and enterprises, acquisitions and
divestments et al.

They can be seen at the level of operations- through the introduction of, inter
alia, reengineering, quality movements, productivity initiatives, new shopfloor
practices, and new manufacturing technologies. And, of course, they can be
seen at the level of strategy-visible through the use of new strategic planning
techniques and templates, of new initiatives in entering new markets and
growing new products, of boosts in R&D expenditure, of new practices in
managing people, and of attempts to build learning organisations. The BT
Change Survival Index equates the spatial and temporal density of such
evidence of transformation with the likelihood of a business house's adapting
to external changes.

STABILITY. The one dimension along which the business house differs
radically from other corporations is that of stability. After all, the family in
business is prone to splits arising from battling siblings, between feuding
fathers and sons, between warring uncles and cousins-each intent on pursuing
their own ambitions-leading to one or more cases of fission in the empire. The
involvement of daughters' husbands, a grey area in the matrix of family
relationships, is also widening the fault lines. Indeed, history reveals that no
family business house has survived in its original form beyond the third
generation. And even as the relationships between individual members of the
family impact the stability of the business, so do the structures of the group,
which can either hinder or hasten a split. Several factors, then, contribute to
the likelihood of a business house staying undivided as it marches into the
future. The composition of the family-which generation it is in, the number of
brothers and sisters, the presence of heiresses, the nature of their interaction
in their personal lives-is, naturally, the starting point when assessing stability.

Accompanying them are probes for the presence of formal systems of

succession planning and grooming, which make messy internecine feuds less
likely after the patriarch hangs up his boots. The presence of a holding
company-or a chain of investment companies-or significant cross-holdings
between different companies obviously makes it more difficult to cleave the
group. And the third component of the BT Survival Index is the measure of
horizontal strategies-often visible in the form of sharing of resources-within
the group, which ensure that the benefits that the family derives from being
part of a single group outweighs the costs of that affiliation.

LEADERSHIP. Unlike the streamlined, unidirectional, single company, a

business group is of necessity a flotilla sailing in many different directions. A
second important difference: while the corporation, whether it encompasses
one business or a dozen, is managed by a CEO whose responsibility is to
increase shareholder wealth, the family group is headed by one or more people
with personal ambitions of building business empires. That makes the owner-
driven leadership of the business house both qualitatively and quantitatively
distinct from the manager-directed leadership of the standalone company. The
former must provide not only what the latter does-viz., vision, inspiration,
motivation, and a sense of direction to disparate activities- but also the
binding cohesiveness that will knit the group into a monolithic entity in terms
of culture, values, ethics, and objectives. Most important, top-class leadership
of the business house, designed to chart out a survival course for the next 50
years, can only come when the promoters convince the people working in the
group that they are leaders by prowess, and not merely by the accident of
being the owners.

After all, while professional CEOs usually climb to the top by dint of merit, the
CEO of the family business is to the manor born, making it all the more
important for his leadership qualities to prove worthy of the responsibility
thrust upon him. But what are the qualities that will distinguish the leadership
of a business house that survives from that of one which goes under? Speed
and efficiency of response, the articulation of an over-reaching but cogent
vision, and the charisma to rise above the role of the feudal head are crucial
components. So is the propensity for championing change, being forthright
and decisive, and the ability to resolve conflicts. And, most of all it is the
aptitude for conducting a group of diverse managers into an orchestra playing
a single melody that makes for quality leadership in the BT Business House
Survival Index.

Using this framework, the individual assessments of the survival prospects of

the country's 50 largest business houses operate at two levels. A qualitative
analysis traces the progress made by each of the houses along the axes over its
past in general, and the post-liberalisation years in particular. Simultaneously,
a quantitative assessment-The BT Matrix-seeks to capture the present
standing of each of the 50 houses. This assessment covers the qualitative
parameters, and includes two more: a measure of the value added by a group's
listed companies to shareholders; and a gauge of investorfriendliness,
calibrated by the stockmarket performance of each of the 50 business houses
(see The Methodologies for the details of the scoring system).

The aggregate of the scores under the nine parameters measures the survival
prospects of a business house in the future in terms of a snapshot of its
present strengths, summarising the results in the form of the intensity of the
survival signal it's emitting: Powerful (corresponding to a survival score of
over 800). Strong (between 650 and 799). Medium (between 550 and 649).
Weak (between 450 and 549).

Very Weak (between 350 and 449). Or Feeble (less than 349). And the
qualitative assessment projects the future of each group from its post-
liberalisation track-record. Of course, like every model that attempts to
impose patterns of predictability on complex events, the BT Business House
Survival Index, too, is a generalised framework for assessing unidentical
institutions. Ideally, each group should be evaluated with a customised model,
and the one-size-fitsall model used here does try to generalise some nuances.
Nor can it be denied that its results necessarily represent only a moment of
each group frozen in time, and not an on-line profile of its changing
competitiveness. Even so, in extrapolating the future from the past, these
results offer a powerful pointer to the destiny of the Indian business family.

POLITICAL STABILITY

The standard definition of political instability is the propensity of a

government collapse either because of conflicts or rampant competition
between various political parties. Also, the occurrence of a government
change increases the likelihood of subsequent changes. Political instability
tends to be persistent.

Economic growth and political stability are deeply interconnected. On the

one hand, the uncertainty associated with an unstable political environment
may reduce investment and the pace of economic development. On the
other hand, poor economic performance may lead to government collapse
and political unrest. However, political stability can be achieved through
oppression or through having a political party in place that does not have to
compete to be re-elected. In these cases, political stability is a double edged
sword. While the peaceful environment that political stability may offer is a
desideratum, it could easily become a breeding ground for cronyism with
impunity. Such is the dilemma that many countries with a fragile political
order have to face.

Political stability is by no means the norm in human history. Democratic

regimes, like all political regimes, are fragile. Irrespective of political regimes,
if a country does not need to worry about conflicts and radical changes of
regimes, the people can concentrate on working, saving, and investing. The
recent empirical literature on corruption has identified a long list of variables
that correlate significantly with corruption. Among the factors found to
reduce corruption are decades-long tradition of democracy and political
stability. In todays world, however, there are many countries that combine
one of these two robust determinants of corruption with the opposite of the
other: politically stable autocracies or newly formed and unstable
democracies.

Some see political stability as a condition that not only precludes any form of
change, but also demoralizes the public. Innovation and ingenuity take a
backseat. Many seek change in all sectors of life--politics, business, culture--
in order to have a brighter future through better opportunities. Of course
change is always risky. Yet it is necessary. Political stability can take the form
of complacency and stagnation that does not allow competition. The
principles of competition do not only apply to business. Competition can be
applied in everything political systems, education, business, innovation,
even arts. Political stability in this case refers to the lack of real competition
for the governing elite. The politically stable system enforces stringent
barriers to personal freedoms. Similarly, other freedoms such as freedom of
press, freedom of religion, access to the internet, and political dissent are
also truncated. This breeds abuse of power and corruption.

Vietnam, for example, is controlled entirely by the ruling party. The economy
is one of the most volatile in Asia. What once was thought of being a
promising economy has recently been in distress. Vietnams macro economy
was relatively stable in the 1997-2006 period, with low inflation, a 7 to 9
percent total output expansion annually and a moderate level of trade
deficit. But Vietnam could not weather the adverse impact from the 1997-98
Asian financial turmoil, which partly curbed the FDI flow into its economy.
Starting in late 2006, both public and private sector firms began to
experience structural problems, rising inefficiency, and waste of resources.
The daunting problem of inflation recurred, peaking at an annualized 23
percent level for that year.
On the supply side, cross-country competitiveness assessments show that
Vietnam is falling behind relative to comparator economies. The proliferation
of so-called zombie workers at Vietnam's state-owned enterprises (SOEs) is
only one of many manifestations of the economys underperformance.
Economic growth last year was 5.03 percent. SOEs account for 40 percent of
GDP. Many of them are hurting because they took advantage of easy credit
to make foolish investments. Over the years, powerful interest groups within
the ruling Communist Party have largely resisted calls to reform the SOEs.
Senior party officials allegedly regard them as their personal cash cows.

While it is true that some African states who have been able to achieve high
growth rates are stable, a number of relatively low performing African states
also have remarkably stable political systems. When we talk about political
stability in the context of growth, leaving aside resource-driven bubbles, we
mean a specific kind of stability: the rule of law, strong institutions rather
than powerful individuals, an efficient bureaucracy, low corruption and an
investment enabling business climate. Indeed, what we really mean is that
stable governance is crucial for growth. This admittedly academic distinction
is an important one to recognize. Governance goes well beyond just politics.

When political stability comes with having one party or a coalition of parties
in office for a long time, it may eventually be detrimental. The economy may
do well in terms of attracting foreign direct investment because stability
means a predictable political environment. However, other aspects of the
society might suffer because of complacency, lack of competition, and
opacity. The economy eventually suffers because of these. Consequently,
stable governments do not necessarily lead to higher economic growth. India
is another case in point. Indias performance on the economic front in the
first 30 years of post-independence era, which epitomized political stability,
exhibited 3 to 3.5 percent level of economic growth, lowest in the last sixty
years. In contrast, in the last 20 years when India saw as many as four Prime
Ministers, industrial growth rates jumped to double digits, something that
had not happened before.
Bottom-line: Not all forms of political stability are equally development
friendly; much depends on the extent to which stability translates into good
governance.

RAGHURAM RAJAN, the governor of Reserve Bank of India, has a reputation as a monetary-policy hawk, a central banker who frets more
about stubborn inflation than sluggish growth. But he also has a fondness for surprises. Twice this year he cut the central banks main rate
outside the usual schedule of the RBIs bi-monthly monetary-policy meetings. Today he sprung a bigger surprise by cutting interest rates by
half a percentage point, to 6.75%. Some analysts had thought Mr Rajan might even keep rates on hold. Most expected a cut to 7%. Inflation
has been stable at 3.7%, well below the RBIs near-term target of 6% and lower even than its medium-term goal of 4%. The economy has
been growing at a respectable annual rate of 7%, but could still use a little stimulus. Yet no one really expected such a big cut.

What prompted it? The decision of the Federal Reserve not to raise interest rates in America earlier this month created room for the RBI to
sneak in a big rate cut now. But growing concern about the world economy was the main spur. In a prepared statement, the RBI noted that
global growth had weakened, particularly in other emerging-market economies, since its last monetary-policy meeting at the beginning of
August. Global trade is shrinking by some measures. Chinas stockmarket crash and the slight devaluation of the yuan has unnerved
financial markets. Capital is flowing out of emerging markets already hurt by falling commodity prices and slow trade. Indias economy is
holding up fairly well in the circumstances (it helps that it is a commodity importer with few strong ties to China). A pick-up in industries, such
as clothing, furniture and cars suggests that Indias bounce-back from a rocky period in 2013 is being led largely by consumer spending. But
the recovery is still far from robust, says the RBI. India cannot evade the global misery. A more persistent drag to growth from weak exports
is now likely.

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Even so there seems more to this big rate cut than just increased nerves about the world economy. The RBI has only marginally marked
down its forecast for GDP growth this fiscal year, from 7.6% to 7.4%, so todays big cut marks a significant shift in Mr Rajans mindset on
inflation. In August he fretted that a shortfall of rain during the monsoon might push up food prices and thus inflation (half of Indias farms rely
solely on rain water for irrigation and food accounts for half the consumer-price index). The monsoon has indeed proved deficient: rainfall has
been 14% below its normal level. But food prices have been largely unaffected. The RBI now reckons that grain production has actually been
higher than last year, thanks to pre-emptive action by government agencies. Meanwhile there has been no let-up in the downward pressure
on inflation. The price of oil and other commodities is low. The RBI says a weaker global economy and overcapacity will mean cheaper
imports for India.

Does that mean rates go lower? Not right away. The RBI says its immediate focus is on working with government to push state-owned banks
to pass on lower borrowing costs to consumers and companies. Inflation is also set to rise in the coming months because of unfavourable
base effects. Yet there the news from China and other emerging markets seems likely to worsen. Mr Rajan is probably not finished yet.