Reduced investment in India by private persons is a key part of the present growth challenge. Investment is shaped by macroeconomic uncertainty, sectoral uncertainty, and regulatory risks that firms face. In this article, we think about the risks that an E-commerce firm such as Amazon perceives in India. These include the changing FDI rules, unresolved issues of data localisation and code disclosure, the multiple reports on technology-related activities that various government agencies are releasing, and the problems of rule of law in licensing and investigation.
Economic policy uncertainty
Shrinking investment in the Indian economy is a concern. Investments in new projects fell to a 15 year low in the last quarter according to the Centre for Monitoring the Indian Economy (CMIE) Capex data which tracks large investment projects.
Firms are deterred from investing by policy uncertainty (Bloom, 2009). When firms are unclear about the future economic environment, they hold back on investing till uncertainty declines. This delays the pickup of the investment cycle, where firms generate jobs and business for linked firms, fueling aggregate economic activity. Uncertainty particularly affects long-term investments that are irreversible in nature, and for which horizons for cost recovery run into years. These can be investments in new technologies or market segments, or investments in infrastructure. Such investments are particularly important, as they can benefit other firms in the economy, fueling productivity and long-term growth in addition to their business cycle effects.
Private sector investment is adversely affected by three kinds of policy uncertainty – macroeconomic uncertainty, sectoral policy uncertainty, and regulatory risk. The role of Economic Policy Uncertainty at the macroeconomic level has been measured globally (Baker et al, 2016). In the original measure, an index is created by quantifying newspaper coverage of policy-related economic uncertainty mentions in the national newspapers, through combinations of keywords related to policy and uncertainty. Macroeconomic policy uncertainty has been applied to understand global events. Brexit-driven policy uncertainty in the UK moved closely with the GBP Real Exchange Rate in recent times, and the uncertainty surrounding US trade policy affected importing firms. This measure of macroeconomic policy uncertainty correlates strongly with stock market volatility.
Firms face much more than macroeconomic uncertainty. They also face uncertainty at sectoral, geographical and individual levels. Sectoral-level policy uncertainty can be measured through surveying firms sampled across sectors, asking them about expectations about future growth and costs at various horizons (Altig et al, 2019). For example, firms can report not just their expectations about future profits, but the distribution across the possible profit outcomes that they can expect.
An additional source of uncertainty that firms operating in India face is regulatory risk. Even when regulations are formulated, there is a lack of predictability, and excessive executive discretion, in how a stated regulation will be enforced. For example, the licensing by the RBI of 11 payment banks from 41 applicants who wanted to start payment systems was a non-transparent process inconsistent with the rule of law (Roy and Shah, 2015). Another example is the Copyright Board order of 2010 on statutory licensing fees paid by Radio stations. This order arose out of nine one-on-one disputes between radio stations and music producers, but was applied as an in rem order rather than an in personem order. Thus, music producers who weren’t part of the original disputes also became governed by the order, despite the appeals by T-Series and SIMCA against the Copyright Board order applying to them. Aggarwal and Zaveri (2019) show the uncertainty induced for private persons through executive discretion in enforcement at SEBI.
Drivers of uncertainty in the E-commerce sector
In the recent Q2 earnings announcement, the Amazon CFO Brian Olsavsky mentioned uncertainty in India’s e-commerce policy. He expressed hope for ‘stable’ and ‘predictable’ policy, for the company to continue with its investments in technology and infrastructure in India. This explicit mention about policy uncertainty in India is an unusual moment, and requires attention by policy thinkers. What is the uncertainty associated with investing in India, as seen by Amazon?
- India’s draft e-commerce policy rules earlier this year preventing firms from influencing prices or selling products in which they hold stakes disrupted business plans for e-commerce companies. It bring companies back to the drawing board to ensure they can comply with the current regulations while limiting losses that rose from lack of clear direction from the start. The final e-commerce policy has been held back for another year, putting existing investments of firms in this sector at risk during the interim months, and deterring further investments.
- The uncertainty around data localisation is another deterrent. The recent announcement by a high-level government panel to do away with data localisation for non-critical data, and the upcoming announcement of the position of the Prime Minister’s Office on data localisation are policy announcements that drive sentiments on this debate, though none are legal instruments. Under data localisation requirements, companies would need to redesign internal algorithms to access data locally, pay up for new servers, and face costs to protect data in less-secure environments. The predictive power of firms’ algorithms would weaken with fewer data points to train models on. The due process of discussions with various government bodies and stakeholders on this issue is still in process. The RBI’s requirement for financial data localisation despite existing provisions (Bailey and Parsheera, 2018) for access under the Payments and Settlements Act (2007) suggest that any Indian regulator can step in with special requirements at unforeseen times.
- A related issue is the disclosure requirement of source code under the draft e-commerce policy. E-commerce firms depend on data-driven marketing and use of collaborative filtering for customer recommendations. A code submission requirement is a coercive technique aimed at achieving ‘the transfer of technology and local needs’ described under the proposed e-commerce policy. Technology transfers cannot and should not be coerced: they happen in an organic and legitimate manner through managers and employees developing skills and passing them onward in data communities or by workers moving across companies (Bloom et al, 2019). It is also doubtful how technological transfers can be achieved with segments of code without underlying data. Will code disclosure requirement be combined with data localisation to pass on core business value to competitors? Will companies need to invest in staff and technologies to find workarounds to be able to mask their key assets? Whether such a code disclosure requirement will come into effect remains unresolved. In mid-2020 the final e-commerce policy will describe the stand of the government on this issue, but this is not definitive either.
Multiple guidelines on the same subject can cause delays in the resolution of uncertainty. The RBI Report of the Working Group on FinTech and Digital Banking includes E-aggregators, Robo advisors and Big Data all under Fintech. E-commerce firms, which are data intensive and provide multiple services, will be included under this description. The fintech steering committee report of the Ministry of Finance is still pending. Each of these reports is a statement about how government agencies are likely to move in the future but these are not legal instruments. Government reports can only suggest but not surely state how future laws will change.
Infirmities of the regulatory processes in India also exacerbate uncertainty. As an example, data localisation requirements by RBI for payments firms were translated from an early idea into an enforced law within a matter of days. There was no due process surrounding how officials could change the law.
The last leg of the legal system – how laws are enforced – also suffers from concerns about non-equal application of law, as shown in the examples from RBI (Roy and Shah, 2015) and SEBI (Aggarwal and Zaveri, 2019). For a prospective investor, the risk of investing in India lies in how the law might change in the future through an undemocratic process, and in how the law will be applied to her.
For India to have a stable investment environment, we need to provide firms a stable and predictable policy environment. Investments from firms in various sectors will boost the investment cycle for India. Resolving policy uncertainty both at the macroeconomic level as well as in different sectors, and reducing regulatory risk through better rule of law is critical for India in the current investment scenario as well as for long term growth.
The author, Megha Patnaik, is faculty at the Indian Statistical Institute, Delhi, and Fellow at the Esya Centre.
(with inputs from Radhika Pandey and Ajay Shah.)
This article was first published on The Leap Blog.